CTA Case No. 5120 (Decision)

REPUBLIC OF THE PHILIPPINES COURT OF TAX APPEALS QUEZON CITY G.D. SEARLE PHILIPPINES, INC. , Petitioner, - versus - C.T.A. CASE NO. 5120 COMMISSIONER OF INTERNAL REVENUE, ' Respondent. Promulgated: AUG 0 5 1997 X-------------------- - - x - DECISION This is a j udicial claim for the refund of alleged overpaid withholding tax on royalties in the amount of P398,963.70. Petitioner is a domestic corporation duly organized and existing under and by virtue of Philippine laws. It represents itself as a corporation existing by virtue of a License Agreement with G.D. Searle, USA, a foreign corporation damici Ied in the United States, to se I I and manufacture pharmaceutical products. Said I icense agreement, presented as Exhibit "A", provides among others, that G.D. Searle, USA, sha I I extend techn i ca I assistance to petitioner to enable it to manufacture and sel I their pharmaceutical products here in the Philippines. Such agreement also contains a provision that the petitioner is

DECISION - C.T.A. CASE NO. 5120 -2- obliged to pay G.D. Searle, USA, royalty fees equivalent to 3% of the net sales of the products in consideratin of the technical assistance and other rights granted by virtue of the said agreement. Petitioner further alleges that it paid royalty fees to G.D. Searle, USA, for the period covering January 1992 to September 1993 in the total amount of P1,994,814.00, net of withholding taxes. As a withholding agent, petitioner claims that it remitted to the Bureau of I nternaI Revenue the sum of P664,939.00 representing 25% of the royalty payments made pursuant to Article 13 of the RP-US Tax Treaty. Shortly thereafter, petitioner filed a claim for refund with the Bureau of Internal Revenue on June 2, 1994 alleging that it should only withhold 10% of the royalty fees and not 25% which it had originally remitted to the BIR. The overpayment of P398,963.70 representing the excess payment corresponds to the difference between the 25% tax rate it paid as opposed to a mere 10% withholding tax on royalties it was obi iged to remit. This overpayment is computed as follows: Tax Withheld (25%) P664,939.00 Less: Tax Due at 10% rate 265,975.30 Excess Remittance P396,963.70 j

DECISION - C.T.A. CASE NO. 5120 -3 - Petitioner claims that Article 13(2)(b)(iii) of the RP- US Tax Treaty grants preferential treatment to residents of the US by allowing them to pay a tax rate lower than 25% imposed on royalties derived from sources within the Phi I ippines, provided that a similar lower rate is granted by the Phi I ippine authorities to a resident of another state by virtue of a treaty. The RP-West Germany Tax Treaty provides for a lower tax rate of 10% as provided in Article 12, paragraph 2(b). Petitioner did not wait for a response on the claim for refund filed but instead immediate I y fi I ed a petition for review with this Court on June 8, 1994. No new matters were raised in this petition other than what was already adduced in the administrative level. Respondent, on the other hand, cited her oft-repeated I ine of defense by dec I aring that in actions for refund, the taxpayer has the burden of showing that taxes paid were erroneously or i I legally collected and that tax refunds are construed strictly against the taxpayer. The issues that confront us is whether or not the royalty fees paid to a US resident is subject to a 10% tax rate and whether or not the petitioner is entitled to the refund of P398,963.70, representing overpaid withholding tax on royalties.

DECISION - C.T.A. CASE NO. 5120 -4- Petitioner submits that under the "most favored nation" clause of the RP-US Tax Treaty in relation to the RP-West Germany Tax Treaty, the applicable tax rate is 109o instead of 25%. This was affirmed by this Court in the case entitled IBM PhiIippines vs. Commissioner of Internal Revenue, CTA Case No. 4 3 08, dated March 3 1 , 199 3 . W e are already well-acquainted with the legal issue that presently confronts Us. In a long line of cases, this Court has remained steadfast in affirming the wisdom of the ruling made by then Commissioner of Internal Revenue, Bienvenido Tan, Jr., in BIR Ruling No. 456-88, dated September 16, 1988, where he categorically declared that a 10% tax rate shall be imposable on royalties derived by a resident of the United States from sources within the Philippines pursuant to Article 13, paragraph 2(b)(iii) of the R.P.-U.S. Tax Treaty in relation to paragraph 2(b) of Article 12 found in the RP-West Germany Tax Treaty. We have consistently applied this ruling in disposing of similar issues in the following cases: 1) Rhone Poulenc Rorer Philippines, Inc. vs. The 2) Commissioner of Internal Revenue, CTA Case No. 5179, July 29, 1997; CaIifornia Manufacturing Company, Inc. vs. Commissioner. of InternaI Revenue, CTA Case No. 5186, June 27, 1997;

DECISION - C.T.A. CASE NO. 5120 - 5- 3) Unisys Australia Limited (Philippine Branch) vs. Commissioner on Interna I Revenue, CTA Case No. 5151, June 24, 1997; 4) Abbot Laboratories (Phi Iippines) vs. Commissioner of Internal Revenue, CTA Case No. 5119, September 9, 1996 (Entry of Judgment, October 2, 1996); 5) S.C. Johnson and Sons, Inc., vs. Commissioner of Internal Revenue, CTA Case No. 5136, May 7, 1996 (CA Affirmed our decision, November 7, 1996); 6) Armco Marsteel Alloy Corporation vs. Case Commissioner of Interna I Revenue, CTA No. 5115, February 6, 1996; 7) Smith K Iine and French Overseas Company vs. Commissioner of Interna I Revenue, CTA Case No. 5048, September 22, 1995 <Entry of Judgement, January 30, 1996); 8) Gi llete (Phi Iippines) Inc. vs. Commissioner of Internal Revenue, CTA Case No. 4248, February 8, 1995 (Entry of Judgment, March 1, 1996); 9) IBM Phi I ippines, Inc. vs. Commissioner No. 4308, March 3, I nterna I Revenue, CTA Case 1993; 10) Kimberly-Clark Corporation (USA) and (Phi Iippines) Inc. vs. Kimber r:y-Ciark Commissioner of Internal Revenue, CTA Case No. 4288, January 30, 1992 (CA Entry of Judgment, September 27, 1994); and 11) Electri9 Philippine Meter and Instrument Co., Inc. vs. Commissioner of I nterna I Revenue, CTA Case No. 4158, December 5, 1991 (CA Entry of Judgment, May 27, 1993 >. For purposes of academic discussion, We quote Article 13 of the RP-US Tax Treaty, thus:

DECISION - C.T.A. CASE NO. 5120 -6- (1) Royalties derived by a resident of one of the Contracting States from sources within the other Contracting state may be taxed-by both Contracting States. (2) However, the tax imposed by that other Contracting State shal I not exceed - (a) In the case of he United States, 15 percent of the gross amount of the royalties, and (b) In the case of the Philippines, the least of, ( i) 25 percent of the gross amount of the royalties; (ii) 15 percent of the gross amount of the royalties, where the royalties are paid by a corporation registered with the Philippine Board of Investments and engaged in preferred areas of activities; and (i i) The Iowest rate of Philippine tax that may be imposed on royalties of the same kind paid under similar circumstances to a resident of a third State." Sectio 2(b)(iii) of the above-quoted Article 13 imposes the Iowest rate of Phi Iippine tax that may be imposed on royalties of the same kind paid under similar circumstances to a resident of a third state. The lowest rate of tax that can be imposed is found in Article 12(2)(b) of the RP-West Germany Tax Treaty, which provides:

DECISION - C.T.A. CASE NO. 5120 -7- Article 12 Royalties 1� XXX XXX 2. However, such royalties may also be taxed in the Contracting State in which they arise, and according to t e law of the State, but the tax so charged shall not exceed: (a) 15 per cent of the gross amount of royalties arising from the use of, or the right to use, any copyright of literary, artistic or scientific work including cinematograph films or tapes for television or broadcasting, or (b) 10 per cent of the gross amount of royalties arising from the use of, or the right to use, any patent, trade mark, design or mode I, pI an, secret formuI a or process, or from the use of, or the right to use, industrial, commercial, or scientific equipment, or for information concerning industrial, commercial or scientific experience. The relevant provisions of these two tax treaties when taken together lead to the lowest tax rate of 10% that shall be imposable on royalties derived by a resident of the US from sources within the Philippines. The interrelationship of these two tax treaties also gives Us the preconditions for the 10% rate to apply because of the phrase "under similar circumstances" found in Article 13(2)(b)(iii) of the RP-US Tax Treaty ear I ier quoted. The first condition is that, the royalties paid must arise from the use, or the right to use, any patent, trademark, design or model plan, secret formula or process, or from the use of, or the right to use, industrial, commercial or scientific experience.

DECISION - C.T.A. CASE NO. 5120 - 8- Secondly, the contract giving rise to such royalties must have been approved by PhiIippine competent authoriti_ es. In the case entitled IBM PhiIippines, Inc. vs. Commissioner of Internal Revenue, CTA Case No. 4308, March 31' 1993, this Court resolved a similar issue, in this manner, thus: This Court is of the persuasion that petitioner's stand is correct and concurs with the opinion rendered by then Commissioner of Internal Revenue, Bienvenido Tan, Jr., (BIR Ruling No. 456- 88, supra.), that under the most favored nation provision of the RP-US Tax Treaty [Article 13, paragraph 2(b)(iii)], the tax imposable on royalties derived by a resident of the United States from sources within the PhiIippines shall be the Iowest rate of PhiIippine tax that may be imposed on royalties of the same kind paid under similar circumstances to a resident of a third state. Article 12, paragraph 2(b) of the RP-West Germany Tax Treaty, provides that royalties arising in the Philippines and paid to a resident of West Germany may also be taxed in the Phi I ippines, but the tax so charged shall not exceed 10% of the gross amount of royalties. Said treaty also provides that for as long as the transfer of technology under Philippine law, is subject to approval, the Iimitation of the tax rate in case of royalties arising in the Philippines, apply if the contract giving rise to such royalties has _been approved by Philippine competnt authorities. The above discussion directs us to the conclusion that royalties derived by a .resident of the United States from sources within the Philippines is subject to the 10% tax rate and not to the rate of 25% withheld by the petitioner. In the Iight of the evidence presented by the petitioner, 81.

DECISION - C.T.A. ASE NO. 5120 -9 - this Court is inclined to uphold petitioner's claim for refund in the amount of P398 , 963 .70. The petitioner has satisfactori I y conv i need us that roya I ty payments made to G. D. Searle, USA, fall under the "most favored nation" clause found in the RP-US Tax Treaty in relation to the RP- West Germany Tax Treaty. The royalties derived b y G. D. Searle, USA, from G.D. Searle, Philippines, arose from the latter corporation's use of the trademarks, secret formula or process, industrial and scientific experience of the former corporation to ena b le it \ to manufacture and se I I pharmaceutica I products in pursuance of the License Agreement entered into b etween the two entities (see Exhi b it "A"). Said License Agreement was duly registered with the Technology Transfer R egistry of the Bureau of Patents, Trademark and Technology Transfer (Exhi b it "B") signifying approval b y Philippine Competent authorities. Thus, in view of the foregoing, petitioner is declared to b e entitled to the amount of P398 ,963 .70 as excess withholding taxes. paid, from J une 1 9 9 2 to O cto b er 1 9 9 3, computed as fo I I ows : Royalty payments net of 25% withholding: Period Exh. Amount January 1992 to June 1992 c p 489, 996.00 July 1992 to September 1992 0 382 ,046.00 October 1992 to March 1992 E Apri I 199 3 to June 199 3 F 460 ,67 3 .00 July 199 3 to September 1993 z 328,763.11 333,336.00 80u

DECISION - C.T.A. CASE N O . 512 0 - 10 - To tal P1,994,814.11 Divided by 75 % To tal ro yalty payments P2,659,753.00 10% Withholding tax on ro yalty based p 265,975.30 on the "m o st favored n ati on cl au se" (P2,659,753.00 X 10%) Less payments based on RP-USA Tax Tre aty: Month D ate Am ount Exh. -- -- 06-09-92 p 39,349.00 H 07-09-92 10,703.00 May 1992 08-07-92 16,703.00 J June 1992 07-09-92 47,805.00 K July 1992 10-16-92 L Aug. 1992 10-09-92 144,909.00 M Sept. 1992 11-10-92 31,212.00 N Sept. 1992 12-09-92 31,553.00 0 Oct. 1992 01-11-93 26,119.00 p N o v. 1992 02-09-93 32,979.00 Q Dec . 1992 03-10-93 21,788.00 R J an . 1993 04-02-93 18,795.00 s Feb. 1993 05-07-93 22,324.00 T Mar. 1993 06-08-93 38,864.00 u Apr. 1993 07-12-93 23,656.00 v May 1993 08-09-93 47,067.00 w June 1993 09-09-93 30,497.00 X July 1993 10-11-93 33,267.00 y Aug. 1993 472574.00 Sept. 1993 Total P665,164.00 Less Adjustment <Exh. D) 225.00 664,939.00 Overpaid Withho lding Tax on Ro yalties (P 398,963.70) WHEREFORE, in vi ew of t he f o reg o ing, re s p o n d en t Comm i s s i o n.r of I n tern a I Re venu e i s here by ORDERED t o REFUND in f a v o r of pe titi o n er t he am o u n t of P398,963.70 re pre s en ting o verp a i d wi t h h o l ding t a xe s o n r o y a l ty p a ym en ts for t he peri ad, J u n e 1992 t o O c t o ber 1 9 9 3 SO ORDERED . fu! / R RAMON 0. DE A s s o c i a te J u d 8S �- //

DECISION - - 11 - C.T.A. CASE NO. 5120 WE CONCUR: CERTIFICATION I hereby certify that this decision was reached after due consultation with �the members of the c oil'rt of Tax Appeals in accordance with Section 13, Article VIII of the Constitution. IQ- ERNESTO D. ACOSTA Presiding Judge Court of Tax Appeals