CTA Case No. 5048 (Decision)

REPUBLIC ()f":" TilE PliiLIPPINES COURT OF HlX APPEALS OUEZON CITY SM I THI(L INE AND FRENCH OVERSEAS CO. , PFtitioner, C. T. ll. CASE NO. 5048. COMMISSIONER OF INTERNAL _P�~0__sE1_P_a_22_d_19_95_1ff- REVENUE, Respondent. X- - - - - - - - - - - - - - - - - - - - - - - - - - - X DECJ:SJ:CJN This is a case involving a refund of alleged overpaid withholding tax-at-source on royalty payments in the su� of P372,884.70. Petitioner is a resident foreign corporation duly organized and existing under the laws of the Philippines. It is engaged in the sale of phar11ace1..1t ical and veterinary products and brands in the Philippines under a patent and technical assistance with Smithkline and I nt et~nat i onal Company, a foreign corporation organized and existing under the laws of the State of Pennsylvania, United States of America which was registered and approved by the Bur~au of Patents, ' Trademarks and Technology Transfer, Department of Trade and Industry. 1208 _)

DECISION C.T.A. Case No. 5048 - 2- In consideration of the licenses, technical expertise and infor�ation transferred and services rendered by the licensor, petitioner pays a royalty fee of 3~ of net sales of pharmaceutical products. From January 21, 1992 to Septe�b~r 1992, petitioner paid its licensor royalties in the total amount of P2,485,897.97 from which the amount equivalent to 10~ thereof was withheld and paid the same to the Bureau of Internal Revenue as withholding tax on royalties pl~suant to the "most favored nation clause" under Article 13 of the R.P.- U.S. Tax Treaty in relation to Article 12(b) of the R.P.- West Germany Tax Treaty. On July 1, 1992 the Bureau of Internal Revenue issued Revenue .Memorandu� Circular No. 39-92, ruling that the phrase "under siailar circumstances" requirement of the R.P.- U.S. Tax Treaty is not satisfied because the R.P.- West Germany Tax Treaty allows a �atching tax credit of 20~ to Germans receiving Philippine-source royalty income while the R.P.- U.S. Tax Treaty does not provide for such a credit. Hence, taxpayers who withheld only a 10~ tax on royalties are dee�ed deficient and are required to amend their withholding tax returns and pay the deficiency without penalties on or before October 30, 1992. 1207

DECISION - C.T.A. Case No. 5048 -�3- . On October 30, 1992, petitioner paid under protest the alleged deficiency withholding tax of P372,884.70 on royalties to the Bureau of Internal Revenue <Exh "F"J. Relying on the doctr\ine laid down in the case of General Electric Philippines Meter ~nd Instru�ent Co �., Inc. vs. Co��issioner of Int~rnal Revenue, CTA Case No. 4158, December 5, 1991, petitioner filed on May 12, 1993 a claim for a tax credit/refund in the sum of P372,884.70 with the Bureau of Internal Revenue's Appellate Division. Respondent did not act on said claim for refund. Hence, this appeal. The issue is: Whether or not petitioner is entitled to the claim for refund in accordance to the "most favored nation clause" as provided in the R.P.- U.S. Tax 13<2> (iii) in l~elation to Article 12(2) (b) of the R.P.- West Germany Tax Treaty. We answer in the affirmative. In the case of General Electric Philippines, supra, this court ruled, thus: On the basis of the most favored nation clause of the RP - U.S. Tax Treaty, Art. 13 (2) <b> (ii>, taken in relation to Article 12 <2> (b) of the RP - West German Tax Treaty and BIR Ruling No. 263-86, petitioner should have withheld and paid only 10~ tax instead of 25~ on the royalties paid by petitioner to General Electric Company in the U.S�� 1.208

DECISION - t.T.A. Case No. 5048 - 4- Of th~ accru~d royalti~s in 1984 in . th~ amount of Pl5,570,208.22 paid in 1985 - 25" ta"' was actually paid by p~tition~r on May 10, 1985 by way of withholding ta"' in th~ amount of P81,743.59 (EMhs. 1, K & J, pp. 53-54, CTR r~c.>. Sine~ th~ taM du~ th~r~on is only 10", according to th~ abov~ provision of law, th~ sum of P54,495.73 was du~ and paid r~sulting to an ov~rpaym~nt of P27,247.86. Of th~ t~chnical s~rvic~ f~~ of ~168,474.91, p~tition~r paid on Jun~ 10, 1985 th~ 15" withholding taM in th~ sum of P25,271.23. <E"'hs. E, G, & F, pp. 50-51 CTA r~c.>. Sine~ th~ ta"' du~ is only 10", according to th~ abov~ provision of law, th~ sum of Pl4,44(~7l was du~ and paid r~sulting to an ov~rpaym~nt of Pl0,830.52. Said dPcision b~camP final aft~r th~ Court of App~als d~ni~d pPtitioner's (he�~~ in, r~spondPnt> Petition for RPvi ~w. <Com�issioner of Internal Revenue vs. General Electric Philippines Meter and lnstru�ent Co., Inc. C.R. G. R. -No. 30674> ThP Entry of Judgm~nt was issupd on January 26, 1994. ln a 'latt~r cas~, this Court r~it~ratPd th~ abov~ r1.1l i ng, thus: On th~ sPcond issue, whethPr or not pPtition~r should bP taMed at the reduc~d ratP of 10" withholding ta"' on royalti~s in accol~dancP with Rt~ticl~ 12 <2> (b) of th~ R.P.- W~st Germany Ta"' Treaty and not 25" withholding taM on royaltiPs und~r A�~ticl~s 13 (2) (b) (iii) of th~ R.P.- U.S. Ta"' Treaty. This Court is of the persuasion that pPtition~r's stand is corr~ct and concurs with the opinion rPndered by th~n Commissioner of lnte.~nal RevenuP, Bienv~nido Tan, <BJR Ruling No. 456-88, supra., that under the most favor~d nation provision of the R.P.- U.S. Ta"' Treaty 1208

DECISION -- C.T.A. Case No. 5048 - '5 - <Article 13 paragraph 2 Cb> (iii), the .tax imposable on royalties derived by a resident of the United States fro� sources within the Philippines shall be 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 third state. Article 12, paragraph 2 Cb> of the R.P.- West Germany Tax Treaty, provides that royalties arising in the Philippines an~ paid to a resident of West Germany may also be taxed in the Philippines, 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 limitation of the tax rate in case of royalties ar'ising in the Philippines, apply if the contract giving rise to such royalties has been approved by Philippine competent authorities. Thus, i nasmt..&ch as the Agreement between World Tt~ade and IBM Phils. as well as the Agreement between IBM and IBM Phils. had been approved by the Central Bank of the Philippines, royalties arising in th~ Philippines and payable to World Trade as well as to IBM by IBM Phils. should be taxed at the rate of 10~ because said rate is indicated in the R.P.- West Ger�any Tax Treaty and ~ursuant t�o Article 13, paragraph 2 (b) (iii>, of the RP - US Tax Treaty. CIBM Philippines Inc. vs. Coaaissioner of Internal Revenue, CTA ~ase No. 4308, March 31, 1993 pp. 10-12) In her Answer, Respondent raised as one of her Special and Affirmative Defenses that Petitioner is not entitled to the application of the "�ost favored nation clause" since under the "provisions of the German Tax Tt~eaty, there is 'matching ct~edit' in Get~many of 15,C. and 20~" while there is allegedly no such credit in the !210

DECISION - C.T.A. Case No. 5048 - 6- United States. Hence, according to her, "their payment is not under similar circumstances" and should not therefore be entitled to the "most favored nation clause". The above-cited argument is not of first impression. In fact, such argument was already raised in a Motion for Reconsideration filed by the same Respondent in the above-cited IBM case, supra, and has been accordingly resolved by this Court in a Resolution dated July 21, 1993, thus: It is claimed by the respondent that this Court erred in granting the refund since "petitioner is not entitled to the �most favored ta~ rate' on royalties." <Motion, C.T.A. Records, p.345) The applicable provision of the R.P.-U.S. Ta~ Treaty provides: "Art. 13<2> (b) <iii> � . ~~~ <T>he ta~ imposed by that other Contracting State shall not e~ceed the lowest rate of Philippine ta~ that may be imposed on royalties of the same ~ind paid under similar circumstances to a resident of a third state." <Underscoring supplied) Respondent advanced his argument on the pre~ise that the R.P.-Germany Tax Treaty, which provides for a 10~ tax on royalties, does not apply in the case under consideration. He ar~gued that: "Under the HHX provisions of the German Tax Treaty, there is a �matching credit' in Germany of 15~ and 20~. A perusal of At~t icl e 23 1211

'' DECISION - C.T.A. Case No. 5048 - 7- <Relief from Double Ta~ation of the R. P. -U.S. Ta~ Treaty>, thet~e is no such tax credit so that the IBM WORLD TRADE CORPORATION AND INTERNATIONAL BUSI,NESS MACHINES CORPORATION are not entitled to the '�ost favored nat.ion' ta~ rate on royalties <10~) because their payment of the ta~ is not under similar circumstances i.e., there is 'matching credit' in Germany <20~ for royalties>, while there is no such credit in the U.S. xxx.> <Motion, C.T.A. Records, p.348) Quoted below is the pertinent provisions of the R.P.-Germany Tax Treaty which reads: "Article 24 Relief from Double Taxation 1. Tax shall be deter�ined in the case of a resident of the Federal Republic of Germany as follows: KKK XXX XXX b) Subject to the provisions of German tax law regarding credit for foreign tax, there shall be allowed as a credit against German income and corporation tax payable in respect of the following items of income arising in the Republic of the Philippines, the tax paid under the laws of the Philippines and in accordance with this Agreement on: XXX XXX KKK dd) royalties, as defined in paragraph 3 of Article 12; KKK KKK KKK c) For the purpose of credit referred to in subparagraph (b), the Philippine tax shall be deemed to be

DECISION - C.T.A. Case No. 5048 - 8- )()()( )()()( )()()( cc) in the case of royalties for which the tax is reduced to 10 or 15 per cent according to paragraph 2 of Article 12, 20 per cent of the gross a�ount of such royalties." To settle once and for all the legal issue involved in this case, this Court deems it wise to decide on the proper interpretation of the phrase "paid under similar circumstances". Does the phrase refer to tax paid as claimed by respondent or does it refer to royalties paid as advanced by petitioner? A cursory perusal of the provision makes this Court to agree with the petitioner's interpretation. The phrase "paid under similar circumstances" is followed by the phrase "to a resident of a third state". It is clear that what is paid to a resident of a third state is royalty and not tax. Petitioner succinctly put in its "Opposition to Motion for that: Reconsideration" "Respondent is in effect a�ending the provision of the R.P.-U.S. tax treaty. Article 13<2> (b) (iii) speaks of �royalties of the same kind paid under similar circumstances to a resident of third state'. Nowhere does it speak, whether express or implied, of tax paid under similar ~ircumstances. Respondent is reading into the R.P.-U.S. tax treaty something that is clearly not there. The requirement of 'similar circumstances' is in relation to the payment of royalty, not payment of the ta)(. Thus, for instance, the royalty in question paid to a U.S. resident by petitioner (which is neither BOI-registered enterprise nor engaged in a preferred-pioneer activity> is not paid under similar

DECISION - C.T.A. Case No. 5048 - 9- circu�stances as a royalty paid to an Austrian resident by a Philippine company that is BOI-registered and engaged in a preferred-pioneer activity. Also, a royalty paid to a resident of Denmark or Sweden in respect of motion picture films and tapes is not paid under similar circumstances as the royalty herein paid by petitioner ~o its U.S. Clearly, th~ phrase licensors. 'similar circumstances' is used in reference to the payment of the royalty, and not in reference to the payment of tax .. " <Opposition, C.T.A. Records, pp.3&3-364> IN VIEW OF THE FOREGOING, THIS COURT HEREBY "Motion resolves to DENY the s l~espondent' merit. for Reconsideration", for lack of The Entry of Judgment on said case was issued on December 15, 1993 after the Court of Appeals granted petitioner's (herein respondent) withdrawal of the case. (Co��issioner of Internal Revenue vs. IBM Philippines, Inc., C. A. G. R.- SP No. 31791> We do not intend to depart from the wisdom of the said rulings and thus, the sa�e should be applied in the case at bar. Prescinding �from the above discussions, records of the case reveal that petitioner indeed overpaid its payment on royalties in the amount of P372,884.70 <Exh. F> and thus, should be entitled to the refund of said amount.

DECISION - C.T.A. Case No. 5048 - 10 - WHEREFORE, in all the foregoing, respondent is hereby ORDERED to ISSUE a TAX CREDIT CERTIFICATE in the amount of P372,884.70 in favor of the petitio SO ORDERED. . ' f . o / RAMON 0. D: :tv'IM Associate Judge WE CONCUR: Q.....x;;-Q. ~ ERNESTO D. Associ CERTIFICATION I hereby certify that this decision was reached after due consultation among the members of the Court of Tax Appeals in accordance with Section 13 Article VIII of the Constitution. ~Q,~ ERNESTO D. ACOSTA Presiding Judge Court of Tax Appeals