CIR - v - SC Johnsons and Sons
Facts from Court of Tax Appeals -
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1.
[Respondent] a
domestic corporation organized and operating under the Philippine laws, entered
into a license agreement with SC Johnson and Son, (USA), a non-resident foreign
corporation based in the U.S.A.
2.
[Respondent] was
granted the right to use the trademark, patents and technology owned by the SC
Johnson and son USA including the right to manufacture, package and distribute
the products and secure assistance in management, marketing and production
3.
For the use of
the trademark or technology, [respondent] was obliged to pay SC Johnson and
Son, USA royalties based on a percentage of net sales and subjected the same to
25% withholding tax on royalty payments which [respondent] paid for the period
covering July 1992 to May 1993 in the total amount of P1.6 M.
4.
1993:
[respondent] filed with the International Tax Affairs Division (ITAD) of the
BIR a claim for refund of overpaid withholding tax on royalties
5.
Since the agreement
was approved by the Technology Transfer Board, the preferential tax rate of 10%
should apply to the [respondent] pursuant to the most-favored nation principle (explained in decision)
a.
RP-US Tax Treaty [Article 13 Paragraph 2 (b) (iii)] and
b.
RP-West Germany Tax Treaty [Article 12 (2) (b)]
6.
The Commissioner
did not act on said claim for refund.
7.
SC Johnson and
son then filed a petition for review before the Court of Tax Appeals (CTA) to
claim a refund of the overpaid withholding tax on royalty payments from July
1992 to May 1993.
8.
CTA rendered its
decision in favor of S.C. Johnson and ordered the CIR to issue a tax credit
certificate in the amount of P963,266.00 representing overpaid withholding tax
on royalty payments
9.
CIR thus filed a
petition for review with CA which rendered the decision subject of this appeal
finding no merit in the petition and affirming in toto the CTA ruling.
Issue: WON CA
erred in ruling that SC Johnson and Son, USA is entitled to the most favored
nation tax rate of 10% on royalties as provided in the RP-US tax treaty in
relation to the RP-West Germany tax treaty.
Held: YES. Decision of CA set aside.
CIR contends:
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SC Johnson and Son answers:
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RP-US Tax Treaty -
the lowest rate of the Philippine tax at 10% may be imposed on royalties
derived by a resident of the US from sources within the Philippines only if
the circumstances of the resident of the US are similar to those of the
resident of West Germany.
S.C. Johnsons
invocation of the most favored nation clause is in the nature of a claim for
exemption from the application of the regular tax rate of 25% for royalties,
the provisions of the treaty must be construed strictly against it.
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RP-US Tax Treaty
refers to royalties paid under similar circumstances as those royalties
subject to tax in other treaties; that the phrase paid under similar
circumstances does not refer to payment of the tax but to the subject
matter of the tax, that is, royalties
Most favored
nation clause is intended to allow the taxpayer in one state to avail of more
liberal provisions contained in another tax treaty wherein the country of
residence of such taxpayer is also a party thereto.
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1.
SC is not aware
of any law or rule pertinent to the payment of royalties, and none has been
brought to their attention, which provides for the payment of royalties under
dissimilar circumstances. The tax rates
on royalties and the circumstances of payment thereof are the same for all the
recipients of such royalties and there is no disparity based on nationality in
the circumstances of such payment.
2.
The RP-US Tax
Treaty is just one of a number of bilateral treaties which the Philippines has
entered into for the avoidance of double taxation.
Purpose of these
international agreements: to
reconcile the national fiscal legislations of the contracting parties in order
to help the taxpayer avoid simultaneous taxation in two different
jurisdictions. Tax conventions are drafted with a view towards the elimination
of international juridical double taxation[1].
Rationale for
doing away with double taxation: to
encourage the free flow of goods and services and the movement of capital,
technology and persons between countries, conditions deemed vital in creating
robust and dynamic economies. Foreign
investments will only thrive in a fairly predictable and reasonable
international investment climate and the protection against double taxation is
crucial in creating such a climate.
3.
Double taxation
usually takes place when a person is resident of a contracting state and
derives income from, or owns capital in, the other contracting state and both
states impose tax on that income or capital.
4.
In order to
eliminate double taxation, a tax treaty resorts to several methods.
A.
Sets out the
respective rights of tax of the state of source or situs and of the state of
residence with regard to certain classes of income or capital. In some cases, an exclusive right to tax is
conferred on one of the contracting states; however, for other items of income
or capital, both states are given the right to tax, although the amount of tax
that may be imposed by the state of source is limited.
B.
The elimination
of double taxation applies whenever the state of source is given a full or
limited right to tax together with the state of residence. In this case, the
treaties make it incumbent upon the state of residence to allow relief in order to avoid double
taxation.
2 methods of relief:
i.
the exemption
method - the income or capital which is taxable in the state of source or situs
is exempted in the state of residence, although in some instances it may be
taken into account in determining the rate of tax applicable to the taxpayers
remaining income or capital.
ii.
credit method -
although the income or capital which is taxed in the state of source is still
taxable in the state of residence, the tax paid in the former is credited
against the tax levied in the latter.
The basic difference between the two methods is that
in the exemption method, the focus is on the income or capital itself, whereas
the credit method focuses upon the tax.
5.
Tax treaties rationale
for reducing the tax rate: That the
Philippines will give up a part of the tax in the expectation that the tax
given up for this particular investment is not taxed by the other country. Thus the petitioner correctly opined that ‘royalties’
paid under similar circumstances in the most favored nation clause of the US-RP
Tax Treaty necessarily contemplated circumstances that are tax-related.
6.
RP-US Tax Treaty
- the state of residence and the state of sources are both permitted to tax the
royalties, with a restraint on the tax
that may be collected by the state of source.
The
method employed to give relief from double taxation is the allowance of a tax
credit to citizens or residents of the US (in an appropriate amount based upon
the taxes paid or accrued to the Philippines) against the US tax, but such
amount shall not exceed the limitations provided by US law for the taxable
year. Under Article 13 thereof, the
Philippines may impose one of the 3 rates –
a.
25 % of the gross
amount of the royalties OR
b.
15 % when the
royalties are paid by a corporation registered with the Philippines Board of
Investments and engaged in preferred areas of activities OR
c.
the lowest rate
of Philippine tax that may be imposed on royalties of the same kind paid under
similar circumstances to a resident of a 3RD state.
7.
Given the purpose
underlying tax treaties and the rationale for the most favored nation clause,
the concessional tax rate of 10 % provided for in the RP-Germany Tax Treaty
should apply only if the taxes imposed upon royalties in the RP-US Tax Treaty
and in the RP-Germany Tax Treaty are paid under similar circumstance. This would mean that private respondent must
prove that the RP-US Tax Treaty grants similar tax reliefs to residents of the
United States in respect of the taxes imposable upon royalties earned from
sources within the Philippines as those allowed to their German counterparts
under the RP-Germany Tax Treaty.
8.
The RP-US and
the RP-West Germany Tax Treaties do not contain similar provisions on tax
crediting.
Article
24 of the RP-Germany Tax Treaty - expressly allows crediting against German
income and corporation tax of 20% of the gross amount of royalties paid under
the law of the Philippines.
Article
23 of the RP-US Tax Treaty, which is the counterpart provision with respect to
relief for double taxation, does not provide for similar crediting of 20% of
the gross amount of royalties paid.
[1] imposition of comparable
taxes in two or more states on the same taxpayer in respect of the same subject
matter and for identical periods
