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Returning to the basics of the Long-term deposit or investment certificate

(Article Published in the Dec 19,2012 issue of Manila Standard Today)

       The otherwise placid waters of the investment community of the country were recently stirred, not so mildly, by the issuance of the Department of Finance of Revenue Regulation No. 14-2012. What caused a lot of consternation amongst the always sober and somber investment community is Section 3 which deals with Section 22(FF) of the National Internal Revenue Code relating to a bank product known as the "Long-term Deposit or Investment Certificate."

       If my recollection serves me right (and I intend to confirm this as soon as I am able to do research at the Senate archives), the banks were at that time under severe criticism for their lending practice: they were predominantly lending short-term. This forced companies to borrow short-term in order to fund their projects which had long-term gestation periods.

       The defense of the banks was simple. They lent short-term because the money they have, aside from their capital, is also short-term, in the form of savings deposits which can be withdrawn any time and in time deposits which ordinarily are in 30, 60, or 90 day maturities. Thus, they cannot, said the banks, afford the risks involved in the mismatch of borrowing short and lending long.

       The solution was therefore to supply the banks with long-term money. A source for long-term funds that was identified was the pool of savers in many households who kept their excess funds, not in the banks but under their mats and, for the more affluent ones, mattresses. The idea was to entice these savers to put their savings with banks and the enticement, was, tax-exemption on the interest income.

       This history explains the characteristics demanded by Revenue Regulations No. 14-2012 and reiterated Revenue Memorandum Circular No. 81-2012 that was issued on December 10, 2012.

       First and foremost, is that the persons benefitted by the tax exemption are individuals, not corporations. The reason is that it is persons who keep their money in mats and mattress. Corporations have their safes. Not all individuals, however, are benefitted. For obvious reasons, non-resident aliens who are not engaged in trade or business in the Philippines are not included because they do not stay here long enough. In fact, they are, in their incomes from the Philippines, taxed on the gross.

       It follows, from the fact that the owner is the individual, that the name of the said individual must be what appears on the certificate itself. Not the name of the bank managing his or her account, regardless of any authorization, private to the bank and the individual, authorizing the bank to put the certificate in the bank's name.

       It also follows that the denominations of the certificate be in small amounts, specficially, Php10,000 or other denominations prescribed by the BSP. Again, we are after the small depositors; hence, the threshold ought to be at the low level that small depositors can afford.

       Because the arrangement is a bank product, it is similarly logical that the form be that prescribed by the regulator of banks, the Bangko Sentral. To my knowledge, the BSP has yet to formally prescribe a form for this type of certificates.

       The law, unfortunately, had an imbedded defect right at its inception, with regard to the arrangement that was to be benefitted. There is no doubt that savings and time deposit certificates are "issued" by banks; they are the bank's liabilities. However, for reasons which I will deal with later, the tax code also gives the same treatment to "common or individual trust funds, deposit substitutes, investments management accounts..." The error is that while savings and time deposits are bank liabilities, common or individual trust funds and investment management accounts are not. They are service arrangements where the bank does not owe the owner money (as in the case savings and time deposits) but instead owes the owner the duty of managing the owner's money. In other words, whereas in savings and time deposits, banks do business with their clients. In trust and investment management accounts, the banks do business for their clients. The former has maturities (time when the money owed must be paid back; the latter has none, and in most cases terminable at will depending on the confidence that the owner of the money has in the managing bank.

       In trusts and investment management accounts, what has maturity are the instruments in which the money is placed by the trustee or the agent, not the relationship of trustor-trustee or owner-agent. The question that arises is therefore which ought to be for five years? Is it the relationship of trust or agency or is it the instruments that the trustee or agent has placed the money?

       Revenue Memorandum Circular No. 81-2012 makes it very clear: the trust or investment management account must be for five years AND the underlying investments (the outlets where the money was placed) must be also for five years. Those underlying investments must also comply with the requirements of Section 22(FF) of the tax code. And, very important, the trust or investment management account must hold on to the underlying investment for at least five years.

       What is also crucial is that the certificate be issued by banks and not by any other institution, even if they happen to be financial institutions. It was only the banks who could issue the certificates because it is they who had complained, in the defense of their predeliction for short-term lending, that they had no long-term funds to lend. Other financial institutions were by legally constrained by their very nature to go into this or that type of lending. Only the banks had the statutory authority to lend short or long as the exigencies of their business demanded. Revenue Memorandum Circular No. 81-2012 stresses that the bank needs to have a license to do banking by the Bangko Sentral.

       The maturity period of the deposit or investment must be for at least five (5) years. This is written in the law itself to ensure the long-term nature of the money placed in the hands of the bank. As a way of supporting this long-holding period, there is some sort of "penalty" for pre-terminating the placement. This penalty is graduated, according to the length of time that the deposit or investment was maintained in the bank. The longer it had stayed in the bank, the lighter the penalty, which is the imposition of a tiered system of tax on the interest that would otherwise have been tax-free if the depositor or investor had stuck with the original intent of the arrangement.

       The maturity period of the deposit or investment must be for at least five (5) years. This is written in the law itself to ensure the long-term nature of the money placed in the hands of the bank. As a way of supporting this long-holding period, there is some sort of "penalty" for pre-terminating the placement. This penalty is graduated, according to the length of time that the deposit or investment was maintained in the bank. The longer it had stayed in the bank, the lighter the penalty, which is the imposition of a tiered system of tax on the interest that would otherwise have been tax-free if the depositor or investor had stuck with the original intent of the arrangement.

       In effect what the Commissioner had done was to return to the original purpose and intent of the long-term deposit or investment certificate. In the process, some pruning had to be done. But pruning is essentially a life-enhancing exercise.

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