G.R. No.

195909 September 26, 2012

COMMISSIONER OF INTERNAL REVENUE

vs.
ST. LUKE'S MEDICAL CENTER, INC.

x-----------------------x

G.R. No. 195960

ST. LUKE'S MEDICAL CENTER, INC.

vs.
COMMISSIONER OF INTERNAL REVENUE

Facts:

St. Luke's Medical Center, Inc. (St. Luke's) is a hospital organized as a non-stock and non-profit corporation.

BIR assessed St. Luke's deficiency taxes amounting to P76,063,116.06 for 1998, comprised of deficiency
income tax, value-added tax, withholding tax on compensation and expanded withholding tax. The BIR reduced the
amount to P63,935,351.57 during trial in the First Division of the CTA.

St. Luke's filed an administrative protest with the BIR against the deficiency tax assessments. The BIR did
not act on the protest within the 180-day period under Section 228 of the NIRC. Thus, St. Luke's appealed to the CTA.

The BIR argued before the CTA that Section 27(B) of the NIRC, which imposes a 10% preferential tax rate
on the income of proprietary non-profit hospitals, should be applicable to St. Luke's. According to the BIR, Section
27(B), introduced in 1997, "is a new provision intended to amend the exemption on non-profit hospitals that were
previously categorized as non-stock, non-profit corporations under Section 26 of the 1997 Tax Code x x x." It is a
specific provision which prevails over the general exemption on income tax granted under Section 30(E) and (G) for
non-stock, non-profit charitable institutions and civic organizations promoting social welfare.

BIR:

The BIR claimed that St. Luke's was actually operating for profit in 1998 because only 13% of its
revenues came from charitable purposes. Moreover, the hospital's board of trustees, officers and employees
directly benefit from its profits and assets. St. Luke's had total revenues of P1,730,367,965 or
approximately P1.73 billion from patient services in 1998.

St. Luke's

St. Luke's contended that the BIR should not consider its total revenues, because its free services to
patients was P218,187,498 or 65.20% of its 1998 operating income (i.e., total revenues less operating expenses)
of P334,642,615. St. Luke's also claimed that its income does not inure to the benefit of any individual.

St. Luke's maintained that it is a non-stock and non-profit institution for charitable and social welfare
purposes under Section 30(E) and (G) of the NIRC. It argued that the making of profit per se does not destroy
its income tax exemption.

The petition of the BIR before this Court in G.R. No. 195909 reiterates its arguments before the CTA that
Section 27(B) applies to St. Luke's. The petition raises the sole issue of whether the enactment of Section 27(B)
takes proprietary non-profit hospitals out of the income tax exemption under Section 30 of the NIRC and instead,
imposes a preferential rate of 10% on their taxable income. The BIR prays that St. Luke's be ordered to
pay P57,659,981.19 as deficiency income and expanded withholding tax for 1998 with surcharges and interest for
late payment.

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CTA En Banc: affirmed in toto the CTA First Division

The CTA ruled that St. Luke's is a non-stock and non-profit charitable institution covered by Section 30(E)
and (G) of the NIRC. This ruling would exempt all income derived by St. Luke's from services to its patients, whether
paying or non-paying. The CTA reiterated its earlier decision in St. Luke's Medical Center, Inc. v. Commissioner of
Internal Revenue, which examined the primary purposes of St. Luke's under its articles of incorporation and various
documents identifying St. Luke's as a charitable institution.

The CTA adopted the test in Hospital de San Juan de Dios, Inc. v. Pasay City, which states that "a
charitable institution does not lose its charitable character and its consequent exemption from taxation merely
because recipients of its benefits who are able to pay are required to do so, where funds derived in this manner are
devoted to the charitable purposes of the institution x x x." The generation of income from paying patients does not
per se destroy the charitable nature of St. Luke's.

The CTA held that Section 27(B) of the present NIRC does not apply to St. Luke's. The CTA explained that
to apply the 10% preferential rate, Section 27(B) requires a hospital to be "non-profit." On the other hand, Congress
specifically used the word "non-stock" to qualify a charitable "corporation or association" in Section 30(E) of the NIRC.
According to the CTA, this is unique in the present tax code, indicating an intent to exempt this type of charitable
organization from income tax. Section 27(B) does not require that the hospital be "non-stock." The CTA stated, "it is
clear that non-stock, non-profit hospitals operated exclusively for charitable purpose are exempt from income tax on
income received by them as such, applying the provision of Section 30(E) of the NIRC of 1997, as amended."

St Luke’s:

St. Luke's claims tax exemption under Section 30(E) and (G) of the NIRC. It contends that it is a charitable
institution and an organization promoting social welfare. The arguments of St. Luke's focus on the wording of Section
30(E) exempting from income tax non-stock, non-profit charitable institutions. St. Luke's asserts that the legislative
intent of introducing Section 27(B) was only to remove the exemption for "proprietary non-profit" hospitals. The
relevant provisions of Section 30 state:

SEC. 30. Exemptions from Tax on Corporations. - The following organizations shall not be taxed under this Title in
respect to income received by them as such:

xxxx

(E) Nonstock corporation or association organized and operated exclusively for religious, charitable, scientific, athletic,
or cultural purposes, or for the rehabilitation of veterans, no part of its net income or asset shall belong to or inure to
the benefit of any member, organizer, officer or any specific person;

(G) Civic league or organization not organized for profit but operated exclusively for the promotion of social welfare;

Issue:

Whether St. Luke's is liable for deficiency income tax in 1998 under Section 27(B) of the NIRC, which
imposes a preferential tax rate of 10% on the income of proprietary non-profit hospitals.

Held:

Yes. The 10% income tax rate under Section 27(B) specifically pertains to proprietary educational
institutions and proprietary non-profit hospitals. The BIR argues that Congress intended to remove the exemption that
non-profit hospitals previously enjoyed under Section 27(E) of the NIRC of 1977, which is now substantially
reproduced in Section 30(E) of the NIRC of 1997.

We hold that Section 27(B) of the NIRC does not remove the income tax exemption of proprietary
non-profit hospitals under Section 30(E) and (G). Section 27(B) on one hand, and Section 30(E) and (G) on the
other hand, can be construed together without the removal of such tax exemption.

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 The effect of the introduction of Section 27(B) is to subject the taxable income of two specific
institutions, namely, proprietary non-profit educational institutions and proprietary non-profit hospitals,
among the institutions covered by Section 30, to the 10% preferential rate under Section 27(B) instead of the
ordinary 30% corporate rate under the last paragraph of Section 30 in relation to Section 27(A)(1).

Section 27(B) of the NIRC imposes a 10% preferential tax rate on the income of (1) proprietary non-
profit educational institutions and (2) proprietary non-profit hospitals. The only qualifications for hospitals are
that they must be proprietary and non-profit. "Proprietary" means private, following the definition of a "proprietary
educational institution" as "any private school maintained and administered by private individuals or groups" with a
government permit. "Non-profit" means no net income or asset accrues to or benefits any member or specific person,
with all the net income or asset devoted to the institution's purposes and all its activities conducted not for profit.

"Non-profit" does not necessarily mean "charitable." In Collector of Internal Revenue v. Club Filipino Inc. de
Cebu, this Court considered as non-profit a sports club organized for recreation and entertainment of its stockholders
and members. The club was primarily funded by membership fees and dues. If it had profits, they were used for
overhead expenses and improving its golf course. The club was non-profit because of its purpose and there was no
evidence that it was engaged in a profit-making enterprise.

The sports club in Club Filipino Inc. de Cebu may be non-profit, but it was not charitable. The Court defined "charity"
in Lung Center of the Philippines v. Quezon City as "a gift, to be applied consistently with existing laws, for the
benefit of an indefinite number of persons, either by bringing their minds and hearts under the influence of education
or religion, by assisting them to establish themselves in life or [by] otherwise lessening the burden of government." A
non-profit club for the benefit of its members fails this test. An organization may be considered as non-profit if it
does not distribute any part of its income to stockholders or members. However, despite its being a tax
exempt institution, any income such institution earns from activities conducted for profit is taxable, as
expressly provided in the last paragraph of Section 30.

This is the rationale for the tax exemption of charitable institutions. The loss of taxes by the
government is compensated by its relief from doing public works which would have been funded by
appropriations from the Treasury.

Charitable institutions, however, are not ipso facto entitled to a tax exemption. The requirements for a
tax exemption are specified by the law granting it. The power of Congress to tax implies the power to exempt from tax.
Congress can create tax exemptions, subject to the constitutional provision that "[n]o law granting any tax exemption
shall be passed without the concurrence of a majority of all the Members of Congress." The requirements for a tax
exemption are strictly construed against the taxpayer because an exemption restricts the collection of taxes
necessary for the existence of the government.

The Court in Lung Center declared that the Lung Center of the Philippines is a charitable institution for the purpose of
exemption from real property taxes. This ruling uses the same premise as Hospital de San Juan and Jesus Sacred
Heart College which says that receiving income from paying patients does not destroy the charitable nature of
a hospital.

As a general principle, a charitable institution does not lose its character as such and its exemption
from taxes simply because it derives income from paying patients, whether out-patient, or confined in the
hospital, or receives subsidies from the government, so long as the money received is devoted or used
altogether to the charitable object which it is intended to achieve; and no money inures to the private benefit
of the persons managing or operating the institution.

For real property taxes, the incidental generation of income is permissible because the test of exemption is
the use of the property. The Constitution provides that "[c]haritable institutions, churches and personages or convents
appurtenant thereto, mosques, non-profit cemeteries, and all lands, buildings, and improvements, actually, directly,
and exclusively used for religious, charitable, or educational purposes shall be exempt from taxation." The test of
exemption is not strictly a requirement on the intrinsic nature or character of the institution. The test requires that the
institution use the property in a certain way, i.e. for a charitable purpose. Thus, the Court held that the Lung Center of
the Philippines did not lose its charitable character when it used a portion of its lot for commercial purposes.
The effect of failing to meet the use requirement is simply to remove from the tax exemption that portion of the
property not devoted to charity.

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 The Constitution exempts charitable institutions only from real property taxes. In the NIRC, Congress
decided to extend the exemption to income taxes. However, the way Congress crafted Section 30(E) of the NIRC is
materially different from Section 28(3), Article VI of the Constitution. Section 30(E) of the NIRC defines the
corporation or association that is exempt from income tax. On the other hand, Section 28(3), Article VI of the
Constitution does not define a charitable institution, but requires that the institution "actually, directly and exclusively"
use the property for a charitable purpose.

Section 30(E) of the NIRC provides that a charitable institution must be:

(1) A non-stock corporation or association;

(2) Organized exclusively for charitable purposes;

(3) Operated exclusively for charitable purposes; and

(4) No part of its net income or asset shall belong to or inure to the benefit of any member, organizer, officer
or any specific person.

Thus, both the organization and operations of the charitable institution must be devoted "exclusively" for charitable
purposes. The organization of the institution refers to its corporate form, as shown by its articles of incorporation, by-
laws and other constitutive documents. Section 30(E) of the NIRC specifically requires that the corporation or
association be non-stock, which is defined by the Corporation Code as "one where no part of its income is
distributable as dividends to its members, trustees, or officers" and that any profit "obtain[ed] as an incident
to its operations shall, whenever necessary or proper, be used for the furtherance of the purpose or
purposes for which the corporation was organized."

The operations of the charitable institution generally refer to its regular activities. Section 30(E) of the NIRC requires
that these operations be exclusive to charity. There is also a specific requirement that "no part of [the] net income or
asset shall belong to or inure to the benefit of any member, organizer, officer or any specific person." The use of
lands, buildings and improvements of the institution is but a part of its operations.

There is no dispute that St. Luke's is organized as a non-stock and non-profit charitable institution. However,
this does not automatically exempt St. Luke's from paying taxes. This only refers to the organization of St.
Luke's. Even if St. Luke's meets the test of charity, a charitable institution is not ipso facto tax exempt. To be
exempt from real property taxes, Section 28(3), Article VI of the Constitution requires that a charitable
institution use the property "actually, directly and exclusively" for charitable purposes. To be exempt from
income taxes, Section 30(E) of the NIRC requires that a charitable institution must be "organized and
operated exclusively" for charitable purposes. Likewise, to be exempt from income taxes, Section 30(G) of
the NIRC requires that the institution be "operated exclusively" for social welfare.

However, the last paragraph of Section 30 of the NIRC qualifies the words "organized and operated
exclusively" by providing that:

Notwithstanding the provisions in the preceding paragraphs, the income of whatever kind and
character of the foregoing organizations from any of their properties, real or personal, or from any of their
activities conducted for profit regardless of the disposition made of such income, shall be subject to tax
imposed under this Code.

In 1998, St. Luke's had total revenues of P1,730,367,965 from services to paying patients. It cannot be
disputed that a hospital which receives approximately P1.73 billion from paying patients is not an institution "operated
exclusively" for charitable purposes. Clearly, revenues from paying patients are income received from "activities
conducted for profit." Indeed, St. Luke's admits that it derived profits from its paying patients. St. Luke's
declared P1,730,367,965 as "Revenues from Services to Patients" in contrast to its "Free Services" expenditure
of P218,187,498.

The Court cannot expand the meaning of the words "operated exclusively" without violating the NIRC. Services to
paying patients are activities conducted for profit. They cannot be considered any other way. There is a "purpose to

4
make profit over and above the cost" of services. The P1.73 billion total revenues from paying patients is not
even incidental to St. Luke's charity expenditure of P218,187,498 for non-paying patients.

St. Luke's claims that its charity expenditure of P218,187,498 is 65.20% of its operating income in 1998. However, if a
part of the remaining 34.80% of the operating income is reinvested in property, equipment or facilities used for
services to paying and non-paying patients, then it cannot be said that the income is "devoted or used altogether to
the charitable object which it is intended to achieve." The income is plowed back to the corporation not entirely for
charitable purposes, but for profit as well. In any case, the last paragraph of Section 30 of the NIRC expressly
qualifies that income from activities for profit is taxable "regardless of the disposition made of such income."

The question was whether having a hospital is essential to an educational institution like the College of
Medicine of the University of Santo Tomas. Senator Cuenco answered that if the hospital has paid rooms
generally occupied by people of good economic standing, then it should be subject to income tax. He said
that this was one of the reasons Congress inserted the phrase "or any activity conducted for profit."

The question in Jesus Sacred Heart College involves an educational institution. However, it is applicable to
charitable institutions because Senator Cuenco's response shows an intent to focus on the activities of charitable
institutions. Activities for profit should not escape the reach of taxation. Being a non-stock and non-profit corporation
does not, by this reason alone, completely exempt an institution from tax. An institution cannot use its corporate form
to prevent its profitable activities from being taxed.

Summary:

The Court finds that St. Luke's is a corporation that is not "operated exclusively" for charitable or
social welfare purposes insofar as its revenues from paying patients are concerned. This ruling is based not
only on a strict interpretation of a provision granting tax exemption, but also on the clear and plain text of
Section 30(E) and (G). Section 30(E) and (G) of the NIRC requires that an institution be "operated exclusively"
for charitable or social welfare purposes to be completely exempt from income tax. An institution under
Section 30(E) or (G) does not lose its tax exemption if it earns income from its for-profit activities. Such
income from for-profit activities, under the last paragraph of Section 30, is merely subject to income tax,
previously at the ordinary corporate rate but now at the preferential 10% rate pursuant to Section 27(B).

St. Luke's fails to meet the requirements under Section 30(E) and (G) of the NIRC to be completely tax
exempt from all its income. However, it remains a proprietary non-profit hospital under Section 27(B) of the
NIRC as long as it does not distribute any of its profits to its members and such profits are reinvested
pursuant to its corporate purposes. St. Luke's, as a proprietary non-profit hospital, is entitled to the
preferential tax rate of 10% on its net income from its for-profit activities.

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G.R. No. L-68375 April 15, 1988

COMMISSIONER OF INTERNAL REVENUE

vs.
WANDER PHILIPPINES, INC. AND CTA

Facts:

Wander Philippines, Inc. (Wander, for short), is a domestic corporation organized under Philippine laws. It is
wholly-owned subsidiary of the Glaro S.A. Ltd. (Glaro for short), a Swiss corporation not engaged in trade or business
in the Philippines.

Wander filed its withholding tax return for the second quarter ending June 30, 1975 and remitted to its
parent company, Glaro dividends in the amount of P222,000.00, on which 35% withholding tax thereof in the amount
of P77,700.00 was withheld and paid to the Bureau of Internal Revenue.

Again, Wander filed a withholding tax return for the second quarter ending June 30, 1976 on the dividends it
remitted to Glaro amounting to P355,200.00, on wich 35% tax in the amount of P124,320.00 was withheld and paid to
the Bureau of Internal Revenue.

Wander filed with the Appellate Division of the Internal Revenue a claim for refund and/or tax credit in the
amount of P115,400.00, contending that it is liable only to 15% withholding tax in accordance with Section 24 (b) (1)
of the Tax Code, as amended by Presidential Decree Nos. 369 and 778, and not on the basis of 35% which was
withheld and paid to and collected by the government.

Petitioner herein, having failed to act on the above-said claim for refund, Wander filed a petition with
respondent CTA.

CTA: a refund and/or tax credit to petitioner

Petitioner:

Glaro the tax payer, and not Wander, the remitter or payor of the dividend income and a mere withholding
agent for and in behalf of the Philippine Government, which should be legally entitled to receive the refund if any.

Avers the tax sparing credit is applicable only if the country of the parent corporation allows a foreign tax
credit not only for the 15 percentage-point portion actually paid but also for the equivalent twenty percentage point
portion spared, waived or otherwise deemed as if paid in the Philippines; that private respondent does not cite
anywhere a Swiss law to the effect that in case where a foreign tax, such as the Philippine 35% dividend tax, is
spared waived or otherwise considered as if paid in whole or in part by the foreign country, a Swiss foreign-tax credit
would be allowed for the whole or for the part, as the case may be, of the foreign tax so spared or waived or
considered as if paid by the foreign country.

Issue:

Whether or not private respondent Wander is entitled to the preferential rate of 15% withholding tax on
dividends declared and remitted to its parent corporation, Glaro. Yes.

From this issue, two questions were posed by petitioner:

(1) Whether or not Wander is the proper party to claim the refund; Yes.

(2) Whether or not Switzerland allows as tax credit the "deemed paid" 20% Philippine Tax on such dividends. No.

6
Held:

In any event, the submission of petitioner that Wander is but a withholding agent of the government and
therefore cannot claim reimbursement of the alleged overpaid taxes, is untenable.

It will be recalled, that said corporation is first and foremost a wholly owned subsidiary of Glaro. The
fact that it became a withholding agent of the government which was not by choice but by compulsion under
Section 53 (b) of the Tax Code, cannot by any stretch of the imagination be considered as an abdication of its
responsibility to its mother company. Thus, this Court construing Section 53 (b) of the Internal Revenue
Code held that "the obligation imposed thereunder upon the withholding agent is compulsory." It is a device
to insure the collection by the Philippine Government of taxes on incomes, derived from sources in the Philippines, by
aliens who are outside the taxing jurisdiction of this Court (Commissioner of Internal Revenue vs. Malayan Insurance
Co., Inc., 21 SCRA 944). In fact, Wander may be assessed for deficiency withholding tax at source, plus penalties
consisting of surcharge and interest (Section 54, NLRC). Therefore, as the Philippine counterpart, Wander is the
proper entity who should for the refund or credit of overpaid withholding tax on dividends paid or remitted
by Glaro.

Closely intertwined with the first assignment of error is the issue of whether or not Switzerland, the foreign country
where Glaro is domiciled, grants to Glaro a tax credit against the tax due it, equivalent to 20%, or the difference
between the regular 35% rate of the preferential 15% rate. The dispute in this issue lies on the fact that Switzerland
does not impose any income tax on dividends received by Swiss corporation from corporations domiciled in
foreign countries.

Section 24 (b) (1) of the Tax Code, as amended by P.D. 369 and 778, the law involved in this case

From the above-quoted provision, the dividends received from a domestic corporation liable to tax,
the tax shall be 15% of the dividends received, subject to the condition that the country in which the non-
resident foreign corporation is domiciled shall allow a credit against the tax due from the non-resident
foreign corporation taxes deemed to have been paid in the Philippines equivalent to 20% which represents
the difference between the regular tax (35%) on corporations and the tax (15%) dividends.

In the instant case, Switzerland did not impose any tax on the dividends received by Glaro. Accordingly,
Wander claims that full credit is granted and not merely credit equivalent to 20%.

While it may be true that claims for refund are construed strictly against the claimant, nevertheless, the fact
that Switzerland did not impose any tax or the dividends received by Glaro from the Philippines should be considered
as a full satisfaction of the given condition. For, as aptly stated by respondent Court, to deny private respondent
the privilege to withhold only 15% tax provided for under Presidential Decree No. 369, amending Section 24
(b) (1) of the Tax Code, would run counter to the very spirit and intent of said law and definitely will adversely
affect foreign corporations" interest here and discourage them from investing capital in our country.

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G.R. No. L-66838 December 2, 1991

COMMISSIONER OF INTERNAL REVENUE

vs.
PROCTER & GAMBLE PHILIPPINE MANUFACTURING CORPORATION and CTA

Procter and Gamble Philippine Manufacturing Corporation ("P&G-Phil.") declared dividends payable to its
parent company and sole stockholder, Procter and Gamble Co., Inc. (USA) ("P&G-USA"), amounting to
P24,164,946.30, from which dividends the amount of P8,457,731.21 representing the thirty-five percent (35%)
withholding tax at source was deducted.

P&G-Phil. filed with petitioner Commissioner of Internal Revenue a claim for refund or tax credit in the
amount of P4,832,989.26 claiming, among other things, that pursuant to Section 24 (b) (1) of the NIRC the
applicable rate of withholding tax on the dividends remitted was only fifteen percent (15%) (and not thirty-five percent
[35%]) of the dividends.

There being no responsive action on the part of the Commissioner, P&G-Phil., on 13 July 1977, filed a
petition for review with public respondent Court of Tax Appeals.

CTA rendered a decision ordering petitioner Commissioner to refund or grant the tax credit in the amount of
P4,832,989.00.

On appeal by the Commissioner, the Court through its Second Division reversed the decision of the CTA
and held that:

(a) P&G-USA, and not private respondent P&G-Phil., was the proper party to
claim the refund or tax credit here involved;

(b) there is nothing in Section 902 or other provisions of the US Tax Code that
allows a credit against the US tax due from P&G-USA of taxes deemed to have
been paid in the Philippines equivalent to twenty percent (20%) which represents
the difference between the regular tax of thirty-five percent (35%) on corporations
and the tax of fifteen percent (15%) on dividends; and

(c) private respondent P&G-Phil. failed to meet certain conditions necessary in

order that "the dividends received by its non-resident parent company in the US
(P&G-USA) may be subject to the preferential tax rate of 15% instead of 35%."

Issue: Whether or not P&G-Phil, is entitled to the tax refund or tax credit which it seeks.

Held:

Yes. Since the claim for refund was filed by P&G-Phil., the question which arises is: is P&G-Phil.
a "taxpayer" under Section 309 (3) of the NIRC? The term "taxpayer" is defined in our NIRC as referring to "any
person subject to taximposed by the Title [on Tax on Income]." It thus becomes important to note that under Section
53 (c) of the NIRC, the withholding agent who is "required to deduct and withhold any tax" is made " personally liable
for such tax" and indeed is indemnified against any claims and demands which the stockholder might wish to make in
questioning the amount of payments effected by the withholding agent in accordance with the provisions of the NIRC.
The withholding agent, P&G-Phil., is directly and independently liable for the correct amount of the tax that
should be withheld from the dividend remittances. The withholding agent is, moreover, subject to and liable
for deficiency assessments, surcharges and penalties should the amount of the tax withheld be finally found
to be less than the amount that should have been withheld under law.

In Philippine Guaranty Company, Inc. v. Commissioner of Internal Revenue, this Court pointed out that a
withholding agent is in fact the agent both of the government and of the taxpayer, and that the withholding
agent is not an ordinary government agent.

8
 If, as pointed out in Philippine Guaranty, the withholding agent is also an agent of the beneficial owner
of the dividends with respect to the filing of the necessary income tax return and with respect to actual
payment of the tax to the government, such authority may reasonably be held to include the authority to file
a claim for refund and to bring an action for recovery of such claim. This implied authority is especially
warranted where, is in the instant case, the withholding agent is the wholly owned subsidiary of the parent-
stockholder and therefore, at all times, under the effective control of such parent-stockholder. In the
circumstances of this case, it seems particularly unreal to deny the implied authority of P&G-Phil. to claim a refund
and to commence an action for such refund.

We believe and so hold that, under the circumstances of this case, P&G-Phil. is properly regarded as a "taxpayer"
within the meaning of Section 309, NIRC, and as impliedly authorized to file the claim for refund and the suit to
recover such claim.

We turn to the principal substantive question before us: the applicability to the dividend remittances by P&G-
Phil. to P&G-USA of the fifteen percent (15%) tax rate provided for in the following portion of Section 24 (b) (1) of the
NIRC:

The ordinary thirty-five percent (35%) tax rate applicable to dividend remittances to non-resident
corporate stockholders of a Philippine corporation, goes down to fifteen percent (15%) if the country of
domicile of the foreign stockholder corporation "shall allow" such foreign corporation a tax credit for "taxes
deemed paid in the Philippines," applicable against the tax payable to the domiciliary country by the foreign
stockholder corporation. In other words, in the instant case, the reduced fifteen percent (15%) dividend tax rate is
applicable if the USA "shall allow" to P&G-USA a tax credit for "taxes deemed paid in the Philippines" applicable
against the US taxes of P&G-USA. The NIRC specifies that such tax credit for "taxes deemed paid in the Philippines"
must, as a minimum, reach an amount equivalent to twenty (20) percentage points which represents the difference
between the regular thirty-five percent (35%) dividend tax rate and the preferred fifteen percent (15%) dividend tax
rate.

It is important to note that Section 24 (b) (1), NIRC, does not require that the US must give a "deemed paid" tax credit
for the dividend tax (20 percentage points) waived by the Philippines in making applicable the preferred divided tax
rate of fifteen percent (15%). In other words, our NIRC does not require that the US tax law deem the parent-
corporation to have paid the twenty (20) percentage points of dividend tax waived by the Philippines. The NIRC only
requires that the US "shall allow" P&G-USA a "deemed paid" tax credit in an amount equivalent to the twenty
(20) percentage points waived by the Philippines.

The question arises: Did the US law comply with the above requirement? The relevant provisions of the US
Intemal Revenue Code ("Tax Code") are the following:

Close examination of the above quoted provisions of the US Tax Code shows the following:

a. US law (Section 901, Tax Code) grants P&G-USA a tax credit for the amount
of the dividend tax actually paid (i.e., withheld) from the dividend remittances to
P&G-USA;

b. US law (Section 902, US Tax Code) grants to P&G-USA a "deemed paid' tax
credit for a proportionate part of the corporate income tax actually paid to the
Philippines by P&G-Phil.

The parent-corporation P&G-USA is "deemed to have paid" a portion of the Philippine corporate
income tax although that tax was actually paid by its Philippine subsidiary, P&G-Phil., not by P&G-USA. This
"deemed paid" concept merely reflects economic reality, since the Philippine corporate income tax was in fact paid
and deducted from revenues earned in the Philippines, thus reducing the amount remittable as dividends to P&G-
USA. In other words, US tax law treats the Philippine corporate income tax as if it came out of the pocket, as it were,
of P&G-USA as a part of the economic cost of carrying on business operations in the Philippines through the medium
of P&G-Phil. and here earning profits. What is, under US law, deemed paid by P&G- USA are not "phantom
taxes" but instead Philippine corporate income taxes actually paid here by P&G-Phil., which are very real
indeed.

9
 It is also useful to note that both (i) the tax credit for the Philippine dividend tax actually withheld, and (ii) the
tax credit for the Philippine corporate income tax actually paid by P&G Phil. but "deemed paid" by P&G-USA, are tax
credits available or applicable against the US corporate income tax of P&G-USA. These tax credits are allowed
because of the US congressional desire to avoid or reduce double taxation of the same income stream.

In order to determine whether US tax law complies with the requirements for applicability of the reduced or
preferential fifteen percent (15%) dividend tax rate under Section 24 (b) (1), NIRC, it is necessary:

a. to determine the amount of the 20 percentage points dividend tax waived by

the Philippine government under Section 24 (b) (1), NIRC, and which hence goes
to P&G-USA;

b. to determine the amount of the "deemed paid" tax credit which US tax law
must allow to P&G-USA; and

c. to ascertain that the amount of the "deemed paid" tax credit allowed by US law
is at least equal to the amount of the dividend tax waived by the Philippine
Government.

Amount (a), i.e., the amount of the dividend tax waived by the Philippine government is arithmetically determined in
the following manner:

P100.00 — Pretax net corporate income earned by P&G-Phil.

x 35% — Regular Philippine corporate income tax rate
———
P35.00 — Paid to the BIR by P&G-Phil. as Philippine
corporate income tax.

P100.00
-35.00
———
P65.00 — Available for remittance as dividends to P&G-USA

P65.00 — Dividends remittable to P&G-USA

x 35% — Regular Philippine dividend tax rate under Section 24
——— (b) (1), NIRC
P22.75 — Regular dividend tax

P65.00 — Dividends remittable to P&G-USA

x 15% — Reduced dividend tax rate under Section 24 (b) (1), NIRC
———
P9.75 — Reduced dividend tax

P22.75 — Regular dividend tax under Section 24 (b) (1), NIRC

-9.75 — Reduced dividend tax under Section 24 (b) (1), NIRC
———
P13.00 — Amount of dividend tax waived by Philippine
===== government under Section 24 (b) (1), NIRC.

Thus, amount (a) above is P13.00 for every P100.00 of pre-tax net income earned by P&G-Phil. Amount (a)
is also the minimum amount of the "deemed paid" tax credit that US tax law shall allow if P&G-USA is to qualify for
the reduced or preferential dividend tax rate under Section 24 (b) (1), NIRC.

Amount (b) above, i.e., the amount of the "deemed paid" tax credit which US tax law allows under Section
902, Tax Code, may be computed arithmetically as follows:

P65.00 — Dividends remittable to P&G-USA

- 9.75 — Dividend tax withheld at the reduced (15%) rate

10
 ———
P55.25 — Dividends actually remitted to P&G-USA

P35.00 — Philippine corporate income tax paid by P&G-Phil.

to the BIR

Dividends actually
remitted by P&G-Phil.
to P&G-USA P55.25
——————— = ——— x P35.00 = P29.75 10
Amount of accumulated P65.00 ======
profits earned by
P&G-Phil. in excess
of income tax

Thus, for every P55.25 of dividends actually remitted (after withholding at the rate of 15%) by P&G-Phil. to its US
parent P&G-USA, a tax credit of P29.75 is allowed by Section 902 US Tax Code for Philippine corporate income tax
"deemed paid" by the parent but actually paid by the wholly-owned subsidiary.

Since P29.75 is much higher than P13.00 (the amount of dividend tax waived by the Philippine government), Section
902, US Tax Code, specifically and clearly complies with the requirements of Section 24 (b) (1), NIRC.

We should not overlook the fact that the concept of "deemed paid" tax credit, which is embodied in Section
902, US Tax Code, is exactly the same "deemed paid" tax credit found in our NIRC and which Philippine tax law
allows to Philippine corporations which have operations abroad (say, in the United States) and which, therefore, pay
income taxes to the US government.

Under Section 30 (c) (3) (a), NIRC, above, the BIR must give a tax credit to a Philippine corporation for taxes actually
paid by it to the US government—e.g., for taxes collected by the US government on dividend remittances to the
Philippine corporation. This Section of the NIRC is the equivalent of Section 901 of the US Tax Code.

Section 30 (c) (8), NIRC, is practically identical with Section 902 of the US Tax Code.

Section 30 (c) (8), NIRC, the BIR must give a tax credit to a Philippine parent corporation for taxes
"deemed paid" by it, that is, e.g., for taxes paid to the US by the US subsidiary of a Philippine-parent
corporation. The Philippine parent or corporate stockholder is "deemed" under our NIRC to have paid a
proportionate part of the US corporate income tax paid by its US subsidiary, although such US tax was
actually paid by the subsidiary and not by the Philippine parent.

Clearly, the "deemed paid" tax credit which, under Section 24 (b) (1), NIRC, must be allowed by US
law to P&G-USA, is the same "deemed paid" tax credit that Philippine law allows to a Philippine corporation
with a wholly- or majority-owned subsidiary in (for instance) the US. The "deemed paid" tax credit allowed in
Section 902, US Tax Code, is no more a credit for "phantom taxes" than is the "deemed paid" tax credit
granted in Section 30 (c) (8), NIRC.

More simply put, Section 24 (b) (1), NIRC, seeks to promote the in-flow of foreign equity investment
in the Philippines by reducing the tax cost of earning profits here and thereby increasing the net dividends
remittable to the investor. The foreign investor, however, would not benefit from the reduction of the Philippine
dividend tax rate unless its home country gives it some relief from double taxation (i.e., second-tier taxation) (the
home country would simply have more "post-R.P. tax" income to subject to its own taxing power) by allowing the
investor additional tax credits which would be applicable against the tax payable to such home country. Accordingly,
Section 24 (b) (1), NIRC, requires the home or domiciliary country to give the investor corporation a "deemed
paid" tax credit at least equal in amount to the twenty (20) percentage points of dividend tax foregone by the
Philippines, in the assumption that a positive incentive effect would thereby be felt by the investor.

11
The net effect upon the foreign investor may be shown arithmetically in the following manner:

P65.00 — Dividends remittable to P&G-USA

- 9.75 — Reduced R.P. dividend tax withheld by P&G-Phil.

———
P55.25 — Dividends actually remitted to P&G-USA

P55.25
x 46% — Maximum US corporate income tax rate
———
P25.415—US corporate tax payable by P&G-USA
without tax credits

P25.415
- 9.75 — US tax credit for RP dividend tax withheld by P&G-Phil.
at 15% (Section 901, US Tax Code)
———
P15.66 — US corporate income tax payable after Section 901
——— tax credit.

P55.25
- 15.66
———
P39.59 — Amount received by P&G-USA net of R.P. and U.S.
===== taxes without "deemed paid" tax credit.

P25.415
- 29.75 — "Deemed paid" tax credit under Section 902 US
——— Tax Code (please see page 18 above)

- 0 - — US corporate income tax payable on dividends

====== remitted by P&G-Phil. to P&G-USA after
Section 902 tax credit.

P55.25 — Amount received by P&G-USA net of RP and US

====== taxes after Section 902 tax credit.

It will be seen that the "deemed paid" tax credit allowed by Section 902, US Tax Code, could offset the US
corporate income tax payable on the dividends remitted by P&G-Phil. The result, in fine, could be that P&G-USA
would after US tax credits, still wind up with P55.25, the full amount of the dividends remitted to P&G-USA net of
Philippine taxes. In the calculation of the Philippine Government, this should encourage additional investment or re-
investment in the Philippines by P&G-USA.

12
G.R. No. 76573 September 14, 1989
MARUBENI CORPORATION (formerly Marubeni — Iida, Co., Ltd.) vs. CIR and CTA

Facts:

Marubeni Corporation, representing itself as a foreign corporation duly organized and existing under the
laws of Japan and duly licensed to engage in business under Philippine laws with branch office at the 4th Floor,
FEEMI Building, Aduana Street, Intramuros, Manila seeks the reversal of the decision of the Court of Tax
Appeals denying its claim for refund or tax credit in the amount of P229,424.40 representing alleged overpayment of
branch profit remittance tax withheld from dividends by Atlantic Gulf and Pacific Co. of Manila (AG&P).

The following facts are undisputed: Marubeni Corporation of Japan has equity investments in AG&P of Manila.
For the first quarter of 1981 ending March 31, AG&P declared and paid cash dividends to petitioner in the
amount of P849,720 and withheld the corresponding 10% final dividend tax thereon. Similarly, for the third
quarter of 1981 ending September 30, AG&P declared and paid P849,720 as cash dividends to petitioner and
withheld the corresponding 10% final dividend tax thereon.

AG&P directly remitted the cash dividends to petitioner's head office in Tokyo, Japan, net not only of
the 10% final dividend tax in the amounts of P764,748 for the first and third quarters of 1981, but also of the
withheld 15% profit remittance tax based on the remittable amount after deducting the final withholding tax
of 10%. A schedule of dividends declared and paid by AG&P to its stockholder Marubeni Corporation of Japan, the
10% final intercorporate dividend tax and the 15% branch profit remittance tax paid thereon, is shown below:

1981 FIRST THIRD TOTAL OF

QUARTER (three QUARTER (three FIRST and
months ended months ended THIRD quarters
3.31.81) (In 9.30.81)
Pesos)

Cash Dividends Paid 849,720.44 849,720.00 1,699,440.00

10% Dividend Tax Withheld 84,972.00 84,972.00 169,944.00

Cash Dividend net of 10% 764,748.00 764,748.00 1,529,496.00

Dividend Tax Withheld

15% Branch Profit 114,712.20 114,712.20 229,424.40 3

Remittance Tax Withheld

Net Amount Remitted to 650,035.80 650,035.80 1,300,071.60

Petitioner

The 10% final dividend tax of P84,972 and the 15% branch profit remittance tax of P114,712.20 for the first
quarter of 1981 were paid to the Bureau of Internal Revenue by AG&P. Likewise, the 10% final dividend tax of
P84,972 and the 15% branch profit remittance tax of P114,712 for the third quarter of 1981 were paid to the Bureau
of Internal Revenue by AG&P.

Thus, for the first and third quarters of 1981, AG&P as withholding agent paid 15% branch profit remittance on
cash dividends declared and remitted to petitioner at its head office in Tokyo in the total amount of
P229,424.40 on April 20 and August 4, 1981.

Petitioner, through the accounting firm Sycip, Gorres, Velayo and Company, sought a ruling from the Bureau
of Internal Revenue on whether or not the dividends petitioner received from AG&P are effectively connected with its
conduct or business in the Philippines as to be considered branch profits subject to the 15% profit remittance tax
imposed under Section 24 (b) (2) of the National Internal Revenue Code as amended by Presidential Decrees Nos.
1705 and 1773.

In reply to petitioner's query, Acting Commissioner Ruben Ancheta ruled:

13
 Pursuant to Section 24 (b) (2) of the Tax Code, as amended, only profits remitted abroad by a
branch office to its head office which are effectively connected with its trade or business in
the Philippines are subject to the 15% profit remittance tax. To be effectively connected it is
not necessary that the income be derived from the actual operation of taxpayer-corporation's trade
or business; it is sufficient that the income arises from the business activity in which the
corporation is engaged. For example, if a resident foreign corporation is engaged in the buying
and selling of machineries in the Philippines and invests in some shares of stock on which
dividends are subsequently received, the dividends thus earned are not considered 'effectively
connected' with its trade or business in this country. (Revenue Memorandum Circular No. 55-80).

In the instant case, the dividends received by Marubeni from AG&P are not income arising
from the business activity in which Marubeni is engaged. Accordingly, said dividends if
remitted abroad are not considered branch profits for purposes of the 15% profit remittance
tax imposed by Section 24 (b) (2) of the Tax Code, as amended . . .

Consequently, petitioner claimed for the refund or issuance of a tax credit of P229,424.40
"representing profit tax remittance erroneously paid on the dividends remitted by Atlantic Gulf and Pacific
Co. of Manila (AG&P) on April 20 and August 4, 1981 to ... head office in Tokyo.

CIR: denied petitioner's claim for refund/credit of P229,424.40 on the following grounds:

While it is true that said dividends remitted were not subject to the 15% profit remittance tax as the
same were not income earned by a Philippine Branch of Marubeni Corporation of Japan; and
neither is it subject to the 10% intercorporate dividend tax, the recipient of the dividends, being a
non-resident stockholder, nevertheless, said dividend income is subject to the 25 % tax pursuant to
Article 10 (2) (b) of the Tax Treaty dated February 13, 1980 between the Philippines and Japan.

Inasmuch as the cash dividends remitted by AG&P to Marubeni Corporation, Japan is subject to
25 % tax, and that the taxes withheld of 10 % as intercorporate dividend tax and 15 % as profit
remittance tax totals (sic) 25 %, the amount refundable offsets the liability, hence, nothing is left to
be refunded.

CTA: affirmed the denial of the refund by the CIR

Petitioner:

It is the argument of petitioner corporation that following the principal-agent relationship theory,
Marubeni Japan is likewise a resident foreign corporation subject only to the 10 % intercorporate final tax on
dividends received from a domestic corporation in accordance with Section 24(c) (1) of the Tax Code of 1977
which states:

Dividends received by a domestic or resident foreign corporation liable to tax under this Code — (1)
Shall be subject to a final tax of 10% on the total amount thereof, which shall be collected and paid
as provided in Sections 53 and 54 of this Code ....

Public respondents:

Marubeni, Japan, being a non-resident foreign corporation and not engaged in trade or business in
the Philippines, is subject to tax on income earned from Philippine sources at the rate of 35 % of its gross
income under Section 24 (b) (1) of the same Code which reads:

(b) Tax on foreign corporations — (1) Non-resident corporations. — A foreign corporation not
engaged in trade or business in the Philippines shall pay a tax equal to thirty-five per cent of the
gross income received during each taxable year from all sources within the Philippines as ...
dividends ....

but expressly made subject to the special rate of 25% under Article 10(2) (b) of the Tax Treaty of 1980
concluded between the Philippines and Japan. Thus:

14
 Article 10 (1) Dividends paid by a company which is a resident of a Contracting State to a resident
of the other Contracting State may be taxed in that other Contracting State.

(2) However, such dividends may also be taxed in the Contracting State of which the company
paying the dividends is a resident, and according to the laws of that Contracting State, but if the
recipient is the beneficial owner of the dividends the tax so charged shall not exceed;

(a) . . .

(b) 25 per cent of the gross amount of the dividends in all other cases.

Issues/Held:

1. Whether or not the dividends Marubeni Corporation received from Atlantic Gulf and Pacific Co. are
effectively connected with its conduct or business in the Philippines as to be considered branch profits
subject to 15% profit remittance tax imposed under Section 24(b)(2) of the National Internal Revenue Code.
No. Pursuant to Section 24(b)(2) of the Tax Code, as amended, only profits remitted abroad by a branch
office to its head office which are effectively connected with its trade or business in the Philippines are
subject to the 15% profit remittance tax.
The dividends received by Marubeni Corporation from Atlantic Gulf and Pacific Co. are not income arising
from the business activity in which Marubeni Corporation is engaged. Accordingly, said dividends if remitted abroad
are not considered branch profits for purposes of the 15% profit remittance tax imposed by Section 24(b)(2) of the
Tax Code, as amended.

2. Whether Marubeni Corporation is a resident or non-resident foreign corporation.

Marubeni Corporation is a non-resident foreign corporation, with respect to the transaction. Marubeni
Corporation’s head office in Japan is a separate and distinct income taxpayer from the branch in the
Philippines. The investment on Atlantic Gulf and Pacific Co. was made for purposes peculiarly germane to the
conduct of the corporate affairs of Marubeni Corporation in Japan, but certainly not of the branch in the Philippines.

3. At what rate should Marubeni be taxed?

15%. The applicable provision of the Tax Code is Section 24(b)(1)(iii) in conjunction with the Philippine-
Japan Tax Treaty of 1980.
As a general rule, it is taxed 35% of its gross income from all sources within the Philippines.
However, a discounted rate of 15% is given to Marubeni Corporation on dividends received from
Atlantic Gulf and Pacific Co. on the condition that Japan, its domicile state, extends in favor of Marubeni
Corporation a tax credit of not less than 20% of the dividends received. This 15% tax rate imposed on the
dividends received under Section 24(b)(1)(iii) is easily within the maximum ceiling of 25% of the gross amount of the
dividends as decreed in Article 10(2)(b) of the Tax Treaty.

Note: Each tax has a different tax basis.

Under the Philippine-Japan Tax Convention, the 25% rate fixed is the maximum rate, as reflected in the
phrase “shall not exceed.” This means that any tax imposable by the contracting state concerned should not exceed
the 25% limitation and said rate would apply only if the tax imposed by our laws exceeds the same. In other words, by
reason of our bilateral negotiations with Japan, we have agreed to have our right to tax limited to a certain extent to
attain the goals set forth in the Treaty.

15
 Manila Banking Corp. v. CIR

The intent of Congress relative to the minimum corporate income tax(MCIT) is to grant a 4-year suspension
of tax payment to newly formed corporations. Corporations still starting their business operations have to stabilize
their venture in order to obtain a stronghold in the industry.

Facts:

• 1961- Manila Banking Corp was incorporated. It engaged in the banking industry til 1987.
• May 1987- Monetary Board of Bangko Sentral ng Pilipinas (BSP) issued Resolution # 505 {pursuant to the Central
Bank Act (RA 265)} prohibiting Manila Bank from engaging in business by reason of insolvency. So, Manila Bank
ceased operations and its assets and liabilities were placed under charge of a gov.- appointed receiver.
• 1998- Comprehensive Tax Reform Act (RA8424) imposed a minimum corporate income tax on domestic and
resident foreign corporations.
o Implementing law: Revenue Regulation # 9-98 stating that the law allows a 4year period from the time the
corporations were registered with the BIR during which the minimum corporate income tax should not be imposed.
• June 23, 1999- BSP authorized Manila Bank to operate as a thrift bank.
o NOTE: June 15, 1999 Revenue Regulation #4-95 (pursuant to Thrift Bank Act of 1995) provides that the date of
commencement of operations shall be understood to mean the date when the thrift bank was registered with SEC or
when Certificate of Authority to Operate was issued by the Monetary Board, whichever comes LATER.
• Dec 1999- Manila Bank wrote to BIR requesting a ruling on whether it is entitled to the 4 year grace period under
RR 9-98.
• April 2000- Manila bank filed with BIR annual income tax return for taxable year 1999 and paid 33M.
• Feb 2001- BIR issued BIR Ruling 7-2001 stating that Manila Bank is entitled to the 4year grace period. Since it
reopened in 1999, the min. corporate income tax may be imposed not earlier than 2002. It stressed that although it
had been registered with the BIR before 1994, but it ceased operations 1987-1999 due to involuntary closure.
o Manila Bank, then, filed with BIR for the refund. • Due to the inaction of BIR on the claim, it filed with CTA for a
petition for review, which was denied and found that Manila Bank’s payment of 33M is correct, since its operations
were merely interrupted during 1987-1999. CA affirmed CTA.

Issue: Whether or not Manila Bank is entitled to a refund of its minimum corporate income tax paid to BIR for 1999.

Held: Yes.

CIR’s contentions are without merit. He contended that based on RR# 9-98, Manila Bank should pay the min.
corporate income tax beg. 1998 as it did not close its operations in 1987 but merely suspended it. Even if placed
under suspended receivership, its corporate existence was never affected. Thus falling under the category of a
existing corporation recommencing its banking business operations

Sec. 27 E of the Tax Code provides the Minimum Corporate Income Tax (MCIT) on Domestic Corporations.

o (1) Imposition of Tax- MCIT of 2% of gross income as of the end of the taxable year, as defined here in, is
hereby imposed on a corporation taxable under this title, beginning on the 4th taxable year immediately
following the year in which such corp commenced its business operations, when the mcit is greater than the
tax computed under Subsec. A of this section for the taxable year.

o (2) Any excess in the mcit over the normal income tax… shall be carried forward and credited against the
normal income tax for the 3 succeeding taxable years.

Let it be stressed that RR 9-98 imposed the MCIT on corps, the date when business operations commence
is the year in which the domestic corporation registered with the BIR. But under RR 4-95, the date of commencement
of operations of thrift banks, is the date of issuance of certificate by Monetary Board or registration with SEC,
whichever comes later. Clearly then, RR 4-95 applies to Manila banks, being a thrift bank. 4-year period= counted
from June 1999.

16
Banco De Oro, Bank of Commerce, China Banking Corporation, Metropolitan Bank & Trust Company,
Philippine Bank of Communications, Philippine Nation Bank, Philippine Veterans Bank and Planters
Development Bank vs. Republic of the Philippines, Commissioner of Internal Revenue, Bureau of Internal
Revenue, Secretary of Finance, Department of Finance, The National Treasurer and Bureau of Treasury (G.R.
No. 198756. January 13, 2015)

Facts:

This case involves P35 billion worth of 10-year zero-coupon treasury bonds issued by the Bureau of
Treasury (BTr) denominated as the Poverty Eradication and Alleviation Certificates or the PEACe Bonds. These
PEACe Bonds would initially be purchased by a special purpose vehicle on behalf of Caucus of Development NGO
Networks (CODE-NGO), repackaged and sold at a premium to investors. The net proceeds from the sale will be used
to endow a permanent fund to finance meritorious activities and projects of accredited non-government organizations
(NGOs) throughout the country. In relation to this, CODE-NGO wrote a letter to the Bureau of Internal Revenue (BIR)
to inquire as to whether the PEACe Bonds will be subject to withholding tax of 20%. The BIR issued several rulings
beginning with BIR Ruling No.020-2001 (issued on May 31, 2001) and was subsequently reiterated its points in BIR
Ruling No. 035-200119 dated August 16, 2001 and BIR Ruling No. DA-175-0120. The rulings basically say that in
determining whether financial assets such as a debt instrument are deposit substitute, the “20 or more individual or
corporate lenders rule” should apply. Likewise, the “at any one time” stated in the rules should be construed as “at the
time of the original issuance.”

With this BTr made a public offering of the PEACe Bonds to the Government Securities Eligible Dealers
(GSED) wherby RCBC won as the highest bidder for approximately 10.17 billion, resulting in a discount of
approximately 24.83 billion. RCBC Capital Capital entered into an underwriting agreement with CODE-NGO, whereby
RCBC Capital was appointed as the Issue Manager and Lead Underwriter for the offering of the PEACe Bonds.

In October 7, 2011, BIR issued BIR RULING NO. 370-2011 in response to the query of the Secretary of
Finance as to the proper tax treatment of the discounts and interest derived from Government Bonds. It cited three
other rulings issued in 2004 and 2005. The above ruling states that the all treasury bonds (including PEACe Bonds),
regardless of the number of purchasers/lenders at the time of origination/issuance are considered deposit substitutes.
In the case of zero-coupon bonds, the discount (i.e. difference between face value and purchase price/discounted
value of the bond) is treated as interest income of the purchaser/holder.

Held:

The PEACe Bonds, according to the SC, requires further information for proper determination of whether
these bonds are within the purview of deposit substitutes. The Court noted that it may seem that the lender is only
CODE-NGO through RCBC. However, the underwriting agreement reveals that the entire 35billion worth of zero-
coupon bonds were sourced directly from the undisclosed number of investors. These are the same investors to
whom RCBC Capital distributed the PEACe Bonds all at the time of the origination or issuance. Hence, until there is
information as to whether the PEACe Bonds are found within the coverage of deposit substitutes, the proper
procedure for the BIR is to collect the unpaid final withholding tax directly from RCBC Capital/ CODE-NGO, or any
lender if such be the case.

The court also noted that according to the NIRC, Section 24, interest income received by individuals from
long term deposits or investments with a holding period of not less than five years is exempt from final tax.

The decision provided the definition of deposit substitute 1997 National Internal Revenue Code which placed
the 20-lender rule. In particular, Section 22 (Y) states that a debt instrument shall mean “…an alternative form of
obtaining funds from the public (the term 'public' means 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….” The determination as to whether a deposit substitute will be imposed with 20%
final withholding tax rests on the number of lenders.

In construing the phrase “at any one time” provided for in the definition of “public”, the Supreme Court made
an analysis of how financial market works. According to the Court, in the financial market whether this refers to
capital markets securities or money market securities, transactions happen in two venues: the Primary and the
Secondary Market. The primary market transactions happen between issuers and investors where issuance of new
securities is facilitated. The secondary market is where the trading occurs among investors. This goes to show that
for one security, there are different and separate transactions happening depending on the flow of the transaction. In

17
the exact words of the Supreme Court, “an agglomeration of financial transactions in securities performed by market
participants that works to transfer the funds from the surplus units (or investors/lenders) to those who need them
(deficit units or borrowers)….”

When there are 20 or more lenders/investors in a transaction for a specific bond issue, the seller is required
to withhold the 20% final income tax on the imputed interest income from the bonds. The Supreme Court cited
Sections 24(B) (1), 27(D)(1), and 28(A)(7) of the 1997 National Internal Revenue Code. These provisions state the
imposition of a final tax rate of 20% upon the amount of interest from any currency bank deposit and yield or any
other monetary benefit from deposit substitutes. On the other hand, for instruments not considered as deposit
substitutes, these will be subjected to regular income tax. The prevailing provision is Section 32(A). Hence, should
the deposit substitute involves less than 20 lenders in a transaction, the income is considered as “income derived
from whatever source”.

The income is a “gain from sale” and should not be confused with “interest” provided for in Sections 24, 27
and 28. The Supreme Court noted that the “gain” referred to in Section 32 (A) pertains to that realized from the
trading of bonds at maturity rate (difference between selling price in the secondary market and that upon purchase) or
the gain realized by the last holder of the bonds when redeemed at maturity (the difference between proceeds from
retirement of bonds and the price upon acquisition of the last holder). In the case of discounted instruments, like the
zero-coupon bonds, the trading gain shall be the excess of the selling price over the book value or accreted value
(original issue price plus accumulated discount from the time of purchase up to the time of sale) of the instruments.

The Supreme Court finds that the BIR Rulings issued in 2001 and the assailed BIR Rulings are defective
taking into consideration the above discussions on deposit substitutes and its tax treatment. As for the BIR Rulings
issued in 2001, the SC finds that the interpretation of the phrase “at any one time”, is “…to mean at the point of
origination alone is unduly restrictive….” On the other hand, the 2011 BIR Ruling which relied on the 2004 and 2005
BIR Rulings is void for creating a distinction between government bonds and those issued by private corporations,
when there is none in the law. Further, it completely disregarding the 20-lender rule under the NIRC since it says, ““all
treasury bonds . . . regardless of the number of purchasers/lenders at the time of origination/issuance are considered
deposit substitutes…”

18