SC voids revenue regulation on income tax filing by banks, financial institutions

Supreme Court (SC)

The Supreme Court (SC) has voided a 2011 revenue regulation that effectively limited or reduced the operational costs which may be deducted by banks and other financial institutions in the computation of their taxable income.

Voided by the SC was Revenue Regulation (RR) No. 4-2011 “for having been issued ultra vires” (beyond the limits of one’s authority) by the Secretary of the Department of Finance (DOF) and the Commissioner of Internal Revenue.

RR 4-2011 provided that a bank may deduct only those costs and expenses attributable to the operations of its Regular Banking Units (RBU) to arrive at the taxable income of the RBU subject to regular income tax.

The regulation also mandated that any cost or expense related with or incurred for the operations of its Foreign Currency Deposit Units (FCDU)/Expanded Foreign Currency (EFCDU) or Offshore Banking Unit (OBU) are not allowed as deductions from the RBU’s taxable income.

Several banking institutions in the country challenged the validity of RR 4-2011 before the Makati City regional trial court (RTC).

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

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

In declaring RR 4-2011 null and void, the RTC pointed out that “the imposition of an accounting method on the banks and financial institutions has no basis in Sections 27 (A) and 28, 50, and 43 of the Tax Code; the imposed method of allocation under the RR is not fair nor equitable to a similar class of taxpayers and in contrast to Section 34 (A) (1) (a) of the Tax Code; and the RR failed to 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 Tax Code or other laws and in violation of the equal protection clause of the Constitution.”

Among the banks that questioned the legality of RR 4-2011 were Asia United Bank, BDO Unibank, Inc., Bank of America, Bank of Commerce, BDO Private Bank, Inc., Citibank, N.A., Philippine Branch, China Banking Corporation, Chinatrust (Phils.) Commercial Bank Corporation, Deutsche Bank AG, Manila Branch, East West Banking Corporation, ING Bank N.V., 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 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 ruling before the SC.

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

They claimed that the cases filed before the RTC are not proper for a petition for declaratory relief in view of the previous issuance of Preliminary Notices of Assessment finding deficiency income taxes for taxable year 2011 arising from the failure to allocate costs and expenses pursuant to RR 4-2011.

They stressed that RR 4-2011 is a valid regulation issued in the exercise of their power to promulgate rules and regulations for the enforcement of the Tax Code.

The regulation, they added, was issued to set the rules on the allocation of cost and expenses between the RBU and FCDU/EFCDU or OBU of a depository bank in view of the different income taxation regimes under the Tax Code in order to arrive at a fair and reasonable estimate of the taxable income for a certain income stream.

The banks countered that RR 4-2021 is an invalid administrative issuance for being issued without legal basis, for curtailing the deductions granted by the Tax Code, and for modifying the Tax Code thereby effectively legislating tax laws.

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

“In this case, the validity or invalidity of RR 4-2011 has far-reaching ramifications among banks and other financial institutions in the Philippines. It has been said that the banking industry is impressed with great public interest as it affects economies and plays a significant role in businesses and commerce.

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

“It is settled that administrative issuances must not override, supplant, or modify the law; they must remain consistent with the law they intend to carry out. When the application of an administrative issuance modifies existing laws or exceeds the intended scope, the issuance becomes void, not only for being ultra vires, but also for being unreasonable.

Surely, courts will not countenance such administrative issuances that override, instead of remaining consistent and in harmony with the law they seek to apply and implement. We underline that the power of administrative officials to promulgate rules in the implementation of a statute is necessarily limited to what is provided for in the legislative enactment.

“Here, the BIR expanded or modified the law when it curtailed the income tax deductions of respondents (banks) and when it sanctioned the method of accounting the respondents should use, without any basis found in the Tax Code.

“In fact, in its petition, the DOF and BIR did not even pinpoint the exact provisions of the Tax Code which they seek to apply and implement. Without a doubt, the RR did not simply provide details for the enforcement of the provisions in the Tax Code. Neither did it interpret the provisions of the Tax Code.

“Instead, RR 4-2011 modified what was explicitly provided therein. This amounts to tax legislation which is a matter within the authority of the legislative department only.

“Without any finding that the accounting method employed by said taxpayers do not reflect their actual income, there is no basis for petitioners (DOF and BIR) to impose an accounting method for allocating the expenses of respondents.

“The CIR cannot simply substitute its own judgment and impose an accounting method on the taxpayer without any reasonable ground, in contravention of the taxpayer’s right to use any accounting method of its choice. To be sure, the CIR may only challenge the propriety of the accounting method employed after the taxpayer has filed a tax return through an audit investigation or assessment of a particular taxpayer when the CIR can properly make a finding on the existence of a distortion, that is, on whether the accounting method used did not clearly reflect income.

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

“Indeed, when the administrative rule goes beyond merely providing for the means that can facilitate or render least cumbersome the implementation of the law but substantially increases the burden of those governed, as in this case, it behooves the agency to accord at least to those directly affected a chance to be heard, and thereafter to be duly informed, before that new issuance is given the force and effect of law.

“In the present case, RR 4-2011 increases the burden upon the banks and other financial institutions and imposes a penalty in case of its violation. As discussed, prescribing a particular method for allocation of costs and expenses will necessarily result in the limitation or reduction of the amount of deductible expenses allowed to banks and other financial institutions. Moreover, violation thereof results to the imposition of a penalty.

“This substantially adds to the burden of the subject taxpayers. The due observance of the requirements of notice, of hearing, and of publication, then, should not have been ignored by petitioners.

“For failing to conduct prior notice and hearing before coming up with RR 4-2011, said RR should also be declared defective and ineffectual.

“In fine, the CIR is empowered to interpret our tax laws but not expand or alter them. In the case of RR 4-2011, however, the CIR went beyond, if not, gravely abused such authority.

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

“WHEREFORE, premises considered, the petition is DENIED and the Revenue Regulations No. 4-2011 issued by the Secretary of the Department of Finance is declared VOID for having been issued ultra vires. SO ORDERED.”

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