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Tax pretence is now a dead duck

(Article Published in the Nov 21,2012 issue of Manila Standard Today)

       The Department of Finance issued on 07 November 2012 of Revenue Regulations 14-2012 that sets forth what it considers the "proper tax treatment of interest income earnings on financial instruments and other related transactions". The premise of the issuance was obviously that the principles and practices of such treatment as heretofore observed had been less than rational; hence, the need to "rationalize" it. So, what was broke that needed fixing?

       The introductory sentence of Section 1 states that the regulations were being promulgated "pursuant to the provisions of Sections 57, 244 and 245 of the National Internal Revenue Code (NIRC) and in the light of the resolution contained in the PEACe Bond Ruling..." Sections 57, 244 and 245 of the NIRC are without doubt the statutory provisions granting the national internal revenue authority the power to promulgate regulations implementing the tax code's provisions in general; but the term "PEACe Bond Ruling" is not as obvious. However, a quick scan of the website of the Supreme Court shows no ruling as yet has been issued by the highest court on the PEACe Bonds. Hence, what must have been meant was the latest ruling of the Bureau of Internal Revenue on the matter, namely, BIR Ruling No. 378-11, which was the latest ruling on the matter.

       It is thus important, for the proper understanding of RR No. 14-2012, that BIR Ruling No. 378-11 that was addressed to the Bureau of Treasury, regarding the PEACe Bonds, be given a good review.

       The PEACe (short for Poverty Eradication and Alleviation Certificate) bonds were instruments of indebtedness issued by the government on October 16, 2001. On its face, it yielded no interest. Since interest payments due on long term instruments used to be represented by "coupons" (literally, perforated small slips of paper attached to the main body of the bond which are, in the early days, torn away and surrendered to the bond issuer who then pays the interest stated on the coupon), the PEACe Bonds had a zero-coupon rate. The interest was effectively paid when the face value of the bond, which was initially sold at a discount, is paid in full at maturity. The difference between the discounted issue price and the maturity value is really the interest, or compensation paid by the issuer for the use of the money in the meantime.

       When the PEACe bonds were issued in 2001, the understanding of the investing public, thanks in part to the assurances of those holding the reins of government at that time, was that the "interest" when eventually paid at maturity would not be subjected to any tax. This understanding was apparently aided and abetted by rulings made by the then fiscal authorities that, indeed, the interest would be tax-free.

       When my former tax student, Kim Henares, became Commissioner of Internal Revenue, she, remembering one of the most basic rules of taxation I had taught her class, took the position that the interest which the government had to pay on maturity had to be subjected to the withholding tax because there was no law that exempted the payment from the income tax. Tax exemptions, being in derogation of sovereignty, had to come from the representatives of the sovereign people, namely, Congress and not the just from the tax implementors.

       Although previous administrative rulings had already been made earlier that actually reversed the earlier stance that the PEACe bonds interest was tax-free, her position that merely articulated the rethinking on the matter stirred up more a storm in the holders bigger than a teapot. It caused a lot of weeping and gnashing of teeth primarily from taxpayers who were holding the bonds and were waiting to be paid at maturity. The financial institutions holding the instrument, mostly banks, ran to the Supreme Court for a determination of their rights and obligations, specifically asking that the Bureau be prohibited from withholding any tax when the interest fell due. Ordinarily, parties would wait until the judiciary has had its say.

       But time and tide wait for no one, and in this case did not wait even for the Supreme Court. When the maturity date of the PEACe bonds came without any restraining order from the court having been received by the payor-government, the Treasurer of the Philippines had no choice but to withhold the tax prior to the payment of the interest. The Supreme Court served its temporary restraining order kind of late, and even at present is yet to decide the main case before it.

       The crucial advance in thought, as ingrained in RR No. 14-2012, is the determination that the instruments of indebtedness or securities issued by the government for the purpose of evidencing its borrowing from the public in order to, among other purposes, finance its own needs are in the nature of deposit-substitutes, if the said instruments are, right from the beginning, by design and structure, intended to be traded and sold amongst many investors and holders, even if initially the first buyers are very few and do not qualify as "public". If the issuance has that initial purpose and avowed dispersal to be made eventually, then they are deemed to fall squarely within the definition of deposit-substitute articulated in Section 22(Y) of the NIRC, regardless of how few the original or first buyers may be.

       This innovation renders useless and to no avail schemes that have heretofore been devised and designed (in "conspiracy" has too criminal an innuendo to be used) by smart traders and dealers that see as fronts only a few buyers who then turn around to sell to others who are legion. If the instrument, at the end of the day, walks like a duck, quacks like a duck, and waddles like a duck, then the taxman, under RR No. 14-2012, will consider it a duck, even if from all appearances it looks like a hybrid chick and turkey.

       More on the waves of rationalization under RR No. 14-2012 will be treated in the subsequent issues of this corner.

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