Smart Communications, Inc. vs. City of Davao

The phrase "in lieu of all taxes" in a legislative franchise does not automatically exempt a telecommunications company from local franchise taxes unless the franchise expressly and categorically states that the exemption applies to both national and local taxes; tax exemptions are construed strictissimi juris against the taxpayer and liberally in favor of the taxing authority, and Section 23 of RA 7925 does not extend to tax liabilities but only to regulatory or reporting requirements.

Smart Communications, Inc. operates a telecenter in Davao City pursuant to Republic Act No. 7294, its legislative franchise. The City of Davao imposes a franchise tax on businesses enjoying a franchise within its territorial jurisdiction under its local Tax Code. Smart sought to ascertain its rights regarding this local tax imposition, claiming exemption based on the tax provisions of its franchise and subsequent telecommunications legislation.

• Smart Communications, Inc. operates a telecenter in Davao City under Republic Act No. 7294, which grants it a legislative franchise to construct, install, establish, operate, and maintain telecommunications systems.
• Section 9 of RA 7294 imposes upon Smart a franchise tax equivalent to three percent (3%) of all gross receipts of the business transacted under the franchise, which shall be "in lieu of all taxes on this franchise or earnings thereof," with the proviso that Smart shall continue to be liable for income taxes under the National Internal Revenue Code.
• The City of Davao imposes a franchise tax on businesses enjoying a franchise within its territorial jurisdiction under its local Tax Code.
• On February 18, 2002, Smart filed a special civil action for declaratory relief (Rule 63, Rules of Court) before the RTC of Davao City to ascertain its rights and obligations under the City Tax Code, claiming that its telecenter was exempt from local franchise tax.
• The RTC denied the petition on July 19, 2002, ruling that Smart was liable for the local franchise tax, and subsequently denied Smart's Motion for Reconsideration on September 26, 2002.
• Smart appealed to the Supreme Court, which initially denied the appeal on September 16, 2008.
• In its Motion for Reconsideration, Smart raised four grounds: (1) the "in lieu of all taxes" clause in RA 7294 covers local taxes and the rule of strict construction against tax exemptions is inapplicable; (2) the clause was not rendered ineffective by the Expanded VAT Law; (3) Section 23 of RA 7925 includes a tax exemption; and (4) the imposition of local franchise tax violates the constitutional prohibition against impairment of contracts.

• The "in lieu of all taxes" clause in Section 9 of RA 7294 covers both national and local taxes, and the rule of strict construction against tax exemptions should not be applied to its interpretation.
• The "in lieu of all taxes" clause was not rendered ineffective by Republic Act No. 7716 (the Expanded VAT Law).
• Section 23 of RA 7925 (the Public Telecommunications Policy Act of the Philippines), known as the most favored treatment clause or equality clause, includes a tax exemption that should benefit Smart by extending to it any exemptions granted to other telecommunications entities.
• The imposition of local franchise tax by Davao City violates the constitutional prohibition against impairment of the obligation of contracts.

• N/A (The text does not explicitly detail specific arguments raised by the City of Davao and the Sangguniang Panlungsod, as the case originated from a declaratory relief action where Smart sought to establish its exemption, and the RTC ruled against the exemption based on existing law and jurisprudence.)

• Procedural Issues:
  • Whether the Supreme Court should grant the Motion for Reconsideration filed by Smart Communications, Inc. of the Decision dated September 16, 2008.
• Substantive Issues:
  • Whether the "in lieu of all taxes" clause in Section 9 of RA 7294 exempts Smart from the payment of local franchise tax.
  • Whether Section 23 of RA 7925 operates to exempt Smart from local franchise tax.
  • Whether the Expanded VAT Law (RA 7716) abolished the imposition of local franchise tax.
  • Whether the imposition of local franchise tax violates the constitutional prohibition against impairment of contracts.

• Procedural:
  • The Motion for Reconsideration is DENIED with finality.
• Substantive:
  • The "in lieu of all taxes" clause in a legislative franchise must categorically state that the exemption applies to both local and national taxes; otherwise, the exemption claimed must be strictly construed against the taxpayer and liberally in favor of the taxing authority. Smart's franchise (RA 7294) does not expressly and unequivocally exempt it from local franchise tax.
  • Section 23 of RA 7925 does not operate as a blanket tax exemption to all telecommunications entities. The word "exemption" as used in the statute refers merely to an exemption from regulatory or reporting requirements of the Department of Transportation and Communication or the National Transmission Corporation, and not to an exemption from the grantee's tax liability.
  • Republic Act No. 7716 (Expanded VAT Law) did not remove or abolish the payment of local franchise tax; it merely replaced the national franchise tax previously paid by telecommunications franchise holders with a ten percent (10%) VAT. VAT inures to the benefit of the national government, while a local franchise tax is a revenue of the local government unit.
  • The imposition of local franchise tax does not violate the constitutional prohibition against impairment of contracts. The power to tax by local government units emanates from Section 5, Article X of the Constitution, which empowers them to create their own sources of revenues and to levy taxes, fees, and charges subject to guidelines and limitations as Congress may provide.

• Strictissimi Juris (Strict Construction of Tax Exemptions) — Tax exemptions are highly disfavored and must be expressed in the statute in clear language that leaves no doubt of the legislative intent to grant such exemption; when granted, exemptions must be interpreted strictly against the taxpayer and liberally in favor of the taxing authority.
• "In Lieu of All Taxes" Clause Interpretation — For a franchise tax to be considered in lieu of all taxes including local taxes, the legislative franchise must expressly and categorically state that the exemption applies to both local and national taxes; absent such clear language, the exemption applies only to national taxes.
• Most Favored Treatment Clause (Equality Clause) — Section 23 of RA 7925 ensures equality of treatment in the telecommunications industry by extending any advantage, favor, privilege, exemption, or immunity granted under existing franchises to previously granted franchises, but this applies only to regulatory or reporting requirements, not to tax liabilities.
• Local Government Taxing Power — Local government units have the power to create their own sources of revenue and levy taxes, fees, and charges under Section 5, Article X of the Constitution, and this power is not inconsistent with the imposition of VAT by the national government.

• "tax exemptions are highly disfavored and that a tax exemption must be expressed in the statute in clear language that leaves no doubt of the intention of the legislature to grant such exemption"
• "the exemption must be interpreted in strictissimi juris against the taxpayer and liberally in favor of the taxing authority"
• "the word 'exemption' as used in the statute refers or pertains merely to an exemption from regulatory or reporting requirements of the Department of Transportation and Communication or the National Transmission Corporation and not to an exemption from the grantee's tax liability"
• "aside from the national franchise tax, the franchisee is still liable to pay the local franchise tax, unless it is expressly and unequivocally exempted from the payment thereof under its legislative franchise"
• "The 'in lieu of all taxes' clause in a legislative franchise should categorically state that the exemption applies to both local and national taxes; otherwise, the exemption claimed should be strictly construed against the taxpayer and liberally in favor of the taxing authority"
• "Republic Act No. 7716, otherwise known as the 'Expanded VAT Law,' did not remove or abolish the payment of local franchise tax. It merely replaced the national franchise tax that was previously paid by telecommunications franchise holders and in its stead imposed a ten percent (10%) VAT"
• "VAT inures to the benefit of the national government, while a local franchise tax is a revenue of the local government unit"

• Digital Telecommunications Philippines, Inc. (Digitel) v. Province of Pangasinan, G.R. No. 152534, February 23, 2007 — Cited for the ruling that Section 23 of RA 7925 cannot be used to claim exemption from local franchise tax when the franchise holder failed to substantiate its allegation of exemption.
• PLDT v. City of Davao, 415 Phil. 764 (2001) — Controlling precedent holding that Section 23 of RA 7925 did not intend to operate as a blanket tax exemption and that tax exemptions must be strictly construed.
• Philippine Long Distance Telephone Company (PLDT) v. Province of Laguna, G.R. No. 151899, August 16, 2005 — Applied the rule of strict construction of tax exemptions and held that Section 23 of RA 7925 did not amend PLDT's franchise to entitle it to exemption from local franchise taxes.
• PLDT v. City of Bacolod, G.R. No. 149179, July 15, 2005 — Cited as prior decision denying PLDT's claim for exemption from payment of local franchise tax.

• Section 9 of Republic Act No. 7294 — Contains the "in lieu of all taxes" clause in Smart's legislative franchise imposing a 3% franchise tax.
• Section 23 of Republic Act No. 7925 (Public Telecommunications Policy Act of the Philippines) — The "most favored treatment" or "equality of treatment" clause containing the word "exemption," interpreted by the Court as referring only to regulatory exemptions, not tax exemptions.
• Section 5, Article X of the 1987 Constitution — Grants local government units the power to create their own sources of revenue and levy taxes, fees, and charges.
• Republic Act No. 7716 (Expanded VAT Law) — Replaced the national franchise tax with VAT but did not abolish local franchise taxes.
• Section 108 of the National Internal Revenue Code — Cited in relation to the 10% VAT imposed on telecommunications services under RA 7716.