BIR Ruling No. OT-022-2024: Clarification on the Applicable Taxes Due on Termination Fee

On 11 April 2024, the Bureau of Internal Revenue (“BIR”) issued Ruling No. OT-022-2024 (“Ruling”), clarifying the applicability of value-added tax (“VAT”) and income tax on the termination fee to be received by Air Liquide Philippines, Inc. (“Air Liquide”) from Pilipinas Shell Petroleum Corporation (“Pilipinas Shell”) due to the termination of the Hydrogen Supply Agreement (“Subject Agreement”) previously entered into by the parties.

The Subject Agreement required Air Liquide to construct a Manufacturing Unit and Liquid Carbon Dioxide Plant on Pilipinas Shell’s refinery in Tabangao, Batangas. Construction began in 2020 and was scheduled for completion in the first quarter of 2021. However, in August 2020, Pilipinas Shell’s Board of Directors decided to cease refinery operations and close its Tabangao refinery. Consequently, the parties executed a Termination Agreement whereby Pilipinas Shell agreed to pay Air Liquide a termination fee of USD 36,500,000, subject to the latest reference Bangko Sentral ng Pilipinas exchange rate at the invoice dates (January 25, 2021, and January 25, 2022).

In this Ruling, the BIR emphasized that VAT is levied on any individual, trust, estate, partnership, corporation, joint venture, cooperative, or association on the sale, barter, exchange, lease, rendering of service, or importation of goods, as delineated by Section 105 of the National Internal Revenue Code of 1997 (the “Tax Code”), as amended. Furthermore, the Tax Code aligns with Sections 4.105-1 and 4.105-2 of Revenue Regulations (“RRs”) No. 16-2005, as amended. These RRs correspond to the VAT liability as a tax on consumption imposed on any person who, in the course of their trade or business, sells, barters, exchanges, or leases goods or properties, renders services, or imports goods.

In this case, beyond indemnification for contractual breach and obligations under the Subject Agreement and early termination, the proceeds from the Termination Agreement represent full compensation for costs, expenses, efforts, and other claims related to the Hydrogen Manufacturing Unit and the Liquid Carbon Dioxide Plant. It constitutes a settlement for underlying payment for services rendered by Air Liquide, payment that has not yet been received. Therefore, VAT is imposed since it is relevant to taxpayer Air Liquide’s course of trade or business.
Notably, the BIR also highlighted Section 27(A) of the Tax Code, which imposes a 25% income tax on the taxable income derived during each taxable year by domestic corporations (those organized in, or existing under the laws of the Philippines) from all sources within and without the Philippines. In this context, income, as interpreted in the case of CIR v. Filinvest, means “the amount of money coming to a person within a specific time or something distinct from principal or capital.” Additionally, the BIR ruled that the definition of income is broad enough to encompass the termination fee resulting from the Subject Agreement breach, making it subject to regular income tax.