Commissioner of Internal Revenue v. 3M Philippines, Inc.

FIFTEENTH DIVISION [CA-G.R. SP No. 43893. December 13, 2000.] COMMISSIONER OF INTERNAL REVENUE , petitioner , vs . 3M PHILIPPINES, INC. , respondent . D E C I S I O N DE GUIA-SALVADOR , J p : This is a petition for review under Rule 43 of the 1997 Rules of Civil Procedure which seeks to revise the decision of the Court of Tax Appeals ( CTA ) dated March 25, 1997 in C.T.A. Case No. 5118 granting 3M Philippines, Inc.'s (or " respondent ") claim for refund of their overpaid withholding tax on royalty payments for the period July 1992 to October 1993. The facts of the case which are undisputed are set forth in the assailed decision of the CTA, to wit: "Petitioner, a domestic corporation organized and opening under Philippine laws, entered into a Patent and Trademark License and Technical information Agreement with Minnesota Mining and Manufacturing Corporation (MMMC) (Exhs. "B" and "A"), a non-resident foreign corporation duly organized and existing under the laws of the State of Delaware, United States of America. Pursuant to this agreement, petitioner was granted the right to use the trademark, patent and technical information owned by the latter for the manufacture of household and industrial tapes, adhesives, abrasives, coatings and sealers, reflective paints and tapes and health care products. "The said license agreement as amended was duly registered with the Technology Transfer Registry of the Bureau of Patents, Trade Marks and Technology Transfer as evidence by Certificate of Registration No. 989-A (Exh. "C"). For the use of the trademark or technology, petitioner was obligated to pay MMMC royalties computed at three and one-half percent (3.5%) of net sales for locally manufactured products and two and one-half percent (2.5%) of net sales for converted products (Exh "A"), these royalty payments were subjected to 25% withholding tax by the petitioner, acting as the withholding agent, for the period covering July 1992 to October 1993 in the total amount of P3,593,021.83 (Exhs. "F" to "V", inclusive) and the same were remitted to the Bureau of Internal Revenue (BIR). On April 18, 1994, petitioner filed with the BIR a claim for refund or tax credit of overpaid withholding taxes on royalties premised on the application of the most favored nation clause provision of the RP-US Tax Treaty in relation to the RP-Germany Tax Treaty granting a preferential rate of 10% on royalties derived by a resident of the United States from sources within the Philippines (Exh "X"). Petitioner's claim for the refund of P2,155,813.10 was computed as follows: (Exh. "W", p. 176, CTA rec.) MONTH/ TECHNICAL 10% COLLECTIBLE EXH. YEAR SERVICE FEE 25% TAX PAID (SHLD BE) FROM THE BIR F Oct. 1993 P1,402,259.04 P350,564.76 P140,225.90 P210,338.86 G Sep. 1,113,366.08 278,341.52 111,336.61 167,004.91 H Aug. 957,567.32 239,391.83 95,756.73 143,635.10 I Jul. 874,171.72 218,542.93 87,417.17 131,123.76 J Jun. 728,519.11 182,129.78 72,831.91 109,277.87 K May 879,324.83 219,831.21 87,932.48 131,898.73 L Apr. 561,380.16 140,345.04 36,138.02 84,207.02 M Mar. 1,186,493.08 296,623.27 118,649.31 177,973.96 N Feb. 1,005,301.42 251,325.36 100,530.14 150,795.22 O Jan. 1,019,231.72 254,807.93 101,923.17 152,884.76 P Dec. 1992 467,231.78 116,807.94 46,723.18 70,084.76 Q Nov. 579,901.24 144,975.31 57,990.12 86,985.19 R Oct. 1,095,175.75 273,793.94 109,317.58 164,276.36 T Sep. 773,852.01 193,463.00 77,385.20 116,077.80 U Aug. 724,790.66 181,197.67 72,479.07 108,718.60 V Jul. 1,003,521.36 250,880.34 100,352.14 150,528.20 P14,372,087.28 P3,593,021.83 P1,437,208.73 P2,155,813.10 ============ ============ ============ ============ ( Rollo, pp . 30-32 ) On the failure of petitioner Commissioner of Internal Revenue (or "petitioner" ) to act on the letter-request of respondent, respondent, as petitioner, filed a claim for refund or tax credit of the overpaid withholding tax on royalties paid to MMMC for the period July 1992 to October 1993 with the CTA docketed as CTA Case No. 5118. HAaDTE On March 25, 1997, the CTA rendered its assailed decision granting respondent's claim for refund, the decretal portion of which reads: " WHEREFORE , in view of the foregoing, Respondent is hereby ORDERED to REFUND or in the alternative ISSUE a TAX CREDIT CERTIFICATE in favor of the petitioner in the amount of P2,155,813.10, representing overpaid withholding tax on royalty payments for the period beginning July 1992 to October 1993. SO ORDERED ." ( supra , p. 35) Hence, this petition for review with the lone assignment that: 'THE COURT OF TAX APPEALS ERRED IN RULING THAT MINNESOTA MINING AND MANUFACTURING CORPORATION (MMMC) IS ENTITLED TO THE 'MOST FAVORED NATION' TAX RATE OF 10% ON ROYALTIES AS PROVIDED IN THE RP-US TAX TREATY IN RELATION TO THE RP-WEST GERMANY TAX TREATY." Specifically, the petition raises the sole issue of whether or not respondent is entitled to the refund of the amount of P2,155,813.10 allegedly representing overpaid withholding tax on royalties paid to MMMC for the period July 1992 to October 1993. Tax refunds are in the nature of tax exemptions. As such, they are regarded as in derogation of sovereign authority and to be construed strictissimi juris against the person or entity claiming the exemption. ( Commissioner of Internal Revenue vs. Tokyo Shipping Co., Ltd . , 244 SCRA 332; Magsaysay Lines, Inc. vs. Court of Appeals, 260 SCRA 513 ) The burden of proof is upon him who claims the exemption in his favor to show that his claim is justified by the clearest grant of organic or statute law. ( Wonder Mechanical Engineering Corp. vs. Court of Tax Appeals, 64 SCRA 555 ) In the case at bar, respondent failed to discharge the burden. Anent the rate of tax to be imposed by the Philippines upon royalties derived by a non-resident U.S. corporation from sources within the Philippines, Article 13(2)(b)(iii) of the RP-US Tax Treaty pertinently provides: 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 Contracting State shall 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 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 (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 . (emphasis supplied) xxx xxx xxx" Respondent claims that pursuant to the "most favored nation clause" above-quoted (Article 13, paragraph 2 [b][iii], it is entitled to the preferential or concessional tax rate of 10 percent on royalties provided for in Article 12 (2) (b) of the RP-Germany Tax Treaty which states: (2) However, such royalties may also be taxed in the Contracting State in which they rise, and according to the law of that State, but the tax so charged shall not exceed: xxx xxx xxx b) 10 percent of the gross amount of royalties arising from the use of, 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 equipment, or for information concerning industrial, commercial or scientific experience . (emphasis supplied) EADCHS For as long as the transfer of technology, under Philippine law, is subject to approval, the limitation of the tax rate mentioned under b) shall, in the case of royalties arising in the Republic of the Philippines, only apply if the contract giving rise to such royalties has been approved by the Philippine competent authorities. On the other hand, petitioner contends that respondent cannot invoke the concessional tax rate of 10 percent on the royalties paid to MMMC on the strength of the "most favored nation" clause in the RP-US Tax Treaty because the taxes upon royalties under said treaty are not paid under circumstances similar to those in the RP-Germany Tax Treaty since there is no provision for a 20 percent matching credit in the former treaty. The petition is meritorious. The RP-US and RP-Germany Tax Treaties do not contain similar provisions on tax crediting. Article 24 of the RP-Germany Tax Treaty expressly allows crediting against German income or corporation tax of 20 percent of the gross amount of royalties paid under the law of the Philippines. Article 24 of the RP-Germany Tax Treaty states 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 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 the credit referred in subparagraph 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 to 15 percent according to paragraph 2 of Article 12, 20 percent of the gross amount of such royalties . (emphasis supplied). xxx xxx xxx On the other hand, Article 23 of The RP-US Tax Treaty, which is the counterpart provision on relief for double taxation, does not provide for similar crediting of 20 percent of the gross amount of royalties paid. Said Article 23 reads: "Article 23 Relief from double taxation Double taxation of income shall be avoided in the following manner: 1) In accordance with the provisions and subject to the limitations of the law of the United States (as it may be amended from time to time without changing the general principle thereof), the United States shall allow to a citizen or resident of the United States as a credit against the United States tax the appropriate amount of taxes paid or accrued to the Philippines and, in the case of a United States corporation owning at least 10 percent of the voting stock of a Philippine corporation from which it receives dividends in any taxable year, shall allow credit for the appropriate amount of taxes paid or accrued to the Philippines by the Philippine corporation paying such dividends with respect to the profits out of which such dividends are paid. Such appropriate amount shall be based upon the amount of tax paid or accrued to the Philippines, but the credit shall not exceed the limitations (for the purpose of limiting the credit to the United States tax on income from sources within the Philippines or on income from sources outside the United States) provided by United States law for the taxable year. . ." From the quoted provisions, it is evident that in the case of royalties for which the tax is reduced to 10 to 15 percent according to paragraph 2, Article 12 of the RP-Germany Tax Treaty, the credit shall be 20 percent of the gross amount of such royalty. The RP-US Tax Treaty contains no similar "matching credit." Thus, petitioner correctly argued that since the tax on royalties under the RP-US Tax Treaty is not paid under similar circumstances as those obtaining in the RP-Germany Tax Treaty, the "most favored nation" clause in the RP-Germany Tax Treaty cannot be availed of in interpreting the provisions of the RP-US Tax Treaty. The issue raised before Us has already been settled in the recent case of Commissioner of Internal Revenue vs. S.C. Johnson and Son, Inc ., 309 SCRA 81-109 , which ruled that "entitlement to the concessional 10% rate by U.S. firms despite the absence of a matching credit of 20% for royalties under the RP-US Tax Treaty would derogate from the design behind the most favored nation clause to grant equality of international treatment, since the RP-US Tax Treaty does not grant similar tax reliefs to residents of the U.S. in respect of the taxes imposable upon royalties earned from sources within the Philippines as allowed to their German counterparts under the RP-Germany Tax Treaty. The similarity in the circumstances of payment of taxes, ruled the Supreme Court, is a condition for the enjoyment of most favored nation treatment precisely to underscore the need for equality of treatment." Worthy of note is the interpretation given by the Supreme Court to the phrase "paid under similar circumstances" as used in Article 13(2)(b)(iii) of the RP-US Tax Treaty as referring not to the royalties paid to the similarity in the circumstances of payment of taxes on such royalty. The Supreme Court instructs us on the rationale behind this, thus: "In negotiating tax treaties, the underlying rationale for reducing the tax rate is that the Philippines will give up a part of the tax in the expectation that the tax given up for this particular investment is not taxed by the other country. (T. Toledo, International Institute on Tax Law (1976) @ pp. 18-19) Thus, the petitioner correctly opined that the phrase "royalties paid under similar circumstances" in the most favored nation clause of the US-RP Tax Treaty necessarily contemplated "circumstances that are tax-related." ( supra, pp . 103-104 ) xxx xxx xxx "Given the purpose underlying tax treaties and the rationale for the most favored nation clause, the concessional tax rate of 10 percent provided for in the RP-Germany Tax Treaty should apply only if the taxes imposed upon royalties in the RP-US Tax Treaty and in the RP-Germany Tax Treaty are paid under similar circumstances. This would mean that private respondent must prove that the RP-US Tax Treaty grants similar tax reliefs to residents of the United States in respect of the taxes imposable upon royalties earned from sources within the Philippines as those allowed to their German counterparts under the RP-Germany Tax Treaty. "The RP-US and the RP-West Germany Tax Treaties do not contain similar provisions on tax crediting. Article 24 of the RP-Germany tax Treaty, supra , expressly allows crediting against German income and corporation tax of 20% of the gross amount of royalties paid under the law of the Philippines. On the other hand, Article 23 of the RP-US Tax Treaty, which is the counterpart provision with respect to relief for double taxation, does not provide for similar crediting of 20% of the gross amount of royalties paid. . . ( Ibid., p . 105 ) "At the same time, the intention behind the adoption of the provision on "relief from double taxation" in the two tax treaties in question should be considered in light of the purpose behind the most favored nation clause. ASDTEa "The purpose of a most favored nation clause is to grant to the contracting party treatment not less favorable than that which has been or may be granted to the "most favored" among other countries. ( Salonga, Yap, Public International Law, 255 ) The most favored national clause is intended to establish the principle of equality of international treatment by providing that the citizens or subjects of the contracting nations may enjoy the privileges accorded by either party to those of the most favored nation. ( Black's Law Dictionary, 5th ED ., 913 ) The essence of the principle is to allow the taxpayer in one state to avail of more liberal provisions granted in another tax treaty to which the country of residence of such taxpayer is also a party provided that the subject matter of taxation, in this case, royalty income, is the same as that in the tax treaty under which the taxpayer is liable. Both Article 13 of the RP-US Tax Treaty and Article 12(2)(b) of the RP-West Germany Tax Treaty, above-quoted, speaks of tax on royalties for the use of trademark, patent and technology. " We accordingly agree with petitioner that since the RP-US Tax Treaty does not give a matching tax credit of 20 percent for the taxes paid to the Philippines on royalties as allowed under the RP-West Germany Tax Treaty, private respondent cannot be deemed entitled to the 10 percent rate granted under the latter treaty for the reason that there is no payment of taxes on royalties under similar circumstances ." ( emphasis supplied ) ( supra , pp . 107-108 ) Accordingly, in line with the foregoing doctrinal pronouncement, We hold and rule that respondent is not entitled to the concessional 10 percent tax rate on royalties allowed under the RP-Germany Tax Treaty. WHEREFORE, premises considered, the petition is hereby GRANTED. The decision of the Court of Tax Appeals dated March 25, 1997 is REVERSED and SET ASIDE. SO ORDERED. Reyes and Umali, JJ ., concur.