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Department of Finance
DOF Building, BSP Complex
Roxas Blvd., 1004
Manila
Gentlemen :
This refers to your letter dated September, 2011 requesting for the proper
tax treatment of the discount or interest income arising from the Php35 billion
worth of 10-year zero coupon treasury bonds issued by the Bureau of Treasury
("BTr") on October 18, 2001 (hereinafter referred to as the "Poverty Eradication
and Alleviation Certificates" or the "PEACe Bonds").
It is represented that the issuance of the PEACe Bonds by the BTr stemmed
from the proposal of the Caucus of Development NGO Networks ("CODE-NGO")
sometime in March 2001 for the Department of Finance ("DOF") to issue Php15
billion worth of 10-year zero coupon treasury notes. Under the said proposal,
CODE-NGO will purchase the notes and sell them to investors. The net proceeds
from the sale of the notes, which were estimated at Php1.45 billion, will be used
by CODE-NGO to establish a fund that will finance anti-poverty projects of
non-government organizations ("NGOs") nationwide.
However, the original plan of CODE-NGO did not materialize because the
BTr, under the leadership of then Treasurer Eduardo Sergio Edeza, questioned the
propriety of issuing the bonds directly to CODE-NGO considering that the latter
was not a Government Securities Eligible Dealer ("GSED"). Former Treasurer
Edeza recommended that the issuance of the bonds be done through an auction and
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that CODE-NGO should get a GSED to make a tender on its behalf.
Accordingly, on October 16, 2001, the BTr sold the PEACe Bonds via
auction to eligible GSEDs. The terms of the issuance of the subject bonds are as
follows: cDCEHa
With regard to the taxation of the discount or interest income realized from
the issuance of the PEACe Bonds, the BTr specified in the Public Offering of
Treasury Bonds that ". . . the issue being limited to 19 lenders and while taxable
shall not be subject to 20% final withholding tax." 1(1)
The foregoing tax treatment of the interest income arising from the PEACe
Bonds was based on three (3) BIR Rulings issued shortly before the auction
("2001 Rulings"), which provides:
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1. BIR Ruling No. 020-2001 dated May 31, 2001 —
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"public", particularly on the interpretation of the phrase "at any one time",
Section 22(Y) of the 1997 Tax Code defines the term "public" in relation to
"deposit substitutes", as "borrowing from twenty (20) or more individual or
corporate lenders at any one time".
You also wish to know whether the phrase 'at any one time' in
respect to borrowing from the 'public' may refer to single borrowing only,
e.g., time of origination only, or one series or tranch, i.e., sale to secondary
market; and that in any case, whether the number of would-be holders shall
be the factor in determining whether or not the bonds or certificates of
indebtedness are to be considered "deposit substitutes". aTEScI
In this particular instance, the phrase 'at any one time' covers only
the origination or original issuance of the bonds regardless of whether
sale or trading is made in the secondary market. Thus, in the case of
PEACe Bonds, the determining factor in ascertaining whether such bonds
are 'deposit substitutes', is the fact of their original issuance to a single
entity, RCBC.
The flowchart attached to your letter shows that RCBC will sell the
bonds to CODE-NGO, which will then sell bonds to RCBC Capital as
underwriter. In this regard, it should be noted that CODE-NGO cannot
acquire the bonds directly, not being an accredited government securities
dealer, hence, the original purchase by RCBC, and subsequent sale of the
same bonds to CODE-NGO. RCBC Capital, on the other hand, purchases
the bonds for its own account, and not for the account, or as agent of, any
other buyer. Under these circumstances, it is clear that the bonds are
issued to a single entity, whether such entity be RCBC, CODE-NGO or
RCBC Capital. In this regard, a representation or warranty should be
made to the effect that the bonds are acquired upon their original issuance
by the original purchaser thereof, for and on its own behalf, or on behalf
of a single purchaser only, and in the latter case, that the purchaser is
acquiring such bonds for its own account and not for the account of other
entities." (Emphasis provided)
"We hereby confirm the foregoing rulings, after taking into account
the above-stated features of the proposed PEACe bond issuance:
During the auction, RCBC was declared as the winning bidder having
tendered the lowest bid interest rate of 12.75% for a total face value of Php35
billion. Thus, the BTr issued the PEACe Bonds to RCBC and latter paid BTr
approximately Php10.7 billion for Php35 billion worth of treasury bonds, thus
resulting in a discount of approximately Php24.3 billion.
It appears from their later public statements that RCBC then sold the
PEACe Bonds to CODE-NGO. The latter, in turn, sold the bonds to RCBC Capital
for approximately Php12.1 billion, thereby realizing a "gain" of approximately
Php1.4 billion.
About three years after the issuance of the PEACe Bonds, BIR Ruling No.
007-04 dated July 16, 2004 was issued in response to the request for confirmation
of the BTr on the tax consequences of its regular and special issuance of treasury
bills and bonds, thereby reversing the 2001 Rulings, to wit:
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"In previous BIR rulings issued to BTR, this Office had enunciated
the rule that to be able to determine whether the financial assets, i.e., debt
instruments and securities are deposit substitutes, the "20 or more
individual or corporate lenders" rule must apply. Moreover, the
determination of the phrase "at any one time" for purposes of determining
the "20 or more lenders" is determined at the time of the original issuance.
This has been so on the basis of the fact that it is on the original issuance
that the act of lending is done. aDIHCT
In view of the foregoing, this Office opines and so rules that mere
issuance of government debt instruments and securities is deemed as
falling within the coverage of "deposit substitutes" irrespective of the
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number of lenders at the time of origination. Accordingly, since
government debt instruments and securities are not exempt from taxes,
interest income derived therefrom shall be subject to the following:
b) 25% tax imposed under Section 25 (B) of the Tax Code, if the
bondholder is a nonresident alien individual not engaged in trade or
business within the Philippines;
c) 20% final tax imposed under Sections 27 (D) (1) and 28 (A)
(7) (a), of the Tax Code, for domestic and resident foreign corporations,
respectively;
Moreover, based on above discussion, the phrase "at any one time"
in relation to public borrowing is deemed to refer to the flotation of the
debt instrument or security. In other words, since the actual number of
bondholders or investors may be, at maturity date of the financial
instrument, more than 20 individuals or corporation, the said direct
lenders (origination) and indirect investors (secondary market) are
deemed to be what constitute "public."
In BIR Ruling No. 007-2004 dated July 16, 2004, this Office has
ruled that the mere issuance of government debt instruments and securities
is deemed as falling within the coverage of "deposit substitutes"
irrespective of the number of the lenders at the time of origination, and
therefore interest income derived therefrom shall be subject to the
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applicable final withholding tax rate imposed on deposit substitutes as
prescribed under the Tax Code of 1997. This ruling applies in general, to
all kinds of debt instruments and securities and in particular, to Treasury
bonds, notes and bills being issued by the Republic of the Philippines.
This Office also took note of your representation that the Fixed
Rate Promissory Notes will be issued to one corporate or institutional
lender and that the feature of the PN does not allow the holder/investor to
trade/sell the PN in the secondary market to more than one corporate or
institutional buyer or that should the holder/investor opts to sell the PN
holdings, it shall be required to trade/sell its "entire participation interest" in
the PN, thus, preventing the splitting of the PN in favour of two or more
investors. With the new rule enunciated in the abovementioned BIR Ruling
No. 007-2004 in respect to issuance of Government debt instruments and
securities, we are therefore reinstating the applicable provision of
Revenue Regulations (Rev. Regs.) No. 17-84, to wit:
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xxx xxx xxx
Thus, we opine and hereby rule that notwithstanding the fact that
there is only one corporate or institutional lender the mere issuance of
such PN by the Republic will classify the borrowing as "deposit
substitutes" pursuant to the abovecited Section 2(h)(iii)(b) of Rev. Regs.
No. 17-84. Consequently, the interest income derived therefrom by the
corporate or institutional lender shall be subject to the twenty percent
(20%) final tax imposed under Section 27(D)(1) of the Tax Code of 1997.
7-2004 and further emphasized that the matter of determining the number
of lenders no longer comes into play insofar as government debt
instruments and securities are concerned, particularly, Treasury bonds,
notes and bills being issued by the Republic of the Philippines. SacTAC
In short, the new rule has in effect, reinstated Section 2 (h) (iii) (b)
of Revenue Regulations No. 17-84 which considers all borrowings of the
national and local government and its instrumentalities including the
Central Bank of the Philippines (now the BSP), evidenced by debt
instruments denoted as treasury bonds, bills, notes, certificate of
indebtedness and similar instruments as "deposit substitutes."
1) Whether or not the interest income arising from the PEACe Bonds
shall be subject to the 20% Final Tax, or in the alternative, to
Ordinary Income Tax;
In reply thereto, this Office is of the opinion and hereby resolves the
foregoing issues as follows:
The Php24.3 billion discount on the issuance of the PEACe Bonds should
be subject to 20% Final Tax on interest income from deposit substitutes. It is now
settled that all treasury bonds (including PEACe Bonds), regardless of the number
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of purchasers/lenders at the time of origination/issuance are considered deposit
substitutes. In the case of zero coupon bonds, the discount (i.e., difference between
the face value and purchase price/discounted value of the bond) is treated as
interest income of the purchaser/holder. Thus, the Php24.3 interest income should
have been properly subject to the 20% Final Tax as provided in Section 27 (D) (1)
of the Tax Code of 1997 which states: IESAac
In the case of Treasury Bonds, the 20% final income tax shall be
withheld on discounts valued at present value on every original sale.
Periodic coupon payments on Treasury bonds shall be subject to the 20%
final income tax to be withheld at the time the coupon payments are made.
The Documentary Stamp Tax on the original issue shall be for the
account of the issuer.
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"Section 5. Treasury Bonds. — Treasury Bonds shall be issued at
a discount basis, at a premium, or at par and payable on maturity of not
earlier than one (1) year but not later than twenty-five (25) years. They may
be offered for sale through competitive or non-competitive auction or any
other method as determined appropriate by the Bureau of Treasury."
The foregoing is applied in BIR Ruling No. DA-522-03 dated December 16,
2003, to wit:
"2. With respect to the calculation of the 20% tax on such interest
income, please be informed that pursuant to Section 7 in relation to Section
5 of Department of Finance Order No. 141-95, Series of 1995 (Revised
Rules and Regulations for the Issuance, Placement, Sale, Service and
Redemption of Treasury Bills and Bonds under R.A. No. 245, as
amended), which read as follows:
In view of the foregoing, BIR Ruling No. 008-05 also emphasized that the
final tax on the original issue discount is required to be withheld upfront.
However, at the time of the issuance of the PEACe Bonds in 2001, the BTr
was not able to collect the final tax on the discount/interest income realized by
RCBC as a result of the 2001 Rulings. Subsequently, the issuance of BIR Ruling
No. 007-04 dated July 16, 2004 effectively modifies and supersedes the 2001
Rulings by stating that the Tax Code is clear that the "term "public" means
borrowing from twenty (20) or more individual or corporate lenders at any one
time." The word "any" plainly indicates that the period contemplated is the entire
term of the bond, and not merely the point of origination or issuance. The said
provision is clear and does not require any statutory construction. Thus, by taking
the PEACe Bonds out of the ambit of deposits substitutes and exempting it from
the 20% Final Tax, an exemption in favour of the PEAce Bonds was created when
no such exemption is found in the law. Thus, the 2001 Rulings are null and void
and cannot be given any legal effect for being contrary to law. It is basic principle
in administrative law that the interpretation given by an administrative agency
cannot run contrary to the law which it seeks to implement. As held by the
Supreme Court in the case of Commissioner of Internal Revenue vs. The Hon.
Court of Appeals, R.O.H. Auto Products Philippines, Inc. and The Hon. Court of
Tax Appeals — 2(2)
Thus, considering the fatal legal infirmity of the 2001 rulings, RCBC
should be held liable to pay the 20% Final Tax on interest income it realized from
its purchase of the PEACe Bonds. As to the amount of its tax liability, had RCBC
paid 20% final tax upon issuance, it would have paid approximately Php1.4 billion
(i.e., 20% of the present value of the discount/interest income as of October 18,
2001, discounted at 12.75%, which is approximately Php7 billion) in addition to
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the purchase price of the PEACe Bonds. However, since no final tax was paid by
RCBC upon issuance of the PEACe Bonds, RCBC is held liable to pay 20% final
tax on the entire Php24.3 billion discount, which is the present value of the
original discount to date, or approximately Php4.86 billion.
In BIR Ruling No. 007-04, it was categorically stated that the 2001 Rulings
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were issued based on representations made as follows:
"In previous BIR rulings issued to BTR, this Office had enunciated
the rule that to be able to determine whether the financial assets, i.e., debt
instruments and securities are deposit substitutes, the "20 or more
individual or corporate lenders" rule must apply. Moreover, the
determination of the phrase "at any one time" for purposes of determining
the "20 or more lenders" is determined at the time of the original issuance.
This has been so on the basis of the fact that it is on the original issuance
that the act of lending is done." (Emphasis supplied)
Also, in the case of Emilio Y. Hilado vs. The Collector of Internal Revenue
and The Court of Tax Appeals 5(5) the Supreme Court held:
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to say that General Circular No. V-123, having been issued on a wrong
construction of the law, cannot give rise to a vested right that can be
invoked by a taxpayer. The reason is obvious: a vested right cannot spring
from a wrong interpretation. This is too clear to require elaboration.
Again, as emphasized in BIR Ruling No. 008-05, the final tax on the
original issue discount is required to be withheld upfront.
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upfront, your opinion that the 20% final income tax withheld on such
discounts should be valued at its present value is hereby confirmed.
Consequently, as first ruled, the Bureau of the Treasury shall withhold and
remit the corresponding 20% final income tax withheld on discounts
valued at present value upon original issue of the subject 7-year Peso
Denominated Zero Coupon." (Emphasis provided)
In view thereof, BTr shall withhold the Final Tax due on interest income
derived from the PEACe Bonds prior to its payment on the date of maturity.
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Endnotes
1 (Popup - Popup)
1. BTr Memorandum to all GSEDs dated October 9, 2001.
2 (Popup - Popup)
2. G.R. No. 108358, January 20, 1995.
3 (Popup - Popup)
3. Philippine Guaranty Co., Inc. vs. Commissioner of Internal Revenue, 13 SCRA
775.
4 (Popup - Popup)
4. Philippine Bank of Communications vs. Commissioner of Internal Revenue, G.R.
No. 112024, January 28, 1999.
5 (Popup - Popup)
5. G.R. No. L-9408, October 31, 1956.
6 (Popup - Popup)
6. Supra.
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