(First of two parts)
The Supreme Court (SC) has finally spoken.
The PEACE bonds are not deposit substitutes subject to the 20 percent final tax, therefore, the Bureau of Treasury (BTr) should immediately return to the investors the 20 percent final tax it withheld and deducted from the redemption value of the bond when it matured in 2011.
The SC anchored its decision on the fact that, upon origination, the bond was issued to only one buyer/lender, the CODE-NGO, and not to 20 or more lenders (the 20-lender rule) which is a requirement for a debt instrument to become a public borrowing making the instrument a deposit substitute subject to the 20 percent final tax.
Well, tax experts and market players expected the decision to be along this line. But the court did not stop there.
The SC injected a new doctrine as regards the reckoning point for the counting of the 20-lender rule.
The phrase “at any one time” for purposes of counting the number of lenders (20-lender rule) in determining whether the debt instrument is a deposit substitute was interpreted by the SC to mean every transaction transacted in the primary or secondary market in connection with the purchase and sale of securities.
Deposit substitute
With this pronouncement, a debt instrument which is not originally a deposit substitute at origination can become one at any time during its term at the secondary market.
On this basis, the court ruled that if CODE-NGO/RCBC Capital sold the bonds simultaneously (take note of the word “simultaneous” which the court kept repeating in its decision) to 20 or more lenders/investors, the PEACE bonds would have become a deposit substitute and CODE-NGO/RCBC Capital should have been liable to the 20 percent final tax on the interest/bond discount.
The BIR can still run after CODE-NGO/RCBC Capital for the unpaid 20 percent final tax as the liability has not prescribed because there was an omission to pay that justifies the application of a 10-year prescription to be counted from the discovery of omission.
To emphasize this new doctrine, the Court further said that the obligation to withhold the 20 percent final tax on the corresponding interest on the PEACE bonds would likewise be required of any lender/investor had the latter turned around and sold said PEACE bonds, whether in full or in part, simultaneously to 20 or more lenders or investors.
Point of origination
It used to be that the counting of lenders is reckoned only at the point of origination, the reason being, the act of lending happens only at that point when the owner of the bond raises funds to meet its financial needs.
All subsequent transfers are just plain trading—it’s the buying and selling of the instrument—but it is not anymore lending. The only exception is in the case of government issuances which are deemed issued to the public regardless of the number of lenders at origination. This is the very issue questioned in the PEACE bond case. Now that is abandoned in the PEACE bond case.
Under this new doctrine of the SC, the borrowing and lending happens throughout the life of the instrument. It introduced the concept of a direct and semidirect financing—direct, being at the origination; and semidirect, at the secondary trading when investors change money for the instrument with the holder still taking the borrower’s risks.
The SC took a totally new concept which is, that the counting of the 20-lender rule is on “every transaction” executed in the primary and secondary market. It is on every transaction when funds are simultaneously obtained from the public.
In the case of government bonds, for example, the counting of the 20-lender rule happens at any transaction (note the phrase “any transaction”) in connection with the purchase and sale transactions, at any of the following: (1) issuance by the BTr of the bond to GSEDs in the primary market; (2) sale and distribution by GSEDs to various lenders/investors in the secondary market; (3) subsequent sale or trading by a bondholder to another lender/investor in the secondary market through a broker or dealer; (4) sale of a financial intermediary-bondholder of its participation interests in the bonds to individual or corporate lenders in the secondary market.
Subject to interpretation
The court said that, when through any of the foregoing transactions, funds are simultaneously obtained from 20 or more lenders/investors, there is deemed to be a public borrowing and the bonds, at that point, are deemed deposit substitutes, and the seller shall withhold the 20 percent final tax on the interest computed on the bonds.
The court’s decision, to some extent, is not so clear at some point with regard to its interpretation of “at any one time” for purposes of counting the 20-lender rule, hence, could be subject to different interpretation. Does it mean at any time there are a total of 20 holders regardless of whether investor is a primary or secondary holder? In short, is the counting of the 20-lender accumulated from primary to secondary? Or is it counted on a per transaction basis?
A reading of the entire decision points more to a counting on a “per transaction” basis whether that transaction be at the primary or secondary market.
This finds support from the repetitive use of the words “every transaction” and “simultaneous borrowing.”
The court also made itself clear when it said that “the obligation to withhold the 20 percent final tax would likewise be required of any lender or investor if the latter turned around and sold said PEACE bonds, in whole or in part, simultaneously to 20 or more lenders.
New doctrine
If we are to apply this new doctrine to the PEACE bond, clearly, there was no public borrowing at origination as there was only one lender, the CODE-NGO.
At this point, the bond is not yet a deposit substitute and the BTr has no obligation to withhold the 20 percent final tax.
If subsequently, CODE-NGO or its underwriter RCBC Capital issued the bond to 20 or more lenders/investors, the bond would become a public borrowing or deposit substitute in the hands of CODE-NGO/RCBC Capital and it would be liable to pay the 20 percent final tax imposed on the present value of the discount/interest on the bonds in the amount of P24.83 billion.
Under existing rules, the 20 percent final tax shall be based on the present value of the discount/interest at the time of sale or issuance (2001). In case of non-payment, additional penalty interest shall be imposed at the rate of 20 percent per annum computed from 2001 until paid, or a total of 13 years if paid this year.
(To be continued)
(This article reflects the personal opinion of the author and does not reflect the official stand of the Management Association of the Philippines. The author is the governor-in-charge of the MAP tax committee, and managing partner and CEO of Du-Baladad and Associates [BDB Law]. Feedback at <map@map. org.ph> and <dick.du-baladad@bdblaw.com.ph>. For previous articles, please visit <map.org.ph>.)