Taxing interest

Following the declaration of the taxability of Poverty Eradication and Alleviation Certificates (PEACe Bonds) in 2011, the Department of Finance recently released Revenue Regulations No. 14-2012 (RR 14-2012), a unified set of guidelines providing for the tax treatment of financial instruments and the interest income earnings thereon. Revenue Memorandum Circular No. 77-2012 (RMC 77-2012) was also issued to clarify certain provisions of the RR.

According to the commissioner of Internal Revenue Kim S. Jacinto-Henares, this new regulations aims to cover “as many instruments as possible”, considering that the Philippines is among the most active borrowers in the Asia Pacific Region, pioneering various kinds of debt papers for both local and foreign investors.

At the outset, RR 14-2012 appears to simply collate, clarify and reiterate existing regulations and pronouncements. However, a careful reading of the issuance reveals that it also introduces new definitions, new rules, and new rates. Given the fact that banks heavily generate and invest on financial instruments, they are most likely to feel the brunt this new issuance.

The RR now classifies government securities as “deposit substitutes” irrespective of the definition found under the Tax Code. Under Section 22(Y) of the Tax Code, the term “deposit substitutes” is defined as “an alternative form of obtaining funds from the public other than deposits, through the issuance…of debt instruments… for the purpose of relending or purchasing of receivables and or financing their own needs...” “Public” means borrowing of money from 20 or more individual or corporate lenders at any one time.

Notwithstanding the above definitions, the RR declares that government debt instruments and securities shall be considered as deposit substitutes irrespective of the number of lenders at the time of origination if such debt instruments and securities are to be traded or exchanged in the secondary market. Thus, the 19-lender rule finds no more application on government securities, and interest income derived therefrom is subject to final withholding tax (FWT) at the rate of 20 percent, 25 percent or 30 percent, depending on the classification of the income earner (individual, corporation, resident or non-resident, etc.).

This clarification is a reiteration of BIR’s position on the tax treatment of interest income derived from PEACe Bonds, which were 10-year zero coupon treasury bonds issued by the Bureau of Treasury in 2001. At the time of issuance, BIR exempted the bonds from taxes on the basis that the issue will be limited to a maximum of 19 lenders in the primary market. However, in 2004, the BIR declared the bonds to be within the scope of “deposit substitute”, regardless of the number of lenders during the issuance, as the intention is to raise funds from the public and the bonds will be traded in the secondary market, thus putting them in the position of more than 20 lenders. Days before the bonds’ maturity last year, the tax bureau again reiterated its position on the taxability of PEACe bonds. This has greatly dissatisfied the investors who initially banked on the paper’s tax exemption and led to petitions for court intervention. However, the advent of this new regulations now concretized the inclusion of government securities in the definition of “deposit substitutes”.

According to the RR, FWT on interest income from government debt securities and instruments shall be payable upon original issuance thereof. RMC 77-2012 clarifies that this shall apply only to zero-coupon instruments and securities. In the case of interest-bearing instruments and securities, the FWT is payable upon payment of the interest.

Another provision is the increased rate of withholding on interest income from all other debt instruments. From the former rate of zero percent or two percent, all other debt instruments not within the coverage of deposit substitutes shall now be subject to creditable withholding tax (CWT) of 20 percent, at par with the FWT on deposits and deposit substitutes. Under this new rule, taxpayers required to withhold under RR 2-98 are covered, thus repealing the former rule which requires that only top 20,000 corporations are required to withhold 2 percent on their interest payments. According to RMC 77-2012, this new rate shall apply to interest payments made beginning 23 November 2012, irrespective of the date when the instruments or securities were issued.

Likewise, the new RR states the conditions for the tax exemption of interest income from long-term deposits or investment certificates, among which is the requirement that the investment must not be terminated before the fifth year. It is emphasized in the RR that negotiation or transfer of long-term deposits or investment certificates is considered pre-termination, thus subject to the graduated rate of withholding taxes. Banks currently rely on the Bangko Sentral ng Pilipinas (BSP) circular which contains the guidelines for the issuance of long-term negotiable certificates of deposit. The circular provides that negotiations/transfers from one holder to another does not constitute pre-termination. However, the BIR holds firm that the interpretation of the BSP is not binding upon the BIR.

Finally, the RR reiterates the existing rule that any assignment or reassignment of debt instruments is subject to documentary stamp tax. Note, however, that this occurs only when the assignment or reassignment entails changing the maturity date or remaining period of coverage from that of the original instrument or carries with it a renewal or issuance of new instruments in the name of the transferee to replace the old ones.

System changes are currently being planned and effected by banks across the country to accommodate these new changes. However, bank organizations and associations are still in the process of clarifying and seeking instructions concerning the correct application of the new RR.

The new issuance took effect last Nov. 23, 2012, and its impact on the banking industry is yet to be witnessed.

Christy Irene D. Enrile is an assistant manager from the tax group of Manabat Sanagustin & Co. (MS&Co.), the Philippine member firm of KPMG International.

This article is for general information purposes only and should not be considered as professional advice to a specific issue or entity.

The views and opinions expressed herein are those of the author and do not necessarily represent the views and opinions of KPMG International or MS&Co. For comments or inquiries, please email [email protected] or [email protected].