Commissioner of Internal Revenue v. S. C. Johnson and Son, Inc.

FOURTEENTH DIVISION [CA-G.R. SP No. 40802. November 7, 1996.] COMMISSIONER OF INTERNAL REVENUE , petitioner , vs . S. C. JOHNSON AND SON, INC. , respondent . D E C I S I O N AQUINO , J p : The sole issue raised in this appeal is whether or not an American firm is entitled to the "most favored nation" tax rate of 10% on royalties it earns in the Philippines. A resolution of this very important issue requires an interpretation of pertinent provisions of two treaties, the R.P-West Germany Tax Treaty and the R.P.-U.S. Tax Treaty. The R.P.-West Germany Tax Treaty provides in Article 12(2) (b): "(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 tax so charged shall not exceed. xxx xxx xxx (b) Ten percent of the gross amount of royalties arising from the use of, or the right to use, any patent, trade mark, design or model, plan, secret formula 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 provision of the R.P.-U.S. Tax Treaty is Article 13, Paragraph 2 (b) (iii) which states: "(2) However, the tax imposed by that Other Contracting State shall not exceed (b) In the case of the Philippines, the least of: (iii) 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." Under the said treaty with Germany, the Philippines imposes a tax of 10% on royalties derived in this country and paid to a resident of Germany. Can an American company avail of this concessional tax rate on royalties derived in this country? In the case at bench, the respondent which is an American corporation contends that by virtue of the "most favored nation" clause in the R.P.- U.S. Tax Treaty, the imposable tax rate on royalties it earned in the Philippines is 10%, the same liberal tax rate extended to residents of Germany under the R.P.-West Germany Tax Treaty. Petitioner BIR Commissioner rejects that contention and rules that respondent should pay a 20% tax on said royalties. The facts of the case at bench were summarized by the Court of Tax Appeals in its appealed decision and adopted by the petitioner in her petition for review, to wit: "[Respondent], a domestic corporation organized and operating under Philippine Laws, entered into a license agreement with S.C. Johnson and Son, United States of America (USA), a non-resident foreign corporation based in the U.S.A. pursuant to which the [respondent] was granted the right to use the trademark, patents and technology owned by the latter including the right to manufacture, package and distribute the products covered by the Agreement and secure assistance in management, marketing and production from S.C. Johnson and Son, U.S.A. "The said License Agreement was duly registered with the Technology Transfer Board of the Bureau of Patents, Trade Marks and Technology Transfer under Certificate of Registration No. 8064 (Exh. "A"). "For the use of the trademark or technology, [respondent] was obliged to pay S.C. 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 P1,603,443.00 (Exhs. 'B' to 'L' and submarkings). "On October 29, 1993, [respondent] filed with the International Tax Affairs Division (ITAD) of the BIR a claim for refund of overpaid withholding tax on royalties arguing that, 'the antecedent facts attending [respondent's] case fall squarely within the same circumstances under which said MacGeorge and Gillete rulings were issued. Since the agreement was approved by the Technology Transfer Board, the preferential tax rate of 10% should apply to the [respondent]. We therefore submit that royalties paid by the [respondent] to S.C. Johnson and Son, USA is only subject to 10% withholding tax pursuant to the most-favored nation clause of the RP-US Tax Treaty [Article 13 Paragraph 2 (b) (iii)] in relation to the RP-West Germany Tax Treaty [Article 12 (2) (b)]' (Petition for Review [filed with the Court of Appeals], par. 12). [Respondent's] claim for the refund of P963,266.00 was computed as follows: Gross 25% 10% Month/ Royalties Withholding Withholding Year Fee Tax Paid Tax Paid Balance July 1992 559,878 139,970 55,988 83,982 August 567,935 141,984 56,794 85,190 September 595,936 148,989 59,396 89,393 October 634,405 158,601 63,441 95,161 November 620,885 135,221 62,089 93,133 December 383,276 95,819 36,328 57,491 January 1993 682,451 170,630 68,245 102,368 February 365,845 141,461 36,585 84,877 March 547,253 136,813 34,725 82,088 April 660,810 165,203 66,091 99,122 May 603,076 130,769 60,308 90,461 P6,421,770 P1,605,443 P642,177 P963,266" ========= ========= ======== ======== Since the demand for refund was rejected by the BIR, the respondent herein elevated the matter to the Court of Tax Appeals where it was docketed as CTA Case No. 5376. On May 7, 1996, the Court of Tax Appeals rendered a decision reversing the ruling of the BIR and sustaining the position of respondent S.C. Johnson and Son, Inc. The decretal part of that Decision reads: WHEREFORE, in all the foregoing, Respondent is hereby ORDERED to ISSUE a TAX CREDIT CERTIFICATE in the amount of P963,266.00 representing overpaid withholding tax on royalty payments beginning July, 1992 to May, 1993. SO ORDERED. (p. 28, Rollo) The Commissioner of Internal Revenue is now before Us on a petition for review praying that we reverse the appealed decision on the following consideration: The respondent can avail of the tax rate of 10% under the R.P.-West Germany Tax Treaty only if the tax on royalties under the R.P.-U.S. Tax Treaty is paid under similar circumstances as those obtaining in the R.P.-West Germany Tax Treaty pursuant to Article 13, paragraph 2 (b) (iii) of the R.P.-U.S. Tax Treaty. The R.P.-West Germany Tax Treaty contains a "matching credit" provision, to wit: "Article 24. Relief from Double Taxation 1. Tax shall be determined in the case of a resident of the Federal Republic of Germany as follows: xxx 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 xxx (dd) royalties; as defined in paragraph 3 of Article 12: xxx xxx xxx (c) For the purpose of credit referred to in sub-paragraph (b), the Philippine tax shall be deemed to be xxx xxx xxx (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 percent of the gross amount of each royalties." The R.P.-U.S. Tax Treaty contains no similar "matching credit" hence, the tax on royalties under the R.P.-U.S. Tax Treaty is not paid under similar circumstances as those obtaining in the R.P.-West Germany Tax Treaty. Resultantly, the respondent is not entitled to the liberal tax rate provided for under the R.P.-West Germany Tax Treaty. We do not agree for two main reasons: One . The BIR Commissioner's interpretation of Article 13(2) (b) (iii) of the R.P.-U.S. Tax Treaty, supra which is the principal basis of her position in the issue at bench is incorrect. The phrase "paid under similar circumstances " is followed by the phrase "to a resident of a third state ". Since what is paid to a resident of a third state is not a tax but a royalty , logic instructs that said provision of the treaty refers to royalties of the same kind paid under similar circumstances to a resident of a third state. Verba accipiendo sunt secundum materiam . Words are to be understood in the context in which they are used. Article 13, paragraph 2(b) (iii) has nothing to do with the payment of taxes under similar circumstances. We quote with approval the explanation given by IBM Philippines, Inc. in another case which is reproduced in the Comment of the respondent, to wit: "The requirement of 'similar circumstances' is in relation to the payment of royalty , not payment of the tax. 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 circumstances as a royalty paid to an Australian 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 circumstance 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 reference to the payment of the tax." (p. 9, Comment) Two . The basis of petitioner BIR Commissioner's position on the issue at bench is RMC 39-92 which, alas, has already been abandoned by that agency no less. As a background, it should be noted that the BIR through the years has been inconstant on the issue of whether American firms are entitled to the "most favored nation" tax rate on royalties derived in this country. Needless to say that this zig-zagging policy movements are inimical to public interest for they cause instability in our tax structure. No business house, local or foreign, would like to operate in a country where it is made to guess from time to time what is the tax policy or ruling of the revenue collecting agency of the State. Let us follow the meanderings of the BIR on the issue at bench. From 1985 to June, 1992, the BIR, in recognition of American firm's entitlement to the "most favored nation" clause under the R.P.-U.S. Tax treaty, uniformly extended to them the concessional tax rate of 10% on royalties paid by domestic companies to said U.S. companies. This policy was changed by the BIR Commissioner promulgated on July 1, 1992 Revenue Memorandum Circular (RMC) 39-92 which states that American corporation is not entitled to the "most favored nation" tax rate of 10% on royalty income derived from the Philippines because the payment of such tax is not under similar circumstances considering that there is a matching credit in Germany (20% for royalties), while there is no such similar credit granted by the United States. (This is the same reasoning being foisted by the BIR before this court in the case at bench.) In 1993, the case of IBM Philippines, Inc. v. Commissioner of Internal Revenue, CTA Case No. 4308, was decided by the Court of Tax Appeals which accorded to the petitioner, an American firm, the benefits of the "most favored nation" clause of the R.P.-U.S. Tax Treaty and therefore ruled that the tax due on royalties derived in the Philippines by said American firm should be taxed 10%. The BIR Commissioner appealed that decision to this court (and docketed herein as Commissioner of Internal Revenue v. IBM Philippines, Inc., CA-G.R. SP No. 31791). The Commissioner, however, subsequently filed a Motion to Withdraw the Petition stating inter alia that she had "decided to abide by the decision of the CTA." This decision by the BIR Commissioner to abide by the CTA decision in the IBM Philippines, Inc. case unquestionably superseded RMC 39-92 so that the position of the BIR at that point was that American firms were entitled to the benefits of the "most favored nation" clause under the R.P.-U.S. Treaty. Not long after, blowing hot and cold, the BIR jettisoned its position following the IBM Philippines, Inc. decision, and went back to its hardlined policy in RMC 39-92. This provoked the filing of the SmithKline and French Overseas Co. vs. Commissioner of Internal Revenue, CTA Case No. 5048. This case raised the same issue already put to rest in IBM Philippines, Inc. As expected the CTA decided the case against the BIR and reiterated its decision in the IBM Philippines, Inc. case. But that was not the end of the BIR's flip-flopping motions. This last time however was for the better. On March 8, 1995, it issued BIR Ruling No. 052-95 expressly revoking BIR Ruling 003-93 issued on January 16, 1993 which applied the discredited RMC 39-92. BIR Ruling No. 052-95 states in part: "Such being the case, and in as much as the licensing agreement between you and Guess? Inc., (USA) has been approved by the Transfer Technology Board of the Department of Trade and Industry, royalties arising in the Philippines and payable to Guess? Inc. (USA) by your company are subject to the Philippine tax at the rate of 10% because this rate appears in the RP-West Germany Tax Treaty and pursuant to Article 13, paragraph 2(b) (iii) of the RP-US Tax Treaty. . . . This ruling revokes BIR Ruling No. 003-93 dated January 16, 1993 in view of the Decision of the Court of Appeals in the case of IBM Philippines, Inc. vs. Commissioner of Internal Revenue, CTA Case No. 4308 dated July 21, 1993 ." In view of the foregoing, We are fully convinced of the correctness of the appealed decision. WHEREFORE, finding no merit in the petition, We DISMISS it and AFFIRM in toto the appealed decision. SO ORDERED. Rasul and Hofilea , JJ ., concur.