CTA Case No. 6243 (Decision)

REPUBLIC OF THE PHILIPPINES COURT OF TAX APPEALS QUEZON CITY MALAYAN INSURANCE CO., INC., Petitioner, -versus- C.T.A. CASE NO. 6243 COMMISSIONER OF INTERNAL Promulgated: REVENUE, DEC 16 2002 Respondent. x- ---------------------------------------------------------x DECISION This case involves a claim for refund or issuanc~ of a tax credit certificate in the amount of P5,3 12,545.00, allegedly representing erroneously withheld 20% final tax on interest income derived by petitioner from investments on fixed rate treasury notes (FXTN's for brevity) with a maturity of more than five (5) years during the taxable year 1999. Petitioner is a corporation organized and existing under and by virtue of the laws of the Philippines, with principal office located at Yuchengco Tower, 500 Q. Paredes Street, Binondo, Manila (par. 1, Joint Stipulation ofFacts and Issues). From 1996 to 1999, petitioner purchased long-term FXTN's from the Bureau of Treasury, detailed as follows: Treasury JSJN # Issue Date Maturity Date Principal Interest Rate Semi-annual Note Interest PIBD0703R029 29 Feb 96 29 Feb 03 P6,000,000 15 .375% Payment FXTN7-2 PIBD0703AO II 25 Jan 96 25 Jan 03 5,000,000 15 .500% FXTN7-I PIBD0703E044 30 May 96 30 May 03 4,860,000 15 .3 7 5 % P461 ,250 FXTN7-4 PIBD0703G051 25 Jul 96 25 Jul 03 5,000,000 15 .750% 387,500 FXTN7-5 373 ,612 .50 393 ,750

DECISION- C.T.A. CASE NO. 6243 PAGE2 FXTNI0-1 PIBDI0061010 26 Sep 96 26 Sep 06 15,000,000 16.000% 1,200,000 FXTNI0-4 PIBD I007K042 27 Nov 97 27 Nov 07 17,800,000 22.875% 2,035,875 FXTNI0-7 PIBDI008KT29 26 Nov 98 26 Nov 08 19,000,000 17.800% 1,691 ,000 FXTN7-10 PIBD0705D I02 30 Apr 98 30 Apr 05 23 ,200,000 20 .500% 2,378,000 FXTN7-12 PIBD0705J 124 29 Oct 98 29 Oct 05 32,800,000 18.375% 3,013 ,500 FXTNI0-8 PIBD I009B084 25 Feb 99 25 Feb 09 30,000,000 16.500% 2,475 ,000 FXTN7-II PIBD0705G 118 30 Jul 98 30 Jul 05 10,000,000 20 .000% 1,000,000 For the months of February to December 1999, the Bureau of Treasury paid interest on the said treasury notes for which the corresponding 20% final tax in the aggregate amount ofP5,312,545.00 was withheld, details ofwhich are shown below: Treasury Note Interest Payment Date Total Interest Payable 20% Withholding Tax Net Amount FXTN7-2 Paid to 28 Feb 99 p 461 ,250 p 92 ,250 Malayan FXTN7-I 28 Aug 99 FXTN7-4 25 Jul99 461 ,250 92 ,250 p 369,000 30 May 99 369,000 FXTN7-5 30 Nov 99 387,500 77,500 310,000 FXTNI0-1 25 Jul99 298,890 26 Mar 99 373 ,612 .50 74,722 .50 298,890 FXTNI0-4 26 Sep 99 315,000 27 May 99 373,612.50 74 ,722 .50 960,000 FXTNI0-7 29 Nov 99 960,000 26 May 99 393 ,750 78,750 FXTN7-10 26 Nov 99 1,628 ,700 30 Apr 99 1,200,000 240,000 1,628 ,700 FXTN7-12 30 Oct 99 1,352,800 29 Apr 99 1,200,000 240,000 1,352,800 FXTNI0-8 29 Oct 99 1,902,400 FXTN7-II 25 Aug 99 2,035,875 407, 175 1,902,400 30 Jul99 2,410,800 2,035,875 407, 175 2,410,800 1,980,000 1,691 ,000 338,200 800,000 1,691 ,000 .. 338,200 2,378,000 475 ,600 2,378,000 475 ,600 3,013 ,500 602 ,700 3 ,013 ,500 602,700 2,475 ,000 495 ,000 1,000,000 200,000 Total Withholding Tax P5,312,545.00 On October 25, 1999, the BIR issued BIR Ruling No. 166-99 stating that the interest income, yield or gain derived from bonds, debentures or certificates of indebtedness as deposit substitutes, which are ordinarily subject to 20% final tax under section 27 (D)(1) of the NIRC, should be excluded from the gross income if the bonds, debentures or the certificates of indebtedness have matt:t~ties of more than five (5) years.

DECISION- C.T.A. CASE NO. 6243 PAGE3 On the strength of the aforementioned ruling and citing Section 32 (B)(7)(g) of the National Internal Revenue Code of 1997 which provides that gains realized from the sale or exchange or retirement of boDds, debentures or other certificate of indebtedness with a maturity of more than five (5) years are exclude from taxable income, petitioner wrote a letter on February 27, 2001 addressed to the respondent requesting that a refund or a tax credit in the amount of Five Million Four Hundred Sixty-Eight Thousand Seven Hundred Ninety-Five Pesos (P5 ,468,795 .00), which included the Five Million Three Hundred Twelve Thousand Five Hundred Forty-Five Pesos (P5 ,312,545 .00) corresponding to the tax withheld by the Bureau of Treasury on the said treasury notes, be issued by the respondent in favor of petitioner. On the following day, Februmy 28, 2001 , petitioner filed the instant petition for review to toll the running of the two-year prescriptive period. In his answer filed on April 4, 2001 , respondent raised the following Special and Affirmative Defenses, thus: "6. Petitioner's claim for refund is still subject to administrative investigation/examination before the Bureau. 7. Petitioner's (sic) failed to prove that the tax subject of the case at bar comes within the scope of claims for refund pursuant to section 204 of the National Internal Revenue Code. The said section of the Tax Code explicitly enumerates the grounds upon which a taxpayer is allowed to claim for refund, to wit: (a) erroneously or illegally received or collected internal revenue taxes; (b) penalties imposed without authority. The above:.mentioned grounds are exclusive. 8. Claims for refund are construed strictly against the claimant as they partake the nature of an exemption from tax and it is incumbent upon petitioner to prove that it is entitled thereto under the law. Failure to prove the same is fatal to its claim for tax refund. Exemptions from taxation are highly disfavored in law and he who claims exemption must be able to justify his claim by

DECISION- C.T.A. CASE NO. 6243 PAGE4 the clearest grant of organic or statutory law. An exemption from common burden can riot be permitted to exist upon the vague implications. (Asiatic Petroleum Co. vs. ~lamas 49 Phil 466). 9. Moreso, it is incumbent upon petitioner to prove that it has complied with the governing rules relative to tax recovery or refund as provided for under Sections 204 and 209 of the National Internal Revenue Code. 10. Finally, following the well entrenched principle that tax refunds are in the nature of tax exemptions, they are regarded as derogation of sovereign authority and are to be construed in stricssimi juris against the person or entity claiming the exemption." The following issues have been jointly stipulated by the parties, to wit: 1. Whether or not interest income derived from treasury notes which have a maturity in excess of five years is exempt from the 20% withholding tax. 2. Whether or not the treasury notes purchased by petitioner from the Bureau of Treasury can be considered as bonds, debentures or certificates of indebtedness under the Tax Code. 3. Whether or not the claim for refund/tax credit of petitioner in the amount of P5,312,545 is properly substantiated by documentary evidence. The resolution of the legal issue centers on the proper interpretation of the term "gains" as used in Section 32(B)(7)(g) of the Tax Code of 1997. Under the said section, gains realized from the sale or exchange or retirement of bonds, debentures or other certificates of indebtedness with a maturity of more than five (5) years shall not be included in gross income and shall be exempt from taxation. Petitioner interpreted the

DECISION- C.T.A. CASE NO. 6243 PAGES word "gains" in Section 32(B)(7)(g) as broad enough to include interest income from FXTNs. In BIR Ruling No. 166-99, issued on October 25, 1999 and addressed to Aegon Life Insurance (Philippines), Inc., respondent ruled that interest income or yields or gain from the sale of bonds, debentures and certificates of indebtedness with maturities of more than five (5) years are excluded from gross income in accordance with Section 32(B)(7)(g) of the 1997 Tax Code and therefore exempt from the 20% final withholding tax on deposit substitutes. Pertinent portion of BIR Ruling No. 166-99 is hereby quoted as follows: "B. As a general rule, the interest income on currency bank deposit and yield or other monetary benefit from these "deposit substitutes" and similar arrangement derived by banks and non-bank financial intermediaries are being taxed at the final rate of 20% under Section 27(D)(l) of the 1997 Tax Code. However, Section 32(B)(7)(g) of the 1997 Tax code, provides an exception, thus: "Section 32. Gross Income. - XXX XXX XXX "(B) Exclusions from Gross Income. - The following items shall not be included in gross income and shall be exempt from taxation under this Title: XXX XXX XXX "(7) Miscellaneous Items. - XXX XXX XXX "(g) Gains from the Sale of Bonds, Debentures or other Certificate of Indebtedness. Gains realized from the sale or exchange or retirement of bonds, debentures or other certificate of indebtedness with a maturity of more than five (5) years."

DECISION- C.T.A. CASE NO. 6243 PAGE6 The idea therefore, is to still treat bonds, debentures or other certificates of indebtedness as "deposit substitutes" the interest income yield or gain derived therefrom subject to the 20% final tax under Section 27(D)(1) of the 1997 Tax Code, but exclude said interest income, yield or gain from the gross income if the bonds, debentures or the certificate of indebtedness have maturities of more than five (5) years. Conversely, only the income derived on these debt instruments with maturity of more than five (5) years shall be excluded from the gross income. Furthermore, the term sale is nor limited to the subsequent transfer of the instrument but to its origination and issuance, as well. Thus, from the time of its issuance, we should consider the "income" which is actually the amount coming to a person within a specified time, whether as payment for the services, interest, or profit from investment. Its usual synonyms being "gain", "profit", "revenue". (Trefry v. Putnam, 116 N.E. 904, 907 227 Mass. 522, L.R.A. 191F, 806." (Words & Phrases, Gain, page 11 , Permanent Edition 18) (BIR Ruling No. 166-99) Notwithstanding the abovementioned rulings, we cannot agree with petitioner's contention that interest income on its long-term investments in FXTNs should be considered as 'gains' exempt from income tax pursuant to Section 32(B)(7)(g) of the 1997 Tax Code. Rulings issued by the Commissioner of Internal Revenue command respect and weight. However, such rulings are not conclusive upon the courts and will be ignored if found to be erroneous. (Philippine Bank of Communications vs. Commissioner of Internal Revenue, G.R. No. 112024, January 28, 1999). In the present case, we conclude that the aforementioned BIR rulings are erroneous. Such rulings were based on the mistaken belief that the term "gains" as used in Section 32(B)(7)(g) of the 1997 Tax Code include interest. (Nippon Life Insurance Company of the Philippines, Inc. vs. Commissioner �.f Internal Revenue, CTA Case No. 6142, February 4, 2002)

DECISION- C.T.A. CASE NO. 6243 PAGE7 It is a well-settled rule of statutory construction that tax exemptions are strictly construed against the taxpayer. Consequently, where Section 32(B)(7)(g) of the 1997 Tax Code, which grants tax exemption, is susceptible of a restrictive interpretation, such interpretation must be adopted. We take the view that "gains" as the term is used therein in Section 32(B)(7)(g) of the 1997 Tax Code cannot include interest since it clearly refers to gains from the sale of bonds, debentures and other certificates of indebtedness. Initially, it must be pointed out that whereas the term "gains" includes "interest" as a general rule, this rule cannot be applied to Section 32(B)(7)(g) of the 1997 Tax Code which particularly refers to "Gains from the Sale of Bonds, Debentures or other Certificate ofIndebtedness " in its title and "Gains rea!i7ed from the sale or exchange or retirement of bonds, debentures and other certificate of indebtedness with a maturity of more than fi ve (5) years" in its body. Stated otherwise, Section 32(B)(7)(g) of the 1997 Tax Code specifically refers to gains from the sale of bonds, debentures and other certificates of indebtedness as contradistinguished from the term "gains" in its general sense, which is synonymous to income. In this regard, Section 32(A) of the 1997 Tax Code defines "gross income" as follows : SEC. 32. Gross Income. - (A) General Definition. - Except when otherwise provided in this Title, gross income means all income derived from whatever source, including (but not limited to) the following items: (1) Compensation for services in whatever form paid, including, but not limited to fees, salaries, wages, commissions and similar items: (2) Gross income derived from the conduct of trade or business or the exercise of profession;

DECISION - C.T.A. CASE NO. 6243 PAGE8 (3) Gains derived from dealings in property; (4) Interests; (5) Rents; (6) Royalties; (7) Dividends; (8) Annuities; (9) Prizes and winnings; (10) Pensions; and (11) Partner' s distributive share from the net mcome of the general professional partnership. From the aforequoted Section 32(A) of the 1997 Tax Code, it is clear that there is a distinction between "gains derived from dealings in property" and "interests", which are separately classified as items of gross income. ''Gains realized from the sale or exchange or retirement of bonds, debentures and other certificate of indebtedness" would fall under the category of "gains derived from dealings in property". On the other hand, "interests" would include interest from bonds, debentures and other certificate of indebtedness . Gain realized from the sale or exchange or retirement of bonds, debentures and other certificate of indebtedness and interest from bonds, debentures and other certificate of indebtedness fall under separate and distinct income categories. Moreover, Section 24 of the 1997 Tax Code governs the taxation of interest, including interest from deposits and yield from deposit substitutes and trust funds and similar arrangements, realized by citizens and resident aliens, which provides in pertinent part: SEC. 24. Income Tax Rates. - (A) Rates of Income Tax on Individual Citizen and Individual Resident Alien ofthe Philippines. - (1) An income tax is hereby imposed:

DECISION- C.T.A. CASE NO. 6243 PAGE9 (a) On the taxable income defined in Section 31 ofthis Code, other than income subject to tax under Subsections (B), (C) and (D) of this Section, derived for each taxable year from all sources within and without the Philippines by every individual citizen of the Philippines residing therein; (b) On the taxable income defined in Section 31 of this Code, other than income subject to tax under Subsections (B), (C) and (D) of this Section, derived for each taxable year from all sources within the Philippines by an individual citizen of the Philippines who is residing out of the Philippines, including � overseas contract workers referred to in Subsection (C) of Section 23 hereof; and (c) On the taxable income defined in Section 31 of this Code, other than income subject to tax under Subsections (B), (C) and (D) of this Section, derived for each taxable year from all sources within the Philippines by an individual alien who is a resident of the Philippines The tax shall be computed in accordance with and at the rates established in the following schedule: XXX XXX XXX (B) Rate ofTax on Certain Passive Income. - (1) Interests, Royalties, Prizes, and Other Winnings. - A final tax at the rate of twenty percent (20%) is hereby imposed upon the amount of interest from any currency bank deposit and yield or any other monetary benefit from deposit substitutes and from trust fund and similar arrangements; x x x: Provided, however, That interest income received by an individual taxpayer (except a nonresident individual) from a depository bank under the expanded foreign currency deposit system shall be subject to a final income tax at the rate of seven and one-half percent (7%) of such interest income: Provided, furth er, That interest income from long-term deposit or investment in the form of savings, common or individual trust funds, deposit substitutes, investment management accounts and other investments evidenced by certificates in such form prescribed by the Bangko Sentral ng Pilipinas (BSP) shall be exempt from the tax imposed by this Subsection: Provided, finally, That should the holder of the certificate preterminate the deposit or investment before the fifth (5th) year, a final tax shall be imposed on the et:' �re income and shall be deducted and withheld by the depository bank from the proceeds of the long-term deposit or investment certificate based on the remaining maturity thereof:

DECISION- C.T.A. CASE NO. 6243 PAGE 10 Four (4) years to less than five years - 5% Three (3) years to less than four years - 12% Less than three (3) years - 20% XXX XXX XXX On the other hand, Section 25(A)(l) and (2) of the 1997 Tax Code taxes nonresident alien individuals engaged in trade or business within the Philippines on interest realized from Philippine sources in the same manner as citizens and resident alien individuals taxed under the aforequoted Section 24(A) ar.d 24(B)(l ), to wit: SEC. 25. Tax on Nonresident Alien Individual. - (A) Nonresident Alien Engaged in Trade or Business Within the Philippines - (1) In General. -A nonresident alien individual engaged in trade or business in the Philippines shall be subject to an income tax in the same manner as an individual citizen and a resident alien individual, on taxable income received from all sources within the Philippines. A nonresident alien individual who shall come to the Philippines and stay therein for an aggregate period of more than one hundred eighty (180) days during any calendar year shall be deemed a 'nonresident alien doing business in the Philippines.' Section 22(G) of this Code notwitstanding. (2) Cash and/or Property Dividends fro a Domestic Corporation or Joint Stock Company, or Insurance or Mutual Fund Company or Regional Operating Headquarter of Multinational Company, or Share in the Distributable Net Income of a Partnership (Except a General Professional Partnership), Joint Venture Taxable as a Corporation or Association, Interests, Royalties, Prizes, and other Winnings. - Cash and/or property dividends from a domestic corporation, or from a joint stock company, or from an insurance or mutual fund company or from a regional operating headquarter of multinational company, or the share of a nonresident alien individual in the distributable net income after tax of a partnership (except a general professional partnership) of which he is a partner, or the share of a nonresident alien individual in the net income after tax of an association, a joint account, or a joint venture taxable as a corporation of which he is a member or a co-owner; interests; royalties (in any form); and prizes (except prizes amounting to Ten thousand pesos

DECISION- C.T.A. CASE NO. 6243 PAGE 11 [PlO,OOO] or less which shall be subject to tax under Subsection [B][l] of section 24); and other winnings (except Philippine Charity Sweepstakes and Lotto winnings), shall be subject to an income tax of twenty percent (20%) on the total amount thereof: Provided, however, That cinematographic films and similar works shall be subject to the tax provided under Seetin 28 of this Code: Provided, furthermore , That interest income from long-term deposit or investment in the form of savings, common or individual trust funds, deposit substitutes, investment management accounts and other investmtnes evdienced by certificates in such form prescribed by the Bangko Sentral ng Pilipinas (BSP) shall be exempt from the tax imposed under this Subsetion: Provided, finally, That should the holder of the certficate pre-terminate the deposit or investment before the fifth (5th) year, a final tax shall c' imposed on the entire income and shall be deducted and withheld by the depository bank from the proceeds of the long-term deposit or investmtne certificate based on the remaining maturity thereof: xxx However, Section 25(B) of the 1997 Tax Code taxes nonresident alien individuals not engaged in trade or business within the Philippines on their interest realized from Philippine sources. For easy reference, pertinent portions of Section 25(B) of the 1997 Tax Code is hereby quoted as follows: SEC. 25. Tax on Nonresident Alien Individual. - X XX (B) Nonresident Alien Individual Not Engaged in Trade or Business Within the Philippines. - There shall be levied, collected and paid for each taxable year upon the entire income received from all sources within the Philippines by every nonresident alien individual not engaged in trade or business within the Philippines as interest x x x, or other fixed or determinable annual or periodic or casual gains, profits, and income, and capital gains, a tax equal to twenty-five (25%) of such mcome. x x x It should be noted that both Sections 24(B)(l) and 25(A)(2) ofthe 1997 Tax Code expressly exempt interest derived fror:~. certain long-term deposit or investment (covered by Bangko Sentral ng Pilipinas (BSP) certificates and with maturity of five years or

DECISION- C.T.A. CASE NO. 6243 PAGE 12 more) by citizens, resident aliens and nonresident aliens engaged in trade or business within the Philippines from income tax. However, like in the case of nonresident alien individuals not engaged in trade or business in the Philippines, there is no similar exemption from income tax on such interest for corporations, domestic or foreign, under Sections 27 and 28 of the 1997 Tax Code, to wit. SEC. 27. Rates ofIncome Tax on Domestic Corporations. - (A) In General. - Except as otherwise provided in this Code, an income tax of thirty-five percent (35%) is hereby imposed upon the taxable income derived during each taxable yea; from all sources within and without the Philippines by every corporation, as defined in Section 22(B) of this Code and taxable under this Title as a corporation, organized in, or existing under the laws of the Philippines: Provided, That effective January 1, 1998, the rate of income tax shall be thirty-four percent (34%); effective January 1, 1999, the rate shall be thirty-three percent (33%); and effective January 1, 2000 and thereafter, the rate shall be thirty-two percent (32%). XXX XXX XXX (D) Rates ofTax on Certain Passive Incomes. - (1) Interest from Deposits and Yield or any Monetary Benefit from Deposit Substitutes and from Trust Funds and Similar Arrangements, and Royalties. - A final tax at the rate of twenty percent (20%) is hereby imposed upon the amount of interest on currency bank deposit and yield or any other monetary benefit from deposit substitutes and from trust funds and similar arrangements received by domestic corporations, and royalties, derived from sources within the Philippines: Provided, however, That interest income derived from a depository bank under the expanded foreign currency deposit system shall be subject to a final income tax at the rate of seven and one-half percent (7%) of such interest income. XXX XXX XXX SEC. 28. Rates ofIncome Tax on Foreign Corporations. - . (A) Tax on Resident Foreign Corporations. - (1) In General. - Except as otherwise provided in this Code, a corporation organized, authorized, or existing under the laws of any

DECISION - C.T.A. CASE NO. 6243 PAGE 13 foreign country, engaged in trade or business within the Philippines, shall be subject to an income tax equivalent to thirty-five percent (35%) of the taxable income derived in the preceding taxable year from all sources within the Philippines: xxx XXX XXX XXX (7) Tax on Certain Incomes Received by a Resident Foreign Corporation. - (a) Interest from Deposits and Yield or any other Monetary Benefit from Deposit Substitutes, Trust Funds and Similar Arrangements and Royalties. - Interest from any currency bank deposit and yield or any other monetary benefit from deposit substitutes and from trust funds and similar arrangements and royalties derived from sources within the Philippines shall be subject to a final income tax at the rate of twenty percent (20%) of sucht interest: Provided, however, That interest income derived by a resident foreign corporation from a depository bank under the expanded foreign currency deposit system sh~ll be subject to a final income tax at the rate of seven and one-half percent (7Y2%) of such interest income. (B) Tax on Nonresident Foreign Corporation. - (1) In General. - Except as otherwise provided in this Code, a foreign corporation not engaged in trade or business in the Philippines shall pay a tax equal to thirty-five percent (35%) of the gross income received during each taxable year from all sources within the Philippines, such as interests, dividends, rents, royalties, salaries, premiums (except reinsurance premiums), annuities, emoluments or other fixed or determinable annual, periodic or casual gains, profits and income, and capital gains, except capital gains subject to tax under subparagraphs 5(c) and (d): Provided, That effective January 1, 1998, the rate of income tax be thirty-four percent (34%); effective January 1 1999, the rate shall be , thirty-three (33%); and, effective January 1, 2000 and thereafter, the rate shall be thirty-two percent (32%) XXX XXX XXX (Underscoring supplied.) Under Section 28(A) of the 1997 Tax Code, resident foreign corporations are subject to the same tax imposed on interest income realized from Philippine sources as

DECISION- C.T.A. CASE NO. 6243 PAGE 14 domestic corporations. On the other hand, under Sect ~n 28(B) of the 1997 Tax Code, nonresident foreign corporations are generally subject to 32% tax based on gross income, including interest, effective January 1, 2000. However, on interest income derived from foreign loans contracted on or after August 1, 1986, a final withholding tax rate of 20% is imposed pursuant to Section 28(B)(5)(a) of the 1997 Tax Code. Obviously, from the aforementioned Sections 24, 25 , 27 and 28 of the 1997 Tax Code, in relation to Sections 31 and 32 of the same Code, there is no sweeping exemption from income tax of interest income derived from bonds, debentures or other certificates of indebtedness with a maturity of more than five (5) years. There is a clear distinction between interest from bonds and gain from the sale of bonds. It is only the "Gains realized from the sale or exchange or retirement of bonds, debentures or other certificate of indebtedness with a maturity of more than five (5) years" that is excluded from gross income and thus exempt from income tax under Section 32(B)(7)(g) of the 1997 Tax Code. Such gains from sale or exchange or retirement of bonds, debentures or other certificate of indebtedness fall within the general category of "Gains derived from dealings in property," as distinguished from interest from bonds, debentures or other certificate of indebtedness, which fall within the general category of "Interests" under Section 32(A) of the 1997 Tax Code. If this is not so, then there will be no need to specifically exempt interest under the provisions of Sections 24(B)(l) and 25(A) because Section 32 pertains to exclusions from gross income which generally applies to all persons subject to income tax, whether individual or corporate. As previously noted, only citizens, resident aliens and nonresident aliens engaged in trade or business are exempt from income tax on interest from long-term (with a

DECISION- C.T.A. CASE NO. 6243 PAGE 15 maturity of five years or more) deposit or investment in the form of savings, common or individual trust funds, deposit substitutes, investment management accounts and other investments evidenced by certificates in such form prescribed by the Bangko Sentral ng Pilipinas (BSP) pursuant to Sections 24(B)(1) and 25(A) of the 1997 Tax Code. On the other hand, domestic and resident foreign corporations are subject to a 20% final tax on such interest pursuant to Sections 27(D)(l) and 28(A) ofthe 1997 Tax Code. We believe that if Congress intended to exempt interest from bonds, debentures and other certificates of indebtedness under Section 32(B)(7)(g) of the 1997 Tax Code, it would have done so in clear and specific terms. The fact that it used the term "Gains ' from sale" in the aforementioned section, knowing full well of the reference to interest under Sections 24, 25 , 27 and 28 of the 1997 Tax Code shows that it did not intend to exempt such interest under the aforementioned Section 32(B)(7)(g). Parenthetically, in the United States, where it is the interest on certain state and local bonds that is exempt whereas gain from the sale thereof is taxable, there is a clear distinction between interest and gain from sale. Hence, Section 8.07 of Mertens, The Law OfFederal Income Taxation, provides in pertinent part: �8.07. Interest. The interest exclusion on state and local bonds is limited to interest income relating to tax-exempt bonds. It does not include gain on the sale or exchange of obligations. Discount The word "interest" in the Code includes "discount." When state or municipal securities are issued at a discount, amounts representing the discount received by the holder either upon the redemption or sale of the securities are tax-exempt as being equivalent to interest. As between

DECISION- C.T.A. CASE NO. 6243 PAGE 16 successive holders of a tax-exempt municipal bond, the original issue discount which is tax-exempt is apportioned on the basis of the time each of the holders held the bond. The remainder of t~ � proceeds is treated as the amount realized on the redemption or sale for purpose of determining gain or loss. Market Discount When a dealer resells bonds at a discount which he purchased at par or above, that discount is commonly referred to as "market" discount in contrast to "issue" discount. If the bonds are capital assets in the hands of the purchaser from the dealer, then the market discount when subsequently realized would give rise to a capital gain. Certain insurance companies, however, would be required to accrue this market discount each taxable year as investment income and would also adjust the basis for the bonds so that no gain would be realized upon redemption if the bonds were held to maturity. The distinction must be noted between accrued interest and discount received upon the redemption of state or local obligations prior to maturity and any premium paid on such redemption. It has been ruled that while the accrued interest and discount constitute interest and are, thus, tax-exempt, any premium received upon redemption is taxable income. (Mertens, The Law Of Federal Income Taxation, Section 8.07, Vol. 1, Chap. 8, pp. 22- 24. (Underscoring supplied.) Consequently, this court has on several occasions ruled that the tax exemption on long-term gains under Section 32(B)(7)(g) does not include interest (Nippon Life Insurance Company of the Philippines, Inc. vs. Commissioner of Internal Revenue, CTA Case No. 6142, February 4, 2002; Malayan Reinsurance Corporation vs. - Commissioner of Internal Revenue, CTA Case No. 6252, July 24, 2002, Resolution dated November 19, 2�02; Malayan Zurich Insurance Company, Inc. vs. Commissioner of Internal Revenue, CTA Case No. 6251, September 30, 2002; and First Nationwide Assurance Corporation vs. Commissioner of Internal Revenue, CTA Case No. 6253, October 3, 2002).

DECISION - C.T.A. CASE NO. 6243 PAGE 17 In fine , only the gam from sale (as distinguished from interest) of bonds, debentures or other certificate of indebtedness with maturity of more than five years shall be exempt from income tax. Corollary, since the present appeal involves claim for refund of 20% final withholding tax on interest income earned from long term investment in FXTNs, the same has no basis in law. WHEREFORE, in view of all the foregoing, the instant petition for review is hereby DENIED for lack of merit. SO ORDERED. c.<r2u~A_N.~'i.r.:o-f.Ce. ~ .~ . CASTANEDA,~:� Associate Judge I CONCUR: L-t> .C~ ERNESTO D. ACOSTA Presiding Judge CERTIFICATION I hereby certify that the above decision was reached after due consultation with the members of the Court of Tax Appeals in accordance with Section 13, Article VIII of the Constitution. ~(S2, o~ ERNESTO D. ACOSTA Presiding Judge