LAST Friday, exactly 12 days before the government honors a commitment established 10 years ago when it issued zero coupon (Zeros) treasury bonds in its effort to reduce borrowing rates, in a curious departure from established protocols, the Department of Finance (DOF) summoned bank treasury officers and other ranking executives.
Many of those called were caught unawares. Finance officials, through the Bureau of Internal Revenue (BIR), informed the Government Securities Eligible Dealers (GSED) that their long-held P35-billion tax-exempt receivables due on October 18, 2011, would be slapped a withholding tax of 20 percent.
Taxing previously un-taxed transactions is not new under Benigno Aquino III. Indexing excise taxes effectively creates new taxes. The controversy on the expanded value-added tax (E-VAT) on tolls rages. So does the debate on an E-VAT on real-property transfers, thus killing the Real-Estate Investment Trust (REIT) program designed to catalyze capital market development.
To justify its imposition, officials evoked BIR rulings issued in 2004 and 2005. Both were spawned halfway through the life of the 10-year Zeros after the bond transferred ownership several times over, eventually nesting among stronger financial institutions and longer-term holders.
The rulings stem from the notion that the mere issuance of government-debt instruments falls within the definition of a deposit substitute regardless of the number of lenders at origination. Thus, the withholding tax on deposit substitutes applies.
Through the belated reclassification, economic managers hope to compensate for their revenue deficiencies. Considering the growing criticism of economic governance and charges of incompetence, the imposition is understandable on one end, albeit totally incomprehensible on another.
The repercussion is on the sanctity of obligations and contracts. There is a growing concern among foreign investors on the government’s whimsical abrogation of contractual commitments and policies.
While the concept of ex post facto does not apply to taxation, like other laws, tax legislation is generally prospective. A belated imposition cannot retroact if it infringes on constitutional due processes. Likewise, previous especially applicable rulings cannot be superseded by broad-stroke rulings absent a manifested intent to repeal specific policies.
Note the regulatory gauntlet applied in 2001. On May 31, 2001, BIR Ruling 020-2001 stipulated the Zeros as tax-exempt. This was reaffirmed on August 16, 2001, under BIR Ruling 035-2001.
On September 28, 2001, Presidential full powers were granted firmly exempting Zeros from withholding taxes.
On October 3, 2001, the Bureau of the Treasury (Treasury) discussed the tax treatment with GSEDs. Between October 1 and October 7, 2001, the Treasury requested its electronic bidding providers to allow for withholding tax exemptions. On October 9, 2001, the Treasury announced the Zero offering and its tax exemptions. On October 12, 2001, the Treasury discussed those exemptions with the Bankers Association of the Philippines. On October 16, 2001, the Treasury issued an official memorandum fortifying those exemptions.
On Friday, evoking the 2004 and 2005 rulings, finance officials announced its 180-degree turn.
However, the 2004 and 2005 BIR rulings reclassifying treasury papers as deposit substitutes apply only where interest is periodically paid out.
Zeros are different. For Zeros, interest is accrued but not paid out. When a latter general ruling conflicts with a previous specifically applied ruling, the latter ruling should apply prospectively. This is especially important because the altered rules affect the Zero’s inherent and specifically applied features that ensured its viability.
Perhaps one of the strongest arguments against taxation is one every investment banking trainee knows. Taxes are levied on taxable gross income, less exclusions. Under Chapter VI, Section 32. B.7.(g) of the National Internal Revenue Code (NIRC), exclusions include “gains realized from the same or exchange, or retirement of bonds, debentures or other certificates of indebtedness with a maturity of more than five years.”
Rulings cannot supersede statutes. For the numerically challenged, use all 10 fingers to count. A 10-year maturity is twice the NIRC threshold.
For the accounting-challenged, note that by imposing taxes at maturity, officials forget that Zeros accrue but do not pay out interest. The unpaid interest is capitalized and is incorporated into the principal upon ownership changes or at redemption. When sold prior to maturity, sellers take whatever interest has been accrued at that point and then pass the bond to the secondary or tertiary markets.
As this reoccurs, the accrued interest slowly gets paid, effectively advanced for the Treasury by the next holder. As the Zeros approach maturity, what residual interest diminishes and the eventual substance is essentially the principal.
Because latter holders advanced for the Treasury, the accrued interest due earlier holders, the difference between P35 billion and the original P10 billion, is the amount that “last-touch” holders recover. Thus, a tax at maturity impacts upon what is substantially a return of the principal and a recovery of advances. Withholding taxes at a Zero’s maturity robs the longer-term holder capital he risked. Besides, taxing the principal is ludicrous, unfair and wrong.
