TL;DR

The Supreme Court clarified the tax treatment of zero-coupon treasury bonds, specifically the PEACe Bonds, and defined when government-issued debt instruments qualify as “deposit substitutes” subject to a 20% final withholding tax. The Court ruled that the 20% final withholding tax applies only when the government borrows from twenty or more individual or corporate lenders ‘at any one time.’ This determination should consider transactions in both the primary and secondary markets. The Bureau of Internal Revenue (BIR) cannot retroactively impose taxes based on revised interpretations of tax law. The BIR was wrong to impose the tax, but their initial hesitation to pay out the full value of the bond after the TRO was delivered, was deemed justified. Bondholders are now entitled to the full face value of the bonds.

PEACe Bonds and Taxing Questions: Decoding the Deposit Substitute Debate

This case revolves around the P35 billion PEACe Bonds issued by the Bureau of Treasury in 2001. The central question is whether the discount or interest income from these bonds should be subject to a 20% final withholding tax. The Commissioner of Internal Revenue declared in 2011 that these bonds, being deposit substitutes, were indeed taxable. This prompted a legal battle, as the bondholders argued they were promised tax exemptions.

The petitioners, several banks, and intervenors, RCBC, RCBC Capital, and CODE-NGO, sought to annul BIR Ruling No. 370-2011, arguing it was unconstitutional and issued with grave abuse of discretion. They sought to prohibit the Bureau of Treasury (BTr) from withholding the 20% final withholding tax (FWT) and compel them to pay the full face value of the bonds upon maturity. The core of their argument rested on the assertion that the PEACe Bonds did not qualify as “deposit substitutes” under the 1997 National Internal Revenue Code (NIRC).

The respondents, representing the government, contended that the petitioners should have first exhausted administrative remedies before resorting to the courts. They also argued that the discount or interest income derived from the PEACe Bonds was not a trading gain but interest income subject to tax. The government maintained it had the right to impose the 20% FWT, as there had been no change in the laws governing the taxability of interest income from deposit substitutes. The core of their argument was that the 2001 BIR rulings were erroneous and could not give rise to vested rights.

The Supreme Court first addressed procedural issues, finding that the case merited direct recourse due to the purely legal questions involved and the urgency of the matter. The Court then delved into the substantive issues, dissecting the definition of “deposit substitutes” under Section 22(Y) of the 1997 NIRC. This section defines deposit substitutes as an alternative form of obtaining funds from the public where ‘public’ means borrowing from twenty (20) or more individual or corporate lenders at any one time.

The Court emphasized that the phrase “at any one time” should be interpreted from the perspective of the financial market. This means considering every transaction in the primary or secondary market when determining whether the 20-lender rule applies. According to the ruling, all transactions must be examined to determine whether a public borrowing occurred. Only debt instruments satisfying the requirements of a public borrowing are considered deposit substitutes and subject to the 20% final withholding tax. The Court highlighted that the income tax does apply to instruments not considered deposit substitutes.

BIR Ruling No. 370-2011 was declared void because it disregarded the 20-or-more lender rule established by Congress in the 1997 National Internal Revenue Code. The court noted the Bureau of Internal Revenue’s interpretation of the law was inconsistent and that the Commissioner is not bound by previous interpretations. But even if they do modify their interpretation, a taxpayer’s rights cannot be disregarded. The Court did note that the Bureau of Treasury was justified in initially withholding the 20% final withholding tax, as it had not yet received the TRO. But in the end, the Bureau of Treasury was directed to release the amounts withheld to the bondholders.

Ultimately, this case provides valuable clarity on the taxation of government debt instruments. It underscores the importance of adhering to statutory definitions and considering market realities when interpreting tax laws. Bondholders and investors can now have greater confidence in the tax treatment of similar financial products in the future.

For inquiries regarding the application of this ruling to specific circumstances, please contact Atty. Gabriel Ablola through gaboogle.com or via email at connect@gaboogle.com.

Disclaimer: This analysis is provided for informational purposes only and does not constitute legal advice. For specific legal guidance tailored to your situation, please consult with a qualified attorney.
Source: BANCO DE ORO V. REPUBLIC, G.R. No. 198756, January 13, 2015