September 15, 2019

Atty. Eduardo L. Pagulayan, Jr.

Regional Director
Bureau of Internal Revenue
Revenue Region No.13, Cebu City
Archbishop Reyes Ave, Cebu City, Cebu, 6000

Dear Sir;

This has reference to your Formal Letter of Demand and Final Assessment
(“FLD/FAN” for brevity) dated August 16, 2019 referring to this Corporation’s
alleged unpaid tax liabilities covering taxable year 2015 (hereto attached as
Annex “A” forming an integral part hereof).

Said FLD/FAN was personally received only on August 27, 2019. Please be
informed that the herein taxpayer is availing Section 228 of the National
Internal Revenue Code of 1997, as recently amended by R.A. No. 10963
Tax Reform for Acceleration and Inclusion (“TRAIN Law” for brevity), and
Section 3.1.4 of Revenue Regulations 18-2013 to wit:

“SEC. 228. Protesting of Assessment. - When the Commissioner or

his duly authorized representative finds that proper taxes should be
assessed, he shall first notify the taxpayer of his findings x x x

x x x Within a period to be prescribed by implementing rules and

regulations, the taxpayer shall be required to respond to said notice.
If the taxpayer fails to respond, the Commissioner or his duly
authorized representative shall issue an assessment based on his
findings.

Such assessment may be protested administratively by filing a

request for reconsideration or reinvestigation within thirty (30) days
from receipt of the assessment in such form and manner as may be
prescribed by implementing rules and regulations. Within sixty (60)
days from filing of the protest, all relevant supporting documents shall
have been submitted; otherwise, the assessment shall become final.

“SECTION 3. Due Process Requirement in the Issuance of

a Deficiency Tax Assessment. -

3.1 Mode of procedure in the issuance of a deficiency tax

assessment:
 3.1.3 Formal Letter of Demand and Final Assessment
Notice (FLD/FAN). — The Formal Letter of Demand and Final
Assessment Notice (FLD/FAN) shall be issued by the
Commissioner or his duly authorized representative. The
FLD/FAN calling for payment of the taxpayer's deficiency tax
or taxes shall state the facts, the law, rules and regulations, or
jurisprudence on which the assessment is based; otherwise,
the assessment shall be void x x x

by submitting its response and disagreement to the aforementioned Final

Assessment Notice, as follows:

I. DEFICIENCY INCOME TAX

It is respectfully submitted that the reliance on Section 27 of the NIRC of

1997 as basis for income tax liability is erroneous, in which the pertinent
provision is quoted as follows:

(C) Government-owned or Controlled-Corporations, Agencies or

Instrumentalities. - The provisions of existing special or general laws
to the contrary notwithstanding, all corporations, agencies, or
instrumentalities owned or controlled by the Government, except the
Government Service Insurance System (GSIS), the Social Security
System (SSS), the Philippine Health Insurance Corporation (PHIC),
the Philippine Charity Sweepstakes Office (PCSO) and the Philippine
Amusement and Gaming Corporation (PAGCOR), shall pay such rate
of tax upon their taxable income as are imposed by this Section upon
corporations or associations engaged in s similar business, industry,
or activity.

Although the Section 27(C) of the 1997 Tax Code does not expressly
include Local Water Districts, the relevant provision has recently been
amended by the TRAIN law. Under Section 27(C) of the TRAIN Law,
Local Water Districts are expressly granted an income tax exemption,
to wit:

(C) Government-owned or -Controlled Corporations, Agencies or

Instrumentalities.– The provisions of existing special or general laws
to the contrary notwithstanding, all corporations, agencies, or
instrumentalities owned or controlled by the Government, except the
Government Service Insurance System (GSIS), the Social
Security System (SSS), the Philippine Health Insurance
Corporation (PHIC), and the local water districts (LWD) shall pay
such rate of tax upon their taxable income as are imposed by this
Section upon corporations or associations engaged in a similar
business, industry, or activity.
 XYZ Inc., is a government-owned or controlled corporation, duly
organized and existing under and by virtue of the laws of the Republic of
the Philippines, and created pursuant to the provisions of Presidential
Decree (P.D.) No. 1981 as a public utility engaged in the operation and
management of the water supply and distribution within its franchise area
in the Cities of Cebu, Mandaue, Lapu-Lapu, Talisay, and Municipalities of
Consolacion, Liloan, Cordova and Compostela4 in the province of Cebu.

Therefore, it is evident that under existing laws, herein Corporation is

classified as an LWD, covered by the income tax exemption under the
above stated provision.

II. VALUE ADDED TAX

It is also respectfully submitted that the reliance on Section 108 of the

NIRC for VAT liability is likewise erroneous. The applicable provision with
regard to services rendered by LWDs is Section 109 in relation to
Section 119 of the TRAIN Law, in which the pertinent provisions are
quoted as follows:

Section 109. Exempt Transactions. -

(1) Subject to the provisions of subsection (2) hereof, the following

transactions shall be exempt from the value-added tax:

xxx

(E) Services subject to percentage tax under Title V;

xxx

Title V
OTHER PERCENTAGE TAXES

Section 119. Tax on Franchises. – Any provision of general or

special law to the contrary notwithstanding, there shall be levied,
assessed and collected in respect to all franchises on radio and/or
television broadcasting companies whose annual gross receipts of
the preceding year does not exceed Ten million pesos
(PhP10,000,000), subject to Section 236 of this Code, a tax of three
percent (3%) and on gas and water utilities, a tax of two percent
(2%) on the gross receipts derived from the business covered
by the law granting the franchise x x x

1
As amended by P.D. Nos. 768 and 1479 dated August 15, 1975 and June II, 1978, respectively
 LWDs are subject to a tax of two percent (2%) based on its franchise on
water utilities under Section 119 of Title V. Therefore, its transactions
are considered exempt from VAT under Section 109 (E).

III. EXPANDED WITHHOLDING TAX

The undersigned also submits that the assessment of deficient Expanded

Withholding Tax is not in accordance with Revenue Regulation 11-2018,
in which the pertinent provision is quoted as follows:

(I) Income payment made by top withholding agents, either

private corporations or individuals, to their local/resident
supplier of goods and local/resident supplier of services other
than those covered by other rates of withholding tax. [formerly
under letters (M) and (W)] x x x

Top withholding agents shall include the following:

a. Classified and duly notified by the Commissioner as either any of

the following unless previously de-classified as such or had
already ceased business operations:

(1) A large taxpayer under Revenue Regulations No. 1-98, as

amended;
(2) Top twenty thousand (20,000) private corporations under
RR No. 6-2009; or
(3) Top five thousand (5,000) individuals under RR No. 6-2009; x
xx

Based on the cited provisions, the inclusion of XYZ Water Inc. as among
the Top 10,000/20,000 corporate tax payers of the Bureau is not in
accordance with the classification provided in the Revenue Regulation,
for the reason that the herein Corporation is a public corporation and
not a private corporation. The Supreme Court Decision2 of September
13, 1991 declared all Local Water Districts (LWDs) and this included XYZ
Water Inc., as government-owned and controlled corporations (GOCCs)
with original charter. As such, it is submitted that it was erroneous to
include the undersigned among the top corporate tax payers as it is not a
private corporation as contemplated by the Revenue Regulation.

IV. WITHHOLDING TAX ON COMPENSATION

It is respectfully submitted that the undersigned should not be liable for the
deficiency Withholding Tax on Compensation (WTC) because it was erroneous
to compare the Income Tax Return (ITR) and Alphalist in determining possible

2Davao City Water District vs. CSC and COA, G.R. Nos. 95237-38, September 13,
1991.
discrepancies. The salaries of its employees reflected in its ITR does not reflect
the total taxable income paid and received by the employees because the same
refers to the gross salaries of the employees, which included amounts that were
not subject to WTC.

The alleged deficiency in the amount of P397,893.91 pertains to accrued

employee costs in the amount of P187,753.91 and pension cost in the
amount of P210,140 paid for by petitioner's home office for the expatriates
assigned in the Philippines which were erroneously included in the
salaries account. This fact has been duly substantiated in the
undersigned’s Reply to the Preliminary Assessment Notice dated
August 14, 2019.

V. IMPROPERLY ACCUMULATED EARNINGS TAX

The undersigned furthermore respectfully submits that the imposition of

Improperly Accumulated Earnings tax is erroneous as the undistributed
earnings was for a legitimate business purpose. Under Revenue
Regulations No. 2-2001;

Sec. 2. Concept of Improperly Accumulated Earnings Tax (IAET).

- Pursuant to Section 29 of the Code, there is imposed for each
taxable year, in addition to other taxes imposed under Title II of the
Tax Code of 1997, a tax equal to 10% of the improperly accumulated
taxable income of corporations formed or availed of for the purpose
of avoiding the income tax with respect to its shareholders or the
shareholders of any other corporation, by permitting the earnings and
profits of the corporation to accumulate instead of dividing them
among or distributing them to the shareholders. The rationale is that
if the earnings and profits were distributed, the shareholders would
then be liable to income tax thereon, whereas if the distribution were
not made to them, they would incur no tax in respect to the
undistributed earnings and profits of the corporation. Thus, a tax is
being imposed in the nature of a penalty to the corporation for the
improper accumulation of its earnings, and as a form of deterrent to
the avoidance of tax upon shareholders who are supposed to pay
dividends tax on the earnings distributed to them by the corporation.

The touchstone of the liability is the purpose behind the accumulation

of the income and not the consequences of the accumulation. Thus,
if the failure to pay dividends is due to some other causes, such as
the use of undistributed earnings and profits for the reasonable needs
of the business, such purpose would not generally make the
accumulated or undistributed earnings subject to the tax. However, if
there is a determination that a corporation has accumulated income
beyond the reasonable needs of the business, the 10% improperly
accumulated earnings tax shall be imposed.
 Sec. 3. Determination of Reasonable Needs of the Business. - An
accumulation of earnings or profits (including undistributed earnings
or profits of prior years) is unreasonable if it is not necessary for the
purpose of the business, considering all the circumstances of the
case. To determine the "reasonable needs" of the business in order
to justify an accumulation of earnings, these Regulations hereby
adhere to the so-called "Immediacy Test" under American
jurisprudence as adopted in this jurisdiction. Accordingly, the term
"reasonable needs of the business" are hereby construed to mean
the immediate needs of the business, including reasonably
anticipated needs. In either case, the corporation should be able to
prove an immediate need for the accumulation of the earnings and
profits, or the direct correlation of anticipated needs to such
accumulation of profits. Otherwise, such accumulation would be
deemed to be not for the reasonable needs of the business, and the
penalty tax would apply.

Thus, from the above provisions, the rationale of imposing the IAET
serves as a penalty for those corporations who retain its earnings instead
of distributing it to the shareholders with the hopes of avoiding the
payment of income tax for the dividends received.

However, if it can be proven that the reason for the accumulation of the
earnings was for the reasonable needs of the business, then the
undistributed earnings would not be subject to tax. Furthermore, it must
also be established that the accumulated profits must also be used within
a reasonable time after the close of the taxable year and a definite plan
coupled with proper action must also be taken to consummate such plans
in order to establish a clear and convincing intention by the business to
accumulate for an immediate need and avoid surtax.

Under RR No. 2-2001, earnings reserved for corporate expansion

projects or programs requiring considerable capital expenditure as
approved by the Board of directors or equivalent body, constitutes an
accumulation of earnings for the reasonable needs of the business.

In determining whether accumulations of earnings or profits in a particular

year are within the reasonable needs of a corporation, it is necessary to
take into account prior accumulations, since accumulations prior to the
year involved may have been sufficient to cover the business needs and
additional accumulations during the year involved would not reasonably
be necessary.3

From the provisions, the purpose for the accumulated earnings for XYZ
Inc., in the year 2015 to 2019, was needed in order to reach the required
capital for the construction of new water districts in 5 localities for the

3The Manila Wine Merchants Inc., vs. CIR, G.R. No. L-26145. February 20, 1984.
expansion of its water supply service along with the improvement of
rainwater collection systems and state-of-the-art desalination
technologies coupled with renewable energy sources to meet the water
demands of each localities and prevent future water shortage and for
adequate long-term solution and quality supply of water. The duration of
the project was from 2015-2018, but because of the extreme climate
change that brought about El Nino in the year 2018, the expansion project
was delayed until year 2019.

Hence, the undersigned respectfully submits that IAET should not be

imposed against XYZ Water Inc., as the undistributed earnings had
reasonable use for its business. Likewise, the 25% surcharge, along with
the 20% and 12% interests per annum should not be imposed because
the undistributed earnings of prior years was necessarily reserved for the
expansion projects of XYZ Water Inc., and for the installation of improved
rainwater collection systems, which are in accordance with the
reasonable needs of the business.

VI. DOCUMENTARY STAMP TAX

The undersigned respectfully submits that the reliance of the BIR for
imposing Documentary Stamp Tax on every issuance of debt instrument
under section 179 is erroneous. As the transaction of XYZ Inc., was for
the advances to suppliers, which does not fall under the term “debt
instruments” as used in the Tax Code.

SEC. 179. Stamp Tax on All Debt Instruments- On every original

issue of debt instruments, there shall be collected documentary stamp
tax of One peso and fifty centavos (P1.50) on each Two hundred pesos
(P200), or fractional part thereof, of the issue price of any such debt
instrument: Provided, That for such debt instruments with terms of less
than one (1) year, the documentary stamp tax to be collected shall be
of proportional amount in accordance with the ratio of its terms in
number of days to three hundred sixty days (365): Provided, further,
That only one documentary stamp tax shall be imposed on either loan
agreement, or promissory notes issued to secure such loan.

For purposes of this section, the term ‘debt instrument’ shall mean
debt instrument representing borrowing and lending transactions
including but not limited to debentures, certificates of indebtedness,
due bills, bonds, loan agreements, including those signed abroad
wherein the object of contract is located or used in the Philippines,
instruments and securities issued by the government or any of its
instrumentalities, deposit substitute debt instruments, certificates or
other evidences of deposits that are either drawing interest significantly
higher than the regular savings deposit taking into consideration the
size of the deposit and the risks involved or drawing interest and having
a specific maturity date, orders for payment of any sum of money
otherwise than at sight or on demand, promissory notes, whether
negotiable or non-negotiable, except bank notes issued for circulation.
Nowhere from the above provision are the advances to suppliers included
in the term “debt instruments”. While it is true that there should be a
payment Documentary stamp tax on every document, loan agreements,
instruments and papers, section 173 of the Tax code also states that when
one party to the taxable document enjoys exemption from the tax herein
imposed the other party who is not exempt shall be the one directly liable
for the tax.

SEC. 173. Stamp Taxes Upon Documents, Loan Agreements,

Instruments and Papers. - Upon documents, instruments, loan
agreements and papers, and upon acceptances, assignments, sales
and transfers of the obligation, right or property incident thereto, there
shall be levied, collected and paid for, and in respect of the transaction
so had or accomplished, the corresponding documentary stamp taxes
prescribed in the following Sections of this Title, by the person making,
signing, issuing, accepting, or transferring the same wherever the
document is made, signed, issued, accepted or transferred when the
obligation or right arises from Philippine sources or the property is
situated in the Philippines, and the same time such act is done or
transaction had: Provided, That whenever one party to the taxable
document enjoys exemption from the tax herein imposed, the other
party who is not exempt shall be the one directly liable for the tax.

Thus, Section 199 of the Tax Code provides for those instruments,
documents and papers that are exempt from the payment of Documentary
stamp tax.

SEC. 199. Documents and Papers Not Subject to Stamp Tax. - The
provisions of Section 173 to the contrary notwithstanding, the following
instruments, documents and papers shall be exempt from the
documentary stamp tax:

(i) Interbank or interdepartmental advances within the same legal

entity.

In this case, the advances to suppliers made by XYZ Inc., falls under one
of the exemptions from paying DST, because the transaction involved
advances to suppliers, and not on the issuance of debt instrument as
what the BIR claims it to be. The terms “advances” does not fall under
the term “debt instruments” as contemplated by the tax code. Hence BIR
was incorrect to assess the XYZ Inc., for any deficiency taxes for the
payment of DST, because the transaction involved advances to
suppliers, which were made under interdepartmental advances within the
same legal entity. The advances made by the undersigned was for the
improvement of other rainwater collection system for another established
department located in another district. Hence, XYZ INC., is not liable for
the payment of Documentary Stamp tax.

VII. COMPROMISE PENALTIES

With respect to the 'compromise penalties' in the total sum of P25,000.00

on the alleged failure to file Quarterly Summary List of Sales, suffice it to
 say that penalties cannot be imposed in the absence of a showing that
the taxpayer consented thereto.

A compromise is consensual in character, hence, may not be imposed

on the taxpayer without his consent. (Sec. 6, RR 12- 99)

Absent any factual basis, the undersigned respectfully denies having

entered into any compromise agreement nor has it consented thereto.

VIII. STATUTORY INCREMENTS

In view of the foregoing, it is humbly and respectfully requested from your

good office for the cancellation and withdrawal of the 25% surcharges
and 20% interest on all the alleged unpaid tax liabilities for having no
legal basis.

Appropriate action taken immediately pursuant to the provisions of BIR

Citizens Charter and R.A. 110324 will be highly appreciated.

Anticipating for your favorable and usual prompt action.

Very truly yours,

Katherine L. Tan
General Manager
XYZ Water Inc.

Copy furnished:

Hon. Caesar R. Dulay

BIR Commissioner of Internal Revenue

Hon. Carlos Dominguez III

DOF Secretary

4
Ease of Doing Business and Efficient delivery of Government Services of 2018
"ANNEX A"