Under Section 34(B) of the Tax Code, in connection with the taxpayer’s trade, business or exercise of profession, interests on indebtedness—paid or incurred by a corporate or individual taxpayer within a taxable year—are allowed as a deduction from its gross income. However, it is likewise provided therein that a taxpayer’s otherwise allowable deduction for interest expense shall be reduced by 33 percent (effective January 1, 2009, pursuant to Republic Act 9337) of its interest income subjected to final tax.

To implement Section 34(B) of the Tax Code, Section 4(B) of Revenue Regulations (RR) 13-00 was issued. The Bureau of Internal Revenue (BIR), through Section 4(B) of RR 13-00, clarified that the limitation on deductible interest expense shall apply regardless of the date when the investment and the interest bearing loan were made, and whether or not a tax arbitrage scheme was entered into by the taxpayer, for as long as during the taxable year, there is an interest expense incurred on one side and an interest income earned on the other that was subjected to final withholding tax. This notwithstanding, in at least two subsequent rulings issued by the BIR, it recognized the purpose of the limitation provided under Section 34(B) of the Tax Code, i.e. to abate tax arbitrage schemes.

In the BIR Ruling Nos. DA-315-04 and DA-083-06 dated June 8, 2004 and March 6, 2006, respectively, the BIR confirmed that there can be no uncertainty that interest expense paid or incurred within a taxable year on indebtedness in connection with the taxpayer’s trade, business or exercise of profession shall be allowed as a deduction from the gross income. This was distinguished from a tax arbitrage scheme, wherein the proceeds of a taxpayer’s loan are deposited or invested and the interest income derived from the said investment had been subjected to final withholding tax. The BIR ruled that the purpose of the tax arbitrage is to equalize the tax liability of the taxpayer on his interest income and the tax benefit on his interest expense. Finding that there was no tax arbitrage to speak of in both cases, the BIR confirmed that Section 34(B) does not apply to the interest expenses of the applicant banks relative to their interest expenses on savings and time deposits.

However, confronted with conflicting interpretations of the BIR and the Bangko Sentral ng Pilipinas (BSP) of Section 34(B) of the Tax Code, the current Commissioner of Internal Revenue (CIR) issued a directive affirming that there need not be a tax arbitrage scheme in order that the limitation on the deductible interest expense can be applied. This was embodied in a memorandum dated June 6, 2009 (circularized as Revenue Memorandum Circular 31-2009 dated June 15, 2009). Per memorandum dated June 6, 2009, as provided under RR 13-00, the limitation on interest expense shall apply as long as the taxpayer incurred interest expense and had interest income subjected to final withholding tax in the same taxable year, regardless of whether or not a tax arbitrage scheme was entered into by the taxpayer.

The position taken by the CIR in his memorandum dated June 6, 2009 is not barren of legal basis. Section 34(B) of the Tax Code does not provide that there must be a tax arbitrage scheme before the limitation on the deductible interest expense can be applied. RR 13-00 merely interprets what is provided by law. The CIR’s power to issue such interpretation, on the other hand, is sanctioned under Section 4 of the Tax Code, which vests in the CIR the exclusive and original jurisdiction to interpret the Tax Code and other tax laws.

Moreover, such interpretation of Section 34(B) is not without precedent. Memorandum dated June 6, 2009 is merely confirmatory of BIR Ruling No. 06-2000 issued on January 5, 2000 by a former CIR. Section 4(B) of RR 13-00 is likewise cited in BIR Ruling No. DA-230-05 dated May 19, 2005. Earlier cited BIR Ruling Nos. DA-315-04 and DA-083-06 may also not be deemed binding on the CIR. As held in the often quoted Supreme Court case of Hilado v. Collector (100 Phil 288), construction of a statute by a predecessor is not binding on the successors. Applying this ruling of the Supreme Court, the CIR could be deemed vested with authority to revoke, repeal or abrogate previous rulings of predecessors, if he becomes satisfied that a different construction should be given.

In addition to the foregoing, it is well-settled that deductions are strictly construed against taxpayers. He who claims a deduction must point to the specific provision of the statute authorizing it, and he must be able to prove that he is entitled to it. (Western Minolco Corp. v. Commissioner, 124 SCRA 212). It is only when there is an express mention in the law or if the taxpayer falls within the purview of the exemption by clear legislative intent that the rule on strict construction will not apply. (Commissioner v. Arnoldus Carpentry Shop, 159 SCRA 199)

The legislative purpose for providing the limitation on deductible interest expense under Section 34(B) of the Tax Code may be to abate tax arbitrage schemes wherein the proceeds of a taxpayer’s loan obtained in connection with the operations of his trade, business or exercise of profession is deposited or invested, and the interest income derived from the said investment had been subjected to final withholding tax. However, such legislative purpose cannot be gleaned from the letters of Section 34(B) of the Tax Code. In this case, the remedy for taxpayers may not be to seek a favorable interpretation from administrative agencies or even the courts but to seek an amendment of this provision of law, for it to clearly reflect the said legislative purpose. Until then, the BIR would have legal basis for reducing a taxpayer’s otherwise allowable deduction for interest expense by 33 percent of his interest income subjected to final tax, whether the taxpayer entered into a tax arbitrage scheme or not.

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The author is an associate of Du-Baladad and Associates Law Offices (BDB Law). If you have any comments or questions concerning the article, you can e-mail the author at This e-mail address is being protected from spambots. You need JavaScript enabled to view it or call 856-2952.