Finally, peace on the PEACe bonds front

Let’s Talk Tax
Sheena Marie D. Daño

Posted on August 25, 2015

Taxpayers have found some interpretations of the Tax Code to be unfair. There is hope in the courts though as seen in the Supreme Court decision on the Poverty Eradication and Alleviation Certificates (PEACe bonds).

More than a decade ago, the Bureau of Treasury issued to the winning bidder P35 billion worth of 10-year zero-coupon treasury bonds designated as PEACe bonds of the Caucus of Development Non-Governmental Organization Networks (CODE-NGO), the country’s largest nonstock, nonprofit organization, which is composed of six national and six regional member networks, working for social development.

The bonds were issued for the sole purpose of endowing the net proceeds to a permanent fund, called the “Hanapbuhay Fund”, to finance meritorious projects of accredited NGOs in the country.

By nature, a zero-coupon bond is issued at substantially lower than its face value, with the face value and interest repaid one time upon maturity.

Rizal Commercial Banking Corp. (RCBC) was the winning bidder on behalf of CODE-NGO, having tendered the lowest bid at 12.75% out of 45 bids from 15 government securities-eligible dealers.

In response to a query on the tax treatment of PEACe bonds, the BIR issued BIR Ruling Nos. 020-2001 and 035-2001, confirming that the PEACe bonds do not qualify as deposit substitutes since they will be issued only to one entity, which is RCBC in behalf of CODE-NGO; hence, exempt from 20% final withholding tax.

To be classified as deposit substitutes, Section 22 (Y) of the Tax Code provides that the borrowing of the funds, other than deposits, must be obtained from 20 or more individuals or corporate lenders at any one time.

However, in 2011, the Bureau of Internal Revenue (BIR) reversed its ruling in 2001 through the issuance of BIR Ruling Nos. 370-2011 and 378-2011, accentuating that the final withholding tax due on the interest earned on PEACe bonds should be imposed at 20%, not only on RCBC/CODE-NGO but also on all subsequent holders of such bonds.

The new rule effectively applied Section 2 (h)(iii)(b) of Revenue Regulations (RR) No. 17-84, which considers as deposit substitutes all borrowings of the national and local government and its instrumentalities, including Bangko Sentral ng Pilipinas, evidenced by debt instruments denoted as treasury bonds, bills, notes, certificate of indebtedness and similar instruments, regardless of the number of purchasers or lenders at the time of issuance as deposit substitutes.

In protest, RCBC and eight other banks filed a petition for certiorari with urgent application for a temporary restraining order, which the Supreme Court immediately issued, subject to the condition that the 20% final withholding tax on interest income from PEACe bonds shall be withheld by the petitioner banks and placed in escrow pending resolution of the petition.

RR No. 14-2012, clarified by Revenue Memorandum Circular No. 77-2012, further fanned the controversy when it added a provision stating that the 20% creditable withholding tax shall be applied on interest income from all other debt instruments that do not fall within the coverage of deposit substitutes.

In effect, interest income from financial instruments and similar arrangements are subject to 20% final withholding tax for those deemed as deposit substitutes; otherwise, 20% creditable withholding tax applies for non-top 20,000 corporations or 2% creditable withholding tax for top 20,000 corporations.

The main contention is whether or not the PEACe bonds are deposit substitutes subject to 20% final withholding tax. Early this year, the Supreme Court sitting en ranc finally ruled through GR No. 198756 that the sale of bonds upon origination did not fall under the 20 or more lender rule since there is only one lender, which is RCBC in behalf of CODE-NGO. Hence, the PEACe bonds are not subject to 20% final withholding tax.

However, any subsequent sale and distribution of PEACe bonds to 20 or more lenders would oblige RCBC in behalf of CODE-NGO and the rest of the petitioner banks to withhold 20% final withholding tax; unless the holder qualifies for exemption available for long term investments. That is, the holding period is five years or more since PEACe bonds qualify as long term investments, exempt from final withholding tax, pursuant to Section 24 of the Tax Code.

The Supreme Court’s decision nullified the 2011 BIR rulings for completely disregarding the 20 or more lender rule and for creating a distinction between debt instruments issued by the government as against those issued by private corporations where none was mentioned in the Tax Code. Likewise, the decision nullified the 2001 BIR rulings for erroneously interpreting the phrase “at any one time” to mean at the point of origin alone instead of at every point of sale, including subsequent sale.

Looking at the bigger picture, preponderant to all these interpretations is the unspoken concern that the national government’s deficit pegged at 2% of the gross domestic product or about P284 billion for 2015 has been constraining the coalesced efforts of public and private entities towards sustainable economic expansion and comprehensive social protection. While it’s true that the efforts of the BIR in sourcing the needed funds have been laudable, the BIR’s quasi-legislative powers should be exercised with utmost judicious diligence vis-à-vis its executive power in enforcing its sanctioned issuances.

It is therefore imperative that the BIR should act within its limits in issuing rules and regulations. GR No. 198756 is one concrete case that firmly establishes the objective and impartial interpretation of tax laws, wherein interpretations contrary to law are not absolute. After all, it would be most unfortunate if the taxpayers pay more than is required.

Sheena Marie D. Daño is a manager at the Cebu branch of Punongbayan & Araullo’s Tax & Outsourcing Division.