On Jan. 13, 2015, the Supreme Court, through Justice Leonen, ultimately put to rest the issue over the classification of Poverty Eradication and Alleviation Certificates (PEACe) Bonds as deposit substitutes, subject to taxations.
PEACe Bonds are 10-year zero- coupon treasury bonds issued by the Bureau of Treasury (BTr), designed to endow a permanent fund to finance meritorious activities and projects of accredited non-government organizations (NGOs) throughout the country. Zero-coupon bonds are bonds issued at a deep discount or at a price substantially lower than its face value. It does not make periodic interest payments and the face value is repaid at the time of maturity.
On the other hand, deposit substitutes, as defined under Section 22(Y) of the 1997 National Internal Revenue Code, as amended (Tax Code), is an alternative form of obtaining funds from the public, other than deposits through the issuance, endorsement or acceptance of debt instruments for the borrower’s own account. The Tax Code likewise gave a definition of the word “public” in connection with deposit substitutes stating that the term public means borrowing from twenty (20) or more individual or corporate lenders at any one time.
The Bureau of Internal Revenue (BIR), in reply to a letter of the Secretary of Finance regarding the tax treatment of the PEACe Bonds, issued BIR Ruling No. 370-11 dated Oct. 7, 2011. In BIR Ruling No. 370-11, the Commissioner of Internal Revenue (CIR) opined that the PEACe Bonds are deposit substitutes and should be subject to 20 percent final tax on interest income from deposit substitutes. The CIR further stated that it is a settled rule that all treasury bonds (including PEACe Bonds), regardless of the number of purchasers/lender at the time of origination/issuance are considered deposit substitutes.
The BIR likewise issued BIR Ruling No. DA 378-2011 dated Oct. 17, 2011 clarifying that the final withholding tax due on the discount or interest earned on the PEACe Bonds should be imposed and withheld not only on Rizal Commercial Banking Corporation (RCBC) or Caucus of Development NGO Networks (CODE-NGO), as the winning bidder of the PEACe Bonds issued by the BTr, but also on all subsequent holders of the bonds. On the basis of the foregoing issuances, the BTr paid the face value of the PEACe Bonds, at their maturity, net of the amounts corresponding to the 20 percent final withholding tax. These issuances were assailed by bondholders and ultimately resulted in a case being filed before the Supreme Court.
The Supreme Court in Banco de Oro, Bank of Commerce, China Banking Corporation et al., vs. Republic of the Philippines, the Commissioner of Internal revenue et al., G.R. No. 198756 dated Jan. 13, 2015 held that the PEACe Bonds are not subject to the 20 percent final withholding tax and ordered the BTr to release and pay to the bondholders the amount it withheld.
The Supreme Court first declared BIR Ruling No. 370-11 as void because it completely disregarded the 20 or more rule and created a distinction for government debt instruments as against those issued by private corporations when there was none.
In deciding that the PEACe Bonds are not to be taxed as deposit substitutes, the Supreme Court first clarified that the 20-lender rule – 20 or more individuals or corporate lenders at any one time, is determinative of whether a debt instrument should be considered a deposit substitute and consequently subject to 20 percent final withholding tax.
The court likewise expounded on the meaning of the phrase “at any one time”. The Supreme Court ruled that for the purpose of determining the “20 or more lenders”, the phrase “at any one time” would mean every transaction executed in the primary or secondary market in connection with the purchase or sale of securities. The court further ruled that when funds are simultaneously obtained from 20 or more lenders/investors, there is deemed to be a public borrowing and the bonds at that point in time are deemed deposit substitutes.
The Supreme Court also ruled that 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 Tax Code and RCBC/CODE-NGO would have been obliged to pay the 20 percent final withholding tax on the interest or discount from the PEACe Bonds. Further, the obligation to withhold the 20 percent final tax on the corresponding interest from the PEACe Bonds would likewise be required of any lender/investor had the latter turned around and sold the PEACe Bonds, in whole or in part, simultaneously to 20 or more lenders or investors.
In summary, the Supreme Court did not consider the PEACe Bonds as deposit substitutes and therefore not subject to the 20 percent final withholding tax on the interest on deposit substitutes, due to the failure to adequately show that there was borrowing from the public. There was, however, a qualification that should there have been a simultaneous sale of the bonds from BTr and RCBC/CODE-NGO and from RCBC/CODE-NGO to the undisclosed investors, and the total number of the investor/lender exceeded twenty (20), the PEACe Bonds would have been considered as deposit substitutes.
It is likewise worthy to note that this decision of the Supreme Court enlarged the meaning of the phrase “at any one time” to include not only the original issuance of the bonds, as previously interpreted by the earlier BIR issuances, but also transactions within the secondary market. In effect, where a simultaneous sale referred above occurred, the bondholder who sells or trades his bonds to another lender/investor is now constituted as a withholding agent of the 20 percent final withholding tax.
Hana Kamille A. Escueta is a supervisor from the tax group of R.G. Manabat & Co. (RGM&Co.), the Philippine member firm of KPMG International.
This article is for general information purposes only and should not be considered as professional advice to a specific issue or entity.
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