Shell Philippines Exploration B.V. vs. Commission on Audit

The government's 60% share in petroleum service contracts under Presidential Decree Nos. 87, 1206, and 1459 expressly includes all taxes paid by or on behalf of the Contractor, and the government's assumption and payment of the Contractors' income taxes is a valid mechanism distinct from a constitutionally restricted tax exemption.

On December 11, 1990, the Republic of the Philippines, represented by then President Corazon C. Aquino, executed Service Contract No. 38 with Occidental Philippines, Inc. and Shell Exploration B.V., the predecessors-in-interest of Shell Philippines Exploration B.V. (SPEX), PNOC Exploration Corporation (PNOC-EC), and Chevron Malampaya LLC (Chevron), collectively referred to as the Contractors. The Service Contract was entered into pursuant to Presidential Decree No. 87 (the Oil Exploration and Development Act of 1972), which was promulgated to hasten the discovery and production of indigenous petroleum through the utilization of government and/or private resources, local and foreign. Under the Service Contract, the Contractors assumed all exploration risks and were responsible for furnishing the necessary technology and financing. Section 7.3 of the Service Contract provides that 60% of the net proceeds of petroleum operations shall be remitted to the government, while Section 7.4 allots the remaining 40% to the Contractors. Section 12(a) of Presidential Decree No. 87 exempts the Contractors from all taxes except income tax, while Section 19 makes them liable for Philippine income tax on income derived from petroleum operations. Section 6.3 of the Service Contract implements these provisions by requiring the Office of Energy Affairs to assume and pay on behalf of the Contractors all income taxes payable to the Republic of the Philippines, with official receipts issued in the name of the Contractor.

On December 11, 1990, the Republic of the Philippines, represented by then President Corazon C. Aquino, executed Service Contract No. 38 with Occidental Philippines, Inc. and Shell Exploration B.V., the predecessors-in-interest of the Contractors—Shell Philippines Exploration B.V. (SPEX), PNOC Exploration Corporation (PNOC-EC), and Chevron Malampaya LLC (Chevron). The Service Contract, dubbed the Malampaya Natural Gas Project, was entered into pursuant to Presidential Decree No. 87, promulgated to hasten the discovery and production of indigenous petroleum through the utilization of government and/or private resources, local and foreign. Under the contract, the Contractors were responsible for executing all operations for searching and obtaining petroleum in the contract area, obliged to furnish the necessary technology and financing, and assumed all exploration risks without entitlement to reimbursement even if no petroleum in commercial quantity was discovered. The agreement was subject to the control and supervision of the then Office of Energy Affairs, now the Department of Energy (DOE).

Section 7.3 of the Service Contract provides that 60% of the net proceeds of petroleum operations shall be remitted to the government, while Section 7.4 allots the remaining 40% to the Contractors as a retention fee. Under Section 12(a) of Presidential Decree No. 87, the Contractors are exempted from payment of all taxes except income tax, and Section 19 makes them liable each taxable year for Philippine income tax on income derived from petroleum operations. These provisions are operationalized in Section 6.3 of the Service Contract, which requires the Office of Energy Affairs to assume and pay on behalf of the Contractor and its parent company all income taxes payable to the Republic of the Philippines, and to furnish the Contractor with official receipts issued in the Contractor's name. From the start of commercial operations in 2002 through 2009, the 60% Philippine government share in the net proceeds included the corporate income taxes of the Contractors.

During a post-audit in 2004, DOE Supervising Auditor Dolores T. Barraza noted that the corporate income taxes of the Contractors were being deducted from the government's share. She issued Audit Observation Memorandum No. 2004-006, highlighting that the inclusion of corporate income taxes in the government's share from January 2002 to November 2003 resulted in an understatement of government revenue worth PHP 2.63 billion. Auditor Barraza computed the total undercollection of the 60% government share from service income up to December 2009 at PHP 53,140,304,739.86. She then issued Notice of Charge No. 2010-01-151(09) on October 5, 2010, identifying as liable Thelma M. Cerdeña, Chief of the DOE Compliance Division; Nora A. Tuazon, Officer-in-Charge of the DOE Financial Services; and the Contractors.

DOE, SPEX, PNOC-EC, and Chevron sought recourse before the COA, which denied their appeal. They elevated the matter to COA Proper via Petitions for Review, but COA denied the petitions in the assailed Decision No. 2015-115, declaring that the income taxes of the Contractors should not have been part of the 60% government share. COA disputed the Contractors' argument that the government assumed their income taxes and demanded that they settle their back taxes under the Service Contract. DOE and the Contractors' bid for reconsideration was denied in Decision No. 2018-075. Meanwhile, during the pendency of the Supreme Court petitions, the OSG informed the Court of two international arbitration cases: ICSID Case No. ARB/16/22, still pending, and ICC Case No. 21096/CYK/PTA. The ICC issued its Partial Final Award on April 16, 2019, and its Final Award on December 16, 2019, both upholding the validity of the tax assumption mechanism in the Service Contract.

• Inclusion of Income Taxes in Government Share: Petitioners argued that Presidential Decree Nos. 87, 1206, and 1459 clearly and unambiguously provide that the Contractors' income taxes are included in the government's 60% share in the net proceeds, as the laws expressly state that the government's share includes "all taxes paid by or on behalf of the Contractor."
• Validity of Tax Assumption: Petitioners maintained that the tax assumption mechanism under Section 6.3 of the Service Contract is valid and not tantamount to a tax exemption, as the obligation to pay income tax remains with the Contractors and is merely assumed by the government on their behalf.
• Legislative Intent: Petitioners contended that the intent of Presidential Decree No. 87, as confirmed by former Prime Minister Cesar Virata, former DOE Secretary Raphael Perpetuo Lotilla, and former DOE Undersecretary Rufino Bomasang, was to adopt a tax assumption system to attract foreign investment by providing fiscal stability and enabling foreign contractors to claim tax credits in their home jurisdictions.
• Personal Liability of DOE Officials: Petitioners Cerdeña and Tuazon argued that they should not be personally held liable for the Notice of Charge, as the tax assumption mechanism was lawful and consistently applied.

• No Statutory Basis for Inclusion: Respondent COA argued that there was no provision in the law specifically providing that the income taxes of the Contractors would be part of the government's share.
• Sovereign Prerogative to Tax: Respondent postulated that Section 6.3 of the Service Contract infringes upon the sovereign prerogative of the Government to impose tax or exempt a class from taxation, and therefore the tax assumption provision is not valid and enforceable.
• Demand for Back Taxes: Respondent demanded that the Contractors settle their back taxes under the Service Contract, asserting that the government's assumption of the Contractors' income taxes was improper.

• Government Share Composition: Whether the Government's 60% share under Presidential Decree Nos. 87 and 1459 includes the Contractors' income taxes.
• Validity of Tax Assumption: Whether the tax assumption mechanism under Section 6.3 of Service Contract No. 38 is valid and enforceable, or whether it constitutes an unconstitutional tax exemption.
• Personal Liability: Whether the Contractors and petitioners Cerdeña and Tuazon should be personally held liable for the Notice of Charge.

• Government Share Composition: Yes. The governing laws—Presidential Decree Nos. 87, 1206, and 1459—expressly state that the government's share includes "all taxes paid by or on behalf of the Contractor," and the word "include" admits of no other interpretation.
• Validity of Tax Assumption: Yes. Tax assumption is distinct from tax exemption; the obligation to pay remains with the Contractor and is merely passed on to the government, so constitutional restrictions on tax exemptions do not apply.
• Personal Liability: No. Because the Notice of Charge was issued with grave abuse of discretion amounting to lack or excess of jurisdiction, Cerdeña and Tuazon are absolved from any liability, as are the Contractors.

• Government Share Composition: COA committed a patent mistake in finding that no provision of law specifically includes the Contractors' income taxes in the government's share. Section 18(b) of Presidential Decree No. 87 provides that "in no case shall the annual net revenue or share of the Government, including all taxes paid by or on behalf of the Contractor, be less than sixty per cent of the difference between the gross income and the sum of operating expenses and Filipino participation incentive." Section 12(a)(i)(2) of Presidential Decree No. 1206 and Section 1(a) of Presidential Decree No. 1459 invariably echo this language. The word "include" means "to take in or comprise as a part of a whole or group" and leaves no room for any other interpretation. Under the plain-meaning rule or verba legis, the words used must be given their ordinary meaning. Even assuming interpretation were necessary, the intent of the law is the most dominant influence: former Prime Minister Virata, Secretary Lotilla, and Undersecretary Bomasang all confirmed that the tax assumption system was intended to attract foreign investment by providing fiscal stability and enabling foreign contractors to claim tax credits in their home jurisdictions—something a mere tax exemption would not achieve. From the standpoint of the Philippine Government, tax assumption has the same financial consequence as a tax exemption because under both, the government gets its full 60% share. The correct interpretation is that the Contractor is liable to pay income tax, but the Contractor's income tax forms part of or is counted in the government's 60% share.

• Validity of Tax Assumption: COA's postulation that Section 6.3 of the Service Contract infringes upon the sovereign prerogative to tax is untenable. "Exemption" is defined as "freedom from a duty, liability, or other requirement," and is not favored, never presumed, and must be categorically expressed; the Constitution requires that no law granting any tax exemption shall be passed without the concurrence of a majority of all Members of Congress. "Assumption," by contrast, is the "act of taking (especially someone else's debt or other obligation) for or on oneself," meaning the obligation remains, although it is passed on to a different person. The concept of assumption is therefore distinct from and not synonymous to exemption; constitutional provisions on tax exemptions do not apply. In Republic vs. City of Kidapawan, the Court upheld a similar tax assumption provision in a geothermal service contract, holding that although the government actually pays the income taxes, the contract specifically provided that the payment is for and in behalf of the contractor and is chargeable against the 60% government share—the contractor is the actual payee while the government is only its agent. In Mitsubishi Corp.-Manila Branch vs. Commissioner of Internal Revenue, the Court ruled in favor of a private contractor's claim for tax refund by virtue of a tax assumption clause in an Exchange of Notes between Japan and the Philippines, distinguishing tax exemption from tax assumption and holding that constitutional provisions on tax exemptions do not apply to the latter. The language of Section 6.3 of Service Contract No. 38 closely mirrors the tax assumption provision upheld in Mitsubishi. Additionally, the ICC Arbitral Tribunal, in its Partial Final Award and Final Award in ICC Case No. 21096/CYK/PTA, upheld the validity of the tax assumption mechanism, finding that the tax is paid to the government of the Philippines albeit by the DOE, that there is no diminution of the government's 60% share, and that tax assumption is a form of tax avoidance which is allowed in the Philippines. Given that state policy favors arbitration, the Court must give due respect to the ICC's categorical finding.

• Personal Liability: Because the Notice of Charge was issued by COA with grave abuse of discretion amounting to lack or excess of jurisdiction, a discussion on the liability of Cerdeña and Tuazon becomes superfluous. They are absolved from any liability under the Notice of Charge, as are the Contractors.

• Tax Assumption vs. Tax Exemption — Tax exemption is "freedom from a duty, liability, or other requirement" and is not favored, never presumed, and must be categorically expressed; constitutional provisions require concurrence of a majority of all Members of Congress for any law granting tax exemption. Tax assumption is the "act of taking (especially someone else's debt or other obligation) for or on oneself," meaning the obligation or liability remains, although it is merely passed on to a different person. The concept of assumption is distinct from and not synonymous to exemption; constitutional restrictions on tax exemptions do not apply to tax assumption. The Court applied this doctrine to uphold Section 6.3 of Service Contract No. 38, finding that the government's assumption of the Contractors' income taxes is not a tax exemption but a valid assumption, and therefore does not infringe upon the sovereign prerogative to tax.

• Plain-Meaning Rule (Verba Legis) — Wherever possible, the words used in the law must be given their ordinary meaning except where technical terms are employed. The Court applied this rule to the phrase "including all taxes paid by or on behalf of the Contractor" in Presidential Decree Nos. 87, 1206, and 1459, holding that the word "include" means "to take in or comprise as a part of a whole or group" and leaves no room for any other interpretation.

• Deference to Administrative Findings; Exception for Grave Abuse of Discretion — Courts consistently accord considerable deference to the factual findings of administrative bodies vested with expertise in their respective fields; absent a showing of substantial evidence that such findings were premised on a misapprehension or misapplication of the evidence on record, they are deemed final, conclusive, and binding. However, when COA has acted without or in excess of jurisdiction, or with grave abuse of discretion amounting to lack or excess of jurisdiction, its findings may be set aside. The Court found this case to be a rare exception warranting overturning COA's factual and legal findings.

• State Policy Favoring Arbitration — Arbitration agreements are liberally construed in favor of proceeding to arbitration. Given that state policy favors arbitration, the exhaustive contribution of foreign arbitral tribunals such as the ICC is invaluable in resolving disputes. The Court gave due respect to the ICC's categorical finding upholding the validity of the tax assumption mechanism.

• "All the above quoted laws governing oil exploration and development industry in the Philippines clearly and unambiguously state that the Government's share includes all taxes. As the word include means 'to take in or comprise as a part of a whole or group' or 'to contain between or within' and leaves no room for any other interpretation, it becomes the duty of the Court to apply the law as it is worded." — This passage articulates the ratio decidendi on the first issue: the plain and unequivocal language of the governing presidential decrees compels the conclusion that the Contractors' income taxes are included in the government's 60% share.

• "From the foregoing perspective, it becomes quite clear that contrary to the standpoint of COA, the concept of an assumption is distinct and not synonymous to an exemption. Considering that Section 6.3 of the Service Contract is not in the nature of a tax exemption, it therefore does not infringe upon the sovereign prerogative of the Government, and the constitutional provisions on tax exemptions do not find application." — This passage defines the controlling distinction between tax assumption and tax exemption and explains why the constitutional restrictions on tax exemptions are inapplicable to the Service Contract's tax assumption provision.

• "The correct interpretation, therefore, taking into consideration all the provisions of Presidential Decree No. 87, as well as its intent, is that: (a) the Contractor is liable to pay income tax, but (b) the Contractors' income tax forms part of or is counted in the Government's 60% share." — This passage synthesizes the Court's holding on the proper interpretation of the petroleum fiscal framework: the Contractor remains liable for income tax, but that tax is counted within the government's guaranteed 60% share of net proceeds.

• Republic vs. City of Kidapawan, 513 Phil. 440 (2005) — Followed. The Court relied on this case for the principle that a tax assumption provision in a service contract—where the government pays income taxes on behalf of the contractor chargeable against the government's 60% share—is valid. The Court noted that while the exemption from real property taxes was struck down, no such pronouncement was made against the government's assumption of the contractor's income taxes.

• Mitsubishi Corp.-Manila Branch vs. Commissioner of Internal Revenue, 810 Phil. 16 (2017) — Followed. The Court relied on this case for the definitive distinction between tax exemption and tax assumption, and for the ruling that constitutional provisions on tax exemptions do not apply to tax assumption. The Court found that the language of Section 6.3 of Service Contract No. 38 closely mirrors the tax assumption provision upheld in the Exchange of Notes in Mitsubishi.

• Melloria vs. Jimenez, 944 Phil. 300 (2023) — Cited for the scope of certiorari review over COA rulings and the principle that COA's findings may be set aside when it has acted without or in excess of jurisdiction, or with grave abuse of discretion.

• Macalino vs. Commission on Audit, 949 Phil. 517 (2023) — Cited for the plain-meaning rule or verba legis in statutory construction.

• Development Bank of the Phils. vs. Commission on Audit, 424 Phil. 411 (2002) — Cited for the principle that the intent of the law is the most dominant influence in its interpretation.

• Bases Conversion Dev't. Authority vs. DMCI Proj. Developers, Inc., 776 Phil. 192 (2016) — Cited for the principle that arbitration agreements are liberally construed in favor of proceeding to arbitration.

• Section 18(b), Presidential Decree No. 87 (Oil Exploration and Development Act of 1972) — Provides that "in no case shall the annual net revenue or share of the Government, including all taxes paid by or on behalf of the Contractor, be less than sixty per cent of the difference between the gross income and the sum of operating expenses and Filipino participation incentive." The Court held that this provision expressly includes the Contractors' income taxes in the government's 60% share.

• Section 12(a), Presidential Decree No. 87 — Exempts the Contractors from payment of all taxes except income tax. The Court noted that while the Contractors are exempt from other taxes, they remain liable for income tax on income derived from petroleum operations.

• Section 19, Presidential Decree No. 87 — Provides that the Contractors shall be liable each taxable year for Philippine income tax on income derived from petroleum operations, computed based on Sections 20 to 25 of the same law. The Court confirmed that the Contractors' income tax liability remains, but is assumed and paid by the government as part of its 60% share.

• Section 12(a)(i)(2), Presidential Decree No. 1206 — Emodies the phrase "including all taxes paid by or on behalf of the contractor" in referring to the government's annual net revenue or share, echoing the language of Presidential Decree No. 87.

• Section 1(a), Presidential Decree No. 1459 — Provides that "[t]he share of the Government, including all taxes, shall not be less than sixty per cent of the difference between the gross income and the sum of operating expenses and such allowances as the Secretary of Energy may deem proper to grant." The Court found this provision invariably echoes the above-cited laws.

• Section 6.3, Service Contract No. 38 — Requires the Office of Energy Affairs to assume and pay on behalf of the Contractor and its parent company all income taxes payable to the Republic of the Philippines, with official receipts issued in the name of the Contractor. The Court upheld the validity of this provision as a tax assumption mechanism distinct from a tax exemption.

• Section 7.3, Service Contract No. 38 — Provides that 60% of the net proceeds of petroleum operations shall be remitted to the government. Read together with Section 6.3, the Court held that the Contractors' income taxes form part of this 60% government share.

• Section 7.4, Service Contract No. 38 — Allots to the Contractors the 40% retention fee of the net proceeds.

• Article VI, Section 28(4), 1987 Constitution — Provides that "[n]o law granting any tax exemption shall be passed without the concurrence of a majority of all the Members of the Congress." The Court held that this provision does not apply to tax assumption, which is distinct from tax exemption.

• Section XII, Service Contract No. 38 — Governs consultation and arbitration of disputes arising between the Office of Energy Affairs and the Contractor, providing for settlement by arbitration under the Rules of Arbitration of the International Chamber of Commerce. The Court cited this provision in connection with the ICC arbitral proceedings.

Gesmundo, C.J., Inting, Zalameda, M. Lopez, Gaerlan, Rosario, Marquez, Kho, Jr., and Singh, JJ., concurred. Caguioa, J., Hernando, J., and J. Lopez, J., filed separate concurring opinions. The text of the separate concurring opinions was not provided in the source material.

• Leonen, SAJ — A dissenting opinion was indicated, but the text of the dissent was not provided in the source material. The main points of disagreement cannot be summarized from the available text.