Supreme Court Strikes Down BIR Rule on Bank Expense Allocation

The Supreme Court has struck down Revenue Regulations No. 4-2011, which imposed mandatory cost allocation rules on banks and financial institutions. The ruling in Department of Finance v. Asia United Bank (G.R. Nos. 240163 & 240168-69, December 1, 2021) reaffirms a fundamental principle: administrative issuances cannot override, supplant, or modify the very laws they seek to implement. For taxpayers, this decision protects the right to choose accounting methods and claim legitimate expense deductions without arbitrary interference from tax authorities.

The Case

In 2011, the Department of Finance and the Bureau of Internal Revenue issued Revenue Regulations No. 4-2011, prescribing rules on how banks should allocate costs and expenses between their Regular Banking Units (RBU) and their Foreign Currency Deposit Units (FCDU) or Offshore Banking Units (OBU). Under the regulation, banks could only deduct expenses attributable to RBU operations from income subject to regular corporate income tax. Common expenses had to be allocated based on each unit's percentage share of gross income.

Several banks challenged the regulation before the Regional Trial Court of Makati City, which declared it null and void. The DOF and BIR appealed to the Supreme Court.

The Issue

The central question was whether Revenue Regulations No. 4-2011 was a valid exercise of the BIR's rule-making power or an invalid encroachment on legislative authority. The Court also had to address which court properly had jurisdiction over challenges to revenue regulations.

The Ruling

The Supreme Court ruled that Revenue Regulations No. 4-2011 is void for being issued beyond the authority of the Secretary of Finance and the Commissioner of Internal Revenue. While the Court noted that the proper remedy to challenge executive issuances is a petition for certiorari or prohibition—not declaratory relief—it proceeded to decide the case on the merits given the far-reaching implications for the banking industry.

The Court also clarified that it is the Court of Tax Appeals, not the Regional Trial Court, that has jurisdiction to rule on the constitutionality and validity of revenue issuances by the CIR.

Why the Regulation Was Invalid

The Court identified three ways the regulation violated the National Internal Revenue Code:

First, it contravened the Tax Code provisions on accounting methods. The Tax Code allows taxpayers to self-determine the most applicable accounting method. The CIR may only prescribe a method if the taxpayer has employed none, or if the method used does not clearly reflect income. Neither condition existed here. The regulation arbitrarily imposed a uniform allocation method without any finding that the banks' existing accounting methods distorted their income.

Second, it unduly expanded the Tax Code provision on allocation of income and deductions. That provision authorizes the CIR to allocate income or deductions only between two or more organizations, trades, or businesses owned or controlled by the same interests, and only when necessary to prevent tax evasion or clearly reflect income. The RBU and FCDU units are part of a single bank, not separate controlled entities. There was also no evidence that allocation was needed to prevent evasion or reflect true income.

Third, it impaired the right to claim deductions for ordinary and necessary business expenses. The Tax Code allows taxpayers to deduct all ordinary and necessary expenses paid or incurred in carrying on their trade or business. The regulation effectively added a requirement—allocating common expenses among different income streams—that the Tax Code does not impose. This qualified and limited a deduction the law grants in full.

Practical Takeaways

• Administrative issuances cannot amend the law. Revenue regulations and similar issuances must remain consistent with the statutes they implement. If they expand, modify, or contradict the law, courts will strike them down as void.
• Taxpayers generally choose their accounting methods. The CIR cannot substitute its judgment and impose a method unless the taxpayer has no method or the method used does not clearly reflect income. The CIR may challenge a method only through audit or assessment.
• Expense deductions are statutory rights. The Tax Code grants deductions for ordinary and necessary business expenses. The BIR cannot impose additional requirements for deductibility that the law does not provide.
• The Court of Tax Appeals has jurisdiction over challenges to the validity or constitutionality of revenue regulations and other BIR issuances. Taxpayers should file such challenges in the correct forum.
• Different tax treatment of income streams does not justify forced allocation. The fact that a taxpayer earns income subject to different tax rates does not, by itself, authorize the BIR to require allocation of common expenses.

This article is general information and not legal advice. For your specific situation, consult a lawyer or ask ASG Legal AI.