In a dispute over real property tax exemptions, the Supreme Court affirmed that only the actual, direct, and exclusive user of machinery and equipment—not merely a party obligated to pay taxes—can claim tax exemptions. This ruling clarifies that government entities cannot extend their tax privileges to private corporations operating under Build-Operate-Transfer (BOT) agreements until the ownership and operational control of the facilities are fully transferred. This reinforces the principle that tax exemptions are strictly construed and apply only to those directly fulfilling the conditions set by law.

Power Plant Taxes: Who Pays When Ownership is in Transition?

The National Power Corporation (NPC) sought to claim real property tax exemptions for machinery and equipment used in a power plant operated by Mirant Sual Corporation under a Build-Operate-Transfer (BOT) agreement. NPC argued that because it was obligated to pay the real property taxes under the agreement and would eventually own the power plant, it should be entitled to tax exemptions afforded to government-owned and controlled corporations (GOCCs) engaged in power generation. This case hinges on whether NPC had the legal standing to claim these exemptions before the power plant’s ownership was transferred.

The crux of the legal debate centered on Section 234(c) of Republic Act (R.A.) No. 7160, the Local Government Code, which provides tax exemptions for:

All machineries and equipment that are actually, directly and exclusively used by local water districts and government owned or controlled corporations engaged in the supply and distribution of water and/or generation and transmission of electric power.

NPC contended that as the eventual owner and a GOCC engaged in power generation, it should benefit from this exemption. However, the Court emphasized that tax exemptions are the exception, not the rule, and must be strictly construed against the claimant. Building on this principle, the Court examined the specifics of the BOT agreement and the actual use of the power plant facilities.

A critical aspect of the case involved the Energy Conversion Agreement (ECA) between NPC and Mirant. Key provisions of the ECA outlined the ownership and operational responsibilities:

2.10 Ownership of Power Station. From the date hereof until the Transfer Date, [Mirant] shall directly or indirectly, own the Power Station and all the fixtures, fittings, machinery and equipment on the Site and the Ash Disposal Sites or used in connection with the Power Station which have been supplied by it or at its cost. [Mirant] shall operate and maintain the Power Station for the purpose of converting Fuel of NPC into electricity.

2.11 Transfer. On the Transfer Date, the Power Station shall be transferred by [Mirant] to NPC without the payment of any compensation and otherwise in accordance with the provisions of Article 8.

The Court noted that Mirant retained complete ownership and operational control of the power plant facilities until the transfer date. This meant Mirant, not NPC, was the actual, direct, and exclusive user of the machinery and equipment during the relevant tax period. Because of this arrangement the Court concluded that NPC’s claim for tax exemption was untenable. This approach contrasts with NPC’s argument that its obligation to pay taxes and its eventual ownership constituted sufficient legal interest to claim the exemption.

Furthermore, the Court addressed NPC’s argument that Mirant was merely a service contractor. The Court clarified that BOT agreements involve a more complex arrangement than simple service contracts. BOT agreements entail the private entity constructing, owning, and operating the facility to recover costs and earn profits before transferring the facility to the government. This distinction is crucial because it highlights the private entity’s entrepreneurial role and risk-taking, which goes beyond the scope of a mere service provider.

The Supreme Court referred to the case of National Power Corporation v. Central Board of Assessment Appeals (CBAA), where it articulated:

Under this concept, it is the project proponent who constructs the project at its own cost and subsequently operates and manages it. The proponent secures the return on its investments from those using the project facilities through appropriate tolls, fees, rentals, and charges not exceeding those proposed in its bid or as negotiated. At the end of the fixed term agreed upon, the project proponent transfers the ownership of the facility to the government agency.

Building on this understanding, the Court determined that Mirant’s role was far more extensive than that of a mere contractor. It was an owner-operator with significant financial stakes and operational responsibilities. This distinction is vital in understanding why NPC could not claim tax exemptions based on Mirant’s activities.

The Court also dismissed NPC’s reliance on a Memorandum of Agreement (MOA) that outlined NPC’s responsibility to pay real property taxes. The Court clarified that assuming tax liabilities does not automatically entitle a party to tax exemptions. Granting NPC the exemption would effectively extend NPC’s tax privilege to Mirant, a non-exempt entity. To underscore the gravity of such action the Court said that it would open the door to circumvention of tax laws and undermine the integrity of the tax system.

Finally, the Supreme Court rejected NPC’s claim for depreciation allowance under Section 225 of R.A. No. 7160 and exemption for pollution control equipment under Section 234(e) of the same Act. In both instances, the Court found that NPC lacked the requisite legal personality to claim these benefits, as the relevant facilities were owned and operated by Mirant. Further, the Court reiterated that claims for exemption under Section 234(e) require evidence of actual, direct, and exclusive use for pollution control and environmental protection. All of this underscores the importance of strictly adhering to the requirements for claiming tax exemptions.

FAQs

What was the key issue in this case?	The key issue was whether the National Power Corporation (NPC) could claim real property tax exemptions for machinery and equipment used by Mirant Sual Corporation, a private entity, under a Build-Operate-Transfer (BOT) agreement.
Who was responsible for the real property taxes in this case?	Under the Energy Conversion Agreement (ECA), NPC was contractually responsible for the payment of real property taxes, but the actual ownership and operation of the power plant rested with Mirant until the transfer date.
What is a Build-Operate-Transfer (BOT) agreement?	A BOT agreement is a contractual arrangement where a private entity builds, operates, and manages a facility for a specified period to recover costs and earn profits before transferring ownership to the government.
Why did the Supreme Court deny NPC’s claim for tax exemption?	The Court denied NPC’s claim because NPC was not the actual, direct, and exclusive user of the machinery and equipment during the taxable period; Mirant was the owner and operator.
Can a government entity extend its tax privileges to a private entity under a BOT agreement?	No, the Supreme Court clarified that extending a government entity’s tax privileges to a private entity operating under a BOT agreement would circumvent tax laws and undermine the integrity of the tax system.
What does it mean to say that tax exemptions are strictly construed?	It means that tax exemptions are interpreted narrowly and must be explicitly provided by law; any ambiguity is resolved against the party claiming the exemption.
Does assuming tax liabilities in an agreement automatically entitle a party to tax exemptions?	No, merely assuming tax liabilities does not automatically entitle a party to tax exemptions; the party must also meet the legal requirements for the exemption, such as actual and direct use of the property.
What was the basis for NPC’s claim of entitlement to depreciation allowance?	NPC claimed entitlement to depreciation allowance under Section 225 of R.A. No. 7160, but the Court found that NPC lacked the legal personality to claim this benefit, as the facilities were owned and operated by Mirant.

In conclusion, this case reinforces the principle that tax exemptions are strictly personal and cannot be extended to entities that do not directly meet the statutory requirements. Entities entering into BOT agreements must carefully consider the tax implications and ensure that they comply with all relevant laws to avoid disputes regarding real property tax liabilities.

For inquiries regarding the application of this ruling to specific circumstances, please contact ASG Law through contact or via email at frontdesk@asglawpartners.com.

Disclaimer: This analysis is provided for informational purposes only and does not constitute legal advice. For specific legal guidance tailored to your situation, please consult with a qualified attorney.
Source: NATIONAL POWER CORPORATION vs. THE PROVINCE OF PANGASINAN, G.R. No. 210191, March 04, 2019