CTA Case No. 5212 (Decision)

REPUBLIC OF THE PHILIPPINES COURT OF TAX APPEALS QUEZON CITY SYSTEMATICS, INC., (Currently ALLTEL FINANCIAL INFORMATION SERVICES, INC.), Petitioner, - versus - C.T.A. CASE NO. 5212 COMMISSIONER OF INTERNAL REVENUE, Respondent. X- - - - - - - DECISION This is a claim for the refund of P1,475,172.68 representing alleged overpaid withholding taxes on royalties remitted to the petitioner by the Bank of the Phi I ippine Islands (BPI) for the months of February and June, 1993. Pet I t i on e r i s a Ph i I i pp I ne rep res e nt at i ve of f i c e of Systematics, Inc., a non-resident foreign corporation organized and existing under the laws of Arkansas, U.S.A. On April 30, 1989, Petitioner entered into a license agreement with the Bank of the Philippine Islands <BPI), a banking corporation organized and existing under the laws of the Phi I ipplnes. This I icense agreement was cal led "Investment Charter Software License Agreement". Under such an agreement, petitioner granted B~l a non- exclusive I icense to use its software specified therein and in exchange, BPI agreed to pay royalties to the petitioner in an amount equal to 5% of the net amount it

DECISION - C.T.A. CASE NO. 5212 - 2- received from its service bureau customers. This I icense agreement entered into between petitioner and BPI was registered with the Technology Transfer Registry of the Bureau of Patents, Trademark and Technology Transfer (Exhibit "F"). Petitioner alleges that for the months of February and June, 1993, BPI withheld a final tax of 35% on the royalties it received as a consequence of the aforementioned agreement. The withholding taxes that were paid are detailed hereunder as follows: Amount of Tax Rate Amount of Income Payment Tax Withheld 35% p 72,224.37 35% p 25,278.53 4,085.17 35% 1,429.81 5,824,381.14 2,038,533.40 P5,900,690.68 P2,065,241 .74 On March 6, 1995, petitioner filed with the Bureau of Internal Revenue a claim for a tax credit/refund in the amount of P1,475,172.68 (Exhibit "G") declaring therein that BPI erroneously withheld a 35% final tax on its royalties. It further claimed that the correct amount of final withholding tax should only be 10% as enunciated by this Court in the case entitled IBM Philippines, Inc. v. Commissioner of Internal Revenue, CTA Case No. 4308, dated March 31, 1993, pursuant to

DECISION - C.T.A. CASE NO. 5212 - 3- Article 13(2)(4)(b)(i i i) of the RP-US Tax Treaty in relation to Article 12 of the RP-West Germany Tax Treaty, which grants a preferential rate of 10% on royalties derived by a resident of the U.S. from sources within the Phi I i pp i nes. Furthermore, BIR Ruling No. 79-91, dated May 3, 1991, categorically stated that all I icense fees and royalties arising in the Phi I ippines and payable to petitioner are subject to a preferential 10% withholding tax under the aforementioned treaties (Exhibit "1"). Petitioner did not wait for the response of respondent, instead it immediately elevated this cause of action with this Court by the filing of a petition for review on March 10, 1995. The allegations contained in this petition merely mirrored those which were already proposed in the administrative level. Respondent, on the other hand, expressed her objections to this claim for refund or tax credit by setting forth the following Special and Affirmative Defenses, thus: 4. The cited case of IBM Phi I ippines vs. Commissioner of Internal Revenue (CTA Case No. 4308) rei ied upon by petitioner in its herein claim for tax refund is not applicable to the instant case; �~ 5. The decision in the aforesaid CTA Case No. 4308 did not expressly declare RMC No. 39-92 as nul I and void and of no effect.

DECISION - C.T.A. CASE NO. 5212 - 4- Neither did it revoke the same, hence, RMC No. 39-92 sti I I stands valid and enforceable; 6. Beginning January 21, 1992, the tax I iabi I ities which accrue or become payable as royalty payment shal I be determinad at the correct tax rate under the conditions provided for in RMC No. 39-92; 7. The "most favored nation" clause provision found in Article 13(2)(b)(i i i) of the RP-US Tax Treaty which was invoked and made the basis of the decision in the IBM Corporation case can no Ianger be ava i Ied of in the instant case by reason of RMC No. 39-92 dated July 1, 1992 which provides that "rulings previously issued by the Bureau of Internal Revenue allowing avai lment of the benefit of the 'most favored nation clause' on payment of royalties to recipients in the United States are revoked effective January 21, 1992"; 8. The situation on royalties of the contracting parties under the RP-US Tax Treaty is not similar to that under the RP-West Germany Tax Treaty for the reason that the matching credit of 20% for royalties arising in the Phi I ippines allowed under the RP-West Germany Tax Treaty is not available under the RP-US Tax Treaty; 9. The taxes sought to be refunded in this case were collected in accordance with law and applicable BIR rulings and regulations; 10. Petitioner, who has the burden of proving that it is entitled to tax refund, has fa i Ied to estab I ish that the tax subject of its claim for refund was erroneously or i I legally collected. The facts as presented I ead Us to the fo I I owing issues: 1. Whether or not the royalties received by herein petitioner should be taxed at the rate of 10% withholding tax in accordance with

DECISION - C.T.A. CASE NO. 5212 - 5- Article 12(2) of the RP-West Germany Tax Treaty; and 2. Whether or not petitioner is entitled to a tax credit/refund of P1,475,172.68, representing alleged overpaid withholding tax on royalties it received from sources within the Phi I ippines. Petitioner anchors its legal claim on the decision promulgated by this Court in the case entitled IBM Philippines v. Commissioner of Internal Revenue, CTA Case No. 4308, dated March 31, 1993, which upheld the wisdom of the BIR Ruling No. 456-88, rendered by then Commissioner of Internal Revenue, Bienvenido Tan,� Jr., where it was proclaimed that under the "most favored nation provision" of the RP-US Tax Treaty, the tax imposable on royalties derived by a resident of the United States from sources within the Phi I ippines shall be 10% and not 35%. Respondent contested the most favored nation provision rei ied upon by the petitioner and argued that in the I ight of the issuance of Revenue Memorandum, Circular No. 39-92, dated July 1, 1992, all the rulings issued by the Bureau of Internal Revenue recognizing the most favored nation provision are revoked effective January 21, 1992, thus the correct withholding tax rate <;,:. is 35% and not 10% as claimed by herein petitioner. This Court is all too fami I iar with the legal issue that presently confronts Us and in a long I i ne of

DECISION - C.T.A. CASE NO. 5212 - 6- decisions including the much-quoted IBM case aforecited, We have remained resolute in upholding the declarations proclaimed by the former Commissioner, Bienvenido Tan, Jr. , in BIR Ruling No. 456-88. A portion of the aforementioned IBM case is quoted hereunder, thus: "This Court is of the persuasion that petitioner's stand is correct and concurs with the opinion rendered by the 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 Phi I ippines shall be the lowest rate of Phi I ippine tax that may be imposed on royalties of the same kind paid under simi far 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 Phi I ippines and paid to a resident of West Germany may also be taxed in the Phi I i pp i nes, but the tax so charged sha I I not exceed 10% of the gross amount of royalties. Said treaty also provides that for as long as the t~ansfer of technolo~y under Phi I ippine law, is subject to approval, the I imitation of the tax rate in case of royalties arising in the Phi I ippines, apply if the contract giving rise to such royalties has been approved by Phi I i pp i ne competent authorities." � We have reiterated the aforequoted ru I i ng in disposing of simi far and repetitive issues in the following cases: 1. Abbot Laboratories, <Phi I ippines) v. Commissioner of Internal Revenue, CTA Case No. 5119, September 9, 1996;

DECISION - C.T.A. CASE NO. 5212 - 7- 2. S.C. Johnson and Sons, Inc. v. Commissioner of Internal Revenue, CTA Case No. 5136, May 7, 1996; 3. Armco Marsteel AI loy Corporation v. Commissioner of Internal Revenue, CTA Case No. 5115, February 6, 1996; 4. Gillete (Philippines), Inc. v. Commissioner-of lnter~al Revenue, CTA Case No. 4248, February 8, 1995; 5. SmithKI ine and French Overseas Company v. Commissioner of Internal Revenue, CTA Case No. 5048, September 22, 1995; 6. General Electric Phi I ippines Meter and Instrument Co., Inc. vs. Commissioner of Internal Revenue, CTA Case No. 4158, December 5' 1991 i 7. IBM Phi I ippines, Inc. v. Commissioner of Internal Revenue, CTA Case No. 4308, March 3, 1993; and 8. Kimberly-Clark Corporation (USA) and Kimberly-Clark (Phi I ippines) Inc. v. Commissioner of Internal Revenue, CTA Case No. 4288, January 30, 1992. The conclusions that a 10% withholding tax rate shall be imposed on royalties derived by a resident of the U.S. from sources within the Phi I ippines, was based on the analysis of the fc;>llowing provisions found in the RP-US Tax Treaty particularly Art i c Ie 13, paragraph 2(b)(iii), in relation to Article 12, paragraph 2(b) of the RP-West Germany Tax Treaty which are alI quoted ..... hereunder, thus:

DECISION - C.T.A. CASE NO. 5212 - 8- Article 13. (RP-US Tax Treaty) (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 the United States, 15 percent of the gross amount of the royalties; and (b) In the case of the Phi I ippines, the least of, ( i > 25 percent of the gross amount of the royalties; (i i) 15 percent of the gross amount of the royalties where the royalties are paid by a corporation and registered with the Phi I ippine Board of Investments and engaged in preferred areas of activities; and (iii> the lowest rate of Phi I ippine tax that may be imposed on royalties of the same kind paid under similar circumstances to a resident of a Third State." (Underscoring supplied) Article 12(2)(b). <RP-West Germany Tax Treaty) "2. However, such royalties may also be taxed in the Contracting State in which they arise, and according to the law of that State, but the tax so charged shal I not exceed. (b) 10% of the gross amount of royalties arising from the use of, or the right to use, any patent, trademark, design or mode I, pI an, secret formula or process, or from the use of,

DECISION - C.T.A. CASE NO. 5212 - 9- or the right to use, industrial, commercial, or scientific equipment or for information concerning industrial, commercial or scientific experience. A careful reading of the abovequoted Article 13 paragraph 2(b)( iii> of the RP-US Tax Treaty reveals that a lower tax rate shal I be granted to residents of the United States on royalties derived from the Phi I ippines, if a similar Iower rate is granted by the Phi I i pp i nes to a resident of another state by virtue of a tax treaty. Such Iower rate is found in the RP-West Germany Tax Treaty, particularly Article 12(2)(b) aforequoted. The interrelationship of the pertinent provisions found in these two tax treaties resulted in a lower tax rate of 10% Instead of the 35% originally imposed by the Tax Code. The relationship of these two tax treaties also dictated certain conditions before the 10% tax rate shal I apply. First, the royalties must be derived from the use of, or the right to use industrial, commercial or scientific equipment, or for information concerning industrial, commercial or scientific experience. Secondly, the I lcense agreement from where the royalties arose must be registered with Philippine '"competent authorities.

DECISION - C.T.A. CASE NO. 5212 - 10 - The evidence presented by herein petitioner reveal that the royalties it received from BPI were as a result of the latter's right to use the former corporation's software <Exhibit "A") and that this agreement entered into between these two companies were duly registered and approved by the Department of Trade and Industry particularly the Technology Transfer Registry of the Bureau of Patents, Trademarks and Technology Transfer (Exhibit "F"). The above discussion settles the legal issue on the rate of withholding tax to be imposed on royalties remitted to a resident of the United States. We are now confronted with the factual aspect of the claim for refund, that is 1 whether or not petitioner has satisfactorily proven its entitlement to the amount of P1,475,172.68 representing alleged overpaid withholding taxes on royalties for the months of February and June, 1993. To prove its cla.im, petitioner presented the monthly remittance returns of BPI, its withholding agent, for the months of February and June <Exhibit "B" and "C") as well as its Annual Information Return of I,:.n. come Tax Withheld on Compensation; Expanded and Final Withholding Taxes of BPI for the year 1993 <Exhibit "D"). In addition, petitioner offered the Schedule of Withholding

DECISION - C.T.A. CASE NO. 5212 - 11 - Taxes on Royalties showing the amounts of P5,900,690.68 and P2,069,241.74, representing the income payments made by BPI and the tax withheld thereon, respectively <Exhibit "E"). Respondent, . for her part, did not propose any objection to the aforementioned evidence and limited her arguments to the legal basis of this instant claim for refund. Moreover, respondent did not submit any memorandum nor offered any evidence to refute the legal and factual bases laid down by the petitioner. In the absence of any substantial objection to the amount claimed, We find the evidence offered by the petitioner sufficient to establish its entitlement to the claim for refund. The amount of P1 ,475, 172.68, represents the difference between the withholding taxes actually paid by petitioner and the correct withholding tax at the rate of 10% on the royalties remitted. The total amount of P1,475,172.67 to be granted to petitioner is computed in detai I as follows: Total amount of royalty P5,900,690.68 35% Withholding Tax Paid 2,065,241.74 Less: Correct Withholding 590,06"9.07 Tax - 10% P1,475,172.67 Amount Refundable

- DECISION - C.T.A. CASE NO. 5212 - 12 - WHEREFORE, in view of the foregoing, respondent is hereby ORDERED to REFUND or ISSUE a tax credit certificate in favor of petitioner the amount of P1,475,172.67, representing overpaid income taxes withheld on royalties for the months of February and June 1993. SO ORDERED. ,_' P. I~I RAMON 0. DE Associate Judge WE CONCUR: ~(S25~ ERNESTO D. ACOSTA Presiding Judge J~~~� I Q. Associ ate ;..- CERTIFICATION I hereby certify tha~ the above deciJion was reached after due consultation with the members of the Court of Tax Appeals in accordance with Section 13, Article VI I 1 of the Constitution. GCQ.~ ERNESTO D. ACOSTA Presiding Judge Court of Tax Appeals