BDO V REP OF THE PHILS
The case involves the proper tax treatment of the discount or interest income arising
from the 35B worth of 10-year zero coupon treasury bonds issued by the Bureau of
Treasury on October 18, 2001 (denominated as the Poverty Eradication and Alleviation
Certificates or the PEA Ce Bonds by the Caucus of Development NGO Networks).
October 7, 2011, the CIR issued BIR ruling 370-2011 (2011 Bir Ruling) declaring that
PEACE bonds being deposit substitutes are subject to 20% FW, thus the SOF directed
the BT to withhold a 20% FT from the face value of the PEACE bonds upon their
payment at maturity October 18, 2011.
Factual antecedents
On March 23, 2001 CODE NGO with assistance of financial advisors RCBC, CAPEX,
SEED requested an approval form DOF for the issuance of the (10 year worth zero
coupon bonds) T-notes, which would be initially purchased by a special purpose vehicle
on behalf of CODE NGO, repackaged and sold at a premium to investors as the PEACE
Bonds. The net proceeds will be used to endow a permanent fund “HANAPBUHAY
FUND” to finance meritorious activities of accredited NGO throughout the country.
A zero-coupon bond is a bond bought at a price substantially lower than its face value
(or at a deep discount), with the face value repaid at the time of maturity. It does not
make periodic interest payments, or have so called "coupons," hence the term zero-
coupon bond. However, the discount to face value constitutes the return to the
bondholder.
May 31, 2001, BOR issued BIR Ruling 020-2001 on the tax treatment of PEACE bonds,
that it would not be classified as deposit substitutes and would not be subject to
withholding tax. That to be classified as such the borrowing of funds must be obtained
from 20 or more individuals or corporate lenders at any one time (at the time of the
original issuance), in this case, the PEACE bonds will only be issued to one entity
CODE NGO. This ruling was subsequently reiterated in the subsequent rulings
collectively called as 2001 rulings.
Meanwhile, July 4, 2001, Former Treasuer Edeza questioned the propriety of issuing
bonds directly to a special purpose vehicle and recommended that the issuance be
done through ADAPS and that CODE NGO should get Government Securities Eligible
Dealer to bid in its behalf. The notice was issued stating that the bonds shall be issued
to not more than 19 buyers/lenders and shall not be subject to 20% FT.
In the said auction, RCBC participated on behalf of CODE NGO and was declared as
the winning bidder having tendered the lowest bids, BT issued 35B worth of bonds at
yield to maturity of 12.75% approx. 10.17B resulting in a discount approx. 24.83B.
RCBC entered into underwriting agreement with CODE NGO, where the former was
appointed as the Issue Manager and Lead Underwriter for offering the PEACE Bonds.
RCBC sold the government bonds in the secondary marker for price issue of
11,995,513, 716.51. Petitioners purchased the PEACE bonds on different dates.
On October 7, 2011, BIR issued a ruling imposing 20% FT on government bonds
directing the BT to withhold said final tax at maturity. That the discount (difference
between the face value and purchase price/discounted value of the bond) is treated as
income of the purchaser or holder. That the term “any one time” indicates the period
contemplated is the entire term of the bond and not merely at the point of origination or
issuance. BIR issued BIR Ruling DA 378-2011 clarifiying that the final WT due should
be imposed and withheld not only on RCBC/CODE NGO but also to all subsequent
holders prompting petitioner to file this petition for certiorari.
Issues:
1. WON the PEACE bonds are deposit substitutes and thus subject to 20% FT and the
interpretation of the phrase “borrowing from 20 or more individual or corporate lenders
at any one time, particularly on whether the reckoning 20 lenders includes trading of the
bonds in the secondary market
2. If those are “deposit substitutes” whether the government is estopped from imposing
the 20% FT from the face value
a. will imposition of 20% violate non impairment clause
b. will it constitute deprivation of property without due process of law
c. will it violate section 245 of the tax code on non-retroactivity of rulings
Ruling
1. Procedural non-exhaustion of administrative remedies proper
Section 4 of 1997 tax code, interpretative rulings are reviewable by SOF, nonetheless,
this case falls under 2 of the exceptions given: (2) when the issue involved is purely a
legal question, and 11) when there are circumstances indicating the urgency of judicial
intervention. The question involved is purely legal, namely: (a) the interpretation of the
20-lender rule in the definition of the terms public and deposit substitutes under the
1997 National Internal Revenue Code; and (b) whether the imposition of the 20% final
withholding tax on the PEACe Bonds upon maturity violates the constitutional provisions
on non-impairment of contracts and due process. Judicial intervention is likewise urgent
with the impending maturity of the PEACe Bonds on October 18, 2011.
Another ground would be resorting to admin remedies would be futile, an appeal to the
Secretary of Finance from the questioned 2011 BIR Ruling would be a futile exercise
because it was upon the request of the Secretary of Finance that the 2011 BIR Ruling
was issued by the Bureau of Internal Revenue. It appears that the Secretary of Finance
adopted the Commissioner of Internal Revenue’s opinions as his own. This position was
in fact confirmed in the letter dated October 10, 2011 where he ordered the Bureau of
Treasury to withhold the amount corresponding to the 20% final withholding tax on the
interest or discounts allegedly due from the bondholders on the strength of the 2011
BIR Ruling.
The CTA has the jurisdiction to review rulings of CIR and not the RTC, although the CA
took cognizance of the petition for certiorari properly. The nature and importance of the
issues raised to the investment and banking industry with regard to a definitive
declaration of whether government debt instruments are deposit substitutes under
existing laws, and the novelty thereof, constitute exceptional and compelling
circumstances to justify resort to this court in the first instance.
The tax provision on deposit substitutes affects not only the PEACe Bonds but also any
other financial instrument or product that may be issued and traded in the market. Due
to the changing positions of the Bureau of Internal Revenue on this issue, there isa
need for a final ruling from this court to stabilize the expectations in the financial market.
Finally, non-compliance with the rules on exhaustion of administrative remedies and
hierarchy of courts had been rendered moot by this court’s issuance of the temporary
restraining order enjoining the implementation of the 2011 BIR Ruling. The temporary
restraining order effectively recognized the urgency and necessity of direct resort to this
court.
2. Tax treatment of deposit substitutes (Section 22 (y))
Under the 1997 National Internal Revenue Code, Congress specifically defined "public"
to mean "twenty (20) or more individual or corporate lenders at any one time." Hence,
the number of lenders is determinative of whether a debt instrument should be
considered a deposit substitute and consequently subject to the 20% final withholding
tax.
Petitioner argue that there is only one lender while respondent argue that the word “any”
indicates that the period contemplated is the entire term such that if the debt
instruments were subsequently sold in secondary markets and so on in such a way that
20 or more buyers eventually own, then it becomes indubitable that the funds would be
obtained from public.
Financial markets are classified based on their maturity, and whether as short term
(money market) or long term (capital market), transactions occur either in the primary
market or secondary market. Primary markets facilitate the issuance of new securities.
Secondary markets facilitate the trading of existing securities, which allows for a change
in the ownership of the securities." The transactions in primary markets exist between
issuers and investors, while secondary market transactions exist among investors.
Meaning of "at any one time"
Thus, from the point of view of the financial market, the phrase "at any one time" for
purposes of determining the "20 or more lenders" would mean every transaction
executed in the primary or secondary market in connection with the purchase or sale of
securities.
When, through any of the foregoing transactions, funds are simultaneously obtained
from 20 or morelenders/investors, there is deemed to be a public borrowing and the
bonds at that point intime are deemed deposit substitutes. Consequently, the seller is
required to withhold the 20% final withholding tax on the imputed interest income from
the bonds.
It must be noted, that debt instruments that do not qualify as deposit substitutes must be
subject to regular income tax. The definition of gross income is broad enough to cover
all passive incomes subject to tax rate. However, since these passive incomes are
already subject to different rates and taxed finally at source, they are no longer included
in the computation of gross income, which determines taxable income." Stated
otherwise . . . if there were no withholding tax system in place in this country, this 20
percent portion of the ‘passive’ income of [creditors/lenders] would actually be paid to
the [creditors/lenders] and then remitted by them to the government in payment of their
income tax."
3. The 2001 BIR rulings is not consistent with law, the interpretation of at any one time
to mean at the point of origination is unduly restrictive
4. Tax treatment of income derived from PEACE Bonds
It may seem that there was only one lender — RCBC on behalf of CODE-NGO — to
whom the PEACe Bonds were issued at the time of origination. However, a reading of
the underwriting agreement and RCBC term sheet reveals that the settlement dates for
the sale and distribution by RCBC Capital (as underwriter for CODE-NGO) of the
PEACe Bonds to various undisclosed investors at a purchase price of approximately
₱11.996 would fall on the same day, October 18, 2001, when the PEACe Bonds were
supposedly issued to CODE-NGO/RCBC. In reality, therefore, the entire ₱10.2 billion
borrowing received by the Bureau of Treasury in exchange for the ₱35 billion worth of
PEACe Bonds was sourced directly from the undisclosed number of investors to whom
RCBC Capital/CODE-NGO distributed the PEACe Bonds — all at the time of origination
or issuance. At this point, however, we do not know as to how many investors the
PEACe Bonds were sold to by RCBC Capital.
Should there have been a simultaneous sale to 20 or more lenders/investors, the
PEACe Bonds are deemed deposit substitutes within the meaning of Section 22(Y) of
the 1997 National Internal Revenue Code and RCBC Capital/CODE-NGO would have
been obliged to pay the 20% final withholding tax on the interest or discount from the
PEACe Bonds. Further, the obligation to withhold the 20% final tax on the
corresponding interest from the PEACe Bonds would likewise be required of any
lender/investor had the latter turnedaround and sold said PEACe Bonds, whether in
whole or part, simultaneously to 20 or more lenders or investors.
Thus, should the PEACe Bonds be found to be within the coverage of deposit
substitutes, the proper procedure was for the Bureau of Treasury to pay the face value
of the PEACe Bonds to the bondholders and for the Bureau of Internal Revenue to
collect the unpaid final withholding tax directly from RCBC Capital/CODE-NGO, orany
lender or investor if such be the case, as the withholding agents.
5. The collection is not barred by 3-year prescriptive period
Should it be found that RCBC Capital/CODE-NGO sold the PEACe Bonds to 20 or more
lenders/investors, the Bureau of Internal Revenue may still collect the unpaid tax from
RCBC Capital/CODE-NGO within 10 years after the discovery of the omission.
