Taxability of Gains Realized from Sale of Zero Coupons

May 31, 2001 BIR RULING NO. 020-01 Caucus of Development NGO Networks 2/F CCS Bldg. Social Development Complex Ateneo de Manila University Loyola Heights, Quezon City Attention: Ms . Ma . Socorro Camacho-Reyes Chairperson and Mr . Danilo A . Songco National Coordinator Gentlemen : This refers to your letters dated May 10, 15 and 25, 2001 requesting for confirmation of your opinion that by the very nature of zero coupons, the PEACe Bonds, when sold to investors at a deep discount, the gains realized therefrom are exempt from capital gains tax pursuant to Section 32(B)(7)(g) of the 1997 Tax Code. It is represented that since mid February this year, CODE-NGO has been working towards the establishment of Hanap Buhay Fund to contribute to the government anti-poverty program; that it would entail the flotation of up to Php15,000,000,000.00 (Fifteen Billion Pesos) special issue, 10-year zero-coupon Treasury Notes (T-Notes) eligible as secondary reserves and for agri-agra compliance purposes; that the bonds were renamed Poverty Eradication and Alleviation Certificates (PEACe Bonds) for public relations purposes; that CODE-NGO will purchase the T-Notes/PEACe Bonds, and immediately resell these at a premium to prospective investors on a fully underwritten basis; that upon full issuance of the Bonds, civil-society expects to raise some Php1,000,000,000.00 (one Billion Pesos) after flotation expenses to serve as a permanent endowment and capital fund that will support micro-credit and capacity building projects for the poor; that the Monetary Board has approved in principle your request for the grant of such eligibilities to the PEACe Bonds subject to their issuance; that among the salient features of the PEACe Bonds are as follows: Rationale for the Issue : Deepening of the capital markets Issuer : Republic of the Philippines Instrument : 10-year, zero-coupon Treasury Notes (T-Notes) Issue Manager : RCBC Capital Corporation Face Amount : Up to Php 15.0 Billion Issue Price : The T-Notes do not pay interest throughout its entire life; in lieu thereof, these are sold at an appropriate discount to give prospective investors the same gross equivalent yield as other fixed income instruments of comparable risk and tenor. Term of Maturity : Ten (10) years Redemption Schedule : In one lump sum at maturity date of the Issue Yield-to-Maturity : As determined by the market, which for purposes of the Issue, shall be the bid yield of the most recent "on-the-run" 10-year FXTN issue as shown on the Bloomberg MARTI page at 11:30 a.m. on Issue Date. Form : Uncertificated, to be registered with the Registry of Scripless Securities (ROSS) Manner of Offering : Through a firmly underwritten private placement Security of the Issue : Direct, unconditional and general obligation of the National Government Firms Eligible (to Purchase) : Government Securities Eligible Dealers (GSEDs) and any other financial institutions as provided under Section 28 of the Department of Finance Order No. 141-95, as amended, Series of 1995. Other Features : Freely tradeable and transferable that you posited that the issuance of PEACe Bonds by the Philippine Government are necessary to borrow funds to meet public expenditures authorized by law or to provide for the purchase, redemption or refunding of any obligations, either direct or guaranteed, of the Philippine Government, hence, essentially, they are classified as certificates of indebtedness; that further, the issuance of PEACE Bonds, is by its nature, a sale of certificate of indebtedness ; that issuance thereof qualifies as a sale of bonds, debentures and certificates of indebtedness; that PEACe Bonds are not deposit substitutes and consequently not subject to withholding tax; that your opinion is premised on the fact that the PEACe Bonds will be issued to only one buyer, i.e., Code NGO; that assuming the discount can be treated as an interest income, the 20% final withholding tax imposed under the 1997 Tax Code applies only to interest income derived from bank deposits and deposit substitutes; that one of the conditions to be classified as deposit substitutes , as defined in Section 22 (Y) of the 1997 Tax Code is, the " alternative form of obtaining funds from the public [the term "public" means borrowings from twenty (20) or more individual or corporate lenders at any one time] other than deposits . . .", which fact is lacking in the proposed floatation of PEACe Bonds; that the withholding tax on interest income will apply only if a debt instrument is issued to twenty (20) or more individuals or corporate lenders; and neither any gain or income derived from PEACe Bonds will be subject to income tax, whether as a result of the discount or of its subsequent sale to financial institutions, otherwise there will be no occasion or situation where the tax exemption granted under Sec. 32(B)(7)(g) of the 1997 Tax Code will ever apply considering that the gain corresponding to the discount will actually be realized only upon retirement of the PEACe Bonds. In reply, please be informed that your opinion is hereby confirmed as follows: 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 financing 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, certificates 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 five (5) days to cover deficiency 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 classified 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 definition. Hence, the withholding tax on deposit substitutes will not apply. Furthermore, gains from the sale, exchange, or retirement of the PEACe bonds shall not be subject to the twenty percent (20%) final withholding tax imposed under Section 27(D)(1) of the Tax Code, since the gains that may be derived from PEACe Bonds with maturity of more than five (5) years, shall be exempt from income tax as provided for under Section 32(B)(7)(g) of the 1977 Tax Code pertinent portion of which reads as follows, viz. : "(g) Gains from the sale of bonds, debentures or other certificates of indebtedness . Gains realized from the sale or exchange or retirement of bonds, debentures or other certificate of indebtedness with a maturity of more than five (5) years" shall not be included in gross income and shall be exempt from taxation. The exemption from income tax and from the withholding tax on the income derived from the sale of bonds with maturity of more than five (5) years is given by law as an incentive to encourage cash savings in such investment securities and to develop both the capital market as well as the secondary market for these investments. Thus, the appellation, kind or form under which the bonds come is immaterial for the purpose of recognition of the income tax exemption for so long as the gains are derived from bonds with maturity of more than five (5) years. Finally, Section 180 of the same 1997 Tax Code specifically provides that bonds are among those subject to documentary stamp tax ". . . at the rate of Thirty Centavos (P0 . 30) on each Two-Hundred Pesos (P200) or fractional part thereof, of the face value . . ." of such instrument. There is therefore no legal basis to further exempt the PEACe Bonds from the payment of the documentary stamp tax notwithstanding the fact that, pursuant to Section 32(B)(7)(g) of the 1997 Tax Code, bonds with maturity of more than 5 years are exempt from income tax. This ruling is being issued on the basis of the foregoing facts as represented. However, if upon investigation, it shall be disclosed that the facts are different, then this ruling shall be considered null and void. IECAaD Very truly yours, (SGD.) REN G. BAEZ Commissioner of Internal Revenue