EXECUTIVE SUMMARY

Introduction

The North Luzon Railways Corporation (NORTHRAIL) is a pre-operating, wholly-owned

subsidiary of the Bases Conversion and Development Authority (BCDA), registered with
the Securities and Exchange Commission on August 22, 1995 with the purpose to
develop, construct, operate, and manage a railroad system to serve Metro Manila, Central
Luzon, and Northern Luzon; and to develop, construct, manage, own, lease, sublease,
and operate establishments and facilities of all kinds related to the railroad system.

On February 7, 1996, NORTHRAIL entered into an Engineering, Procurement and

Construction (EPC) Contract with Spanish Railways Group (SRG) for the construction of
the railway system between Caloocan and Malolos. This failed because SRG could not
raise the necessary funds.

On August 19, 2003, Executive Order No. 232 was promulgated, directing the Department
of Transportation and Communications (DOTC), now the Department of Transportation
(DOTr), to exercise primary oversight functions over the NORTHRAIL Project and
transferring supervision of the NORTHRAIL from the BCDA under the Office of the
President to the DOTr.

On August 30, 2003, a Memorandum of Understanding (MOU) was signed between the
Department of Finance (DOF) and ChinaEXIM Bank for the US$400 million financing
covering 95 per cent of the NORTHRAIL Project, Phase I, Section I contract price.

On December 30, 2003, NORTHRAIL signed the Original Contract with China National
Machinery and Equipment Corporation (Group) (CNMEG) for the construction of the
Phase I, Section I, Caloocan to Malolos, amounting to US$421.05 million. The contract
with CNMEG, now SINOMACH, was later amended on September 29, 2009, increasing
the contract cost to US$593.88 million, to address the problems encountered in the
implementation of the Original Contract. However, these problems were not resolved.

SINOMACH issued the Notice of Termination of the contracts to NORTHRAIL on August

17, 2012. This was followed by a Notice of Claim on August 22, 2012 and, subsequently,
a Notice of Arbitration on September 27, 2012.

Arbitration proceeding was held in the Hongkong International Arbitration Center (HKIAC),
following the rules of the United Nations Commission on International Trade Law
(UNCITRAL). On February 19, 2016, NORTHRAIL received, thru email, the Partial Award
issued by the Arbitral Tribunal. The arbitral tribunal has resolved the preliminary issues
between the parties and declared the contracts subject of arbitration as valid, with costs
against NORTHRAIL.

On October 28, 2017, a Settlement Agreement was executed between SINOMACH and
NORTHRAIL which provides that both parties release and forever discharge all claims
inclusive of interests and costs.

In pursuance of the Settlement Agreement, a Joint letter signed by Pinsent Masons (for
SINOMACH) and the Office of the Government Corporate Counsel (OGCC) (for
NORTHRAIL) was submitted to the Arbitral Tribunal asking the latter to issue a Final

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Consent Award on November 11, 2017. On August 1, 2018, the Arbitral Tribunal issued
the Consent Award which was received by NORTHRAIL thru the OGCC on August 10,
2018.

Earlier or on February 16, 2015, the National Economic and Development Authority
approved the North-South Commuter Railway (NSCR) Project of DOTC which will traverse
from Malolos, Bulacan to Calamba, Laguna and will also utilize the Philippine National
Railways right-of-way just like the NORTHRAIL Project Phase 1, Section 1. With the
approval of the NSCR Project, the NORTHRAIL Project Phase 1, Section 1 is deemed
terminated.

On August 27, 2019, NORTHRAIL received GCG Memorandum Order (GCG-MO) No.
2019-05 dated May 20, 2019 ordering the deactivation of the North Luzon Railways
Corporation (NORTHRAIL). This order was subsequently adopted by the NORTHRAIL
Board of Directors on January 15, 2020. On January 28, 2021, the Board approved the
deactivation plan with the exception on the matter on NORTHRAIL’s successor-in-interest
and certain matters regarding personnel.

Financial Highlights

Comparative Financial Position

2020 2019 Increase (Decrease)

Assets 7,549,248,553 8,133,971,087 (584,722,534)
Liabilities 18,033,228,667 17,796,290,578 236,938,089
Capital Deficiency (10,483,980,114) (9,662,319,491) 821,660,623

Comparative Pre-operating Income/Expenses

2020 2019 Increase (Decrease)

Expenses 818,118,045 3,862,477,262 (3,044,359,217)
Miscellaneous Income (3,542,578) 1,327,442,056 (1,330,984,634)
Net Pre-operating Expenses 821,660,623 2,535,035,206 (1,713,374,583)

Scope and Objectives of Audit

Our audit covered the examination, on a test basis, of the accounts and transactions of
NORTHRAIL for the period January 1 to December 31, 2020 in accordance with International
Standards of Supreme Audit Institutions (ISSAIs) to enable us to express an opinion on the
fairness of presentation of the financial statements for the years ended December 31, 2020
and 2019. Also, we conducted our audits to assess compliance with pertinent laws, rules and
regulations, as well as adherence to prescribed policies and procedures.

The audit did not include the propriety of contracting loans as well as the utilization of loan
proceeds for the NORTHRAIL Project, Phase 1, Section 1, as these were covered in COA
Special Audits Office (SAO) Report No. 2012-002.

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Independent Auditor’s Opinion on the Financial Statements

We rendered an unmodified opinion on the fairness of presentation of the financial

statements of NORTHRAIL for the years 2020 and 2019.

Observations and Recommendations

Below are the significant observations and recommendations which are discussed in detail
in Part II of this Report:

1. The recovery of accumulated input tax against output tax in the amount of P514.206
million is doubtful since NORTHRAIL was declared deactivated by the Governance
Commission for Government-Owned and Controlled Corporations (GCG) through its
Memorandum Order No. 2019-05 dated May 20, 2019, unless appropriate actions will
be taken by the management.

We recommended that Management:

a. Apply for a change or cessation of status as VAT-registered person following the

provisions of Section 106 of the Tax Code; and

b. Consider the options provided under Section 112 of the Tax Code which will be
more advantageous to NORTHRAIL.

2. The collectability of the long outstanding receivables in the total amount of P134.768
million is doubtful due to the non-enforcement of the terms and conditions of the
contracts of lease between NORTHRAIL and the relocatees of Harmony Hills
properties.

We recommended that Management:

a. Revisit the Contracts of Lease with Option to Purchase and their amendments and
enforce the terms and conditions indicated therein;

b. Undertake necessary measures to intensify the collection of overdue accounts

and/or recovery of the housing units from defaulting relocatees; and

c. Monitor the timely collection of rental dues from relocatees including those who
signified their intention to purchase their units.

Summary of Total Suspensions, Disallowances and Charges as of Year-end

As of December 31, 2020, unsettled audit disallowances amounted to P14.170 million.

Status of Implementation of Prior Years’ Audit Recommendations

Of the eight audit recommendations embodied in the previous years’ Annual Audit Reports
(AARs), one was implemented, one was reconsidered and six were partially implemented.
Details are presented in Part III of this report.

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