The Supreme Court affirmed that Revenue Regulations (RR) issued by the Department of Finance (DOF) and Bureau of Internal Revenue (BIR) cannot override or modify existing tax laws. The Court declared RR 4-2011, prescribing rules on cost allocation for banks, as invalid because it unduly restricted banks’ rights to claim expense deductions and imposed a specific accounting method without legal basis, encroaching on legislative authority. This ruling safeguards taxpayers’ rights against administrative issuances that exceed the scope of implementing laws and ensures adherence to due process requirements in tax regulations.

Balancing Government Revenue and Taxpayer Protections: When Does Regulation Exceed Authority?

This case, Department of Finance (DOF) vs. Asia United Bank, revolves around the validity of Revenue Regulations (RR) 4-2011, issued by the Department of Finance (DOF) and the Bureau of Internal Revenue (BIR). These regulations prescribed rules on the “proper allocation of costs and expenses amongst income earnings of banks and other financial institutions for income tax reporting purposes.” The core legal question is whether RR 4-2011 exceeded the authority of the DOF and BIR by effectively amending the Tax Code, thereby infringing upon the legislative power to enact tax laws.

The contested RR 4-2011 stipulated that banks could only deduct costs and expenses attributable to their Regular Banking Units (RBU) when calculating taxable income. Expenses related to Foreign Currency Deposit Units (FCDU), Expanded Foreign Currency Deposit Units (EFCDU), or Offshore Banking Units (OBU) were disallowed as deductions from the RBU’s taxable income. The regulation mandated a specific allocation method, either through specific identification or by allocating common expenses based on the percentage share of gross income earnings. Several banks challenged RR 4-2011, arguing that it lacked basis in the Tax Code, curtailed their right to claim deductions, and violated their right to choose their accounting methods.

The Regional Trial Court (RTC) initially ruled in favor of the banks, declaring RR 4-2011 null and void, asserting that it was issued beyond the authority of the Secretary of Finance and Commissioner of Internal Revenue. The RTC highlighted that the regulation imposed an accounting method not grounded in the Tax Code and unfairly restricted expense deductions. Dissatisfied, the DOF and BIR appealed to the Supreme Court, contesting the RTC’s jurisdiction and defending the validity of RR 4-2011 as an exercise of their rule-making power.

The Supreme Court, while acknowledging that the petition for declaratory relief was not the proper remedy to question the validity of executive issuances, recognized the far-reaching implications of RR 4-2011. Citing its power to resolve issues of public interest, the Court treated the petition as one for certiorari. However, the Court emphasized that the Court of Tax Appeals (CTA) holds exclusive jurisdiction to rule on the validity of tax regulations. As such, the RTC’s initial ruling was deemed void for lack of jurisdiction.

Despite this procedural issue, the Supreme Court proceeded to rule on the merits of the case, emphasizing the importance of resolving the validity of actions affecting numerous banks and financial institutions. The Court reiterated the fundamental principle that administrative issuances must not override or modify the law. They must remain consistent with the statute they intend to implement. The Court applied the completeness test and the sufficient standard test to evaluate the validity of RR 4-2011.

The Court found that RR 4-2011 failed these tests because it effectively amended the Tax Code by curtailing income tax deductions and prescribing a specific accounting method without legal basis. The decision thoroughly examined how RR 4-2011 contravenes Section 43 of the Tax Code, which allows taxpayers to choose their accounting methods, and Section 50, which authorizes the Commissioner of Internal Revenue to allocate income and deductions only under specific conditions, such as to prevent tax evasion or clearly reflect income.

“Section 43. General Rule. – The taxable income shall be computed upon the basis of the taxpayer’s annual accounting period (fiscal year or calendar year, as the case may be) in accordance with the method of accounting regularly employed in keeping the books of such taxpayer, but if no such method of accounting has been so employed. or if the method employed does not clearly reflect the income, the computation shall be made in accordance with such method as in the opinion of the Commissioner clearly reflects the income.”

The Court noted that the conditions under Section 43 of the Tax Code were not met, as there was no showing that banks and financial institutions had not employed an accounting method or that their methods did not accurately reflect their true income. The Court emphasized that the allocation rules under RR 4-2011 amounted to an arbitrary imposition of a uniform accounting method. This infringed upon the banks’ right to adopt their own methods, violating the Tax Code.

The Court further ruled that RR 4-2011 unduly expanded Section 50 of the Tax Code. This provision authorizes the CIR to allocate gross income or deductions between two or more organizations only if it is necessary to prevent tax evasion or clearly reflect income. The Court highlighted that these conditions were not met in this case and that Section 50 is limited to allocating expense deductions between two or more organizations, trades, or businesses, not within a single entity.

“Section 50. Allocation of Income and Deductions. – In the case of two or more organizations, trades or businesses (whether or not incorporated and whether or not organized in the Philippines) owned or controlled directly or indirectly by the same interests, the Commissioner is authorized to distribute, apportion or allocate gross income or deductions between or among such organization, trade or business, if he determines that such distribution, apportionment or allocation is necessary in order to prevent evasion of taxes or clearly to reflect the income of any such organizations, trades or businesses.”

Moreover, the Supreme Court found that RR 4-2011 impaired the taxpayers’ right to claim deductions under Section 34 of the Tax Code. This provision allows taxpayers to deduct ordinary and necessary expenses paid or incurred in carrying on their trade or business. By requiring the allocation of costs and expenses, the RR effectively imposed an additional requirement for deductibility not provided under the Tax Code, thereby modifying the law.

The Court also highlighted the failure to conduct prior notice and hearing before issuing RR 4-2011. Given the burden imposed by the regulation, the requirements of due process, including notice, hearing, and publication, should have been strictly observed. This procedural defect further supported the Court’s decision to declare the regulation invalid.

FAQs

What was the key issue in this case?	The key issue was whether Revenue Regulations (RR) 4-2011, which prescribed rules on cost allocation for banks, was a valid regulation or whether it exceeded the authority of the Department of Finance (DOF) and Bureau of Internal Revenue (BIR).
Why did the Supreme Court declare RR 4-2011 invalid?	The Supreme Court declared RR 4-2011 invalid because it unduly restricted banks’ rights to claim expense deductions, imposed a specific accounting method without legal basis, and effectively amended the Tax Code, which is a legislative function.
What is the significance of Section 43 of the Tax Code in this case?	Section 43 of the Tax Code allows taxpayers to choose their accounting methods, and the Court found that RR 4-2011 contravened this provision by arbitrarily imposing a uniform accounting method without demonstrating that the banks’ existing methods did not accurately reflect their income.
How did RR 4-2011 unduly expand Section 50 of the Tax Code?	RR 4-2011 expanded Section 50 by applying it to different units within a single bank, whereas Section 50 is intended for allocating income and deductions between two or more separate organizations or businesses under common control.
What impact did RR 4-2011 have on taxpayers’ rights to claim deductions under Section 34 of the Tax Code?	RR 4-2011 impaired taxpayers’ rights to claim deductions under Section 34 by imposing additional requirements for deductibility that were not provided in the Tax Code, effectively modifying the law.
What procedural defects were identified in the issuance of RR 4-2011?	The Supreme Court noted that RR 4-2011 was issued without prior notice and hearing, which is a violation of due process, particularly considering the burden imposed by the regulation on banks and financial institutions.
What is the role of the Court of Tax Appeals (CTA) in cases involving the validity of tax regulations?	The CTA has exclusive jurisdiction to rule on the constitutionality or validity of tax laws, rules, regulations, and other administrative issuances of the Commissioner of Internal Revenue.
What are the completeness and sufficient standard tests, and how did they apply to this case?	The completeness test requires that a law sets forth the policy to be executed, and the sufficient standard test requires adequate guidelines to prevent abuse of delegated authority; RR 4-2011 failed these tests by exceeding the scope of the Tax Code and lacking sufficient guidelines.
What was the key outcome of the Supreme Court’s decision?	The Supreme Court denied the petition and declared Revenue Regulations No. 4-2011 issued by the Secretary of the Department of Finance as void for having been issued ultra vires, meaning beyond legal authority.

In conclusion, the Supreme Court’s decision in Department of Finance vs. Asia United Bank reinforces the principle that administrative agencies must act within the bounds of their delegated authority and that regulations cannot override or modify existing laws. This ruling protects taxpayers’ rights and ensures that tax regulations are consistent with the Tax Code and due process requirements.

For inquiries regarding the application of this ruling to specific circumstances, please contact ASG Law through contact or via email at frontdesk@asglawpartners.com.

Disclaimer: This analysis is provided for informational purposes only and does not constitute legal advice. For specific legal guidance tailored to your situation, please consult with a qualified attorney.
Source: Department of Finance (DOF) vs. Asia United Bank, G.R. Nos. 240163 & 240168-69, December 01, 2021