Limits of the nonimpairment clause

The Duterte administration’s plan to include in the second package of its tax reform program the reduction of the tax privileges that some businesses are presently enjoying has met opposition from the Philippine Economic Zone Authority (Peza).

Under the proposal, those perks shall be good only up to a certain number of years, after which the affected companies shall be governed by new tax rules. The longer a company has availed of the tax incentives, the shorter the transition period.

If Congress agrees to this arrangement, the companies registered under Peza would be obliged to give up some of the tax breaks they earlier received as a come-on to operate in Peza’s economic zones.

Peza believes the proposal is unconstitutional because it would violate the constitutional provision on inviolability of contracts, which states that “no law impairing the obligations of contracts shall be passed.”

The objective of the nonimpairment clause is to safeguard the integrity of contracts between parties, which includes the government, from unwarranted interference by the State.

Thus, as a rule, Congress cannot enact laws that would alter, modify or amend the rights and obligations of the parties in contracts that have been validly entered into.

The prohibition applies regardless of the manner by which the impairment is done, i.e., by way of an executive order, administrative regulation, or city or municipal ordinance.

An impairment arises if the terms of the contract are changed, new conditions are imposed, existing provisions are cancelled, or remedies for the enforcement of the parties’ rights are modified.

At first blush, Peza’s opposition to the reduction or withdrawal of the tax privileges it has, by way of written contracts, granted to the companies it invited to operate in its zones appears to have legal basis.

Peza’s opposition does not come as a surprise. The application of the nonimpairment clause is often questioned in the Supreme Court whenever a law or ordinance is enacted, or a government office issues an order, that tends to alter or amend contracts between private parties and government entities.

In the 2010 case of “Surigao del Norte Electric Cooperative vs Energy Regulatory Commission,” the high court clarified the generally held belief that this clause is absolute.

It ruled that: “It has long been settled that police power legislation adopted by the State to promote the health, morals, peace, education, good order, safety, and the general welfare of the people prevail not only over future contracts but even over those already in existence, for all private contracts must yield to the superior and legitimate measures taken by the State to promote public welfare.”

Stripped of verbiage, it means the rule on inviolability of contracts may be set aside if the objective is to promote the welfare of the people. Thus, when there is a conflict between public and private interests, the latter has to yield even if they are covered by written agreements.

In the case of Peza-registered companies, the argument can be made that the additional revenues that will be raised from such action would redound to the best interests of the public in the form of, say, improved infrastructure projects and additional cash assistance to indigent families.

Aside from the “public welfare” justification, also going in favor of the government on this issue is the long standing doctrine that “taxes are the lifeblood of the government.” Following this principle, any doubts about the validity of a tax is resolved in favor of the government, while tax exemptions are strictly construed against their claimants.

Whether or not the reduction or withdrawal of the tax privileges will result in the pullout of the businesses that would be adversely affected by such action is a different story.

Bottom line, based on existing jurisprudence, there appears to be no legal or constitutional impediment to the move to streamline tax arrangements with businesses that may have already overstayed the government’s tax hospitality.

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