October 25, 2011 · Posted in: General

Vanishing trade in PEACe Bonds:

The truth, the banks, and the BIR

Please click here for the full–size version of the infographic.

TRENDS in the volume of trading in any government bond are usually of interest only to money market investors and dealers who buy and sell the stuff in search of profits from price fluctuations.

But not when it’s about the PEACe Bonds, the 10-year government debt that matured October 18 amid legal drama and suspense. A day before the redemption date for the bonds, eight banks sought to stop the government from imposing a 20-percent final withholding tax on interest gains from the P35-billion bond that was said to be exempt from the tax when it was first sold in 2001.

Standing for Poverty Eradication and Alleviation Certificates, the PEACe bonds were at the heart of a controversial fund-raising venture by CODE-NGO, the country’s biggest network of non-government organizations, to raise P1.4 billion to endow an anti-poverty foundation. CODE-NGO came under fire for using its influence to lobby several government agencies for tax exemption and other extraordinary features that made the bonds attractive to investors.

Kim Henares, chief of the Bureau of Internal Revenue (BIR), triggered some curiosity about the trading of the bonds when she said recently in a television talk show on the ABS-CBN News Channel that the sharp drop in buying and selling activity in the bonds in 2004 (see graph) was a sign the banks are not being entirely truthful about some of their claims.

In their petition, the eight banks said they were utterly surprised to learn last Oct. 7, just 11 days before the bonds matured, that the BIR “unilaterally changed a material term of the government bonds by declaring that the BTr (Bureau of Treasury) will withhold 20 percent final withholding tax from the payment of the full face value of the government bonds.”

Henares, however, noted that BIR’s policy reversal on the PEACe Bonds’ tax-exempt status happened in 2004, or seven years ago. At the time, the tax agency issued a new ruling that modified and superseded the 2001 ruling, which Henares said was a case of an “erroneous interpretation” of the provisions of the tax code.

“I don’t believe the banks don’t know about it because if you look at the history of the trading of that bond, right after we issued the 2004 ruling, the trading became markedly decreased,” she said during the television talk show last week. “I hate to say that they are not saying the truth but the circumstances seem to point (to the fact) that the banks know that it’s no longer as attractive.”

It was worse than a marked decrease. Monthly trading activity collapsed to zero for more than a year shortly after the BIR issued its ruling in July 2004. Trading resumed only in early 2006 but the monthly values were very small compared to what went on before.

Bad news about the PEACe Bonds generally tended to depress trading in the debt paper. Monthly trading volumes progressively fell between January and May 2002 when the Senate conducted a series of public hearings on the issue, which revealed how government agencies generously bent over to accommodate the requests of CODE-NGO, the influential civil society group that cooked up the bonds issue to raise funds to finance its anti-poverty programs.

Henares also said that the 2004 ruling could be applied to the PEACe Bonds issued three years before; the tax code allows rulings to be applied retroactively when there is misrepresentation of facts, discovery of new information, or bad faith on the part of the taxpayer. In a press conference right before the bonds matured, Henares pointed out as well that the 2004 ruling clearly referred to nothing else but the PEACe Bonds.

Bankers continue to insist, however, that they were unaware of the existence of the 2004 BIR ruling or that it was to be applied retroactively. “If we knew, we would have questioned it back in 2004,” said a lawyer for one of the banks affected by the latest BIR ruling.

Indeed, Rizal Commercial Banking Corp (RCBC), CODE NGO’s partner and underwriter, said in a separate petition before the Court of Tax Appeals that BIR itself signaled that the 2004 ruling will only cover future bonds. In 2005, the BIR issued a new ruling exempting notes issued by the National Food Authority, a state firm, from the 20-percent final withholding tax because, among others, the debt was issued “at a time when the applicable rule” was the principle enunciated in the 2001 ruling.

If the banks are to be believed, then it is just coincidence that trading in the PEACe Bonds collapsed shortly after the BIR issued its ruling in 2004. What are the odds of that? Perhaps the same odds of RCBC winning all the zero-coupon bonds awarded by the Bureau of Treasury ten years ago. –PCIJ, October 2011

1 Response to The truth, the banks, and the BIR


David Carl Grimes

October 25th, 2011 at 8:53 pm

Under Section 22 (Y) of the 1997 Tax Code, the borrowing of funds can be classified as deposit substitutes “if the funds are obtained from twenty (20) or more individuals or corporate lenders at any one time.” The 2001 Banez Rulings on the PEACe Bonds were erroneous because they very narrowly defined the phrase “at any one time” to mean the point of origination or the point at which the bonds are first issued to the public at a Treasury Bond auction. Ordinarily, common sense would dictate the phrase “at any one time” to mean throughout the life of the bond. In this case, “at any one time” meant only the primary Treasury bond auction and not the secondary market where the bonds are actively traded back and forth among institutional investors. Why is this crucial? Because it expands the size of the potential market for the bonds – enormously. The bonds can now be sold in the secondary market in much much smaller chunks without losing its tax-exempt status. By eliminating the 19-lender constraint, the bonds now had more uses. The bonds could be used for the creation of retail products based on the zero coupon bonds. More importantly, they can be “sold” down to the level of a bank’s delinquent borrowers to wash the NPLs of a bank’s books. Is it any wonder that of the nine banks that are affected by the imposition of the 20% FWT, five of them have very high levels of distressed assets relative to their capital?

All this and more at: A Tax on the PEACe Bonds – Who is left holding the bag? http://systemisbroken.blogspot.com/2011/10/tax-on-peace-bonds-who-is-left-holding.html

Comment Form