G.R. No. 155491 - Smart Communications, Inc. vs. City of Davao

Case Summary (G.R. No. 155491)

Factual Background

On February 18, 2002, Smart instituted a special civil action for declaratory relief before the RTC of Davao City, seeking the ascertainment of its rights and obligations under the Tax Code of the City of Davao, which imposes a franchise tax on businesses operating under a franchise within Davao City’s territorial jurisdiction. Smart asserted that its telecenter in Davao City was exempt from payment of franchise tax to the City.

The RTC denied Smart’s petition on July 19, 2002. Smart sought reconsideration, but the RTC denied the motion by order dated September 26, 2002. Smart then appealed to the Court, which denied the appeal by decision dated September 16, 2008. Smart subsequently filed a motion for reconsideration in which it reargued the legal questions concerning Section 9 of RA 7294, Section 23 of RA 7925, and the constitutionality of imposing a local franchise tax in light of the franchise contract clause.

Procedural History

The record shows the procedural sequence that culminated in the Court’s consideration of Smart’s motion for reconsideration. After the RTC decision and the denial of reconsideration, Smart appealed to the Court. The Court denied the appeal in a decision dated September 16, 2008. Smart then filed a motion for reconsideration, which the Court resolved in the resolution that denied the motion.

The Controlling Franchise and Statutory Provisions at Issue

The Court identified Section 9 of RA 7294 as the core source of Smart’s claimed exemption. The provision contains two relevant components. First, it states that the grantee is liable to pay the same taxes on real estate buildings and personal property as other persons or corporations required by law to pay such taxes “exclusive of this franchise.” Second, it provides a franchise tax equivalent to three percent (3%) of all gross receipts from business transacted under the franchise, specifying that this percentage “shall be in lieu of all taxes on this franchise or earnings thereof,” while also preserving liability for income taxes under Title II of the National Internal Revenue Code pursuant to Section 2 of Executive Order No. 72, unless later amended or repealed.

The other key provision was Section 23 of RA 7925, which the Court quoted as part of the telecommunications industry’s “equality of treatment” or “most favored treatment” concept. Section 23 provides that any advantage, favor, privilege, exemption, or immunity granted under existing franchises, or thereafter granted, shall ipso facto become part of previously granted telecommunications franchises and shall be accorded immediately and unconditionally. The proviso limits the operation of the clause as it excludes matters concerning franchise territory, the life span of the franchise, or the type of service authorized.

Smart’s Grounds for Reconsideration

Smart’s motion for reconsideration presented several grounds. First, it argued that the “in lieu of all taxes” clause in Smart’s franchise under RA 7294 covers local taxes and that the rule of strict construction against tax exemptions should not apply. Second, it contended that the clause was not rendered ineffective by the Expanded VAT Law. Third, it invoked Section 23 of RA 7925 and claimed that it includes a tax exemption. Fourth, it maintained that imposing a local franchise tax on Smart would violate the constitutional prohibition against impairment of the obligation of contracts.

In framing these arguments, Smart again placed Section 9 of RA 7294 and Section 23 of RA 7925 at the center of the dispute, insisting that the legal effect of the “in lieu of all taxes” clause, as reinforced by the “equality” provision, should exempt it from local franchise tax liability imposed by the City.

Prior Jurisprudence Reviewed by the Court

The Court treated the resolution of Smart’s claims as requiring reference to established rulings on telecommunications franchise tax exemptions and the meaning of “exemption” in Section 23 of RA 7925.

First, the Court cited Digital Telecommunications Philippines, Inc. (Digitel) v. Province of Pangasinan. In that case, Digitel used the “in lieu of all taxes” clauses and provisos in telecommunications franchises, including those of Smart and other entities, in an attempt to claim exemption from provincial franchise tax. The Court in Digitel denied the exemption claim for failure to substantiate the allegation that Smart had been exempted from local franchise tax.

Second, the Court reiterated its ruling in PLDT v. City of Davao, which had held that Congress, in approving Section 23 of RA 7925, did not intend it to operate as a blanket tax exemption for all telecommunications entities. The Court ruled that Section 23 could not be considered as amending PLDT’s franchise so as to entitle it to exemption from local franchise taxes. It further emphasized the disfavored character of tax exemptions and required that a tax exemption be expressed in clear language leaving no doubt as to legislative intent. It also required strict construction of tax exemptions against the taxpayer and liberal construction in favor of the taxing authority. In addition, the Court clarified that the “exemption” referred to in Section 23 pertains to exemption from regulatory or reporting requirements of the Department of Transportation and Communications or the National Transmission Corporation, rather than an exemption from the grantee’s tax liability.

Third, the Court discussed PLDT v. Province of Laguna, where the Court addressed whether a telecommunications entity holding a franchise containing an “in-lieu-of-all taxes” clause was liable for franchise tax to the Province of Laguna in view of Section 23 of RA 7925. The Court, applying strict construction of tax exemption laws and the rule that doubts are resolved in favor of municipal corporations in interpreting provisions on municipal taxing powers, ruled that Section 23 could not be regarded as amending the franchise to exempt it from local franchise taxes. The Court in PLDT v. Province of Laguna relied on prior decisions including PLDT v. City of Davao and PLDT v. City of Bacolod, which had denied similar exemption claims.

From these decisions, the Court synthesized an overarching principle: besides any national franchise tax, the franchisee remained liable to local franchise tax unless its legislative franchise expressly and unequivocally exempted it from local franchise tax. The Court further stated that 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 claimed exemption would be strictly construed against the taxpayer and liberally in favor of the taxing authority.

The Court’s Treatment of the Expanded VAT Law Argument

Smart also relied on the proposition that the Expanded VAT Law had rendered ineffective the “in lieu of all taxes” clause or, at least, the claimed exemption from local franchise tax. The Court rejected this approach. It held that Republic Act No. 7716, known as the Expanded VAT Law, did not remove or abolish local franchise tax. It explained that the Expanded VAT Law replaced the national franchise tax previously paid by telecommunications franchise holders and in its place imposed VAT pursuant to Section 108 of the Tax Code. Thus, while VAT replaced the national franchise tax, it did not prohibit or abolish the imposition of local franchise tax by cities or municipalities.

The Court grounded this reasoning on local taxing power derived from Section 5, Article X of the Constitution, under which local government units could create their own sources of revenue and levy taxes, fees, and charges subject to guidelines and limitations Congress may provide. The Court stated that the imposition of local franchise tax was not inconsistent with VAT’s advent. It characterized the franchise tax as a revenue of the local government unit, while VAT inured to the benefit of the national government. Therefore, the expanded VAT regime did not extinguish the local franchise tax authority in question.

Legal Basis and Reasoning for Denial of the Motion for Reconsideration

The Court, in resolving the motion for reconsideration, a

Case Syllabus (G.R. No. 155491)

Smart Communications, Inc. filed a Motion for Reconsideration seeking reversal of a prior decision dated September 16, 2008 that denied its appeal.
The respondents were the City of Davao, represented by its Mayor Hon. Rodrigo Duterte, and the Sanggunian Panlungsod of Davao City.
The motion challenged the lower courts’ rejection of Smart’s claim of exemption from local franchise tax despite its legislative franchise under Republic Act No. 7294 (RA 7294).

Parties and Procedural Posture

Smart instituted a special civil action for declaratory relief before the Regional Trial Court (RTC) of Davao City on February 18, 2002.
The RTC rendered a Decision on July 19, 2002 denying Smart’s petition.
The RTC subsequently issued an Order dated September 26, 2002 denying Smart’s motion for reconsideration.
Smart appealed to the Court, which denied the appeal by a Decision dated September 16, 2008.
Smart then filed the present Motion for Reconsideration, raising grounds centered on the construction and effect of the “in lieu of all taxes” clause in its franchise and the most favored treatment clause in Section 23 of RA 7925.

Key Factual Allegations

Smart sought a declaration of its rights and obligations under the Tax Code of the City of Davao, which imposed a franchise tax on businesses enjoying a franchise within Davao City.
Smart alleged that its telecenter in Davao City was exempt from payment of franchise tax to the City.
Smart anchored its exemption theory on its legislative franchise under RA 7294, particularly Section 9 containing the “in lieu of all taxes” clause.
The trial court and appellate court rulings rejected Smart’s exemption claim, leading to the filing of this motion for reconsideration.

Statutory Provisions Involved

Section 9 of RA 7294 required the grantee to pay the same taxes on real estate buildings and personal property as other persons or corporations required by law to pay.
Section 9 of RA 7294 also imposed a franchise tax equivalent to three percent (3%) of gross receipts from business transacted under the franchise.
Section 9 of RA 7294 stated that the three percent (3%) franchise tax “shall be in lieu of all taxes on this franchise or earnings thereof.”
Section 9 of RA 7294 included a proviso that the grantee would continue to be liable for income taxes payable under Title II of the National Internal Revenue Code pursuant to Section 2 of Executive Order No. 72, unless amended or repealed.
Section 23 of RA 7925 provided an equality or most favored treatment clause by stating that any advantage, favor, privilege, exemption, or immunity granted under existing or future franchises would ipso facto become part of previously granted franchises and be accorded immediately and unconditionally, subject to exceptions for territory, franchise life span, or type of service.

Central Legal Issues

The motion raised the question whether the “in lieu of all taxes” clause in RA 7294 covered local taxes.
Smart also questioned whether the rule of strict construction against tax exemptions should apply to its franchise’s tax treatment.
The motion further asked whether the “in lieu of all taxes” clause remained effective notwithstanding the enactment of the Expanded VAT Law.
The motion invoked Section 23 of RA 7925, contending that it included a tax exemption benefiting telecommunications franchise holders.
The motion also raised a constitutional contract impairment theory, asserting that imposing a local franchise tax on Smart would violate the prohibition against impairment of the obligation of contracts.

Arguments Raised by Smart

Smart argued that the “in lieu of all taxes” clause in RA 7294 covered local taxes, and it invoked the view that the strict construction rule for tax exemptions should not apply.
Smart contended that Section 23 of RA 7925 incorporated or extended the franchise exemption through its most favored treatment mechanism.
Smart maintained that the Expanded VAT Law did not render its franchise tax clause ineffective, asserting that its tax treatment should still govern despite changes in national taxation.
Smart further argued that imposing local franchise tax would impair the obligation of its legislative franchise contract under constitutional principles.
Smart directly put in issue Section 9 of RA 7294 and Section 23 of RA 7925 as the controlling statutory bases for its exemption theory.

Jurisprudential Backdrop

The Court treated the matter as requiring resolution in light of prior rulings on telecommunications franchise tax exemptions and the meaning of “exemption” in Section 23 of RA 7925.
In Digital Telecommunications Philippine