Navigating Local Franchise Tax: Understanding the Limits of ‘In Lieu of All Taxes’ Exemptions in the Philippines

TLDR; The Supreme Court case of *City Government of San Pablo vs. MERALCO* clarified that the Local Government Code of 1991 (LGC) effectively withdrew prior tax exemptions, including ‘in lieu of all taxes’ provisions in franchises, empowering local governments to impose franchise taxes on businesses operating within their jurisdiction. Businesses can no longer rely solely on older franchise agreements for tax exemption and must comply with local tax ordinances.

G.R. No. 127708, March 25, 1999

INTRODUCTION

Imagine a city struggling to fund essential public services like roads, schools, and healthcare. Local taxes are a crucial revenue source, but what happens when businesses claim exemptions based on decades-old franchise agreements? This was the crux of the dispute in *City Government of San Pablo vs. MERALCO*. The case highlights the evolving landscape of local taxation in the Philippines, particularly the impact of the Local Government Code of 1991 (LGC) on previously granted tax exemptions. At the heart of the matter was Manila Electric Company (MERALCO), arguing against the franchise tax imposed by San Pablo City, citing its legislative franchise which contained an ‘in lieu of all taxes’ clause. The Supreme Court’s decision in this case significantly shifted the balance of power in local taxation, affirming the authority of local government units to levy franchise taxes, even on entities with prior tax exemptions.

LEGAL CONTEXT: FRANCHISE TAX AND THE LOCAL GOVERNMENT CODE

Franchise tax in the Philippine context is a levy imposed on businesses granted a franchise to operate within a specific territory. Historically, many franchises, especially those granted to public utilities, included a provision stating that the franchise holder would pay a certain percentage of their gross earnings ‘in lieu of all taxes’. This clause was often interpreted to mean complete exemption from all other forms of taxation, including local taxes, in exchange for the franchise.

However, the enactment of the Local Government Code of 1991 (Republic Act No. 7160) brought about a significant change. The LGC aimed to empower local government units (LGUs) by granting them greater fiscal autonomy and revenue-generating powers. Key provisions of the LGC relevant to this case include:

• Section 137 – Franchise Tax: “Notwithstanding any exemption granted by any law or other special law, the province may impose a tax on business enjoying a franchise…” This provision explicitly states that the power of provinces (and by extension, cities through Section 151) to impose franchise tax is *notwithstanding* any existing exemptions.
• Section 151 – Scope of Taxing Powers: This section extends the taxing powers granted to provinces to cities, allowing them to levy the same taxes, fees, and charges.
• Section 193 – Withdrawal of Tax Exemption Privileges: “Unless otherwise provided in this Code, tax exemptions or incentives granted to, or presently enjoyed by all persons, whether natural or juridical… are hereby withdrawn upon the effectivity of this Code.” This section broadly withdrew almost all existing tax exemptions, with limited exceptions.
• Section 534(f) – Repealing Clause: This general repealing clause states that all laws inconsistent with the LGC are repealed or modified accordingly.

These provisions, particularly Sections 137 and 193, signaled a clear shift in legislative intent. The LGC aimed to dismantle the patchwork of tax exemptions that had accumulated over time and to strengthen the revenue base of LGUs. The legal question in the *MERALCO* case was whether these LGC provisions effectively nullified the ‘in lieu of all taxes’ clause in MERALCO’s franchise and subjected it to local franchise tax.

CASE BREAKDOWN: SAN PABLO CITY VS. MERALCO

The story begins with Ordinance No. 56, enacted by the Sangguniang Panglunsod of San Pablo City in 1992. This ordinance, known as the Revenue Code of San Pablo City, included Section 2.09, which imposed a franchise tax on businesses operating under franchises within the city. MERALCO, operating in San Pablo City under a franchise originally granted to Escudero Electric Services Company (later transferred to MERALCO) and containing an ‘in lieu of all taxes’ clause, was assessed this franchise tax.

MERALCO protested this assessment, arguing that its franchise, stemming from Act No. 3648 and Republic Act No. 2340, and further reinforced by Presidential Decree No. 551, exempted it from local taxes due to the ‘in lieu of all taxes’ provision. From 1994 to 1996, MERALCO paid the franchise tax under protest, amounting to a substantial sum of P1,857,711.67.

Feeling aggrieved, MERALCO filed a case in the Regional Trial Court (RTC) of San Pablo City against the City Government, City Treasurer, and Sangguniang Panglunsod of San Pablo City. MERALCO sought to declare Ordinance No. 56 null and void insofar as it applied to them and to recover the taxes paid under protest.

The RTC ruled in favor of MERALCO, declaring the franchise tax imposed by San Pablo City ineffective and void against MERALCO. The RTC agreed with MERALCO that the LGC did not repeal MERALCO’s tax exemption. The court ordered San Pablo City to refund the taxes paid by MERALCO.

Unsatisfied with the RTC decision, the City of San Pablo appealed to the Supreme Court. The city argued that the LGC, particularly Sections 137 and 193, had indeed withdrawn MERALCO’s tax exemption, notwithstanding the ‘in lieu of all taxes’ clause. The Supreme Court framed the central issue as: “whether the City of San Pablo may impose a local franchise tax pursuant to the LGC upon the Manila Electric Company which pays a tax equal to two percent of its gross receipts in lieu of all taxes and assessments of whatever nature imposed by any national or local authority on savings or income.”

The Supreme Court reversed the RTC decision and sided with the City of San Pablo. Justice Gonzaga-Reyes, writing for the Court, emphasized the clear language of Section 137 of the LGC, which allows local franchise tax “notwithstanding any exemption granted by any law or other special laws.” The Court stated:

“The explicit language of Section 137 which authorizes the province to impose franchise tax ‘notwithstanding any exemption granted by any law or other special laws’ is all-encompassing and clear. The franchise tax is imposable despite any exemption enjoyed under special laws.”

The Court further reinforced its ruling by citing Section 193 of the LGC, noting that the withdrawal of tax exemptions was broad, with only specific exceptions listed (local water districts, cooperatives, non-stock and non-profit hospitals and educational institutions), none of which applied to MERALCO. The Court applied the principle of *expressio unius est exclusio alterius* (the express mention of one thing excludes all others), arguing that the enumeration of specific exceptions in Section 193 implied the withdrawal of all other unlisted exemptions.

The Supreme Court dismissed MERALCO’s argument that the ‘in lieu of all taxes’ clause constituted a contract that could not be impaired by the LGC. The Court held that the power to tax cannot be contracted away and that franchises are subject to alteration by the taxing power. Citing the constitutional mandate for local autonomy, the Court underscored the need for LGUs to have sufficient revenue-generating powers to deliver essential services.

In conclusion, the Supreme Court granted the petition of San Pablo City, reversed the RTC decision, and dismissed MERALCO’s complaint, effectively upholding the city’s right to impose franchise tax on MERALCO despite its prior tax exemption.

PRACTICAL IMPLICATIONS: WHAT THIS MEANS FOR BUSINESSES AND LGUS

The *City Government of San Pablo vs. MERALCO* case has significant practical implications for businesses operating in the Philippines, particularly those holding legislative franchises granted before the LGC. It clarified the following key points:

• ‘In Lieu of All Taxes’ Clauses Are Not Absolute Shields: The ‘in lieu of all taxes’ clauses in older franchises are no longer absolute guarantees against local taxation. The LGC effectively curtailed the scope of these clauses.
• Local Government Code Prevails: The LGC has supremacy over prior laws and franchise agreements regarding local taxation, except where specifically provided otherwise within the LGC itself.
• Strengthened LGU Taxing Power: Local government units have significantly strengthened taxing powers, including the authority to impose franchise taxes, regardless of prior exemptions.
• Need for Due Diligence: Businesses must conduct due diligence to understand their current tax obligations under the LGC and local ordinances, even if they possess franchises with ‘in lieu of all taxes’ provisions.

Key Lessons:

• Review Franchise Agreements: Businesses should review their franchise agreements, especially older ones, to assess the potential impact of local franchise taxes.
• Consult with Legal Experts: Seek legal advice to determine the extent of current tax liabilities and compliance requirements under the LGC and relevant local ordinances.
• Engage with LGUs: Maintain open communication with local government units to understand local tax regulations and ensure compliance.
• LGUs Must Exercise Power Judiciously: While LGUs have enhanced taxing powers, they must exercise this power judiciously and reasonably to promote a favorable business environment.

FREQUENTLY ASKED QUESTIONS (FAQs)

Q: What is a franchise tax?

A: A franchise tax is a tax imposed by local government units (LGUs) on businesses that are granted a franchise to operate within their jurisdiction. This is separate from national taxes like income tax.

Q: What does ‘in lieu of all taxes’ mean in a franchise agreement?

A: Historically, this clause in a franchise meant that the franchise holder’s payment of a specific tax (usually a percentage of gross receipts) would exempt them from all other taxes – both national and local. However, the LGC has significantly limited the effect of this clause regarding local taxes.

Q: Did the Local Government Code (LGC) repeal all tax exemptions?

A: No, the LGC did not repeal *all* tax exemptions, but it withdrew most of them, especially those granted by special laws and franchise agreements, with a few specific exceptions listed in Section 193 (like local water districts and registered cooperatives).

Q: Does the ‘in lieu of all taxes’ clause still provide any tax exemption after the LGC?

A: Regarding local taxes, the ‘in lieu of all taxes’ clause is generally no longer effective as a complete exemption due to the LGC. Businesses may still be liable for local franchise taxes and other local levies.

Q: What should businesses with old franchises do now?

A: Businesses should review their franchise agreements and local tax ordinances to determine their current tax obligations. Consulting with a legal professional specializing in taxation and local government law is highly recommended to ensure compliance.

Q: Can local governments arbitrarily impose any amount of franchise tax?

A: No, the LGC sets limitations on the rates of franchise tax that LGUs can impose. Section 137 specifies that provinces can impose a tax “at a rate not exceeding fifty percent (50%) of one percent (1%) of the gross annual receipts.” Cities have similar limitations as defined in the LGC.

Q: Is the Supreme Court’s decision in *MERALCO* case applicable to all businesses with franchises?

A: Yes, the principles established in the *MERALCO* case regarding the LGC’s withdrawal of tax exemptions and the power of LGUs to impose franchise taxes are generally applicable to all businesses operating under franchises in the Philippines.

ASG Law specializes in taxation law and local government regulations. Contact us or email hello@asglawpartners.com to schedule a consultation.