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As early as the 1970s, the Philippines had set its sights on promoting the discovery of indigenous petroleum resources, given its heavy reliance on imported fuel for its energy needs. In 2003, the Department of Energy (DOE) ushered in a new era of energy resource development through the Philippine Energy Contracting Round (PECR), a bidding process offering multiple exploration blocks within Philippine territory to revitalise the upstream oil and gas industry.

However, efforts to pursue investor interest hit a snag in 2010, when the Commission on Audit (COA), the government’s auditing watchdog, slapped the DOE with a notice of disallowance in relation to Petroleum Service Contract No. 38 (SC 38), the Malampaya Deep Water Gas-to-Power Project, opening possible floodgates for similar claims against other existing petroleum service contractors.

This move spooked explorationists, who decided to move away from the Philippines as a prospect for fossil fuel search. In February 2025, the Supreme Court finally laid to rest this issue and ruled that the tax assumption clause under SC 38 expressly allows contractor’s income taxes as part of the 60% share of the Philippine government. The uncertainty was removed.

SC 38 provides for, among others, the following terms and conditions:

1. From the petroleum in commercial quantity discovered and produced, there shall be remitted to the government, through the contractor, an amount equal to 60% of the net proceeds;
2. The contractor shall retain an amount equal to its fee of 40% of the net proceeds;
3. The contractor is granted exemption from all taxes except income tax; and
4. While the contractor is not exempt from Philippine income tax, the government agreed to assume and pay the same.

SC 38 specifically provides that the DOE, on behalf of the government, “shall assume and pay on behalf of the contractor all income taxes payable to the Republic of the Philippines based on income and profits”. As proof of such tax assumption, the DOE shall “promptly furnish to the contractor, without fee or other consideration, the official receipts issued in the name of the contractor by any duly empowered government authority, acknowledging the payment of said taxes”.

SC 38 facilities were commissioned in 2001 and commenced commercial operations in 2002. SC 38 supplies natural gas to fuel at least four major gas power plants in the Philippines comprising at least 3,000MW. Until 2022, the power plants fuelled by natural gas from SC 38 provide up to 40% of the electrical power requirement in Luzon.

Commission on Audit claim

In 2004, the COA issued an audit observation against the DOE for purported “understatement of revenues”. The COA claims that there was an under-collection of government share by almost USD1 billion resulting from the deduction of corporate income taxes of SPEX, Chevron and PNOC EC from the 60% government share.

In 2010, despite the DOE’s explanation, the COA issued a notice of charge holding DOE officials liable for non-collection of income taxes; and SPEX, Chevron and PNOC EC for alleged non-payment of income taxes. The appeal of the SC 38 contractors and DOE officials to the COA fell on deaf ears, forcing the elevation of the case to the Philippine Supreme Court.

Supreme Court ruling

In the view of the Supreme Court, the COA acted with grave abuse of discretion when it held the DOE officials and SC 38 contractors liable for income taxes. The Supreme Court pointed out several provisions of PD 87 (Presidential Decree No. 87, or the Oil Exploration and Development Act of 1972) and its predecessors, PD 1206 and PD 1459, which invariably declared that the 60% government share includes “all taxes paid by or on behalf of the contractor”.

Using the verba legis (plain meaning) principle, where the words used must be given their ordinary meaning except where technical terms are employed, the Supreme Court pronounced that all these laws governing oil and gas exploration clearly and unambiguously state that the government’s share includes all taxes.

Given its policy of favouring arbitration, the Supreme Court also gave respect to the final award issued by the ICC Arbitral Tribunal, which upheld the validity of the tax assumption clause in SC 38. The Supreme Court also emphasised the importance of ensuring that the government abides by its obligations under SC 38, a contract it freely entered into and agreed to.

Except for the drilling of one petroleum contractor this year covering three small contract areas, the Philippines has been searching for victory in its battle for energy self-sufficiency. With the final gavel of the Supreme Court, hopefully the tide will turn and bring back foreign investors to Philippine shores.

Jose M Layug Jr is a senior partner at DivinaLaw in Metro Manila

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Contact details:
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