Republic vs. Manila Electric Company

Income tax payments by a public utility are not operating expenses that may be passed on to and recovered from consumers; the 12% rate of return allowed to public utilities is computed solely for the purpose of fixing allowable rates and is distinct from taxable income subject to income tax.

The case arises from the regulation of electricity rates charged by MERALCO, a public utility providing basic services to the general public. The dispute centers on the determination of the proper rate base and allowable return following MERALCO’s 1993 application for a rate increase, specifically addressing whether income taxes may be treated as operating expenses, the proper method for valuing utility property, and the extent of refund obligations for excess collections made under a provisional rate increase.

• On December 23, 1993, MERALCO filed with the Energy Regulatory Board an application for revised rates, seeking an average increase of P0.21 per kilowatthour in its distribution charge.
• On January 28, 1994, the ERB granted a provisional increase of P0.184 per kilowatthour, subject to the condition that should the final determination show entitlement to a lesser increase, all excess amounts collected shall be refunded to customers or credited in their favor.
• The Commission on Audit conducted an examination of MERALCO’s books of accounts and records for the test year February 1, 1994 to January 31, 1995, and recommended that income taxes paid by MERALCO should not be included as part of operating expenses and that the “net average investment method” or “number of months use method” be applied in determining the proportionate value of properties.
• The COA audit revealed that MERALCO derived excess revenue of P2,448,378,000 during the test year, representing 8.15% more than the amount it should have earned at a 12% rate of return on rate base.
• The ERB, in its February 16, 1998 decision, adopted the COA recommendations and authorized a rate adjustment of only P0.017 per kilowatthour, directing MERALCO to credit the excess average amount of P0.167 per kilowatthour to its customers from billing cycles beginning February 1994.
• Even if MERALCO’s income tax liability of P2,135,639,000 were included as an operating expense, the company would still have earned excess revenue of P312,738,000 or an actual rate of return of 13.04%, above the authorized 12%.
• MERALCO did not implement the refund ordered by the ERB; instead, it secured a Temporary Restraining Order and Writ of Preliminary Injunction from the Court of Appeals pending appeal.
• The Energy Regulatory Commission (successor to the ERB) filed a comment in the Motion for Reconsideration reversing its position, arguing that income taxes are reasonable costs recoverable from the public and that disallowing them would reduce the return to 8%.
• The Office of the Solicitor General, representing the Republic, defended the original ERB position, arguing that income taxes should not be recoverable from consumers.

• Income tax payments by a public utility should not be treated as operating expenses recoverable from the consuming public, as this would violate the principle that public utilities cannot overcharge at the expense of the public.
• American jurisprudence allowing the treatment of income taxes as operating expenses is not applicable in this jurisdiction; local laws must be construed according to local legislative intent and public interest.
• The COA and ERB correctly followed the National Accounting and Auditing Manual, which expressly disallows the treatment of income tax as an operating expense.
• Executive Order No. 72 does not grant electric utilities the privilege of treating income tax as an operating expense.
• The “net average investment method” is a reasonable and acceptable method for property valuation for rate-making purposes.
• The ERB decision may be applied retroactively, and the use of a test year is an accepted practice in rate regulation to determine the reasonable return of a public utility.
• Allowing MERALCO to treat income tax as an operating expense would set a dangerous precedent for other public utilities.

• The deduction of income taxes from revenues is firmly entrenched in American jurisprudence and constitutes part of MERALCO’s constitutional right to property; the Public Service Act was patterned after American state public utility laws, making American construction controlling.
• The exclusion of income taxes effectively reduces the return on rate base from the authorized 12% to only about 8%, violating the constitutional guarantee of a fair return on investment.
• The “average investment method” or “simple average” is the correct method for computing the value of properties entitled to a return, as allegedly affirmed by the Supreme Court in previous cases (MERALCO v. PSC and Republic v. Medina).
• The refund of excess collections cannot be given retroactive effect because the figures determined by the ERB only apply to the test year (February 1, 1994 to January 31, 1995); applying the refund uniformly to periods after January 31, 1995 would result in MERALCO earning less than the authorized 12% return in some years.
• Under the Electric Power Industry Reform Act of 2001 (EPIRA) and the ERC’s Uniform Rate Filing Requirements, income taxes are considered reasonable costs that may be recoverable from the consuming public.

• Procedural Issues:
  • Whether the Energy Regulatory Commission’s reversal of position in its comment, wherein it agreed with MERALCO that income taxes are recoverable costs, effectively abandons the appeal or affects the Court’s jurisdiction to uphold the original ERB decision.
  • Whether oral arguments should be conducted prior to the resolution of the Motion for Reconsideration in view of the substantial monetary stakes and the ERC’s change of position.
• Substantive Issues:
  • Whether income taxes paid by a public utility may be treated as operating expenses recoverable from consumers through rate charges.
  • Whether the “net average investment method” (number of months use method) or the “average investment method” (simple average) is the proper valuation method for determining the rate base.
  • Whether the refund of excess collections averaging P0.167 per kilowatthour should be applied retroactively to billing cycles beginning February 1994.

• Procedural:
  • The Court denied the Motion for Reconsideration despite the ERC’s change of position, noting that the Office of the Solicitor General continued to defend the original ERB decision and represent the government’s interest. The Court found no necessity to conduct oral arguments, proceeding to resolve the motion based on the pleadings and records.
• Substantive:
  • Income taxes are not operating expenses that may be passed on to and recovered from consumers. The 12% rate of return is computed solely for the purpose of fixing allowable rates and is distinct from taxable income subject to income tax; even if income tax were treated as an operating expense, MERALCO would still have earned excess revenue above the authorized 12% return (specifically 13.04%).
  • Rate regulating authorities are not hidebound to use any single formula for property valuation. The “net average investment method” is a reasonable method, and the findings of the COA and ERB on this technical matter are entitled to great weight and respect.
  • The refund is properly applied retroactively from February 1994. The test year provides a representative sample for determining reasonable returns, and the use of a test year does not limit the applicability of the findings to that specific period alone. MERALCO collected excess amounts from 1994 without implementing the refund, and a year-by-year adjustment would lead to absurdity and is not normally enjoyed by public utilities.

• Public Interest in Public Utilities — The business and operations of a public utility are imbued with public interest, providing basic commodities and services indispensable to the general public; consequently, public utilities submit to government regulation and surrender certain business prerogatives, including the amount of rates they may charge.
• Persuasive but Not Controlling Foreign Jurisprudence — American decisions and authorities are not per se controlling in Philippine jurisdiction; at best, they are persuasive, for no court holds a patent on correct decisions. Local laws must be construed according to the intention of local lawmakers and to serve the distinct public interest of the Philippines.
• Test Year Doctrine in Rate-Making — The use of a test year in rate regulation provides a representative sample of data to determine the reasonable return of a public utility; it assumes that within a reasonable period after the test year, figures will vary only slightly, and the findings are not limited in application to the test year alone.
• Respect for Administrative Findings — Findings of administrative or regulatory agencies on matters within their technical area of expertise are generally accorded not only respect but at times even finality if such findings and conclusions are supported by substantial evidence.

• "The business and operations of a public utility are imbued with public interest. In a very real sense, a public utility is engaged in public service providing basic commodities and services indispensable to the interest of the general public. For this reason, a public utility submits to the regulation of government authorities and surrenders certain business prerogatives, including the amount of rates that may be charged by it. It is the imperative duty of the State to interpose its protective power whenever too much profits become the priority of public utilities."
• "American decisions and authorities are not per se controlling in this jurisdiction. At best, they are persuasive for no court holds a patent on correct decisions. Our laws must be construed in accordance with the intention of our own lawmakers and such intent may be deduced from the language of each law and the context of other local legislation related thereto. More importantly, they must be construed to serve our own public interest which is the be-all and the end-all of all our laws."
• "Public utilities cannot be allowed to overcharge at the expense of the public and worse, they cannot complain that they are not overcharging enough."
• "Yesterday cannot govern today, no more than today can determine tomorrow."
• "Rate regulators should strain to strike a balance between the clashing interests of the public utility and the consuming public and the balance must assure a reasonable rate of return to public utilities without being unreasonable to the consuming public."

• MERALCO v. Public Service Commission (G.R. Nos. 24762, 24841, 24854, 24872, November 14, 1966, 18 SCRA 651) — Distinguished; the Court did not independently affirm the “average investment method” as the exclusive standard but merely upheld the PSC’s findings as supported by substantial evidence.
• Republic v. Medina (G.R. Nos. 32068, 32083, 32155, 32374, 32402, 32464, October 4, 1971, 41 SCRA 643) — Cited for the principle that property valuation in rate-making is not to be solved by formula but depends upon the particular circumstances and relevant facts affecting each utility, and that regulatory bodies must balance investor and consumer expectations.
• Radio Communications of the Philippines, Inc. v. National Telecommunications Commission (G.R. No. 66683, April 23, 1990, 184 SCRA 517) — Cited for the doctrine that findings of administrative agencies on technical matters within their expertise are entitled to respect and finality if supported by substantial evidence.

• Commonwealth Act No. 146 (Public Service Act) — The governing law for public utility regulation; MERALCO argued its provisions were patterned after American laws to support inclusion of income taxes as operating expenses.
• Republic Act No. 9136 (Electric Power Industry Reform Act of 2001), Section 36 — Mandates the unbundling of rates and charges the ERC with regulating rate structures; cited by MERALCO to support its claim that income taxes are recoverable costs under the Uniform Rate Filing Requirements.
• Executive Order No. 72 — Cited by the Office of the Solicitor General to argue that it does not grant electric utilities the privilege of treating income tax as an operating expense.

• Panganiban, J. — Expressed reservation about voting on the Motion for Reconsideration without prior oral arguments. Raised critical questions regarding: (1) the effect of the ERC’s “self-reversal” on the validity of the appeal and whether the OSG could argue against its own client’s new position; (2) the impact of the newly enacted EPIRA (R.A. 9136) on the continued validity of the decision; (3) the apparent inconsistency in computations regarding whether the decision reduces MERALCO’s return to 8% or allows 13%; and (4) whether MERALCO was being accorded special privilege not granted to other public utilities. Called for oral arguments before the full Court or the Third Division to clarify these questions, noting the case affects all electric utilities and consumers nationwide involving approximately P20 billion in refunds.