October 7, 2011

BIR RULING NO. 370-11

Sections 22 (Y) and 27 (D) of the

Tax Code of 1997;
BIR Ruling No. [DA-007-04];
BIR Ruling No. [DA-491-04];
BIR Ruling No. 008-05

Department of Finance
DOF Building, BSP Complex
Roxas Blvd., 1004
Manila

Attention: Hon. Cesar V. Purisima

Secretary of Finance

Gentlemen :

This refers to your letter dated September, 2011 requesting for the proper
tax treatment of the discount or interest income arising from the Php35 billion
worth of 10-year zero coupon treasury bonds issued by the Bureau of Treasury
("BTr") on October 18, 2001 (hereinafter referred to as the "Poverty Eradication
and Alleviation Certificates" or the "PEACe Bonds").

It is represented that the issuance of the PEACe Bonds by the BTr stemmed
from the proposal of the Caucus of Development NGO Networks ("CODE-NGO")
sometime in March 2001 for the Department of Finance ("DOF") to issue Php15
billion worth of 10-year zero coupon treasury notes. Under the said proposal,
CODE-NGO will purchase the notes and sell them to investors. The net proceeds
from the sale of the notes, which were estimated at Php1.45 billion, will be used
by CODE-NGO to establish a fund that will finance anti-poverty projects of
non-government organizations ("NGOs") nationwide.

However, the original plan of CODE-NGO did not materialize because the
BTr, under the leadership of then Treasurer Eduardo Sergio Edeza, questioned the
propriety of issuing the bonds directly to CODE-NGO 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 an auction and

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 that CODE-NGO should get a GSED to make a tender on its behalf.

Accordingly, on October 16, 2001, the BTr sold the PEACe Bonds via
auction to eligible GSEDs. The terms of the issuance of the subject bonds are as
follows: cDCEHa

Authorized Amount : Up to Php50.0 Billion

Minimum Offered Amount : Php30 billion

Issue Price : At a Discount

Term : Ten (10) years

Redemption : In one lump sum at maturity date of the Issue (i.e.,

October 18, 2011)

Yield to Maturity : Market determined

Form : Uncertificated, to be registered with the Registry

of Scripless Securities

Taxation : Not subject to 20% withholding tax as the issue

will be limited to a maximum of 19 lenders in the
primary market (pursuant to BIR Ruling No.
020-2001 dated May 31, 2001)

Eligibilities : Eligible as liquidity reserves (Pursuant to MB

Resolution No. 1545 dated September 27, 2001)

Security of Issue : Direct, unconditional and general obligations of

the National Government

Firms Eligible : Government Securities Eligible Dealers (GSEDs)

and any Financial Institutions (as provided under
Sec. 36 of Department of Finance Order (DOF)
No. 141-95, as amended)

With regard to the taxation of the discount or interest income realized from
the issuance of the PEACe Bonds, the BTr specified in the Public Offering of
Treasury Bonds that ". . . the issue being limited to 19 lenders and while taxable
shall not be subject to 20% final withholding tax." 1(1)

The foregoing tax treatment of the interest income arising from the PEACe
Bonds was based on three (3) BIR Rulings issued shortly before the auction
("2001 Rulings"), which provides:

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 1. BIR Ruling No. 020-2001 dated May 31, 2001 —

In response to the request of the CODE-NGO and considering that the

PEACe Bonds were proposed to be issued to a single entity (therefore complying
with the "19-Lender Rule"), the said Bonds were not considered to be a "public"
borrowing, the PEACe Bonds are not considered "deposit substitutes", as defined
under Section 22 (Y) of the 1997 Tax Code. Hence, it was resolved that the
interest income arising from the PEACe Bonds is not subject to the 20% final
withholding tax, to wit: TAEcCS

"As defined in Section 22(Y) of the 1997 Tax Code, to wit:

The term "deposit substitutes" shall mean an alternative form of

obtaining funds from the Public (the term 'public' means the 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 or receivables and other obligations, or financing
their own needs or the needs of their agents or dealer. These instruments
may include, but need not be limited to banker's 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.

Thus, to be classified as "deposit substitutes", 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, i.e., Code NGO, the same shall not
be considered as "deposit substitutes" falling within the purview of the
above definition. Hence, the withholding tax on deposit substitutes will not
apply."

2. BIR Ruling No. 035-2001 dated August 16, 2001 —

In connection with the request of BTr seeking further clarification on BIR

Ruling No. 020-2001 dated May 31, 2001 relative to the meaning of the word
"public", particularly on the interpretation of the phrase "at any one time", Section
22 (Y) of the 1997 Tax Code, this Office resolved as follows:

"I. In connection with your query as to the meaning of the word

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 "public", particularly on the interpretation of the phrase "at any one time",
Section 22(Y) of the 1997 Tax Code defines the term "public" in relation to
"deposit substitutes", as "borrowing from twenty (20) or more individual or
corporate lenders at any one time".

It should be noted that at the time of issuance or origination of the

PEACe Bonds, there is no borrowing from the public, since the bonds
are-being issued only to one entity, that is, RCBC. It has been the practice
of the BSP that debt instruments and certificates are being issued only to
banks and/or financial institutions.

You also wish to know whether the phrase 'at any one time' in
respect to borrowing from the 'public' may refer to single borrowing only,
e.g., time of origination only, or one series or tranch, i.e., sale to secondary
market; and that in any case, whether the number of would-be holders shall
be the factor in determining whether or not the bonds or certificates of
indebtedness are to be considered "deposit substitutes". aTEScI

In this particular instance, the phrase 'at any one time' covers only
the origination or original issuance of the bonds regardless of whether
sale or trading is made in the secondary market. Thus, in the case of
PEACe Bonds, the determining factor in ascertaining whether such bonds
are 'deposit substitutes', is the fact of their original issuance to a single
entity, RCBC.

The flowchart attached to your letter shows that RCBC will sell the
bonds to CODE-NGO, which will then sell bonds to RCBC Capital as
underwriter. In this regard, it should be noted that CODE-NGO cannot
acquire the bonds directly, not being an accredited government securities
dealer, hence, the original purchase by RCBC, and subsequent sale of the
same bonds to CODE-NGO. RCBC Capital, on the other hand, purchases
the bonds for its own account, and not for the account, or as agent of, any
other buyer. Under these circumstances, it is clear that the bonds are
issued to a single entity, whether such entity be RCBC, CODE-NGO or
RCBC Capital. In this regard, a representation or warranty should be
made to the effect that the bonds are acquired upon their original issuance
by the original purchaser thereof, for and on its own behalf, or on behalf
of a single purchaser only, and in the latter case, that the purchaser is
acquiring such bonds for its own account and not for the account of other
entities." (Emphasis provided)

3. BIR Ruling No. [DA-175-01] dated September 29, 2001 —

In relation to the subsequent request of BTr for clarification on the

application of BIR Ruling No. 020-2001 dated May 31, 2001 and BIR Ruling No.
035-2001 dated August 16, 2001 to other cases of issuances or only to the
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 proposed issuance of the PEACe Bonds, this Office ruled, viz.:

"We hereby confirm the foregoing rulings, after taking into account
the above-stated features of the proposed PEACe bond issuance:

I. As defined in Section 22(Y) of the 1997 Tax Code, the term

"deposit substitutes" as an alternative form of obtaining funds from the
"public" requires that the borrowing must be made from twenty (20) or
more individual or corporate lenders at any one time. Corollarily, if the
proposed PEACe Bonds are issued to less than twenty (20) individual or
corporate lenders, the borrowing shall not be considered as "public"
borrowing. Hence, the instrument shall not be classified as "deposit
substitutes".

II. In connection with your query as to the meaning of the phrase

"at any one time" as an element of public borrowing in order that the same
may be considered as "deposit substitutes", we hereby reiterate that the
phrase 'at any one time' covers only the origination or original issuance of
the bonds regardless of whether sale or trading is made in the secondary
market. CIAacS

However, in the case of PEACe Bonds, since the determining

factor in ascertaining whether or not such bonds are 'deposit substitutes' is
the original issuance to more than twenty (20) individual or corporate
lenders, it holds to say that the issuance to less than 20 individual or
corporate lenders will necessarily exclude them from the coverage of
"deposit substitutes". Such being the case, the time element, i.e., "at any
one time" required in "public "borrowing" shall not apply in the instant
case."

During the auction, RCBC was declared as the winning bidder having
tendered the lowest bid interest rate of 12.75% for a total face value of Php35
billion. Thus, the BTr issued the PEACe Bonds to RCBC and latter paid BTr
approximately Php10.7 billion for Php35 billion worth of treasury bonds, thus
resulting in a discount of approximately Php24.3 billion.

It appears from their later public statements that RCBC then sold the
PEACe Bonds to CODE-NGO. The latter, in turn, sold the bonds to RCBC Capital
for approximately Php12.1 billion, thereby realizing a "gain" of approximately
Php1.4 billion.

About three years after the issuance of the PEACe Bonds, BIR Ruling No.
007-04 dated July 16, 2004 was issued in response to the request for confirmation
of the BTr on the tax consequences of its regular and special issuance of treasury
bills and bonds, thereby reversing the 2001 Rulings, to wit:

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 "In previous BIR rulings issued to BTR, this Office had enunciated
the rule that to be able to determine whether the financial assets, i.e., debt
instruments and securities are deposit substitutes, the "20 or more
individual or corporate lenders" rule must apply. Moreover, the
determination of the phrase "at any one time" for purposes of determining
the "20 or more lenders" is determined at the time of the original issuance.
This has been so on the basis of the fact that it is on the original issuance
that the act of lending is done. aDIHCT

Moreover, since the financial assets involved are basically debt

instruments and government securities, and usually traded in the debt
market, the reckoning time of determining the 20 lenders is done in the
primary market considering that it is the time when the issuer "sells" the
new financial asset to the public. In effect, it is the time, the borrower is
said to "issue" the financial asset. After a certain period of time, the
financial asset is bought or sold (i.e., exchanged or traded) among
investors. The market where the activity takes place is referred to as the
secondary market. (See page 11, Chapter I of Capital Markets —
Institutions and Instruments, Third Edition by Frank J. Fabozzi and Franco
Modigliani). Thus, it has been concluded that the time element "at any one
time" is deemed to be reckoned when the borrowing or "issuance" is done
in the primary market. Subsequent trading among investors in the
secondary market is merely an act of buying and selling and not borrowing
in nature. This therefore, removed the secondary market from the very act
of borrowing or lending itself, as a necessary element required by the term
"deposit substitutes".

xxx xxx xxx

Significantly, we have noted BTR's contention and position on the

matter. In short, as we understand from the discussion we had with the
representative of the BTR, since the object of the issuance is to obtain the
required government funding, the issuance and subsequent distribution
(exchange and trading) of Government debt instruments and securities in
the secondary market to other market participants, specifically, the
investors, is in itself a public borrowing of the government. The financial
assets (i.e., debt instruments and securities) in the hands of the investors
represent a claim to future cash for which the borrowing entity, at
maturity date, must have to pay. It is, however, in the secondary market
that the investing public make the indirect investment in the borrowing
entity, in this case, the Government.

In view of the foregoing, this Office opines and so rules that mere
issuance of government debt instruments and securities is deemed as
falling within the coverage of "deposit substitutes" irrespective of the

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 number of lenders at the time of origination. Accordingly, since
government debt instruments and securities are not exempt from taxes,
interest income derived therefrom shall be subject to the following:

a) 20% final withholding tax imposed under Sections 24 (B) (1)

and 25 (A) (2) of the Tax Code of 1997, if the bondholder is an individual
citizen or a resident alien, respectively;

b) 25% tax imposed under Section 25 (B) of the Tax Code, if the
bondholder is a nonresident alien individual not engaged in trade or
business within the Philippines;

c) 20% final tax imposed under Sections 27 (D) (1) and 28 (A)
(7) (a), of the Tax Code, for domestic and resident foreign corporations,
respectively;

d) 32% final withholding tax, for nonresident foreign corporation

under, Section 28 (B) (1) of the Tax Code, if the bondholder is nonresident
foreign corporation; and, TIaEDC

e) Such other rate that may be imposed under the appropriate

tax treaty which the Philippines is a signatory.

Moreover, based on above discussion, the phrase "at any one time"
in relation to public borrowing is deemed to refer to the flotation of the
debt instrument or security. In other words, since the actual number of
bondholders or investors may be, at maturity date of the financial
instrument, more than 20 individuals or corporation, the said direct
lenders (origination) and indirect investors (secondary market) are
deemed to be what constitute "public."

Finally, this ruling effectively modifies and supersedes BIR Ruling

Nos. 020-2001 dated August 16, 2001 and DA-175-2001 dated September
28, 2001, as well as other BIR rulings dealing on the matter." (Emphasis
supplied)

The aforementioned ruling was subsequently reiterated in BIR Ruling No.

DA-491-04 dated September 13, 2004 and BIR Ruling No. 008-05 dated July 28,
2005, which provide as follows:

BIR Ruling No. DA-491-04:

In BIR Ruling No. 007-2004 dated July 16, 2004, this Office has
ruled that the mere issuance of government debt instruments and securities
is deemed as falling within the coverage of "deposit substitutes"
irrespective of the number of the lenders at the time of origination, and
therefore interest income derived therefrom shall be subject to the
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 applicable final withholding tax rate imposed on deposit substitutes as
prescribed under the Tax Code of 1997. This ruling applies in general, to
all kinds of debt instruments and securities and in particular, to Treasury
bonds, notes and bills being issued by the Republic of the Philippines.

Moreover, said BIR Ruling No. 007-2004 has completely

abandoned previous BIR rulings which excepted ROP's debt instruments
and securities from the definition of the term "deposit substitutes"
whenever they are issued to less than twenty (20) individual or corporate
lenders. HcSCED

In fine, Sec. 22(Y) of the Tax Code of 1997 qualifies a borrowing

to be a "deposit substitutes" if the number of lenders at any one time of the
issuance of a debt instrument or security is twenty (20) or more.
Conversely, if there are less than twenty (20) individual or corporate
lenders the borrowing is deemed not a "deposit substitutes." Thus, with the
issuance of BIR Ruling No. 007-2004, the matter of determining the
number of lenders does not come into play insofar as government debt
instruments and securities are concerned.

This Office also took note of your representation that the Fixed
Rate Promissory Notes will be issued to one corporate or institutional
lender and that the feature of the PN does not allow the holder/investor to
trade/sell the PN in the secondary market to more than one corporate or
institutional buyer or that should the holder/investor opts to sell the PN
holdings, it shall be required to trade/sell its "entire participation interest" in
the PN, thus, preventing the splitting of the PN in favour of two or more
investors. With the new rule enunciated in the abovementioned BIR Ruling
No. 007-2004 in respect to issuance of Government debt instruments and
securities, we are therefore reinstating the applicable provision of
Revenue Regulations (Rev. Regs.) No. 17-84, to wit:

"SEC. 2. Definitions of Terms. — . . .

(h) "Deposit substitutes" shall mean —

xxx xxx xxx

(iii) In the case of other non-financial companies,

including the national or local government and its
instrumentalities, all borrowings through the issuance of
debt instruments denoted as treasury bonds, treasury bills,
treasury notes, and similar instruments.

In line with the foregoing definitions, the following

borrowings shall be considered as deposit substitutes:

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 xxx xxx xxx

(b) 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." aTEADI

Thus, we opine and hereby rule that notwithstanding the fact that
there is only one corporate or institutional lender the mere issuance of
such PN by the Republic will classify the borrowing as "deposit
substitutes" pursuant to the abovecited Section 2(h)(iii)(b) of Rev. Regs.
No. 17-84. Consequently, the interest income derived therefrom by the
corporate or institutional lender shall be subject to the twenty percent
(20%) final tax imposed under Section 27(D)(1) of the Tax Code of 1997.

This reiterates and clarifies BIR Ruling No. 007-2004. (Boldfacing

and underscoring provided)

BIR Ruling No. 008-05:

I. The present rule as enunciated in BIR Ruling No. 7-2004 and

reiterated in BIR Ruling DA-491-2004 dated September 13, 2004. The
ruling applies in particular, to Treasury bonds, notes and bills being issued
by the Republic of the Philippines.

Notwithstanding the definition of the term "deposit substitutes"

under Section 22 (Y) of the Tax Code of 1997, this Office has ruled in
BIR Ruling No. 7-2004 that the mere issuance of government debt
instruments and securities is deemed as falling within the coverage of
"deposit substitutes," irrespective of the number of lenders at the time of
origination, therefore interest income derived therefrom shall be subject to
the applicable final tax rate imposed on deposit substitutes as prescribed
under the Tax Code. In short, the borrowing and lending activities have
been expanded in meaning as to include trading/investing in secondary
market thereby making the mere issuance of a debt instrument to less than
20 lenders a public borrowing if it is expected to be traded or float in the
secondary market. Further, the final tax is required to be withheld upfront.

BIR Ruling No. 7-2004 has effectively sustained BTr's contention

that the mere issuance and subsequent distribution (exchange and trading)
of these financial assets by government in the secondary market to other
market participants, specifically, the investors, is in itself a public
borrowing of the government. BTr's subsequent request for exclusion from
the coverage of the above rule its proposed issuance of ROP Fixed
Promissory Note in favor of a single investor without any specific detail
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 that would warrant exclusion from the coverage was denied by this Office.
1 As a matter of consistency, this Office has reiterated said BIR Ruling No.

7-2004 and further emphasized that the matter of determining the number
of lenders no longer comes into play insofar as government debt
instruments and securities are concerned, particularly, Treasury bonds,
notes and bills being issued by the Republic of the Philippines. SacTAC

In short, the new rule has in effect, reinstated Section 2 (h) (iii) (b)
of Revenue Regulations No. 17-84 which considers all borrowings of the
national and local government and its instrumentalities including the
Central Bank of the Philippines (now the BSP), evidenced by debt
instruments denoted as treasury bonds, bills, notes, certificate of
indebtedness and similar instruments as "deposit substitutes."

Therefore, since government debt instruments and securities are

not exempt from taxes, the interest income derived therefrom shall be
subject to applicable final withholding tax rates on "deposit substitutes,"
as provided for in the Tax Code, or such other rate that may be imposed
under the appropriate tax treaty to which the Philippines is a signatory."
(Emphasis ours)

Based on the foregoing representations and with the consequent reversal of

the 2001 Rulings together with the impending maturity of the PEACe Bonds, you
raised the following issues with regard to the proper tax treatment of the interest
income arising from the PEACe Bonds —

1) Whether or not the interest income arising from the PEACe Bonds
shall be subject to the 20% Final Tax, or in the alternative, to
Ordinary Income Tax;

2) How much is the tax due on the interest income;

3) Who shall be liable to pay the tax due; and

4) How will the tax be collected.

In reply thereto, this Office is of the opinion and hereby resolves the
foregoing issues as follows:

On Whether Interest Income from

PEACe Bonds is Subject to 20% Final Tax
or to Ordinary Income Tax —

The Php24.3 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
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 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
the face value and purchase price/discounted value of the bond) is treated as
interest income of the purchaser/holder. Thus, the Php24.3 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 which states: IESAac

"(1) Interest from Deposits and Yield or any other Monetary

Benefit from Deposit Substitutes and from Trust Funds and Similar
Arrangements, and Royalties. — A final tax at the rate of twenty percent
(20%) is hereby imposed upon the amount of interest on currency bank
deposit and yield or any other monetary benefit from deposit substitutes
and from trust funds and similar arrangements received by domestic
corporations, and royalties, derived from sources within the Philippines:
Provided, however, That interest income derived by a domestic corporation
from a depository bank under the expanded foreign currency deposit
system shall be subject to a final income tax at the rate of seven and
one-half percent (7 1/2%) of such interest income." (Emphasis supplied)

On the Amount of Tax Due

from Interest Income —

The manner of payment of such final tax is provided under DOF

Department Order No. 141-95, as amended as follows:

"Section 7. Taxation. — The income derived from Treasury Bills

and Bonds, and instruments with recourse as authorized by Bangko Sentral
ng Pilipinas (BSP) shall be subject to the 20% final income tax to be
withheld on discounts valued at the time of issue on every original sale
which shall be deducted by the buyer from the discounts of the
T-Bills/Bonds and included in the remittance of the purchase price.

In the case of Treasury Bonds, the 20% final income tax shall be
withheld on discounts valued at present value on every original sale.
Periodic coupon payments on Treasury bonds shall be subject to the 20%
final income tax to be withheld at the time the coupon payments are made.

The Documentary Stamp Tax on the original issue shall be for the
account of the issuer.

No other taxes shall be collected on subsequent trading of the

securities which have been subjected to tax under the first two paragraphs
herein."

Further, Section 5 of DOF No. 141-95 states: DEaCSA

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 "Section 5. Treasury Bonds. — Treasury Bonds shall be issued at
a discount basis, at a premium, or at par and payable on maturity of not
earlier than one (1) year but not later than twenty-five (25) years. They may
be offered for sale through competitive or non-competitive auction or any
other method as determined appropriate by the Bureau of Treasury."

The foregoing is applied in BIR Ruling No. DA-522-03 dated December 16,
2003, to wit:

"2. With respect to the calculation of the 20% tax on such interest
income, please be informed that pursuant to Section 7 in relation to Section
5 of Department of Finance Order No. 141-95, Series of 1995 (Revised
Rules and Regulations for the Issuance, Placement, Sale, Service and
Redemption of Treasury Bills and Bonds under R.A. No. 245, as
amended), which read as follows:

xxx xxx xxx

The foregoing provision is consistent with the previous ruling of

this Office "that the total discount of coupon bearing government
securities and other similar instruments with maturities of more than one
(1) year shall be considered earned in the year of sales based on the
current values" such that the issuing agency shall remit "the
corresponding final income tax withheld on discount valued at present
value on every original sales [sic] in the primary market within the
period" so then specified under Revenue Regulations No. 17-84.

It is noted though that the zero coupon instrument is different from

a coupon bearing instrument subject of BIR Ruling No. 177-95, supra, and
to which the aforequoted provision is applicable, as there are no
semi-annual cash payments made to security holders. Zero coupons are
therefore issued at a discount to yield par at maturity. The difference
between par and discount is the imputed interest earned on the security.
As you stated, all things being constant, the price of a zero coupon
instrument accordingly would increase with time to account for the
accreted interest. Moreover, since payment is made at maturity, the
interest earned is the accreted interest on the security, but because it is a
zero coupon instrument there is no cash outflow. AaHcIT

Applying the above Section 7 of DOF Order No. 141-95 in the

instant case, this Office opines that the 20% should be present valued by
the net yield on the security to ensure that the interest is taxed at 20%.
Accordingly, since the interest is earned over the life of the security and not
upfront, your opinion that the 20% final income tax withheld on such
discounts should be valued at its present value is hereby confirmed.
Consequently, as first ruled, the Bureau of the Treasury shall withhold and
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 remit the corresponding 20% final income tax withheld on discounts
valued at present value upon original issue of the subject 7-year Peso
Denominated Zero Coupon." (Emphasis provided)

In view of the foregoing, BIR Ruling No. 008-05 also emphasized that the
final tax on the original issue discount is required to be withheld upfront.

However, at the time of the issuance of the PEACe Bonds in 2001, the BTr
was not able to collect the final tax on the discount/interest income realized by
RCBC as a result of the 2001 Rulings. Subsequently, the issuance of BIR Ruling
No. 007-04 dated July 16, 2004 effectively modifies and supersedes the 2001
Rulings by stating that the Tax Code is clear that the "term "public" means
borrowing from twenty (20) or more individual or corporate lenders at any one
time." The word "any" plainly indicates that the period contemplated is the entire
term of the bond, and not merely the point of origination or issuance. The said
provision is clear and does not require any statutory construction. Thus, by taking
the PEACe Bonds out of the ambit of deposits substitutes and exempting it from
the 20% Final Tax, an exemption in favour of the PEAce Bonds was created when
no such exemption is found in the law. Thus, the 2001 Rulings are null and void
and cannot be given any legal effect for being contrary to law. It is basic principle
in administrative law that the interpretation given by an administrative agency
cannot run contrary to the law which it seeks to implement. As held by the
Supreme Court in the case of Commissioner of Internal Revenue vs. The Hon.
Court of Appeals, R.O.H. Auto Products Philippines, Inc. and The Hon. Court of
Tax Appeals — 2(2)

"The authority of the Minister of Finance (now the Secretary of

Finance), in conjunction with the Commissioner of Internal Revenue, to
promulgate all needful rules and regulations for the effective enforcement
of internal revenue laws cannot be controverted. Neither can it be disputed
that such rules and regulations, as well as administrative opinions and
rulings, ordinarily should deserve weight and respect by the courts. Much
more fundamental than either of the above, however, is that all such
issuances must not override, but must remain consistent and in harmony
with, the law they seek to apply and implement. Administrative rules and
regulations are intended to carry out, neither to supplant nor to modify,
the law." IHaCDE

Thus, considering the fatal legal infirmity of the 2001 rulings, RCBC
should be held liable to pay the 20% Final Tax on interest income it realized from
its purchase of the PEACe Bonds. As to the amount of its tax liability, had RCBC
paid 20% final tax upon issuance, it would have paid approximately Php1.4 billion
(i.e., 20% of the present value of the discount/interest income as of October 18,
2001, discounted at 12.75%, which is approximately Php7 billion) in addition to
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 the purchase price of the PEACe Bonds. However, since no final tax was paid by
RCBC upon issuance of the PEACe Bonds, RCBC is held liable to pay 20% final
tax on the entire Php24.3 billion discount, which is the present value of the
original discount to date, or approximately Php4.86 billion.

On Who Shall Be Liable

to Pay the Tax Due —

Again, applying the provisions of Section 7 of DOF Department Order No.

141-95 which requires that the 20% Final Income Tax be withheld on discounts
valued at present value on every original sale, RCBC, as the original purchaser of
the PEACe Bonds should be held liable to pay the Final Tax due thereon.

However, considering that RCBC merely acted as an agent or conduit of

CODE-NGO by virtue of the requirement of BTr that CODE-NGO is not a
Government Securities Eligible Dealer (GSED), the beneficial owner of the
PEACe Bonds and the corresponding interest income thereon is CODE-NGO
which is liable to pay for the Php4.86 billion final tax due on the discount/interest
income realized.

Consequently, RCBC/CODE-NGO may not invoke the principle of

non-retroactivity under Section 246 of the 1997 Tax Code to preclude this Office
from collecting the final tax on the original discount/interest income.

It is noteworthy to mention that Section 246 of the 1997 Tax Code is

explicit when it provides, to wit:

"SEC. 246. Non-Retroactivity of Rulings. — Any revocation,

modification or reversal of any of the rules and regulations promulgated in
accordance with the preceding Sections or any of the rulings or circulars
promulgated by the Commissioner shall not be given retroactive application
if the revocation, modification or reversal will be prejudicial to the
taxpayers, except in the following cases: IcSEAH

"(a) Where the taxpayer deliberately misstates or

omits material facts from his return or any document
required of him by the Bureau of Internal Revenue;

"(b) Where the facts subsequently gathered by the

Bureau of Internal Revenue are materially different from
the facts on which the ruling is based; or

"(c) Where the taxpayer acted in bad faith."

(Emphasis provided)

In BIR Ruling No. 007-04, it was categorically stated that the 2001 Rulings
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 were issued based on representations made as follows:

"In previous BIR rulings issued to BTR, this Office had enunciated
the rule that to be able to determine whether the financial assets, i.e., debt
instruments and securities are deposit substitutes, the "20 or more
individual or corporate lenders" rule must apply. Moreover, the
determination of the phrase "at any one time" for purposes of determining
the "20 or more lenders" is determined at the time of the original issuance.
This has been so on the basis of the fact that it is on the original issuance
that the act of lending is done." (Emphasis supplied)

However, subsequent findings prove to be contrary to the aforementioned

representations, to wit:

"Significantly, we have noted BTR's contention and position on the

matter. In short, as we understand from the discussion we had with the
representative of the BTR, since the object of the issuance is to obtain the
required government funding, the issuance and subsequent distribution
(exchange and trading) of Government debt instruments and securities in
the secondary market to other market participants, specifically, the
investors, is in itself a public borrowing of the government. The financial
assets (i.e., debt instruments and securities) in the hands of the investors
represent a claim to future cash for which the borrowing entity, at maturity
date, must have to pay. It is, however, in the secondary market that the
investing public make the indirect investment in the borrowing entity, in
this case, the Government." (Emphasis supplied)

Therefore, the facts subsequently gathered by the Bureau of Internal

Revenue from which the 2004 Ruling was made are materially different from the
facts on which the 2001 Rulings are based. Hence, BIR Ruling No. 007-04 is
applicable retroactively. IDCcEa

Further, there is ample legal authority to conclude that the non-retroactivity

principle does not apply when the ruling involved is null and void for being
contrary to law, such as the 2001 Rulings. Well-entrenched are the principles that
the Government is never estopped from collecting taxes because of mistakes and
errors of its agents 3(3) and there are no vested rights in a wrong interpretation of
the law. 4(4)

Also, in the case of Emilio Y. Hilado vs. The Collector of Internal Revenue
and The Court of Tax Appeals 5(5) the Supreme Court held:

"With regard to the contention that General Circular No. V-139

cannot be given retroactive effect because that would affect and obliterate
the vested right acquired by petitioner under the previous circular, suffice it

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 to say that General Circular No. V-123, having been issued on a wrong
construction of the law, cannot give rise to a vested right that can be
invoked by a taxpayer. The reason is obvious: a vested right cannot spring
from a wrong interpretation. This is too clear to require elaboration.

"It seems too clear for serious argument that an administrative

officer can not change a law enacted by Congress. A regulation that is
merely an interpretation of the statute when once determined to have been
erroneous becomes nullity. An erroneous construction of the law by the
Treasury Department or the collector of internal revenue does not
preclude or estop the government from collecting a tax which is legally
due." (Ben Stocker, et al., 12 B. T. A., 1351.)

"Art. 2254. No vested or acquired right can arise from acts or

omissions which are against the law or which infringe upon the rights of
others." (Article 2254, New Civil Code.)" (Emphasis provided)

The foregoing principle of non-estoppel was reiterated in the case of

Philippine Bank of Communications, 6(6) viz.:

"Fundamental is the rule that the State cannot be put in estoppel by

the mistakes or errors of its officials or agents. As pointed out by the
respondent courts, the nullification of RMC No. 7-85 issued by the Acting
Commissioner of Internal Revenue is an administrative interpretation
which is not in harmony with Sec. 230 of 1977 NIRC, for being contrary to
the express provision of a statute. Hence, his interpretation could not be
given weight for to do so would, in effect, amend the statute. (Emphasis
supplied)

Based on the foregoing, RCBC/CODE-NGO has no vested right to invoke

the 2001 Rulings and is consequently held liable to pay the Final Tax due on the
discount/interest realized from the PEACe Bonds. AcDHCS

On How Will the

Tax Be Collected —

Again, as emphasized in BIR Ruling No. 008-05, the final tax on the
original issue discount is required to be withheld upfront.

Further, to reiterate the pronouncement made in BIR Ruling No. DA-522-03

dated December 16, 2003:

"Applying the above Section 7 of DOF Order No. 141-95 in the

instant case, this Office opines that the 20% should be present valued by
the net yield on the security to ensure that the interest is taxed at 20%.
Accordingly, since the interest is earned over the life of the security and not

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 upfront, your opinion that the 20% final income tax withheld on such
discounts should be valued at its present value is hereby confirmed.
Consequently, as first ruled, the Bureau of the Treasury shall withhold and
remit the corresponding 20% final income tax withheld on discounts
valued at present value upon original issue of the subject 7-year Peso
Denominated Zero Coupon." (Emphasis provided)

In view thereof, BTr shall withhold the Final Tax due on interest income
derived from the PEACe Bonds prior to its payment on the date of maturity.

This ruling is being issued on the basis of the foregoing facts as

represented. However, if upon investigation it will be disclosed that the facts are
different, then this ruling shall be considered as null and void.

Very truly yours,

(SGD.) KIM S. JACINTO-HENARES

Commissioner
Bureau of Internal Revenue
Footnotes
1. BTr Memorandum to all GSEDs dated October 9, 2001.
2. G.R. No. 108358, January 20, 1995.
3. Philippine Guaranty Co., Inc. vs. Commissioner of Internal Revenue, 13 SCRA
775.
4. Philippine Bank of Communications vs. Commissioner of Internal Revenue, G.R.
No. 112024, January 28, 1999.
5. G.R. No. L-9408, October 31, 1956.
6. Supra.

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 Endnotes

1 (Popup - Popup)
1. BTr Memorandum to all GSEDs dated October 9, 2001.

2 (Popup - Popup)
2. G.R. No. 108358, January 20, 1995.

3 (Popup - Popup)
3. Philippine Guaranty Co., Inc. vs. Commissioner of Internal Revenue, 13 SCRA
775.

4 (Popup - Popup)
4. Philippine Bank of Communications vs. Commissioner of Internal Revenue, G.R.
No. 112024, January 28, 1999.

5 (Popup - Popup)
5. G.R. No. L-9408, October 31, 1956.

6 (Popup - Popup)
6. Supra.

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