CTA Case No. 5115 (Decision)

REPUBLIC OF THE PHILIPPINES COURT OF TAX APPEALS QUEZON CITY AHMCO-MURSTEEL ALLOY CORPORATION, C.T.A. CASE NO. 5115 Petitioner�, Pr�omu 1gated: - versus - FEB 06 1996 ; ; : ; COMMISSlONER OF INTERNAL REVENUE, Respondent. X- - - - - - - - - - - - - - - - - - - - - - - - - - - X DECISION This is a judicial clai� for the refund of alleged overpaid withholding tax on royalties made by the petitioner from the period starting July of 1992 to October of 1993 .in the amount of P769,579.68. Petitioner is a domestic corporation organized and existing under and by virtue of the laws of the Philippines and is register-ed with the Board of Investments as a preferred pioneer enterprise engaged in the production and manufacture of grinding balls. Under a Technical Aid Agreement, which was initially executed in 1972 and extended several times to cover the pr-esent c 1a i 11 for refund, ARMCO, Inc. a corporation du 1 y organized under the laws of Ohio, USA, granted petitioner a non-exclusive license to manufacture and sell grinding 210

DECISION - C.T.A. CASE NO. 5115 -2- balls using its trademark. In addition, ARMCO, Inc. <USA> in to ptn~suance such an agree�ent, shall provide technical assistance and know-how to petitioner which are essential in the continued manufacture and sale of its prod1..1cts. In consideration of the licenses granted as well as the technical assistance it will receive under the agreement, petitioner agreed to pay ARMCO, Inc. royalty the rate of two and one-half percent of its net sales of the licensed products. This agreement was registered with the Bureau of Patents, and Technology Transfer evidenced by a certificate of registration dated November 9, 1992 <Exhibit "T"). The petition alleges that it paid 15~ withholding tax on the royalty payments it remitted to its licensot~, ARMCO, Inc. <USA> ft~om the per~iod beginning J\1ly, 1992 to October 1993 pursuant to Revenue Memorandum Circular No. 39-92 which provides that a 15~ tax rate is imposed on royalty payments made by BOI-,~eg i st ered pi on eel~ enterpr~ise as the payments made to German and U.S. residents are not made "tinder similar circumstances". However, because of the decision rendered by this Court in the case entitled IBM Philippines, lnc. vs. Co��issioner of Internal Revenue, CTA Case No. 4308, March 31, 1993, where we upheld t h e 10~ tax r~ a t e i n s t e ad 211

DECISION - C.T.A. CASE NO. 5115 - 3- of the 15~ earlier imposed, petitio~er filed a claim for refund/tax credit in the sum of P7G9,579.&8 representing the difference between the 15~ tax t~ate it had already withheld and the 10~ rate that should have been paid. This claim for refund which was dated December &, 1993 and received by respondent on Dece�ber B, 1993 was not acted upon, hence petitioner filed a petition for r~eview with this Court on June 1, 1994. Respondent expressed its resistance to the clai� by the following Special and Affir�ative Defenses in her answer, thus: SPECIAL AND AFFIRMATIVE DEFENSES B. Petitioner's claim for~ refund of alleged overpaid withholding tax on .~oyalty payments is still under investigation/ examination by the BIR; 9. Petitioner should be taxed at the rate of 25~ withholding tax on royalties under At~ticle 13<2><b><i> or 15~ of the gross a�ount of t~oyalties <Art. 13<2> (b) <ii) i f petitioner~ is registered with the Philippine Board of Investments and engaged in preferred areas of activities and not 10~ withholding tax on royalties in accordance with Article 12<2) (b) of the RP-West Germany Tax Treaty; a�� 10. Petitioner is not entitled to the most favored nation rate of 10)( because under� Article 13(2) (b) (iii) of the RP-US Tax Tr�eat y sa i d r a t e 111 a y be a v a i 1 e d on on 1 y ~i...:f_~p'""'a""'le...d===--'~-'.:..:n:.::d~e;...:..r similar circumstances to a resident of a Third State, thus: "(iii) the lowest t~at e of Philippine tax that may be imposed on royalties of the same kind paid undet~ 212

DECISION - C.T.A. CASE NO. 5115 �' - 4- similar circumstances to a resident of a third State." The "most favot~ed nation: tax t~ate on royalties is 10~ as provided in the RP-Germany Tax Treaty, quoted as follows: "2. Howev et~, such royalties may also be taxed in the contracting State in which they arise, and according to the law of that State, but the so charged shall not exceed: X)(X X)(X XXX "(b) 10 per cent of the gross amount of royalties arising from the use of, ot~ the t~ight to use, any patent, trade mark, design or model, plan, secret for�ula 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" <At~ticle 12, Section 2(b)." However, in relation to the foregoing provisions, the said treaty further provides: Relief from Double Taxation 1. Tax shall be detet~mined in the case of a resident of the Federal Republic of Germany as follows: XXX X)(){ XX)( (b) Subject to the provisions of German tax law regarding credit fot~ fot~eign tax, thet~e 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: 213

DECISION - C.T.A. CASE NO. 5115 - 5- 11 1<1<1< (dd) royalties, as defin�>d in paragraph 3 of Article 12; "<c> For the purpose of cr~edit referred to in subparagraph (b) the Philippine tax shall be de�>med to be XXX XXX XXX <cc> in the case of royalties for which the tal< is reduced to 10 or 15 oer cent according to paragraph 2 of Article 12, 20 per cent of the gross amount of such royalties. <underlining supplied) From the foregoing provisions, it is evident that Article 13<2> (b) <iii> of the RP-US TaK Treaty is not applicable in this case. According to said Article, the taK imposable on royalties derived by a third State from sources within the Philippines shall be the lowest rate of Philippine taK that may be imposed on royalties of the same kind paid under similar circumstances. Although Article 12(2) (b) of the RP-West Germany tax treaty imposes a lower rate of 10~ royalties derived from sources within the Philippines, said r-ate cannot be availed of because the payment of such tal< is not under similar credit granted by the United States. 11. Article 24 (Relief from Double Taxation of the RP-West Germany Tax Treaty> grants 20~ for royalties whereas a perusal of Article 23 <Relief from Double Taxation of the RP-US Tax Treaty) shows no provision for such tax cr~edit. Petitioner is, ther~efor~e, not entitled to the preferential rate of 10~ on royalty remittance because their payment is not under similar circumstance; 12. Rulings previously issued by the respondent's Bureau allowing the availment of the benefits of the "most favor~ed nation" clause on payments of royalties to recipients 214

DECISION - C.T.A. CASE NO. 5115 - 6- in the United States have already been revoked effective January 21, 1992, und�r RMC No. 39-92 d at e d J u 1 y 1, 1992 ; 13. The taxes sought to be refunded in this case was collected in accordance with law and applicable BIR Rulings and regulations; 14. The claim for tax t~efund, being in the nature of an exe�ption fro� taxation must be construed strictly against petitioner Insular Lumber Co. vs. Court of Tax Appeals, 104 SCRA 710 (1984>. The fate of the present petition depends entirely on the resolution of two issues, thus: 1> Whether or not the royalty payments remitted by petitioner to its licensor in the USA are subject to the 10~ withholding tax; 2> Whethet~ or not petit i onet~ is entitled to the of P769,579.68 representing alleged withholding tax on royalties. The foregoing issues are far from uniq11.ae as they have been comprehensively passed upon in a numbet~ of cases decided by this Court, some of which are hereinbelow mentioned, thus: Kimberly-Clark Corporation (USA> and Kimberly- Clark Philippines vs. Commissioner of Internal Revenue, CTA Case No. 4288, January 30, 1992; 2> Electric Philippines Met et~ and Instrument Company vs. Commissioner of Internal Revena..ae, CTA Case No. 4158, December 5, 1991; ,. 215

DECISION - C.T.A. CASE NO. 5115 - 7- 3) IBM Philippines, Inc. vs. Commissioner of Internal Revenue, CTA Case No. 4308, March 31, 1993; and the most .~ecent, 4> Smith-Kline and French Overseas Company vs. Commissioner of Internal Revenue, CTA Case No. 5048, September 22, 1995. In all of the cases afo-t~eci ted, this Cot..wt subscribed to the view by the then CoMmissioner of Internal Revenue Bienvenido Tan, Jr. in BIR Ruling No. 456-88 to the effect that, under the most favored nation provision of the R.P.-U.S. <Article 13, paragraph 2(b) (iii), the ta~ imposable on royalties derived by a resident of the United States fro1111 sources within the Philippines shall be the correct rate of Philippine ta~ that may be imposed on royalties of the same kind paid under similar circumstances to a resident of a third state. This correct rate mentioned in the R. P. -U.S. Tax Treaty can be found under Article 12, paragraph 2<b> of the R.P.-West Germany Tax Treaty which provides that royalties arising in the Philippines and paid to a resident of West Germany 1111ay also be ta~ed in the Philippines, but the tax so charged shall not e~ceed 10~ of the gross amount of royalties. This treaty also pt�ovides that the 10" tax t�ate shall apply as 1 ong as the 216

DECISION - C.T.A. CASE NO. 5115 - 8- contract giving rise to such royalties has been approved by Philippine competent authorities. In the instant case the agreements entered into between petitioner and ARMCO, Inc., USA is t~egistered with the Technology Transfer Board of the Department of Tt~ade and Indust.~y (E>ehibit "T"> thus., it f o 11 ows that by virtue of such approval, the royalties arising from such an agreement should be ta>eed at the rate of 10~ and not 15~ as opined by respondent. To further seal its case against the claim for refund, respondent proposed the theory that the petitioner is not entitled to the �ost favored nation rate of 10~ because said rate �ay be availed of only if paid under si�ilar circumstances to a resident of a third state. This theory was a result of the correlation made by respondent between Article 13(1) <iii> of the R.P.-U.S. Ta>e Treaty with provisions of the R.P.-West Article B<1> (iii> of the R.P.-U.S. Ta>e Treaty provides the following: Article 13. )()()( )()()( )()()( ( 1) )()()( (iii> The lowest rate of Philippine ta>e that may be imposed on royalties of the sa�e kind paid under similar circu�stances to a resident of a third State. 217

DECISION - C.T.A. CASE NO. 5115 - 9- Under the provisions of the German Tax Treaty, there is a matching credit in Germany of there is allegedly no such credit in the United States, th\.IS the pht~ase "under similar circumstances" provided for in the aforequoted provision of the US Tax Treaty does not apply making the 10~ rate not applicable in the instant case. Again, the argument propounded by the respondent is not novel as such argument was already raised in a Motion for Reconsideration in the JBM case and duly disposed of in our Resolution dated July 21, 1993, thus: Jt is claimed by the respondent that this Court erred in granting the refund since "petitionel~ i s not entitled to the �most favored tax rate' on royalties." <Motion, C.T.A. Records, p. 345) The applicable provision of the R. P. -U.S. Tax Treaty provides: "Al~t. 1 3 ( 2) (b) ( i i i ) � X X X (l) he tax imposed by that other Contracting ....... State shall not exceed 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." <Underscoring supplied) Respondent advanced his argu�ent on the premise that the R.P.-Ger�any TaK Treaty, which provides for a 10~ taK on royalties, does not apply in the case under consideration. He ar-gued that: "Undel~ the XXX provisions of the German Tax Treaty, there is a 218

DECISION - C.T.A. CASE NO. 5115 10 - 'matching ct~edit' in Get~many of 15" and 20". A perusal of Article 23 <Relief from Double Ta~ation of the R. P. -U.S. Ta~ Tr~eaty>, thet~e is no such ta~ credit so that the IBM WORLD TRADE CORPORATION AND INTERNATIONAL BUSINESS MACHINES CORPORATION at~e not entitled to the 'most favored nation' ta~ rate on royalties <10"> because their payment of the taH 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. ~~~.) <Motion, C.T.A. Records, p.348) Quoted below is the pertinent provisions of the R.P.-Germany Ta~ Treaty which reads: "Article 24 Relief from Double Ta~ation 1. Ta~ shall be determined in the case of a resident of the Federal Republic of Germany as follows: )(~X XXX ~)(X 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 cot�por�at ion tax payab 1e 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 ~XX X X>< dd) t�oyalties, as defined in paragraph 3 of Article 12; XXX x~x XXX c) For the purpose of credit referred to in subparagraph <b>, the Philippine tax shall be deemed to be 219

DECISION - C.T.A. CASE NO. 5115 - 11 - )(}(}( )(}()( )()()( cc) in the case of royalties for which the ta~ is reduced to 10 or 15 per cent according to paragraph 2 of Article 12, 20 per cent of the gross amount 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 si�ilar circumstances". Does the phrase refer to ta~ 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 ..mdet~ simi Jar circumstances" is followed by the phrase "to a resident of a third state". It is clear that what is paid to a resident of state is royalty and not ta~. Petitioner succinctly p ... t in its "Opposition to Motion fot~ that: Reconsideration" "Respondent is in effect a~~tending the provision of the R.P.-U.S. ta~ treaty. Article 13(2) (b) (iii) speaks of �,~oyalties of the same kind paid under similar circu�stances to a resident of third state'. Nowhere does it speak, whether eKpress or� implied, of taK paid under similar circumstances. Respondent is reading into the R.P.-U.S. taK treaty so�ething that is clearly not there. The requirement of 'similar c i rc u ms t � n c e s' i s i n r� e 1at i on t o the payment of royalty, not payment of theta~. Thus, fot~ 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 circumstances as a royalty paid to an 220

DECISION - C.T.A. CASE NO. 5115 - 12 - Austrian resident by a Philippine company that is BOI-regi�tered and engaged in a preferred-pioneer activity. Also, a t~oyalty paid to a resident of Denmark or Sweden in respect of �otion pictur� fil�s and tapes is not paid under si�ilar circumstances as the royalty herein paid by petitioner to its U.S. licensors. Clearly, the phrase 'similar circumstances' is used in reference to the payment of the royalty, and not in t~efet~ence to the payment of tax." <Opposition, C.T.A. Records, pp.363-364) IN VIEW OF THE FOREGOING, THIS COURT HEREBY "Motion resolves to DENY the respondent's met~i t . for Reconsideration", for lack of As to the factual basis of petitioner's claim, We find that it has successfully established the a�ount sought to be refunded. Petitioner formally offered the monthly remittance returns <Form No. 1743 W> covet~ing the pet~iod July, 1992 to October, 1993 <Exhibits "A" t p "P", pages 60 to 75, CTA .~ecords>. The amounts so verified are listed be 1ow, thus: July, 1992 Exhibit RoyaJty lax Shou)d 011rrpay1tnt August �A� Frr lhttlM)d Br J5,2ft6.ll Septeeber US1J Sl 1 205.9o\ October �a� 7~,~65 ()(11) 58.330.63 Noveeber �c� lOS. 738.99 o\9,797.49 Deceeber �o� 1,~, 118.80 ISJ.6l7.82 70,ft92.66 52,313. o\6 l, 166.612.60 17ft,991.89 102, o\ll. 88 3ft,Sll.l9 Jan~&arV, 1993 �E� 1o\9, 392. o\6 ll6.66l.26 o\9,606.81 9CJS.9ft9.73 156. 9o\O.l9 99,59ft.97 "F� IOJ. 594.16 "6" 1,~269.27 148,820.U 1~,626.93 690,627.73 69,062.77 992,136.20 99,213.62 221 l

DECISION - C. T. A. CASE NO. 5115 - 13 - Frbruary "H" 680,W1.~0 10Z,090.2J 68,060.14 l',030.07 104,689.05 5Z,l'4.5Z ~rrh ")" 1,046,890.47 157,033.57 59,'170.99 29,985.50 '17,539.05 48, 76'!1.53 April "J" 599,709.93 89,956.49 116,586.23 58,293.11 tlay 114,&.03 57,446.01 Junr "K" 975,390.53 146,308.58 88,356.43 44,J18.ZZ July 174,913.24 87,456.62 Augu!>t "l" 1,165,862.27 J14,879.l' 52,088.10 26.044.05 Srptubrr l,S.rJ, ~~-.15 7691579.68 Dl:tobrr ""N""" I, 148,920.27 172,338.04 TOTA.. 883,564.33 J32,SM.65 "0" I, 749,132.40 2'6Z,369.86 "P" 520,881.00 78,132.15 n. 15, ;m, ~J. 58 2, JOB., 1 oJ WHEREFORE, in view of the foregoing, respondent is hereby ordered to issue a TAX CREDIT CERTIFICATE in the a�ount of P769,579.68 in favor of petitioner. SO ORDERED. ~~ . ~ (v I ERNESTO D. ACOSTA Presiding J\.tdge CERTIFICATION I hereby ~ertify that this decision was reached after due consultation a�ong the me�bers of the Court of Tax Appeals in a~cordance with Section 13, Article VIII of the Constitution. ~\Q'~ ERNESTO D. ACOSTA Pt~es i ding J1..1dge Court of Tax Appeals ��"! 222