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3 April, 2017
In January 2017, the Supreme Court finally resolved with finality the propriety of subjecting interest earnings from the PEACe bonds (Poverty Eradication and Alleviation Certificates) to 20 percent final withholding tax as it denied the government’s second motion for reconsideration. The Supreme Court affirmed its earlier order for the government to return the withholding taxes it charged on the PEACe bonds and pay additional interest for non-compliance with its previous ruling.
The PEACe bonds were zero-coupon bonds sold at less than face value which do not pay periodic interest payments. Instead, the discount on the face value is treated as interest that accrues over the 10-year term of the bonds. The face value of the PEACe bonds amounting to P35 billion, representing the principal and interest, was payable upon maturity in 2011.
When the PEACe bonds were issued in 2001, investors were enticed to invest on the promise by the government that interest earnings would be tax-free. This was confirmed by three 2001 Bureau of Internal Revenue rulings (Ruling Nos. 020-2001, 035-2001 and DA 175-01), that stated that the PEACe bonds were not deposit substitutes and interest earnings thereon would not be subject to 20 percent final withholding tax upon maturity.
A few days before the maturity of the PEACe bonds in late 2011, however, the Aquino administration took a contrary position. To the dismay of innocent investors, the BIR issued two rulings (Nos. 370-2011 and 378-2011) that belatedly subjected the discount (investor’s interest) to 20 percent final withholding tax.
The chair of one of the investor banks referred the matter to me. I constituted a team of litigation and tax lawyers in Accralaw. Several banks later joined to form a consortium. However, another investor bank, through another law firm, already went to the Court of Tax Appeals to question the 2011 BIR rulings.
Due to the transcendental and constitutional significance of the issue, we took another route. We filed a petition directly in the Supreme Court on behalf of the consortium of banks. The high court immediately issued a TRO against the implementation of the two rulings. The TRO was defied by the government on the pretext that the P4.9 billion withholding tax had already been remitted to the BIR.
Ruling on the merits of the case in 2015, the Supreme Court held that the original sale of the PEACe bonds was not subject to final withholding tax. It ruled that under our Tax Code, Congress specifically defined “public” to mean “twenty or more individuals or corporate lenders at any one time.” For this reason, it was the number of lenders that was determinative of whether a debt instrument should be considered a deposit substitute and consequently subject to the final withholding tax. In respect of the original sale of the PEACe bonds, there was only one lender-RCBC.
Noteworthy was the court’s emphatic reprimand of the government for defying the TRO. It found “no justification” for its conduct and labelled it as “reprehensible.” To add emphasis, in its decision on the government’s motion for reconsideration, the court directed the government to pay 6 percent interest a year on the P4.9 billion it withheld for “utter disregard” of the court’s TRO. This translates to some P1.5-billion setback for the government. An expensive proposition, indeed.
All told, the PEACe Bond decision teaches the government a lesson. It should not change the rules of the game midway to the prejudice of investors. It is a powerful message from the Supreme Court that it will protect and uphold the rights of innocent investors even if it is against the government. Indeed, paraphrasing Justice Holmes, the power to tax is not the power to destroy investors’ rights while the Supreme Court sits because without investments, there would be no economic activity to tax at all.
For further information, please contact:
Francisco Ed Lim, Partner, Angara Abello Concepcion Regala & Cruz (ACCRALAW)
felim@accralaw.com
