April 13, 2010

BIR RULING [DA-(TAR-001) 046-10]

Sec. 43; BIR Ruling No. 005-06; BIR Ruling

No. 001-90; BIR Ruling No. DA-432-06

SGV & Co.

6760 Ayala Avenue
Makati City

Attention: Atty. Emmanuel C. Alcantara

Co-Head, Tax Services

Gentlemen :

This refers to your letter dated March 10, 2008 stating that your clients, TeaM
Energy Corporation (TEC), TeaM Sual Corporation (TSC) and TeaM Philippines Energy
Corporation (TPEC), are domestic corporations duly registered with the Securities and
Exchange Commission (SEC); that TEC and TSC are engaged principally in the business
of power generation services and the subsequent sale thereof to National Power
Corporation (NPC) under a Build, Operate, Transfer (BOT) scheme while TPEC is
engaged in the business of power supply; that TEC and TSC directly own power
generation plants in Pagbilao, Quezon and Sual, Pangasinan, respectively; that pursuant
to a Cost Reimbursement Agreement effective January 2001, between the a liated
power plants as parties, TeaM Energy Group currently allocates the following costs and
expenses related to common operational, maintenance and general administrative
requirements of the parties using the asset-based method:
Computer Maintenance
Utilities (electricity and water)
Office Supplies
Couriers and Postage
Telecommunications
Advertising and Marketing
Rental of Office Building/Space (common areas included)
Rental of Equipments
Company Car Maintenance
Janitorial Services
Security Services
Office Building/Space Maintenance
Other operational and maintenance, and general and administrative requirements
similar to those enumerated
Financial and Accounting Services
Tax Consulting Services
CD Technologies Asia, Inc. 2019 cdasiaonline.com
 Legal Services
Computer Consulting Services
that under the asset-based method, the parties to the Cost Reimbursement Agreement
agree to bear the said costs and expenses on the basis of the total assets of each
party in relation to the total assets of all the parties, which received, used and/or
bene ted from the common business requirements; that Article V, Section 5.4.2 of the
current Cost Reimbursement Agreement on the manner of determining sharing and
reimbursement of costs, provides as follows:
"5.4.2. Apportion and charge the costs to be reimbursed by each
Corporate Participant on the basis of the ratio of the Total Assets of the
Corporate Participant to the Total Assets of all Corporate Participants that used
and/or benefited from the business requirement that was provided.''
that TeaM Energy Group currently intends to shift its method of allocation from asset-
based method to contracted capacity method; that the Contracted capacity as de ned
under Article III, Section 3.1 of the proposed Cost Reimbursement Agreement refers to
the "actual Megawatt (MW) capability of the Power Stations nominated by the parties
to their respective customers pursuant to their respective executive bilateral energy
conversion agreements and energy power purchase contracts"; that under the
contracted capacity method, the same costs and expenses as enumerated above shall
be allocated based on the ratio of the total contracted capacity of each power
generating plant to the total contracted capacity of all the power generating plants that
bene ted from the common costs and expenses; that Article 5, Section 5.4.2 of the
proposed Cost Reimbursement Method which is to take effect beginning January 1,
2008, provides for the basis of allocation as follows:
"5.4.2. Apportion and charge the costs to be reimbursed by each
Corporate Participant on the basis of the ratio of the Contracted Capacity of the
Corporate Participant to the Contracted Capacity of all Corporate Participants
that used and/or benefited from the business requirement that was provided."
and that the costs and expenses allocated among the a liates likewise, include labor
costs of support personnel (technical, management and consulting services) covered
by a separate Shared Services Agreement.
Based on the foregoing representations, you now request for a ruling that:
1. TEC, TSC and TPEC are authorized to change their accounting method on cost
allocation from asset-based method to contracted capacity method which
shall be applicable to the Cost Reimbursement Agreement and Shared
Services Agreement executed by the parties; and
2. The allocation of costs and expenses among a liated parties to TeaM Energy
Group is not subject to income/withholding tax.
In reply thereto, please be informed as follows:
1. Section 43 of the Tax Code of 1997 provides that —
"Sec. 43. General Rule. — The taxable income shall be computed upon
the basis of the taxpayer's annual accounting period ( scal or calendar year, as
the case may be) in accordance with the method of accounting regularly
employed in keeping with the books of such taxpayer but if no such method of
accounting has been employed or if the method does not clearly re ect the
income, the computation shall be made in accordance with such method as in
the opinion of the Commissioner clearly reflects the income."
CD Technologies Asia, Inc. 2019 cdasiaonline.com
 Corollarily, Section 167 of Revenue Regulations No. 2 provides that —
"It is recognized that no uniform method of accounting can be prescribed
for all taxpayers and the law contemplates that each taxpayer shall adopt such
forms and systems of accounting as are in his judgment best suited to his
purpose. Each taxpayer is required by law to make a return of his true income.
He must, therefore, maintain such accounting records as will enable him to do
so. Any approved standard method of accounting which re ects taxpayer's
income may be adopted." cAaDCE

In stressing the rationale of the above-cited provisions, this O ce elucidated the

matter in BIR Ruling No. 005-06 dated March 8, 2006, as follows:
''. . . the Tax Code itself prescribes no hard and fast rule that would guide
taxpayers in allocating expenses where the business involves distinct activities
like that of Wyeth, i.e., the operation of its existing two spray dryers (which is
subject to regular taxation) and the proposed third dryer (which is subject to
ITH). It is recognized that no uniform method of accounting can be prescribed
for all taxpayers, and the law contemplates that each taxpayer shall adopt such
forms and systems as are in his judgment best suited to his purpose. (Sec. 167,
Revenue Regulations No. 2)
Allocation of costs is essentially an accounting issue, and given that the
law does not expressly provide rules that will govern situations like that of
Wyeth, the method of allocation adopted, should, at best, be one that is
reasonable and justi able, and is consistently used. Hence, a method of
accounting which re ects the consistent application of generally accepted
principles in a particular trade or business in accordance with accepted
practices in that trade or business ordinarily is regarded as accurately re ecting
income. (Mertens, Law of Federal Income Taxation, Volume 2, Chapter 12B.01)
Moreover, it has been held that the allocation of expenses attributable to exempt
and non-exempt income is to be based on all the facts and circumstances.
(CCH, Standard Federal Tax Reporter, citing Rev. Reg. 63-27, 1963-1CB57)."
Prescinding from the foregoing, it is undisputed that the shift from asset-based
method to contracted capacity method in the allocation of costs and expenses among
the power plants as a liated companies is reasonable and justi able, considering the
correlation between the expenses incurred by the power plants and income generated
as indicated by contracted capacity. Accordingly, the change in method of accounting
as to allocation of costs is allowable as long as the same is relevant, consistently
applied and favourable to the demands of the business.
2. Mere reimbursements of actual expenses/costs without any mark-up or pro t
element do not constitute income payments and are, therefore, not subject to
Philippine income taxes. Thus, the allocation of costs and expenses pursuant to the
Cost Reimbursement Agreement and Shared Services Agreement being mere
reimbursement of the actual costs and expenses incurred for the provision of common
operational, maintenance and general administrative requirements among a liated
parties are not subject to income and consequently to withholding tax.
This O ce had already occasion to rule on the matter, when it said in BIR Ruling
No. DA432-06 dated July 18, 2006, as follows:
". . . income, in the broad sense, means all wealth which ows into the
taxpayer other than as a mere return of capital. It has been a settled rule that
reimbursement of cost is merely a return of capital and does not constitute
income, and consequently, is not the proper subject of withholding taxes (BIR
CD Technologies Asia, Inc. 2019 cdasiaonline.com
 Ruling Nos. DA489-05 dated December 6, 2005; DA176-04 dated April 6, 2004;
DA438-03 dated December 4, 2003 citing BIR Ruling Nos. DA158-97 dated April
14, 1997, UN262-95 dated July 11, 1995 and 245-95 dated July 5, 1995). CTcSIA

xxx xxx xxx

In view thereof, and considering that the amounts to be paid under the
Memorandum of Agreement between COL-Branch and COL-Head O ce
represent mere reimbursement of cost, said payments, therefore, are not subject
to the withholding tax nor to the branch pro t remittance tax both imposed
under Revenue Regulations No. 2-98, as amended."
WHEREFORE, in view of the foregoing, this Office holds that —
1. TEC, TSC and TPEC are authorized to change their accounting method on cost
allocation from asset-based method to contracted capacity method which
shall be applicable to the Cost Reimbursement Agreement and Shared
Services Agreement executed by the parties.
2. The allocation of costs and expenses among a liated parties of TeaM Energy
Group is not subject to income tax and consequently to withholding tax.
This ruling is being issued on the basis of the foregoing facts as represented.
However, if upon investigation, it will be disclosed that the facts are different, then this
ruling shall be considered null and void.

Very truly yours,

(SGD.) GREGORIO V. CABANTAC

Deputy Commissioner
Legal & Inspection Group

CD Technologies Asia, Inc. 2019 cdasiaonline.com