BANCO DE ORO vs. REPUBLIC OF THE PHILIPPINES G.R. No. 198756, January 13, 2015 This case involves P35 billion worth of 10-year zero-coupon treasury bonds issued by the Bureau of Treasury (BTr) denominated denominated as the Poverty Eradication and Alleviation Certificates or the PEACe Bonds. These PEACe Bonds would initially be purchased by a special purpose vehicle on behalf of Caucus of Development NGO Networks (CODE-NGO), repackaged and sold at a premium to investors. The net proceeds from the sale will be used to endow a permanent fund to finance meritorious activities and projects of accredited non-government non-government organizations (NGOs) (NGOs) throughout the country. country. In relation to this, CODE-NGO wrote a letter to the Bureau of Internal Revenue (BIR) to inquire as to whether the PEACe Bonds will be subject to withholding tax of 20%. The BIR issued several several rulings beginning with BIR Ruling Ruling No.020-2001 No.020-2001 (issued on May 31, 2001) and was subsequently reiterated its points in BIR Ruling No. 035-200119 dated August 16, 2001 and BIR Ruling No. DA-1750120. The rulings basically say that in determining whether financial assets such as a debt instrument are deposit substitute, the “20 or more individual or corporate lenders rule” should apply. Likewise, the “at any one time” stated in the rules should be construed as “at the time of the original issuance.” With this BTr made a public offering of the PEACe Bonds to the Government Securities Eligible Dealers (GSED) wherby RCBC won as the highest bidder for approximately 10.17 billion, resulting in a discount of approximately 24.83 billion. RCBC Capital Capital entered into an underwriting agreement with CODE-NGO, whereby RCBC Capital was appointed as the Issue Manager and Lead Underwriter for the offering of the PEACe Bonds. In October 7, 2011, BIR issued BIR RULING NO. 370-2011 in response to the query of the Secretary of Finance as to the proper tax treatment of the discounts and interest derived from Government Bonds. It cited three other rulings issued in 2004 and 2005. The above ruling states that the all treasury bonds (including PEACe Bonds), regardless of the number of purchasers/lenders purchasers/lenders at the time of origination/issuance origination/issuance are considered deposit substitutes. In the case of zero-coupon bonds, the discount (i.e. difference between face value and purchase price/discounted price/discounted value of the bond) is treated as interest income of the purchaser/holder.
Ruling: The PEACe Bonds, according to the SC, requires further information for proper determination of whether these bonds are within the purview of deposit substitutes. The Court noted that it may seem that the lender is only CODE-NGO through RCBC. However, the underwriting agreement reveals that the entire 35billion worth of zero-coupon bonds were sourced directly from the undisclosed number of investors. These are the same investors to whom RCBC Capital distributed the PEACe Bonds all at the time of the origination or issuance. Hence, until there is information as to whether the PEACe Bonds are found within the coverage of deposit substitutes, the proper procedure for the BIR is to collect the unpaid final withholding tax directly from RCBC Capital/ CODE-NGO, or any lender if such be the case. The court also noted that according to the NIRC, Section 24, interest income received by individuals from long term deposits or investments with a holding period of not less than five years is exempt from final tax. The decision provided the definition of deposit substitute 1997 National Internal Revenue Code which placed the 20-lender rule. In particular, Section 22 (Y) states that a debt instrument shall mean “an alternative form of obtaining funds from the public (the term 'public' means borrowing from twenty (20) or more individual or corporate lenders at any one time) other than deposits, through the issuance, endorsement, or acceptance of debt instruments for the borrower’s own account” The determination as to whether a deposit substitute will be imposed with 20% final withholding tax rests on the number of lenders. When there are 20 or more lenders/investors in a transaction for a specific bond issue, the seller is required to withhold the 20% final income tax on the imputed interest income from the bonds. The SC cited Sections 24(B) (1), 27(D)(1), and 28(A)(7) of the 1997 NIRC. These provisions state the imposition of a final tax rate of 20% upon the amount of interest from any currency bank deposit and yield or any other monetary benefit from deposit substitutes. On the other hand, for instruments not considered as deposit substitutes, these will be subjected to regular income tax. The prevailing provision is Section 32(A). Hence, should the deposit substitute involves less than 20 lenders in a transaction, the income is considered as “income derived from whatever source”. The “gain” referred to in Section 32 (A) pertains to that realized from the trading of bonds at maturity rate or the gain realized by the last holder of
the bonds when redeemed at maturity. In the case of discounted instruments, like the zero-coupon bonds, the trading gain shall be the excess of the selling price over the book value or accreted value of the instruments. As for the BIR Rulings issued in 2001, the SC finds that the interpretation of the phrase “at any one time”, is “to mean at the point of origination alone is unduly restrictive” On the other hand, the 2011 BIR Ruling which relied on the 2004 and 2005 BIR Rulings is void for creating a distinction between government bonds and those issued by private corporations, when there is none in the law. Further, it completely disregarding the 20-lender rule under the NIRC since it says, “all treasury bonds regardless of the number of purchasers/lenders at the time of origination/issuance are considered deposit substitutes”
