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There is no case against the BIR on tax exemption, only PEACe

(Article published in the February 18, 2002 issue of TODAY, Business Section)

One of the more acrimonious issues raised against the PEACe Bonds is that the tax exemption said to be granted under Bureau of Internal Revenue (BIR) Ruling No. 020-2001, issued on May 31, 2001, and BIR Ruling No. 035-2001, issued on August 16, 2001 caused the government to lose about P1.44 billion in revenues.

Since I decided to become a lawyer partly because I was not very good in math, I dare not quarrel about how the estimate of the tax loss was arrived at. I must, however, take issue with the innuendo that the BIR "granted" tax exemption and its rulings were erroneous.

The BIR does not "grant" tax exemptions. Only the law, such as the Constitution or a treaty or a statute emanating from a lawmaking body (which the BIR obviously is not), grants tax exemptions. Its questioned rulings, which are no more than an adminstrator’s interpretations of the law, are correct articulations of the provisions of the tax code relevant tot he issuance of the PEACe Bonds.

BIR Ruling No. 020-2001 was issued in response to queries posed in May 2001 by CODE-NGO. The Commissioner was essentially asked (1) whether the interest income of the bonds was subject to the 20-percent final tax imposed on the yield from deposit substitutes; (2) whether the gains on the sale, exchange or retirement of the bonds was subject to any income tax; and (3) whether the issuance of the bonds requires the payment of the documentary stamp tax.

Rene Baņez responded to question (1) in the manner I had required generations of students to answer: always start with the law and cite chapter and verse. Then, simply apply it. Citing Section 22(Y) of the Tax Code, which defined deposit substitutes, he pointed out, correctly, that to be a "deposit substitutes," the instrument must be a form of obtaining funds from the "public" by which is meant twenty or more individual or corporate lenders any one time.

Relying on the representation of CODE-NGO that the bonds will be issued to only one buyer, then clearly the borrowing is not from the "public" and instrument is not a deposit substitutes. With law and assumed fact as premises, the conclusion is inescapable: No, the income from the bonds cannot be subject to the 20-percent final tax on yield from deposit substitutes.

National Treasurer Eduardo Sergio Edeza was not satisfied. His letter of August 8, 2001, indicated that he was distributed by the fact that while there was only one buyer for the entire issuance, it was clear that, after the initial sale, many others (which may or may not number twenty or more) would be owning the bonds. Since the law defines public as twenty or more lenders at any one time, should not the bonds be then considered as a borrowing, in the final analysis, from those secondary buyers?

The Baņez response is book legal hermeneutics. A legal term must be read in context. He replied, in Ruling No. 035-2001, that "at any one time" referred only to the origination or original issuance of the bonds and not to the subsequent transfers of the bonds from hand to hand. His interpretation is clearly correct. "Public" was defined under Section 22(Y) in connection with the activity of borrowing or obtaining funds. "Public" is from whom the funds are borrowed and so the crucial question is, when are the funds borrowed? Obviously, when the bonds are issued. It is at that time that the instrument either becomes or does not become a deposit substitute. After the funds are remitted to the borrower, the borrowing ceases, and any change in the number of holders of the instrument that effected the borrowing cannot affect the nature of that instrument because the borrowing cannot affect the nature of that instrument because the borrowing has been previously completed. Otherwise, the instrument could turn into a tax chameleon-changing colors every time, during its ten year lifetime – a deposit substitute when there are twenty or more holders and not a deposit substitute when there are less.

Question (2) was answered by Ruling No. 020-2001 in similar fashion. Section 32(B) of the Tax Code is entitled "Exclusions from Gross Income" and it enumerates items which are not to "be included in gross income and shall be exempt from taxation under this [income tax] title." Quoting verbatim Section 32(B)(7)(g) that exempts from the income tax "gains realized from the sale or exchange or retirement of bonds…with a maturity of more than five [5] years" and, again accepting the representation that the bonds mature in ten (10) years, Baņez had no trouble giving the right answer.

It seems that Treasurer Edeza was once again bothered. He wanted to know what was meant by "gain." More precisely, did "gain" refer to the accrued interest or only to the gain, in the strict sense, namely, the difference between a seller’s cost and the price at which the bond is subsequently sold? The good treasurer was not being picky. In 1999, under the presidency of Joseph Ejercito Estrada, a ruling was issued, numbered 166-99, addressed to Aegeon Life Insurance (Philippines), Inc. that interpreted the word "gain" loosely and exempted the income portion of the five-year bond. Tax experts and accountants were certain the ruling was incorrect; but since it was favorable to their clients, no one dared pose a query that would provide the government an opportunity to reverse it.

Baņez, in responding to Edeza, seized the opportunity. The exempted "gain," said he, refers only to the gain from secondary trading, when the more than five-year bond passes from one hand to another, all the way up to the time the said bond is surrendered to the issuer at maturity. But it does not refer to the interest. The PEACe Bonds critics may not have realized it. This ruling earned back for the government what Aegeon gave away.

Baņez is not alone in that reading of the law. The Court of Tax Appeals on February 4, 2002, in the case of Nippon Life Insurance Company of the Philippines, Inc. v. Commissioner of Internal Revenue, Case No. 6142, distinguished interest from gains, and went along the same lines as Baņez.

The response to question (3) no critic of the PEACe Bonds mentioned. That is because Ruling No 020-2001 said that the issuance of the bonds was not exempted from the documentary stamp tax. Baņez pointed out that Section 180 of the Tax Code clearly includes bonds as among the taxable instruments.

Obviously remembering that in his youth I taught him that the taxes imposed by the different titles in the tax code are to be treated independently, he simply said "there is therefore no legal basis to further exempt the PEACe Bonds from pay of the documentary stamp tax, notwithstanding the fact that, pursuant to Section 32(B)(7)(g) of the 1997 Tax Code, bonds with maturity of more than 5 years are exempt from income tax."

Clearly, there can be no revenue loss that can be blamed on the BIR rulings issued on the PEACe Bonds. The Bureau did not grant any tax exemption. Its rulings simply reflected what the law, which was made by our very own Congress, itself granted for the purpose of spurring the development of our capital market.

It is most ironic that our Congress is now permitting itself to be used as a venue for a totally senseless exercise that, when the screaming and shouting eventually die down, leads to no other end but damage to what, in a rare act of wisdom and vision, it once wanted to build.