BANCO DE ORO vs. REPUBLIC OF THE PHILIPPINES

BANCO DE ORO, BANK OF COMMERCE, CHINA BANKING CORPORATION, METROPOLITAN BANK & TRUST COMPANY, PHILIPPINE BANK OF COMMUNICATIONS, PHILIPPINE NATIONAL BANK, PHILIPPINE VETERANS BANK AND PLANTERS DEVELOPMENT BANK, RIZAL COMMERCIAL BANKING CORPORATION (RCBC) AND RCBC CAPITAL CORPORATION (RCBC CAPITAL), CAUCUS OF DEVELOPMENT NGO NETWORKS (CODE-NGO) (Petitioner-Intervenor) vs REPUBLIC OF THE PHILIPPINES, THE COMMISSIONER OF INTERNAL REVENUE, BUREAU OF INTERNAL REVENUE, SECRETARY OF FINANCE, DEPARTMENT OF FINANCE, THE NATIONAL TREASURER AND BUREAU OF TREASURY

G.R. No. 198756, January 13, 2015

LEONEN, J.:

FACTS:

          By letter dated March 23, 2011, the CODE-NGO with the assistance of its financial advisers, RCBC, RCBC Capital, Capex finance investment corporation (CAPEX) and Seed Capital Ventures, Inc., (SEED), requested and approval from the Department of Finance (DOF) for the issuance by the Bureau of Treasury (BTr) of 10- year zero-coupon Treasury Certificates (T-Notes).

          The t-notes would initially be 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 from the sale of the bonds will be used to endow a permanent fund (Hanapbuhay fund) to finance meritorious activities and projects of accredited non-government organization (NGOs) throughout the country.

          Prior to and around the time of the proposal of CODE-NGO, other proposals for the issuance of zero-coupon bonds were also presented by banks and financial institutions. Both the proposal of First Metro Investment Corp. and ATR-Kim Eng Fixed Income indicate that the interest income or discount earned on the proposed zero-coupon bonds would be subject to the prevailing withholding tax.

          On May 31, 2001, the Bureau of Internal Revenue (BIR), in reply to CODE-NGO’s Letters dated May 10,15 and 25, 2001, issued BIR Ruling no. 020-2001 on the tax treatment of the proposed PEACe bonds. It confirmed that the PEACe bonds would not be classified as deposit substitutes and would not be subject to the corresponding withholding tax:

To be classified as “Deposit Substitute:, the borrowing of funds must be obtained from twenty (20) or more individuals or corporate lenders at any one time. In the light of your representation that the PEACe Bonds will be issued only to one entity, the same shall not be considered as “deposit substitute” falling within the purview of the above definition. Hence, the withholding tax on deposit substitute will not apply.

          The tax treatment of the proposed PEACe bonds was subsequently reiterated in BIR Ruling no. 035-2001(2001) and BIR Ruling No.DA-175-01 (2001). The determination of the phrase “at any one time” for purposes of determining the “20 or more lenders” is to be determined at the time of the original issuance.

          Meanwhile, Former Treasurer Eduardo Sergio G. Edeza questioned the propriety of issuing the bonds directly to a special purpose vehicle 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 the Automated Debt Auction Processing System (ADAPS)” and that CODE-NGO “should get a GSED to bid in its behalf.”

          Subsequently, in the notice to all GSEDs entitled Public Offering of Treasury Bonds, the Bureau of Treasury announced that “P30.0B worth of 10-year Zero-Coupon Bonds would be auctioned. The notice stated that the Bonds “shall be issued to not more than 19 buyers/lenders hence, the necessity of a manual auction for this maiden issue.”

          On October 16, 2001, the Bureau of Treasury held an auction for the 10-year zero-coupon bonds. Also on the same date, the Bureau of Treasury issued another memorandum quoting excerpts of the ruling issued by the Bureau of Internal Revenue concerning the Bonds’ exemption from 20% final withholding tax and the opinion of the Monetary Board on reserve eligibility.

          During the auction, there were 45 bids from 15 GSEDs. After the auction, RCBC which participated on behalf of CODE-NGO was declared as the winning bidder having tendered the lowest bids.  Accordingly, on October 18, 2001, the Bureau of Treasury issued P35 billion worth of Bonds at yield-to-maturity of 12.75% to RCBC for approximately P10.17 billion, resulting in a discount of approximately P24.83 billion.

Also on October 16, 2001, RCBC 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.  RCBC Capital agreed to underwrite on a firm basis the offering, distribution and sale of the P35 billion Bonds at the price of P11,995,513,716.51.47  In Section 7(r) of the underwriting agreement, CODE-NGO represented that “all income derived from the Bonds, inclusive of premium on redemption and gains on the trading of the same, are exempt from all forms of taxation as confirmed by BIR letter rulings.

RCBC Capital sold the Government Bonds in the secondary market for an issue price of P11,995,513,716.51.  Petitioners purchased the PEACe Bonds on different dates.

BIR Ruling:

          On October 7, 2011, “the BIR issued the assailed 2011 BIR Ruling, in response to a query of the Secretary of Finance on the proper tax treatment of the discount or interest income derived from the Government Bonds, imposing a 20% FWT on the Government Bonds and directing the BIR to withhold said final tax at the maturity thereof, allegedly without consultation with Petitioners as bondholders, and without conducting any hearing.”

The Php 24.3 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 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 face value and purchase price/discounted value of the bond) is treated as interest income of the purchaser/holder.  Thus, the Php 24.3 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.

          On October 17, 2011, replying to an urgent query from the BTr, the BIR issued BIR Ruling No. DA 378-201157 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 RCBC/CODE NGO but also on ‘all subsequent holders of the Bonds.’”

Petitioners’ Actions

On October 17, 2011, petitioners filed a petition for certiorari, prohibition, and/or mandamus with urgent application for a temporary restraining order and/or writ of preliminary injunction before this court.

On October 18, 2011, the Supreme Court issued a temporary restraining order (TRO) “enjoining the implementation of BIR Ruling No. 370-2011 against the PEACe Bonds, subject to the condition that the 20% final withholding tax on interest income therefrom shall be withheld by the petitioner banks and placed in escrow pending resolution of the petition.”

Meanwhile petitioners filed their “Manifestation with Urgent Ex Parte Motion to Direct Respondents to comply with the TRO.” They alleged that on the same day that the TRO was issued, the BTr paid to petitioners and other bondholders the amounts representing the face value of the Bonds, net however of the amounts corresponding to the 20% final withholding tax on interest income, and that the Bureau of Treasury refused to release the amounts corresponding to the 20% final withholding tax.

ISSUES:

1.    Whether the PEACe Bonds are “deposit substitutes” and thus subject to 20% final withholding tax under the 1997 National Internal Revenue Code. 

2.    Interpretation of the phrase “borrowing from twenty (20) or more individual or corporate lenders at any one time” under Section 22(Y) of the 1997 National Internal Revenue Code

3.    Whether the reckoning of the 20 lenders includes trading of the bonds in the secondary market

4.    If the PEACe Bonds are considered “deposit substitutes,” whether the government or the Bureau of Internal Revenue is estopped from imposing and/or collecting the 20% final withholding tax from the face value of these Bonds

5.    Will the imposition of the 20% final withholding tax violate the non-impairment clause of the Constitution?

6.    Will it constitute a deprivation of property without due process of law?

7.    Will it violate Section 245 of the 1997 National Internal Revenue Code on non-retroactivity of rulings?

ARGUMENTS:

Petitioners; RCBC, RCBC Capital, and CODE-NGO

1.    The Government cannot impair the efficacy of the Bonds by arbitrarily, oppressively and unreasonably imposing the withholding of 20% FWT upon the Bonds a mere eleven (11) days before maturity and after several, consistent categorical declarations that such bonds are exempt from the 20% FWT, without violating due process and the constitutional principle on non-impairment of contracts.

2.    Petitioners insist that the PEACe Bonds are not deposit substitutes as defined under Section 22(Y) of the 1997 National Internal Revenue Code because there was only one lender (RCBC) to whom the BTr issued the Bonds. They allege that the 2004, 2005, and 2011 BIR Rulings “erroneously interpreted that the number of investors that participate in the ‘secondary market’ is the determining factor in reckoning the existence or non-existence of twenty (20) or more individual or corporate lenders.”

3.    They contend that the BIR unduly expanded the definition of deposit substitutes under Section 22 of the 1997 National Internal Revenue Code in concluding that “the mere issuance of government debt instruments and securities is deemed as falling within the coverage of ‘deposit substitutes. Thus, “the 2011 BIR Ruling clearly amounted to an unauthorized act of administrative legislation.

4.    Petitioners further argue that their income from the Bonds is a “trading gain,” which is exempt from income tax. They insist that “they are not lenders whose income is considered as ‘interest income or yield’ subject to the 20% FWT under Section 27 (D)(1) of the 1997 National Internal Revenue Code” because they “acquired the Government Bonds in the secondary or tertiary market.”

5.    Even assuming without admitting that the Government Bonds are deposit substitutes, petitioners argue that the collection of the final tax was barred by prescription. They point out that under Section 7 of DOF Department Order No. 141-95, the final withholding tax “should have been withheld at the time of their issuance.” Also, under Section 203 of the 1997 National Internal Revenue Code, “internal revenue taxes, such as the final tax, should be assessed within three (3) years after the last day prescribed by law for the filing of the return.

6.    Petitioners contend that the retroactive application of the 2011 BIR Ruling without prior notice to them was in violation of their property rights, their constitutional right to due process as well as Section 246 of the 1997 National Internal Revenue Code on non-retroactivity of rulings.  Allegedly, it would also have “an adverse effect of colossal magnitude on the investors, both local and foreign, the Philippine capital market, and most importantly, the country’s standing in the international commercial community.”

7.    Respondent Commissioner “gravely and seriously abused her discretion in the exercise of her rule-making power” when she issued the assailed 2011 BIR Ruling which ruled that “all treasury bonds are ‘deposit substitutes’ regardless of the number of lenders, in clear disregard of the requirement of twenty (20) or more lenders mandated under the NIRC.” They argue that “by her blanket and arbitrary classification of treasury bonds as deposit substitutes, respondent CIR not only amended and expanded the NIRC, but effectively imposed a new tax on privately-placed treasury bonds.”

8.    Petitioners-intervenors RCBC and RCBC Capital further argue that the 2011 BIR Ruling will cause substantial impairment of their vested rights under the Bonds since the ruling imposes new conditions by “subjecting the PEACe Bonds to the twenty percent (20%) final withholding tax notwithstanding the fact that the terms and conditions thereof as previously represented by the Government, through respondents BTr and BIR, expressly state that it is not subject to final withholding tax upon their maturity.” They added that “[t]he exemption from the twenty percent (20%) final withholding tax [was] the primary inducement and principal consideration for [their] participat[ion] in the auction and underwriting of the PEACe Bonds.”

9.    Petitioners-intervenors RCBC and RCBC Capital argue that “the implementation of the 2011 assailed BIR Ruling and BIR Ruling No. DA 378-2011 will have pernicious effects on the integrity of existing securities, which is contrary to the State policies of stabilizing the financial system and of developing capital markets.”

10. “The tax exemption privilege relating to the issuance of the PEACe Bonds partakes of a contractual commitment granted by the Government in exchange for a valid and material consideration [i.e., the issue price paid and savings in borrowing cost derived by the Government,] thus protected by the non-impairment clause of the 1987 Constitution”

Respondents

1.    Respondents argue that petitioners’ direct resort to this court to challenge the 2011 BIR Ruling violates the doctrines of exhaustion of administrative remedies and hierarchy of courts, resulting in a lack of cause of action that justifies the dismissal of the petition. According to them, “the jurisdiction to review the rulings of the CIR, after the aggrieved party exhausted the administrative remedies, pertains to the Court of Tax Appeals.”

2.    Respondents contend that the discount/interest income derived from the PEACe Bonds is not a trading gain but interest income subject to income tax. They explain that “with the payment of the PhP35 Billion proceeds on maturity of the PEACe Bonds, Petitioners receive an amount of money equivalent to about PhP24.8 Billion as payment for interest.  Such interest is clearly an income of the Petitioners considering that the same is a flow of wealth and not merely a return of capital – the capital initially invested in the Bonds being approximately PhP10.2 Billion.

3.    Maintaining that the imposition of the 20% final withholding tax on the PEACe Bonds does not constitute an impairment of the obligations of contract, respondents aver that: “The BTr has no power to contractually grant a tax exemption in favor of Petitioners thus the 2001 BIR Rulings cannot be considered a material term of the Bonds”; “there has been no change in the laws governing the taxability of interest income from deposit substitutes and said laws are read into every contract”; “the assailed BIR Rulings merely interpret the term “deposit substitute” in accordance with the letter and spirit of the Tax Code”; “the withholding of the 20% FWT does not result in a default by the Government as the latter performed its obligations to the bondholders in full”; and “if there was a breach of contract or a misrepresentation it was between RCBC/CODE-NGO/RCBC Cap and the succeeding purchasers of the PEACe Bonds.”

4.    Similarly, respondents counter that the withholding of “the 20% final withholding tax on the PEACe Bonds does not amount to a deprivation of property without due process of law.” Their imposition of the 20% final withholding tax is not arbitrary because they were only performing a duty imposed by law; “the 2011 BIR Ruling is an interpretative rule which merely interprets the meaning of deposit substitutes and upheld the earlier construction given to the term by the 2004 and 2005 BIR Rulings.” Hence, respondents argue that “there was no need to observe the requirements of notice, hearing, and publication.”

5.    They contend that the assailed 2011 BIR Ruling is a valid exercise of the Commissioner of Internal Revenue’s rule-making power; that it and the 2004 and 2005 BIR Rulings did not unduly expand the definition of deposit substitutes by creating an unwarranted exception to the requirement of having 20 or more lenders/purchasers; and the word “any” in Section 22(Y) of the National Internal Revenue Code plainly indicates that the period contemplated is the entire term of the bond and not merely the point of origination or issuance.

6.    A retroactive application of the 2011 BIR Ruling will not unjustifiably prejudice petitioners. “With or without the 2011 BIR Ruling, Petitioners would be liable to pay a 20% final withholding tax just the same because the PEACe Bonds in their possession are legally in the nature of deposit substitutes subject to a 20% final withholding tax under the NIRC.”  Section 7 of DOF Department Order No. 141-95 also provides that income derived from Treasury bonds is subject to the 20% final withholding tax.144  “While revenue regulations as a general rule have no retroactive effect, if the revocation is due to the fact that the regulation is erroneous or contrary to law, such revocation shall have retroactive operation as to affect past transactions, because a wrong construction of the law cannot give rise to a vested right that can be invoked by a taxpayer.”

7.    Respondents submit that “there are a number of variables and factors affecting a capital market.” “Capital market itself is inherently unstable.” Thus, “petitioners’ argument that the 20% final withholding tax. will wreak havoc on the financial stability of the country is a mere supposition that is not a justiciable issue.”

8.    On the prayer for the temporary restraining order, respondents argue that this order “could no longer be implemented because the acts sought to be enjoined are already fait accompli.” They add that “to disburse the funds withheld to the Petitioners at this time would violate Section 29, Article VI of the Constitution prohibiting ‘money being paid out of the Treasury except in pursuance of an appropriation made by law.”  “The remedy of petitioners is to claim a tax refund under Section 204(c) of the Tax Code should their position be upheld by the Honorable Court.”

9.    Respondents also argue that “the implementation of the TRO would violate Section 218 of the Tax Code in relation to Section 11 of Republic Act No. 1125 (as amended by Section 9 of Republic Act No. 9282) which prohibits courts, except the Court of Tax Appeals, from issuing injunctions to restrain the collection of any national internal revenue tax imposed by the Tax Code.”

SUPREME COURT’s RULING:

Non-exhaustion of administrative remedies proper

Under Section 4 of the 1997 National Internal Revenue Code, interpretative rulings are reviewable by the Secretary of Finance. Thus, it was held that “if superior administrative officers can grant the relief prayed for, then special civil actions are generally not entertained.” The remedy within the administrative machinery must be resorted to first and pursued to its appropriate conclusion before the court’s judicial power can be sought.

Nonetheless, jurisprudence allows certain exceptions to the rule on exhaustion of administrative remedies. It is disregarded:

(1)  When there is a violation of due process,

(2)   When the issue involved is purely a legal question,

(3)  When the administrative action is patently illegal amounting to lack or excess of jurisdiction,

(4)  When there is estoppel on the part of the administrative agency concerned,

(5)  When there is irreparable injury,

(6)  When the respondent is a department secretary whose acts as an alter ego of the President bears the implied and assumed approval of the latter,

(7)  When to require exhaustion of administrative remedies would be unreasonable,

(8)  When it would amount to a nullification of a claim,

(9)  When the subject matter is a private land in land case proceedings,

(10)               When the rule does not provide a plain, speedy and adequate remedy,

(11)                When there are circumstances indicating the urgency of judicial intervention.

The exceptions under (2) and (11) are present in this case.  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. The rule on exhaustion of administrative remedies also finds no application when the exhaustion will result in an exercise in futility.

In this case, 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.

Doctrine on hierarchy of courts

Under Republic Act No. 1125 (An Act Creating the Court of Tax Appeals), as amended by Republic Act No. 9282,160 the jurisdiction to review the rulings of the Commissioner of Internal Revenue pertains to the Court of Tax Appeals.  The questioned BIR Ruling Nos. 370-2011 and DA 378-2011 were issued in connection with the implementation of the 1997 National Internal Revenue Code on the taxability of the interest income from zero-coupon bonds issued by the government.

In exceptional cases, however, the court entertained direct recourse to it when “dictated by public welfare and the advancement of public policy, or demanded by the broader interest of justice, or the orders complained of were found to be patent nullities, or the appeal was considered as clearly an inappropriate remedy.”

Here, 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 is a 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.

Substantive issues

A.   Tax treatment of deposit substitutes

Under Sections 24(B)(1), 27(D)(1), and 28(A)(7) of the 1997 National Internal Revenue Code, a final withholding tax at the rate of 20% is imposed on interest on any currency bank deposit and yield or any other monetary benefit from deposit substitutes and from trust funds and similar arrangements.

This tax treatment of interest from bank deposits and yield from deposit substitutes was first introduced in the 1977 National Internal Revenue Code through Presidential Decree No. 1739168 issued in 1980. Later, Presidential Decree No. 1959, effective on October 15, 1984, formally added the definition of deposit substitutes:

Deposit substitutes’ shall mean 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, for the purpose of relending or purchasing of receivables and other obligations, or financing their own needs or the needs of their agent or dealer. These promissory notes, repurchase agreements, certificates of assignment or participation and similar instrument with recourse as may be authorized by the Central Bank of the Philippines, for banks and non-bank financial intermediaries or by the Securities and Exchange Commission of the Philippines for commercial, industrial, finance companies and either non-financial companies: Provided, however, that only debt instruments issued for inter-bank call loans to cover deficiency in reserves against deposit liabilities including those between or among banks and quasi-banks shall not be considered as deposit substitute debt instruments.

Revenue Regulations No. 17-84, issued to implement Presidential Decree No. 1959, adopted verbatim the same definition and specifically identified the following borrowings as “deposit substitutes”;

1.    All interbank borrowings by or among banks and non-bank financial institutions authorized to engage in quasi-banking functions evidenced by deposit substitutes instruments, except interbank call loans to cover deficiency in reserves against deposit liabilities as evidenced by interbank loan advice or repayment transfer tickets.

2.    All borrowings of the national and local government and its instrumentalities including the Central Bank of the Philippines, evidenced by debt instruments denoted as treasury bonds, bills, notes, certificates of indebtedness and similar instruments.

3.    All borrowings of banks, non-bank financial intermediaries, finance companies, investment companies, trust companies, including the trust department of banks and investment houses, evidenced by deposit substitutes instruments.

The definition of deposit substitutes was amended under the 1997 National Internal Revenue Code with the addition of the qualifying phrase for public – borrowing from 20 or more individual or corporate lenders at any one time. Under Section 22(Y), deposit substitute is defined thus:

The term ‘deposit substitutes’ 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, for the purpose of relending or purchasing of receivables and other obligations, or financing their own needs or the needs of their agent or dealer. These instruments may include, but need not be limited to, bankers’ acceptances, promissory notes, repurchase agreements, including reverse repurchase agreements entered into by and between the Bangko Sentral ng Pilipinas (BSP) and any authorized agent bank, certificates of assignment or participation and similar instruments with recourse: Provided, however, That debt instruments issued for interbank call loans with maturity of not more than five (5) days to cover deficiency in reserves against deposit liabilities, including those between or among banks and quasi-banks, shall not be considered as deposit substitute debt instruments.

B.   Interpretation of the phrase “borrowing from twenty (20) or more individual or corporate lenders at any one time” under Section 22(Y) of the 1997 National Internal Revenue Code

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.

Meaning of “at any one time”

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.

For example, where the financial assets involved are government securities like bonds, the reckoning of “20 or more lenders/investors” is made at any transaction in connection with the purchase or sale of the Government Bonds, such as:

·         Issuance by the Bureau of Treasury of the bonds to GSEDs in the primary market;

·         Sale and distribution by GSEDs to various lenders/investors in the secondary market;

·         Subsequent sale or trading by a bondholder to another lender/investor in the secondary market usually through a broker or dealer; or

·         Sale by a financial intermediary-bondholder of its participation interests in the bonds to individual or corporate lenders in the secondary market.

When, through any of the foregoing transactions, 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.  Consequently, the seller is required to withhold the 20% final withholding tax on the imputed interest income from the bonds.

For debt instruments that are

not deposit substitutes, regular

income tax applies 

It must be emphasized, however, that debt instruments that do not qualify as deposit substitutes under the 1997 National Internal Revenue Code are subject to the regular income tax.

The phrase “all income derived from whatever source” in Chapter VI, Computation of Gross Income, Section 32(A) of the 1997 National Internal Revenue Code discloses a legislative policy to include all income not expressly exempted as within the class of taxable income under our laws.

“The definition of gross income is broad enough to include all passive incomes subject to specific tax rates or final taxes.”197  Hence, interest income from deposit substitutes are necessarily part of taxable income.  “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.”198  “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.”199chanRoblesvirtualLawlibrary

This court, in Chamber of Real Estate and Builders’ Associations, Inc. v. Romulo,200 explained the rationale behind the withholding tax system:chanroblesvirtuallawlibrary

The withholding [of tax at source] was devised for three primary reasons: first, to provide the taxpayer a convenient manner to meet his probable income tax liability; second, to ensure the collection of income tax which can otherwise be lost or substantially reduced through failure to file the corresponding returns[;] and third, to improve the government’s cash flow. This results in administrative savings, prompt and efficient collection of taxes, prevention of delinquencies and reduction of governmental effort to collect taxes through more complicated means and remedies.201 (Citations omitted)

“The application of the withholdings system to interest on bank deposits or yield from deposit substitutes is essentially to maximize and expedite the collection of income taxes by requiring its payment at the source.”202chanRoblesvirtualLawlibrary

Hence, 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.

C.   Whether the reckoning of the 20 lenders includes trading of the bonds in the secondary market

Financial markets

Financial markets provide the channel through which funds from the surplus units (households and business firms that have savings or excess funds) flow to the deficit units (mainly business firms and government that need funds to finance their operations or growth).  They bring suppliers and users of funds together and provide the means by which the lenders transform their funds into financial assets, and the borrowers receive these funds now considered as their financial liabilities.  The transfer of funds is represented by a security, such as stocks and bonds.  Fund suppliers earn a return on their investment; the return is necessary to ensure that funds are supplied to the financial markets.

“The financial markets that facilitate the transfer of debt securities are commonly classified by the maturity of the securities,” namely:  (1) the money market, which facilitates the flow of short-term funds (with maturities of one year or less); and (2) the capital market, which facilitates the flow of long-term funds (with maturities of more than one year).

Whether referring to money market securities or capital market securities, transactions occur either in the primary market or in the 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.

Fund transfers are accomplished in three ways: (1) direct finance; (2) semidirect finance; and (3) indirect finance.

With direct financing, the “borrower and lender meet each other and exchange funds in return for financial assets” (e.g., purchasing bonds directly from the company issuing them).  This method provides certain limitations such as: (a) “both borrower and lender must desire to exchange the same amount of funds at the same time”; and (b) “both lender and borrower must frequently incur substantial information costs simply to find each other.”

In semidirect financing, a securities broker or dealer brings surplus and deficit units together, thereby reducing information costs. In semidirect financing, “the ultimate lender still winds up holding the borrower’s securities, and therefore the lender must be willing to accept the risk, liquidity, and maturity characteristics of the borrower’s debt security.  There still must be a fundamental coincidence of wants and needs between lenders and borrowers for semidirect financial transactions to take place.”

“The limitations of both direct and semidirect finance stimulated the development of indirect financial transactions, carried out with the help of financial intermediaries” or financial institutions, like banks, investment banks, finance companies, insurance companies, and mutual funds. Financial intermediaries accept funds from surplus units and channel the funds to deficit units. “Depository institutions such as banks accept deposits from surplus units and provide credit to deficit units through loans and purchase of debt securities.”  Nondepository institutions, like mutual funds, issue securities of their own (usually in smaller and affordable denominations) to surplus units and at the same time purchase debt securities of deficit units. “By pooling the resources of small savers, a financial intermediary can service the credit needs of large firms simultaneously.”

D.   If the PEACe Bonds are considered “deposit substitutes,” whether the government or the Bureau of Internal Revenue is estopped from imposing and/or collecting the 20% final withholding tax from the face value of these Bonds

E.   Will the imposition of the 20% final withholding tax violate the non-impairment clause of the Constitution?

F.   Will it constitute a deprivation of property without due process of law?

G.   Will it violate Section 245 of the 1997 National Internal Revenue Code on non-retroactivity of rulings? (the two rulings were declared void)

H.   Prescription

The collection of tax is not barred by prescription

The three (3)-year prescriptive period under Section 203 of the 1997 National Internal Revenue Code to assess and collect internal revenue taxes is extended to 10 years in cases of:

(1)  fraudulent returns;

(2)  false returns with intent to evade tax; and

(3)  failure to file a return, to be computed from the time of discovery of the falsity, fraud, or omission

Thus, 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.

I.     Grave abuse of discretion by CIR

The Bureau of Internal Revenue rulings

The Bureau of Internal Revenue’s interpretation as expressed in the three 2001 BIR Rulings is not consistent with law.  Its interpretation of “at any one time” to mean at the point of origination alone is unduly restrictive.

BIR Ruling No. 370-2011 is likewise erroneous insofar as it stated (relying on the 2004 and 2005 BIR Rulings) that “all treasury bonds regardless of the number of purchasers/lenders at the time of origination/issuance are considered deposit substitutes.” Being the subject of this petition, it is, thus, declared void because it completely disregarded the 20 or more lender rule added by Congress in the 1997 National Internal Revenue Code.  It also created a distinction for government debt instruments as against those issued by private corporations when there was none in the law.

It may be granted that the interpretation of the Commissioner of Internal Revenue in charge of executing the 1997 National Internal Revenue Code is an authoritative construction of great weight, but the principle is not absolute and may be overcome by strong reasons to the contrary.  If through a misapprehension of law an officer has issued an erroneous interpretation, the error must be corrected when the true construction is ascertained.

It bears repeating that Revenue memorandum-circulars are considered administrative rulings (in the sense of more specific and less general interpretations of tax laws) which are issued from time to time by the Commissioner of Internal Revenue.  It is widely accepted that the interpretation placed upon a statute by the executive officers, whose duty is to enforce it, is entitled to great respect by the courts.  Nevertheless, such interpretation is not conclusive and will be ignored if judicially found to be erroneous.  Thus, courts will not countenance administrative issuances that override, instead of remaining consistent and in harmony with, the law they seek to apply and implement.

This court further held that “[a] memorandum-circular of a bureau head could not operate to vest a taxpayer with a shield against judicial action because there are no vested rights to speak of respecting a wrong construction of the law by the administrative officials and such wrong interpretation could not place the Government in estoppel to correct or overrule the same.”

In Misamis Oriental Association of Coco Traders, Inc. v. Department of Finance Secretary, this court stated that the Commissioner of Internal Revenue is not bound by the ruling of his predecessors, but, to the contrary, the overruling of decisions is inherent in the interpretation of laws:

In considering a legislative rule a court is free to make three inquiries:

(i)       Whether the rule is within the delegated authority of the administrative agency;

(ii)      Whether it is reasonable; and

(iii)    Whether it was issued pursuant to proper procedure. But the court is not free to substitute its judgment as to the desirability or wisdom of the rule for the legislative body, by its delegation of administrative judgment, has committed those questions to administrative judgments and not to judicial judgments.

In the case of an interpretative rule, the inquiry is not into the validity but into the correctness or propriety of the rule. As a matter of power a court, when confronted with an interpretative rule, is free to

(i)           Give the force of law to the rule;

(ii)          Go to the opposite extreme and substitute its judgment; or

(iii)        Give some intermediate degree of authoritative weight to the interpretative rule.

J.   Tax Refund

Interest income v. gains from sale or redemption

The interest income earned from bonds is not synonymous with the “gains” contemplated under Section 32(B)(7)(g)203 of the 1997 National Internal Revenue Code, which exempts gains derived from trading, redemption, or retirement of long-term securities from ordinary income tax.

The term “gain” as used in Section 32(B)(7)(g) does not include interest, which represents forbearance for the use of money.  Gains from sale or exchange or retirement of bonds or other certificate of indebtedness fall within the general category of “gains derived from dealings in property” under Section 32(A)(3), while interest from bonds or other certificate of indebtedness falls within the category of “interests” under Section 32(A)(4).204  The use of the term “gains from sale” in Section 32(B)(7)(g) shows the intent of Congress not to include interest as referred under Sections 24, 25, 27, and 28 in the exemption.205chanRoblesvirtualLawlibrary

Hence, the “gains” contemplated in Section 32(B)(7)(g) refers to: (1) gain realized from the trading of the bonds before their maturity date, which is the difference between the selling price of the bonds in the secondary market and the price at which the bonds were purchased by the seller; and (2) gain realized by the last holder of the bonds when the bonds are redeemed at maturity, which is the difference between the proceeds from the retirement of the bonds and the price at which such last holder acquired the bonds.  For 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 (original issue price plus accumulated discount from the time of purchase up to the time of sale) of the instruments.

         

         

Tax treatment of income derived from the PEACe Bonds

The transactions executed for the sale of the PEACe Bonds are:

The issuance of the P35 billion Bonds by the Bureau of Treasury to RCBC/CODE-NGO at P10.2 billion; and

The sale and distribution by RCBC Capital (underwriter) on behalf of CODE-NGO of the PEACe Bonds to undisclosed investors at P11.996 billion.

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 agreement221 and RCBC term sheet222 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 P11.996 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 P10.2 billion borrowing received by the Bureau of Treasury in exchange for the P35 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 turned around and sold said PEACe Bonds, whether in whole or part, simultaneously to 20 or more lenders or investors.

We note, however, that under Section 24223 of the 1997 National Internal Revenue Code, interest income received by individuals from long-term deposits or investments with a holding period of not less than five (5) years is exempt from the final tax.

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, or any lender or investor if such be the case, as the withholding agents.

Reiterative motion on the temporary restraining order

Respondents’ withholding of the

20% final withholding tax on

October 18, 2011 was justified 

Under the Rules of Court, court orders are required to be “served upon the parties affected.”224  Moreover, service may be made personally or by mail.225  And, “[p]ersonal service is complete upon actual delivery [of the order.]”226  This court’s temporary restraining order was received only on October 19, 2011, or a day after the PEACe Bonds had matured and the 20% final withholding tax on the interest income from the same was withheld.

Publication of news reports in the print and broadcast media, as well as on the internet, is not a recognized mode of service of pleadings, court orders, or processes.  Moreover, the news reports227 cited by petitioners were posted minutes before the close of office hours or late in the evening of October 18, 2011, and they did not give the exact contents of the temporary restraining order.

“[O]ne cannot be punished for violating an injunction or an order for an injunction unless it is shown that such injunction or order was served on him personally or that he had notice of the issuance or making of such injunction or order.”228chanRoblesvirtualLawlibrary

At any rate, “[i]n case of doubt, a withholding agent may always protect himself or herself by withholding the tax due”229 and return the amount of the tax withheld should it be finally determined that the income paid is not subject to withholding.230  Hence, respondent Bureau of Treasury was justified in withholding the amount corresponding to the 20% final withholding tax from the proceeds of the PEACe Bonds, as it received this court’s temporary restraining order only on October 19, 2011, or the day after this tax had been withheld.

Respondents’ retention of the

amounts withheld is a defiance of

the temporary restraining order

Nonetheless, respondents’ continued failure to release to petitioners the amount corresponding to the 20% final withholding tax in order that it may be placed in escrow as directed by this court constitutes a defiance of this court’s temporary restraining order.231chanRoblesvirtualLawlibrary

The temporary restraining order is not moot.  The acts sought to be enjoined are not fait accompli.  For an act to be considered fait accompli, the act must have already been fully accomplished and consummated.232  It must be irreversible, e.g., demolition of properties,233 service of the penalty of imprisonment,234 and hearings on cases.235  When the act sought to be enjoined has not yet been fully satisfied, and/or is still continuing in nature,236 the defense of fait accompli cannot prosper.

The temporary restraining order enjoins the entire implementation of the 2011 BIR Ruling that constitutes both the withholding and remittance of the 20% final withholding tax to the Bureau of Internal Revenue.  Even though the Bureau of Treasury had already withheld the 20% final withholding tax237 when it received the temporary restraining order, it had yet to remit the monies it withheld to the Bureau of Internal Revenue, a remittance which was due only on November 10, 2011.238  The act enjoined by the temporary restraining order had not yet been fully satisfied and was still continuing.

Under DOF-DBM Joint Circular No. 1-2000A239 dated July 31, 2001 which prescribes to national government agencies such as the Bureau of Treasury the procedure for the remittance of all taxes it withheld to the Bureau of Internal Revenue, a national agency shall file before the Bureau of Internal Revenue a Tax Remittance Advice (TRA) supported by withholding tax returns on or before the 10th day of the following month after the said taxes had been withheld.240  The Bureau of Internal Revenue shall transmit an original copy of the TRA to the Bureau of Treasury,241 which shall be the basis for recording the remittance of the tax collection.242  The Bureau of Internal Revenue will then record the amount of taxes reflected in the TRA as tax collection in the Journal of Tax Remittance by government agencies based on its copies of the TRA.243  Respondents did not submit any withholding tax return or TRA to prove that the 20% final withholding tax was indeed remitted by the Bureau of Treasury to the Bureau of Internal Revenue on October 18, 2011.

Respondent Bureau of Treasury’s Journal Entry Voucher No. 11-10-10395244 dated October 18, 2011 submitted to this court shows:chanroblesvirtuallawlibrary

Account Code

Debit Amount

Credit Amount

Bonds Payable-L/T, Dom-Zero

442-360

35,000,000,000.00

Coupon T/Bonds

(Peace Bonds) – 10 yr

Sinking Fund-Cash (BSF)         

198-001

30,033,792,203.59

Due to BIR  

412-002

4,966,207,796.41

To record redemption of 10yr Zero  coupon (Peace Bond) net of the 20% final  withholding tax pursuant to BIR Ruling No. 378-2011, value date, October 18, 2011 per BTr letter authority and BSP Bank Statements.

The foregoing journal entry, however, does not prove that the amount of P4,966,207,796.41, representing the 20% final withholding tax on the PEACe Bonds, was disbursed by it and remitted to the Bureau of Internal Revenue on October 18, 2011.  The entries merely show that the monies corresponding to 20% final withholding tax was set aside for remittance to the Bureau of Internal Revenue.

We recall the November 15, 2011 resolution issued by this court directing respondents to “show cause why they failed to comply with the [TRO]; and [to] comply with the [TRO] in order that petitioners may place the corresponding funds in escrow pending resolution of the petition.”245  The 20% final withholding tax was effectively placed in custodia legis when this court ordered the deposit of the amount in escrow.  The Bureau of Treasury could still release the money withheld to petitioners for the latter to place in escrow pursuant to this court’s directive.  There was no legal obstacle to the release of the 20% final withholding tax to petitioners.

Congressional appropriation is not required for the servicing of public debts in view of the automatic appropriations clause embodied in Presidential Decree Nos. 1177 and 1967.

Section 31 of Presidential Decree No. 1177 provides:chanroblesvirtuallawlibrary

Section 31. Automatic Appropriations.  All expenditures for (a) personnel retirement premiums, government service insurance, and other similar fixed expenditures, (b) principal and interest on public debt, (c) national government guarantees of obligations which are drawn upon, are automatically appropriated: provided, that no obligations shall be incurred or payments made from funds thus automatically appropriated except as issued in the form of regular budgetary allotments.

Section 1 of Presidential Decree No. 1967 states:chanroblesvirtuallawlibrary

Section 1. There is hereby appropriated, out of any funds in the National Treasury not otherwise appropriated, such amounts as may be necessary to effect payments on foreign or domestic loans, or foreign or domestic loans whereon creditors make a call on the direct and indirect guarantee of the Republic of the Philippines, obtained by:

a. the Republic of the Philippines the proceeds of which were relent to government-owned or controlled corporations and/or government financial institutions;

b. government-owned or controlled corporations and/or government financial institutions the proceeds of which were relent to public or private institutions;

c. government-owned or controlled corporations and/or financial institutions and guaranteed by the Republic of the Philippines;

d. other public or private institutions and guaranteed by government-owned or controlled corporations and/or government financial institutions.

The amount of P35 billion that includes the monies corresponding to 20% final withholding tax is a lawful and valid obligation of the Republic under the Government Bonds.  Since said obligation represents a public debt, the release of the monies requires no legislative appropriation.

Section 2 of Republic Act No. 245 likewise provides that the money to be used for the payment of Government Bonds may be lawfully taken from the continuing appropriation out of any monies in the National Treasury and is not required to be the subject of another appropriation legislation:chanroblesvirtuallawlibrary

SEC. 2. The Secretary of Finance shall cause to be paid out of any moneys in the National Treasury not otherwise appropriated, or from any sinking funds provided for the purpose by law, any interest falling due, or accruing, on any portion of the public debt authorized by law. He shall also cause to be paid out of any such money, or from any such sinking funds the principal amount of any obligations which have matured, or which have been called for redemption or for which redemption has been demanded in accordance with terms prescribed by him prior to date of issue . . . In the case of interest-bearing obligations, he shall pay not less than their face value; in the case of obligations issued at a discount he shall pay the face value at maturity; or if redeemed prior to maturity, such portion of the face value as is prescribed by the terms and conditions under which such obligations were originally issued. There are hereby appropriated as a continuing appropriation out of any moneys in the National Treasury not otherwise appropriated, such sums as may be necessary from time to time to carry out the provisions of this section. The Secretary of Finance shall transmit to Congress during the first month of each regular session a detailed statement of all expenditures made under this section during the calendar year immediately preceding.

Thus, DOF Department Order No. 141-95, as amended, states that payment for Treasury bills and bonds shall be made through the National Treasury’s account with the Bangko Sentral ng Pilipinas, to wit:chanroblesvirtuallawlibrary

Section 38. Demand Deposit Account. – The Treasurer of the Philippines maintains a Demand Deposit Account with the Bangko Sentral ng Pilipinas to which all proceeds from the sale of Treasury Bills and Bonds under R.A. No. 245, as amended, shall be credited and all payments for redemption of Treasury Bills and Bonds shall be charged.

Regarding these legislative enactments ordaining an automatic appropriations provision for debt servicing, this court has held:chanroblesvirtuallawlibrary

Congress . . . deliberates or acts on the budget proposals of the President, and Congress in the exercise of its own judgment and wisdom formulates an appropriation act precisely following the process established by the Constitution, which specifies that no money may be paid from the Treasury except in accordance with an appropriation made by law.

Debt service is not included in the General Appropriation Act, since authorization therefor already exists under RA Nos. 4860 and 245, as amended, and PD 1967. Precisely in the light of this subsisting authorization as embodied in said Republic Acts and PD for debt service, Congress does not concern itself with details for implementation by the Executive, but largely with annual levels and approval thereof upon due deliberations as part of the whole obligation program for the year. Upon such approval, Congress has spoken and cannot be said to have delegated its wisdom to the Executive, on whose part lies the implementation or execution of the legislative wisdom.246 (Citation omitted)

Respondent Bureau of Treasury had the duty to obey the temporary restraining order issued by this court, which remained in full force and effect, until set aside, vacated, or modified.  Its conduct finds no justification and is reprehensible.247chanRoblesvirtualLawlibrarychanrobleslaw

WHEREFORE, the petition for review and petitions-in-intervention are GRANTED.  BIR Ruling Nos. 370-2011 and DA 378-2011 are NULLIFIED.

Furthermore, respondent Bureau of Treasury is REPRIMANDED for its continued retention of the amount corresponding to the 20% final withholding tax despite this court’s directive in the temporary restraining order and in the resolution dated November 15, 2011 to deliver the amounts to the banks to be placed in escrow pending resolution of this case.

Respondent Bureau of Treasury is hereby ORDERED to immediately release and pay to the bondholders the amount corresponding to the 20% final withholding tax that it withheld on October 18, 2011.