SC Cancels Income Regulations on Tax Reporting by Banks and Financial Institutions – Manila Bulletin

The Supreme Court (SC) struck down a 2011 revenue rule that effectively limited or reduced operational costs that can be deducted by banks and other financial institutions in calculating their taxable income.

The SC rescinded Tax By-law (RR) No. 4-2011 “for being issued ultra vires” (beyond the limits of its authority) by the Secretary of the Department of Finance (DOF) and the Commissioner of Internal Revenue.

RR 4-2011 provided that a bank could only deduct costs and expenses attributable to the operations of its regular banking units (RBUs) to arrive at the taxable income of the RBU subject to ordinary income tax.

The regulation also required that any cost or expense related to or incurred for the operations of its Foreign Currency Depository Units (FCDU) / Extended Foreign Currency (EFCDU) or Offshore Banking Unit (OBU) shall not be allowed as a deduction from the taxable income of the RBU.

Several banking institutions in the country challenged the validity of RR 4-2011 in the Regional Trial Court (RTC) of Makati City.

On May 25, 2018, the RTC granted the banks’ request for declaratory judgment as it declared null and void RR 4-2011 “for being issued beyond the authority of the Secretary of Finance (SOF) and the Internal Revenue Commissioner (CIR).”

The RTC also made permanent the writs of preliminary injunction it issued in favor of the banks on April 25, 2015 and February 28, 2018.

In declaring RR 4-2011 null and void, the RTC pointed out that “the imposition of an accounting method on banks and financial institutions has no basis in Articles 27 (A) and 28, 50 and 43 of the Tax Code ; the apportionment method imposed under the RR is neither fair nor equitable for a similar class of taxpayers and contrary to Section 34 (A) (1) (a) of the Internal Revenue Code; and the RR did not meet the criteria for a valid classification under the equal protection clause. »

Thus, the RTC ruled that RR 4-2011 “was issued ultra vires for having no basis in the Internal Revenue Code or other statutes and in violation of the Equal Protection Clause of the Constitution.”

Banks that questioned the legality of RR 4-2011 included Asia United Bank, BDO Unibank, Inc., Bank of America, Bank of Commerce, BDO Private Bank, Inc., Citibank, NA, Philippine Branch, China Banking Corporation, Chinatrust (Phils.) Commercial Bank Corporation, Deutsche Bank AG, Manila Branch, East West Banking Corporation, ING Bank NV, Philippine Bank of Communications,

Philippine National Bank, Philippine Veterans Bank, PNB Savings Bank, Rizal Commercial Banking Corporation, Security Bank Corporation, Standard Chartered Bank Philippine Branch, United Coconut, Bank of the Philippine Islands, Development Bank of the Philippines, United Overseas Bank Philippines, Land Bank of in the Philippines, Metropolitan Bank & Trust Company, Union Bank of the Philippines and BDO Capital and Investment Corporation.

The DOF and the Bureau of Internal Revenue (BIR) challenged the RTC’s decision before the SC.

The DOF and BIR told the SC that it is the Court of Tax Appeals (CTA) that has exclusive jurisdiction to determine the constitutionality or validity of tax laws, rules and regulations and other CIR administrative acts.

They asserted that the cases filed with the RTC are not appropriate for a motion for declaratory relief given the previous issuance of preliminary assessment notices finding an income tax deficiency for the tax year. 2011 resulting from the absence of distribution of costs and expenses in accordance with RR 4 -2011.

They pointed out that RR 4-2011 is a valid regulation issued in the exercise of their authority to promulgate rules and regulations for the purposes of the Internal Revenue Code.

The regulation, they added, was issued to lay down the rules for allocating costs and expenses between the RBU and the FCDU/EFCDU or OBU of a custodian bank in view of the different income tax regimes in under the tax code in order to arrive at a fair and reasonable estimate of taxable income for a certain income stream.

The banks countered that RR 4-2021 is an invalid administrative issue for having been issued without a legal basis, for reducing the deductions granted by the Tax Code and for modifying the Tax Code, thus effectively legislating tax laws.

In a decision released May 12 and written by Associate Justice Rodil V. Zalameda, the SC denied the motion filed by the DOF and BIR. It said:

“In this case, the validity or invalidity of RR 4-2011 has deep ramifications among banks and other financial institutions in the Philippines. It has been said that the banking sector is impressed with great public interest as it affects economies and plays an important role in business and commerce.

“So this RR, which affects their method of accounting and the allocation of costs and expenses to their income, thereby affecting their liability to income tax, is imbued with public interest.

“It is established that administrative decrees should not supersede, supplant or modify the law; they must remain consistent with the law they intend to apply. When the application of an administrative decision modifies existing laws or exceeds the intended scope, the decision becomes void, not only because it is ultra vires, but also because it is unreasonable.

The courts will surely not accept such administrative decisions that take precedence, instead remaining consistent and in harmony with the law they seek to apply and implement. We emphasize that the power of administrative officials to promulgate rules in the application of a law is necessarily limited to what is provided for in the legislative text.

“Here, the BIR expanded or changed the law when it reduced income tax deductions for respondents (banks) and when it sanctioned the method of accounting that respondents must use, without any basis found in the tax code.

“In fact, in their petition, the DOF and BIR have not even identified the exact provisions of the Internal Revenue Code that they seek to apply and enforce. Undoubtedly, the RR did not simply provide details for the application of the provisions of the Tax Code. Nor did it interpret the provisions of the Tax Code.

“Instead, RR 4-2011 changed what was explicitly provided therein. This amounts to tax legislation that is solely within the purview of the Legislative Department.

“Without finding that the accounting method used by said taxpayers does not reflect their actual income, there is no reason for the petitioners (DOF and BIR) to impose an accounting method to allocate respondents’ expenses.

“The CIR cannot substitute for its own judgment and impose an accounting method on the taxpayer without reasonable grounds, in violation of the taxpayer’s right to use any accounting method of his choice. Certainly, the CIR can only challenge the correctness of the accounting method used after the taxpayer has filed a tax return through an audit investigation or an assessment of a particular taxpayer when the CIR can validly note the existence of a distortion, that is to say if the accounting method used did not clearly reflect the result.

“We find that it (the settlement) was published in violation of due process requirements. Given the burden imposed by RR 4-2011, the notice, hearing and publication requirements should have been strictly observed.

“Indeed, when the administrative rule goes beyond the simple provision of means likely to facilitate or burden the application of the law as little as possible but substantially increases the burden of the governed, as in the present case, it is up to the agency to at least give those directly affected a chance to be heard, and then duly informed, before this new broadcast becomes law.

“In this case, RR 4-2011 increases the burden on banks and other financial institutions and imposes a sanction in case of violation. As we have seen, the prescription of a particular method of allocating costs and expenses will necessarily result in the limitation or reduction of the amount of deductible expenses authorized for banks and other financial institutions. Moreover, their violation entails the imposition of a penalty.

“This considerably increases the burden on liable taxpayers. Compliance with the notice, hearing and publication requirements should therefore not have been ignored by the petitioners.

“For failing to give notice and a hearing before presenting RR 4-2011, said RR should also be declared defective and ineffective.

“Ultimately, the CIR is authorized to interpret our tax laws but not to develop or modify them. In the case of RR 4-2011, however, the CIR went beyond, if not seriously abused, that authority.

“Therefore, given the aforementioned substantive and procedural irregularities in its issuance, RR 4-2011 is null and void.

“CONSEQUENTLY, premises considered, the request is DENIED and Tax By-law No. 4-2011 issued by the Secretary of the Department of Finance is declared VOID for having been issued ultra vires. THEREFORE ORDERED.