Tough love from regulators

MWSS, water firms clash over taxes, disallowed expenses

SUBMITTING DOCUMENTS to government regulators is usually a routine matter assigned to messengers who hand over the parcels, and get a receipt in return.

But when Manila Water Corp. sent almost 30 boxes of financial records and documents to the Regulatory Office of the Metropolitan Waterworks and Sewerage System (MWSS) a few minutes before the close of office hours last Friday, what should have been a mundane delivery turned into a mini-crisis of sorts.

Water regulators hesitated to accept the delivery because they were initially told to expect just around 10 boxes.

“We’ve been asking for these documents in the past several months, and they kept delaying submission until now,” complained an irate staff at the Regulatory Office to a colleague. “And then they send us a lot more boxes than expected.”

The tense episode highlights the brewing conflict between MWSS and its two concessionaires, Manila Water Corp. of the Ayala family and Maynilad Water Services Inc. of the Metro Pacific and Consunji groups. The row stems from the water agency’s recent moves to adopt a stricter interpretation of the terms and conditions of the 1997 concession agreement that privatized the operation of the water system in Metro Manila and surrounding towns and cities.

The two water companies are seeking to raise average water rates further in the next five years as part of the MWSS rate-rebasing review. Held once every five years, the review essentially leads to a resetting of basic rates to allow the concessionaires to recover past costs and align tariffs with future plans.

This month, the MWSS is expected to announce water rate adjustments. The new rates are supposed to take effect next month. Consumer groups have asked the Supreme Court to freeze water rates, with a plea for a temporary restraining order, but the tribunal has not acted on their plea.

Maynilad Water wants to increase average basic rates by P8.58 per cubic meter or 25 percent to P42.55 per cubic meter. Manila Water is proposing a rate hike of P5.83 per cubic meter or 21 percent to P34.12 per cubic meter.

MWSS had conducted two rate-rebasing reviews since the national capital region’s water system was privatized in 1997, and both resulted in huge increases in water rates. Rate rebasing is not the only source of rate adjustments. But it has triggered the biggest rate hikes that accounted for 40 to 50 percent of the two water firms’ total rate increases from 1997 to 2013, according to MWSS data. Water tariffs are also adjusted every year to take into account consumer price movements, and once every quarter to reflect foreign exchange rate changes.

Rising water bills

These days, though, consumers may not necessarily be having bigger water bills as a result of all these.

“We have seen indications that perhaps there is a justification that rates will go up but we have also seen many indications that suggest that maybe it’s not going to go up,” MWSS regulatory chief Emmanuel Caparas said in a public consultation last June 13. “Maybe it’s going to stay the same or even go down.”


In the past, water regulators had also disallowed some of the water companies’ expenses claims, but the impact on rate increases was minimal. This time, the combined effect of disallowances, the prohibition against passing on income taxes to customers, and lower applied discounted rate or guaranteed return due to declining cost of capital could be substantial so that water rates could even be lower instead of higher, said Caparas.

In large part, the disallowances have been prompted by what MWSS regulators themselves have described as a rate-rebasing process that is vastly different from past reviews. Regulators have adopted a stricter review of the water companies’ expenses and future plans used as basis to reset water rates.

Detailed audit

In the last two rate-rebasing reviews, former regulators carried out what is called “table audit,” or checking if an expense was allowable or not based largely on the description of the item. By comparison, the current audit is more detailed and exacting, regulators said.

“We went down to the level of the transaction documents such as vouchers and receipts,” said Caparas. The process required auditors to review tens of thousands of records and documents. Expenses that could not be supported by documents were disallowed.

The water companies are now chafing under the MWSS regulators’ stricter approach and demand for detailed documentation.

“We were taken by surprise,” said Manila Water’s chief strategist Ferdinand de la Cruz on the sidelines of a public consultation. “It’s not how it was done in the past. We would have appreciated being given advance notice.”

Maynilad’s chief financial officer Randolph Estrellado meanwhile said that they had a hard time looking for vouchers for expenses from two or three years ago.

Caparas explained that the essence of a regulatory audit is a detailed review of expenses used in setting rates. “Our mandate is to regulate and in regulation, yes, it’s strict, but it’s our job,” he said. “You can’t tell a COA (Commission on Audit) auditor, please don’t examine the documents anymore.”

Income taxes

An early casualty of the MWSS regulators’ tougher posture is the water companies’ ability to pass on corporate income taxes to their customers. In a resolution approved June 7, the Regulatory Office executive committee declared that income taxes are not among the expenses the 1997 concession agreement allows the water companies to recover from water rates. It urged the MWSS Board of Trustees to rescind a July 2004 resolution that allowed the concessionaires to pass on income taxes to customers.

The question of whether or not the two water companies can pass on income taxes to their customers goes back to 2004, two years after the Supreme Court issued a landmark ruling disallowing the Manila Electric Co. (Meralco) as a public utility from including its income taxes in electricity rates. The high court’s ruling forced Meralco not only to cut rates, but also to refund up to P28 billion to customers.

In March 2004, the MWSS Regulatory Office tried to apply the Meralco ruling, believing that the two concessionaires are public utilities like Meralco, and moved to cut Manila Water’s rates. (Maynilad was losing money at that time and didn’t pay income taxes.) But the MWSS Board of Trustees then did not support the position of its regulatory unit. Instead, it formed a technical working group composed of MWSS officials and water company representatives to study the matter.

The technical working group (TWG) took the view that the concessionaires are not public utilities but are mere agents of MWSS. In July 2004, the Regulatory Office adopted the TWG report and rescinded its previous resolution. The MWSS Board also issued a resolution adopting the TWG report.

Can’t pass on taxes

Today’s water regulators are putting forward new arguments to support the view that the concessionaires cannot pass on income taxes to customers.

First, income taxes are not included in the term “Philippine business taxes” listed by the 1997 Concession Agreement among the recoverable expenses.

Second, income tax is a tax on the privilege of earning income and should therefore be borne by concessionaires as the taxpayers.

Third, although they are not public utilities, the same laws and rules applicable to their principal, the MWSS, bind the water companies.

It remains to be seen if the current MWSS Board of Trustees will support the Regulatory Office’s position. But even if the regulators’ resolution is upheld, the full implications of the decision are still unclear. For example, will it only apply prospectively starting 2013, or retroactively as well?

Manila Water, whose income tax holiday ended in 2006, has effectively been passing on its income taxes to consumers from 2007 to 2012, said water regulators. Its total provision for income taxes during the six-year period was P7.3 billion, according to the company’s annual reports submitted to the Philippine Stock Exchange.

Maynilad, which was losing money for a number of years, enjoys an income tax holiday until 2016. The rates approved for Maynilad, however, included a provision for income taxes as its income tax holiday was approved after the rates were set in 2008. Its provision for income taxes amounted to only P1.7 billion from 2007 to 2011, the latest available filed with the Securities and Exchange Commission.

Lower rate hike

Still, unlike Meralco, the two water companies are unlikely to refund customers. Instead, Caparas said, the disallowed amounts will just be deducted from recoverable expenses, lowering prospective rate increases.

And while the MWSS resolution on income taxes will cut water rate adjustments, regulators cannot yet say if it is big enough to actually lower prevailing rates or may simply temper tariff increases. The regulators also have to adjust the applied discount rate (ADR), the guaranteed return that water companies are allowed to earn, to take into account the change in the water firms’ tax status. This could partially offset the rate lowering effect of disallowing them from passing on income taxes to customers.

Understandably, the water companies have raised objections to the MWSS Regulatory Office’s new resolution, in written comments that they have forwarded to the MWSS, say regulators.

Both Manila Water and Maynilad still insist they are not public utilities, and the 2002 Supreme Court ruling on Meralco does not apply to them. Both companies have not yet issued public comments on the matter, but they are expected to challenge the MWSS regulators’ resolution before either the courts or an arbitration panel.

Disallowed expenses

Apart from seeking to prohibit water companies from passing income taxes to customers, the MWSS regulators have also adopted tougher standards for the “prudence and efficiency” test on allowable expense claims that will be the basis for setting future water tariffs.

Their new stance could mean the two water companies would just get a modest rate increase or even a reduction in water rates as water regulators consider disallowing large chunks from their claimed operating and capital expenditures.

In addition to checking the correctness of the amounts, the MWSS regulators also asked detailed questions about the appropriateness of the designs of the water and sewerage projects being implemented by the two water companies.

“For example,” said Caparas, “we asked why a sewage treatment plant is being built with the capacity of 40 million liters per day (MLD) when wastewater from existing customers amount to just 10 MLD. We will ask them to prove that 40 MLD is needed now.”

Another regulator said that such questions were prompted by concerns the water companies may be providing ahead for the future requirements of neighboring property development projects of affiliate companies.

Donations, salaries

The water regulators also asked why the two water companies are passing on the huge sums they are spending for philanthropic donations or corporate social responsibility to their customers. “Not only are they recovering charitable donations from customers, they are even earning a return on it,” said a regulator.

The regulators are considering disallowing most if not all of the water firms’ donations, arguing that the owners rather than their customers should shoulder their companies’ CSR activities.

But the water companies are arguing that some donations are important for their business and should be included in the rates. “Donations to schools where we do our recruitment — that’s important for image-building with the schools to get the best engineers,” said Maynilad’s Estrellado. “Donations to local governments are important for getting permits.”

The water companies’ related party transactions with affiliates are also being closely scrutinized, regulators said. Both Manila Water and Maynilad have sister construction and engineering companies that bagged many of their major construction contracts, including building sewage treatment plants, reservoirs, and pipelines.

MWSS regulators even tried to look into the executive pay of the two water companies, asking for copies of the “alpha list” detailing compensation and payable taxes for each employee submitted to the Bureau of Internal Revenue, to see if the salaries are in line with local and international standards. That set off one the big disagreements between the two parties, as the water firms refused the request, saying it violates privacy.

“We just cannot issue information on individual compensation,” said Manila Water’s de la Cruz. “We could be jailed for that. Not even our employees’ spouses can inquire into their salaries.”

The regulators have countered that they need the information to be able to decide if the water firms’ executive pay are reasonable. After all, one of the country’s top individual income taxpayers in 2011 was Manila Water president Gerardo Ablaza.

Not good enough

Yet for some leaders of water consumer groups, the MWSS regulators’ tougher stance is not good enough. Rodolfo Javellana Jr of the Water for All Refund Movement (WARM) scored the current MWSS Board of Trustees and the regulators for reversing a March 2011 resolution of the previous trustees to stop the two water companies from collecting a portion of the water rates meant to raise funds for two suspended water projects and to put the collected amounts in escrow. He said WARM is planning to file charges of economic plunder or large-scale corruption against MWSS officials for failing to stop the so-called “advance collections.”

Regulators said the March 2011 resolution was set aside because the matter would be more effectively addressed in the rate-rebasing review in 2012. They said the projects will no longer be included in future rates starting 2013 while previous collections will be deducted from the water firms’ outstanding expense claims. While ruling out a direct refund, they said the impact of the move would be almost the same because it will temper future rate increases.

To Manila Water and Maynilad, which are both asking for hefty water rate hikes to recover past expenses and provide for future investments especially in wastewater facilities to clean up the capital region’s polluted waterways, a regulatory decision to cut rather than increase water tariffs will be a problem.

“It will have many far-reaching implications, for example, on the government’s public-private partnership (PPP) program,” said Manila Water’s de la Cruz. He added that the water companies may resort to arbitration, which is provided for in the Concession Agreement, to challenge such an outcome of the MWSS rate-rebasing review.

Implications on PPP

The possibility of water rates being reduced instead of increased has alarmed some commentators.

In a recent op-ed piece, former Department of Finance undersecretary Romeo Bernardo wrote: “Amidst calls for short-sighted tariff reductions, I truly hope that Philippine authorities will take the long view that seriously considers the quality water service requirements of present and future water consumers and safeguards the environment. And faithfully implement the MWSS Concession Agreement with continuity, consistency and fairness. Future private investments in water and in other needed infrastructure critically hinge on it.”

Though MWSS regulators will likely dispute Bernardo’s description of any rate cut as “short-sighted” they agree the Concession Agreement must be faithfully implemented, and are supportive of the government’s efforts to promote PPP in the water sector.

“We’re a regulated industry and if you want to strengthen the PPP program, you need good regulation,” said Caparas. “There has to be very high level of monitoring which unfortunately was not done before.”

Fifteen years after Manila Water and Maynilad took over the MWSS’s water and sewerage services, what was described by the World Bank in 1997 as the “world’s biggest water privatization” is now widely recognized internationally as one of the few successful cases of water privatization in developing countries.

The most visible impact is the sharply faster pace of installation of new water connections that rose five-fold from only 13.212 connections a year in the last eight years under MWSS to more than 62,382 connections a year in the first decade of privatization.

From just 67 percent coverage of the population, the figure has risen to 86 percent in the west zone under Maynilad and 99 percent in the east zone under Manila Water. Water lost to theft and leaks fell from more than 60 percent in 1997 to 43 percent as of 2012 in the west zone and 11.3 percent in the east zone.

Privatization reversed what appeared to be a steady deterioration in access to potable water under the MWSS in the mid-1990s, when the proportion of households connected to community systems fell drastically from 81.2 percent in 1994 to 73.1 percent in 1997. Less than a decade after the two water firms took over MWSS operations, the figure has gone up to 87.3 percent as of 2006.

Nine-fold hike

But the cost of the water-service improvements has not come cheap. Average water tariffs in Manila Water’s east zone have gone up more than nine-fold since 1997 and more than six-fold in Maynilad’s west zone. In contrast, the National Statistics Office’s fuel, light, and water price index, an indicator of utilities rates throughout the country, just tripled in the same period.

The rates of Maynilad and Manila Water are now the third and fourth highest, respectively, in Southeast Asia, after Singapore and Jakarta, according to data from Global Water Intelligence.

PCIJ Table. ASEAN Water

There is, however, no simple and easy way to determine the correct level of rates commensurate to existing or desired levels of service.

For example, Jakarta’s privately run water system, which charges rates that are almost a quarter more than Maynilad’s and 75 percent more than Manila Water’s tariffs, only serves about two-thirds of the target population, according to the concessionaire there.

But then there’s the state-owned Phnom Penh Water Supply Authority in Cambodia, whose rates are just a third of Maynilad’s and almost half of Manila Water’s, but serves more than 90 percent of the target population, according to the authority’s website. Its water losses were only 6.6 percent as of 2012.

It’s best, then, for the MWSS regulators to get started on those newly arrived boxes of financial records and documents. — PCIJ, July 2013