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 nance 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 that CODE-NGO should
get a GSED to make a tender on its behalf.
Authorized Amount : Up to Php50.0 Billion
Minimum Offered : Php30 billion
Amount
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
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 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 speci ed 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
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:
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 de ned 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 nancing 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, certi cates 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
ve (5) days to cover de ciency 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 classi ed 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 de nition. 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 clari cation 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
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 1997 Tax Code, this Office resolved as follows:
"I. In connection with your query as 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 de nes 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 certi cates 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 certi cates 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 owchart 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 clari cation 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 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 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. Corollarily, if the proposed PEACe Bonds are
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 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 con rmation 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:
"In previous BIR rulings issued to BTR, 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.aDIHCT

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".
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 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, speci cally, the investors, is in itself a public borrowing of
the government. The nancial 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% nal 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% nal 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% nal 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 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 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-
0 4 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 O ce has ruled that
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 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 applicable nal 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 de nition of the term "deposit substitutes" whenever they are issued to less
than twenty (20) individual or corporate lenders. HcSCED

In ne, Sec. 22(Y) of the Tax Code of 1997 quali es 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 O ce 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:
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
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 interest income derived therefrom by the corporate or institutional lender shall
be subject to the twenty percent (20%) nal tax imposed under Section 27(D)(1)
of the Tax Code of 1997.
This reiterates and clari es 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 de nition of the term "deposit substitutes" under

Section 22 (Y) of the Tax Code of 1997, this O ce 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 nal 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 oat in the secondary market . Further, the nal 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
nancial assets by government in the secondary market to other market
participants, speci cally, 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 speci c detail 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, certi cate 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 nal 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
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 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 O ce 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 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 Bene t from
Deposit Substitutes and from Trust Funds and Similar Arrangements, and
Royalties. — A nal 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 bene t 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 nal 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 nal 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% nal 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% nal 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% nal income tax to be
withheld at the time the coupon payments are made.

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 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

"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- ve (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
O ce "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 nal income tax withheld on
discount valued at present value on every original sales [sic] in the primary
market within the period" so then speci ed 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 O ce 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% nal 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% nal income tax
withheld on discounts valued at present value upon original issue of the subject
7-year Peso Denominated Zero Coupon." (Emphasis provided)

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 In view of the foregoing, BIR Ruling No. 008-05 also emphasized that the nal 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 nal 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 modi es 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
"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 in rmity 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% nal 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 the purchase price of the PEACe Bonds.
However, since no nal tax was paid by RCBC upon issuance of the PEACe Bonds,
RCBC is held liable to pay 20% nal 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 bene cial owner of the PEACe Bonds and the corresponding
interest income thereon is CODE-NGO which is liable to pay for the Php4.86 billion nal
tax due on the discount/interest income realized.
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 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, modi cation
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,
modi cation 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 were
issued based on representations made as follows:
"In previous BIR rulings issued to BTR, 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." (Emphasis supplied)
However, subsequent ndings prove to be contrary to the aforementioned
representations, to wit:
"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, speci cally, the investors, is in
itself a public borrowing of the government. The nancial 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
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 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
and there are no vested rights in a wrong interpretation of the law. 4
Also, in the case of Emilio Y. Hilado vs. The Collector of Internal Revenue and The
Court of Tax Appeals 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, su ce it 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 o cer
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 viz.:
"Fundamental is the rule that the State cannot be put in estoppel by the
mistakes or errors of its o cials or agents. As pointed out by the respondent
courts, the nulli cation 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 nal 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 O ce 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% nal income tax withheld on such discounts should be valued at its
present value is hereby confirmed. Consequently, as first ruled, the Bureau of the
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 Treasury shall withhold and remit the corresponding 20% nal 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 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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