July 16, 2004

BIR RULING NO. 007-04

Sec. 22 (Y) BIR Ruling Nos. 020-2001 & DA-

175-2001

Bureau of the Treasury

Intramuros, Manila

Attention: Hon. Mina C. Figueroa

Treasurer of the Philippines

Gentlemen :

This refers to your letter dated April 14, 2004, seeking con rmation on the tax
consequences for the regular and special issuances by the Bureau of the Treasury of
Treasury bills and bonds, specifically on the following issues, to wit:
"a) Whether or not all bond issuance should practically be considered
public issuance, and therefore subject to 20% withholding tax, considering the
di culty of monitoring or limiting the movement of the bonds in the secondary
market which eventually would violate the 19 lender rule;

"b) Whether or not the phrase "at any one time" should be applied at all to a
single bond issuance, considering that the same invariably reaches the primary
and secondary market; and
"c) Whether or not BIR Rulings No. 020-2001 dated 16 August 2001 and
DA-175-2001 dated September 2001 be applied in a special issuance which on its
terms is strictly, limited to particular holders which in no case should exceed 19
lenders/investors in both the primary and secondary levels.

CASE BACKGROUND
The Bureau of the Treasury (BTR) is mandated to issue government securities.
BTR has been imposing the 20% nal withholding tax on its regular issuances (even in
some of its special issuances). On the other hand, the Bureau of Internal Revenue (BIR)
issued several rulings which laid down the basis of identifying those nancial assets
( nancial instruments or securities) which would effectively fall within the meaning of
"deposit substitutes." The Bureau of Internal Revenue rst characterized the term
"deposit substitutes" based on the de nition provided for in Section 22(Y) of the Tax
Code of 1997, to wit:
"The term "deposit substitutes" is an alternative form of obtaining funds
from the public (the term public means 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
account, for the purpose of relending or purchasing of receivables and other
obligations, or nancing their own needs or the needs of their agent 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)
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 and any authorized agent bank, certi cates of assignment or participation and
similar instruments with recourse: . . .

Thus, this O ce concluded that in order to identify whether a nancial asset or

instrument is "deposit substitute," the borrowing must be made from twenty (20) or
more individual or corporate lenders at any one time. From this conclusion, the BTR
posed clari cation on the meaning of the phrase "at any one time" for which the BIR
held that —
"I. As de ned 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. . . " 1

"II. ". . . 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." 2

The above interpretation was applied on BTR's rst issuance of a zero-coupon

bonds a.k.a. PEACE Bonds, for which the BIR ruled, to wit:
"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 twenty (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."

This BIR's pronouncement was made in view of the representation that said
Bonds would not be issued to more than nineteen (19) eligible rms/lenders in its
origination; and that PEACE Bond was a special issuance. In other words, the
authorized amount (up to PHP50.0 Billion) indicated in the Full Powers granted by the
President would be issued only once, not in several tranches and the BTR issued PEACE
Bonds in single tranche.
In view of the foregoing BIR ruling, the BTR now poses for this O ce
consideration the following sets of scenarios, to wit:
1. DOF/BTR may be granted by the President, through Presidential Full
Powers, the authority to issue, e.g. PHP200 Billion worth of Treasury
Bonds in tenors of ve (5), six (6), seven (7) and ten (10) years for a
maximum issue size of PHP50.0 Billion per tenor. This scenario by its
nature implies a multiple tranche issue consisting of several
origination, and is usually offered through Auction, Over-the-Counter,
or in some instances, through Tap Method. Even the maximum issue
size of PHP50.0 Billion per tenor may be issued in several tranches
depending on the needs of the National Government and the
prevailing economic or political condition as of such a time;
2. In the above scenario, the BTR may offer bonds using the same Full
Powers, through Tap (a manner of sale or offering or government
securities open exclusively to Government Securities Eligible Dealers
(GSEDs) and Financial Institutions in the event of an acute and
protracted shortage of government securities), for any of the
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 authorized tenors. On the standpoint of the Government, Tap window
is considered a primary issuance or origination;
3. Upon the instance of DOF/BTR, and when circumstances warrant its
issuance, it may be granted an Authority by the President to issue,
e.g., PHP 100.0 Billion of Zero Coupon Bills or Bonds in different
tenors from three (3) years up to ten (10) years, and it can be inferred
by the nature of such an authority that the issue shall be in several
tranches and in several manner of offering, including public offering.
4. Upon the proposal of some nancial institutions and whenever necessary
to meet public expenditures or for any purpose as may be authorized
by law, the DOF/BTR may also be authorized to issue bills or bonds,
through a special issuance. Under this scenario, the Republic
(DOF/BTR) may issue the same in single tranche or in several
tranches, and may likewise be offered through Auction, Tap, Firm
Underwriting, or Combined Bookbuilding and Public Offering. This is
differentiated from the regular issuances usually by its designated
name such as, Small Denominated T-Bonds (SDT-Bonds) or like in the
case of PEACE Bonds or PNs, and there art eligibilities attached to it.
BTR's POSITION ON ITS REQUESTED RULING
I. On the imposition of the 20% Final Tax on "deposit substitutes," if the nancial
assets i.e., debt instruments and securities are floated as regular issuance
In the above three (3) scenarios, BTR maintains that the 20% withholding tax on
deposit substitute shall be imposed regardless of whether or not there are less than
twenty (20) lenders in every origination. In other words, BTR does not have to sum up
the number of lenders in every issuance as it can be inferred from the nature of a
regular issuance that the whole Authority, as evidenced by the Presidential Full Powers,
consists of as many origination or primary issuance(s) as there are numbers of
tranches, and there is an implied offering to the public in general. To do otherwise,
would place National Government (NG)-Issuer in an awkward or di cult situation of
monitoring how many lenders were purchasing such bonds in its origination/primary
issuances, and such Tax Code provisions imposing 20% withholding tax on deposit
substitutes would then make little or no sense, where its applicability is made to
depend on how many lenders are the bonds/bills being issued to during its origination
(which, in these cases, consists of several instances). The BTR concluded that when the
National Government, through the DOF/BTR, issues Bonds or other debt instruments,
and offer to the public, the said issuance is deemed public borrowing and therefore, the
corresponding debt instruments or certi cates (whether scripless or documented),
should be considered deposit substitutes.
Further, BTR posits that if it will simply apply the "20 or more lenders" rule on its
regular issuances of T-Bills and T-Bonds and other government securities, which, most
of the time, in actual practice, is being captured by less than twenty (20) institutional
lenders (most banks and investment houses) in its origination/primary issuance, it
seems that the 20% withholding tax on deposit substitutes will never apply in cases of
government securities. And there is no question that debt instruments issued by the
National Government are generally classified as deposit substitutes.
Moreover, BTR posits that the foregoing should hold true even in cases of regular
issuances of zero-coupon bills/bonds or where bonds/bills are issued at a discount. It
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 has been an established rule that the nal tax on the amount earned as discount is
generally withheld on the date of issuance of the debt instrument. For tax purposes, the
amount of discount which the Treasury Bills are originally sold by the Republic of the
Philippines, is considered interest income already earned by the purchaser upon their
issuance of the Treasury Bills. 3
II. On the imposition of the 20% Final Tax on "deposit substitutes," if the debt
instruments and securities are in the nature of special issuance
Under the fourth scenario, the BTR opines that in determining whether or not the
20% withholding tax on deposit substitutes shall be imposed on that particular
planned/proposed issuance, the number of lenders, assuming there is a pre-conceived
plan of issuing such bonds/bills in several tranches, shall be summed up to determine
the actual numbers of would-be holders of such bonds during the origination, if the BIR
interpretation on the 19 lender count is limited on the origination or primary issuance
(defined as purchase of lenders/investors from the BTr/National Government.)
BIR REPLY
Section 22(Y) of the Tax Code of 1997 de nes "deposit substitutes" as an
alternative form of obtaining funds from the public (the term public means borrowing
from twenty (20) or more individual or corporate lenders at any 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 of receivables and
other obligations, or nancing their own needs or the needs of their agent or dealer.
These instruments may include, but need not be limited to, bankers' acceptances,
promissory notes, repurchase agreements, including reverse repurchase agreements
entered into and between the Bangko Sentral ng Pilipinas (BSP) and any authorized
agent bank, certi cates of assignment or participation and similar instruments with
recourse: . . . "(emphasis supplied.)
In previous BIR rulings issued to BTR, 4 this O ce had enunciated the rule that to
be able to determine whether the nancial 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.
Moreover, since the nancial 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 nancial asset to the public . In effect, it is the time, the
borrower is said to "issue" the nancial asset. After a certain period of time, the
nancial 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".
The simplistic approach made by this O ce was to merely classify the nancial
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 asset (debt instrument or a security) and determine the nancial market (primary or
secondary) where they are traded for the purpose of ascertaining lending activity in
order to determine if the nancial instrument would fall within the meaning of the term
"deposit substitutes." The aforementioned BIR rulings do not deal with and reclassify
the issuance into special or regular issuance. In both cases, this O ce is not bound to
observe the nature of the debt instrument or security [ i.e., whether it is newly issued
(primary market) or seasoned (secondary market)] nor the organizational structure of
the market (e.g. auction market, over-the-counter, and intermediate market). In short,
even a special issuance wherein there has been "20 or more individual or corporate
lenders" warrants classification of debt instruments as "deposit substitutes."
Signi cantly, 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 O ce 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 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,
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 otation of the debt instrument or security.
In other words, since the actual number of bondholders or investors may be, at maturity
date of the nancial 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 modi es and supersedes BIR Ruling Nos. 020-2001
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 dated August 16, 2001 and DA-175-2001 dated September 28, 2001, as well as other
BIR rulings dealing on the matter.

Very truly yours,

(SGD.) GUILLERMO L. PARAYNO, JR.

Commissioner of Internal Revenue
Footnotes

1. BIR Ruling Nos. 020-2001 dated August 16, 2001.

2. BIR Ruling No. DA-175-2001 dated September 9, 2001.

3. BIR rulings No. 186-84 dated December 7, 1984.
4. BIR Ruling Nos. 020-2001 dated August 16, 200 and DA-175-2001 dated September 9, 2001.

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