Commissioner of Internal Revenue v. California Manufacturing Co., Inc.

FIRST DIVISION [CA-G.R. SP No. 44721. September 22, 1999.] COMMISSIONER OF INTERNAL REVENUE , petitioner , vs . CALIFORNIA MANUFACTURING COMPANY, INC. , respondent . D E C I S I O N VIDALLON-MAGTOLIS , J p : Assailed in this petition for review is the Decision of the Court of Tax Appeals (CTA) dated June 27, 1997, granting partially the claim for refund of herein respondent, California Manufacturing Company, Inc. in CTA Case No. 5186, the dispositive portion of which states: cdll "WHEREFORE, finding the instant petition partially meritorious, the Court hereby GRANTS petitioner's claim for refund in the amount of P8,631,804.50, representing overpaid withholding tax on royalties from the period October 1992 to September 1993. Respondent is hereby ORDERED to REFUND in favor of petitioner the amount of EIGHT MILLION SIX HUNDRED FIFTY ONE THOUSAND EIGHT HUNDRED FOUR PESOS AND FIFTY CENTAVOS (P8,651,804.50). "No pronouncement as to costs of suit. "SO ORDERED." The case has its genesis on November 18, 1993 when California Manufacturing Company, Inc. (CMC for brevity) filed before the Commissioner of Internal Revenue (hereinafter referred to as "Commissioner") a claim for a refund in the amount of P14,095,336.50 as alleged overpaid withholding tax on royalty payments to CPC International (Asia) Ltd., Delaware, U.S.A. (CPC Asia for short) corresponding to the year January, 1992 to September, 1993. As a background, CPC Asia entered into a Trademark Licensing Agreement with CMC, whereby for a period of five (5) years, the former would allow the latter to use exclusively certain trademarks in the Philippines. In return, CMC would pay royalties of 1% based on the net sales value of the products sold under the said trademarks. The said agreement was covered by a Trademark Licensing Agreement duly registered with the Bureau of Patents, Trademarks and Technology Transfer (BPTTT) on July 12, 1989, and valid from June 1, 1987 to May 31, 1992. On June 1, 1987, the participating parties also entered into a Technology Licensing Agreement where for a term of five (5) years, CPC Asia, as a service company for CPC U.S.A. and Ajinomoto Company, Inc., would provide CMC technologies of CPC U.S.A. and Ajinomoto, to be used in the manufacture and distribution of certain products in the Philippines. This time, CMC agreed to pay a 2% royalty on the net sales of all products it manufactured and sold. Said agreement was also registered with the BPTTT, and valid from June 1, 1987 to May 31, 1992. The two aforesaid agreements were renewed for another five (5) year term, beginning from June 1, 1992 to May 31, 1997. For the tax year 1992 and the period from January to September 1993, CMC remitted royalties to CPC Asia in the amount of P93,968,907.00 and withheld taxes thereon in the amount of P23,492,227.50, or 25% of the royalties remitted. CMC averred that under Article 13 (2)(b)(iii) of the RP-US Tax Treaty in relation to Article 12 (2)(b) of the RP-West Germany Tax Treaty, the royalties remitted to CPC Asia should only be subject to 10% withholding tax. Consequently, CMC filed a claim with the BIR for a refund or overpaid withholding tax for the corresponding period in the amount of P14,093,336.50, computed as follows: Period Covered Royalty Tax Paid Should Be Tax Amount for Refund (25%) (10%) Jan. - Mar. 1992 P2,752,938.00 P1,101,175.00 P1,651,763.00 Apr. - June 1992 3,169,713.00 1,267,885.00 1,901,828.00 July - Sept. 1992 3,149,902.00 1,259,961.00 1,889,941.00 Oct. - Dec. 1992 4,945,110.00 1,978,044.00 2,967,066.00 Jan. - Mar. 1992 2,926,245.50 1,170,498.00 1,755,747.50 Apr. - June 1992 3,254,565.00 1,301,826.00 1,952,739.00 July - Sept. 1992 3,293,754.00 1,317,502.00 1,976,252.00 P23,492,227.50 P9,396,891.00 P14,095,336.50 ============ ============ ============ Conversely, the Commissioner of Internal Revenue alleged that the royalty payments are subject to 25% withholding tax rate as the rulings allowing the availment of the benefits under the "most favored nation" clause on payments of royalties to recipients in the United States have been revoked effective January 21, 1992. Simply, a resident of the United States is not entitled to the "most favored nation" tax rate of 10% on royalty derived from the Philippines as payment of such tax is not under similar circumstances as that of the RP-West Germany Tax Treaty where there is a matching credit of 20% for royalties vis-a-vis in the United States where there is no such matching credit granted. The Commissioner did not act on said claim for refund, CMC then filed a petition for review before the Court of Tax Appeals where the case was docketed as CTA Case No. 5186. After an exhaustive evaluation on the matter, the Court of Tax Appeals rendered the assailed judgment granting partially the amount of P8,651,804.50 as refund due to CMC for the royalties paid. This amount covers tax refund for the period December 1992 to September 1993, considering that tax payments made prior to December 28, 1992 were considered prescribed. Not satisfied with such decision the Commissioner of Internal Revenue filed this petition, premised on one singular ground, to wit: THE COURT OF TAX APPEALS ERRED IN RULING THAT CPC INTERNATIONAL (ASIA) LTD. (CPC ASIA) 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. It is the contention of the petitioner that the "most favored nation" clause cannot be invoked to justify the 10% tax rate on royalties of CMC. The petitioner cites Article 13 (2)(b)(iii) of the RP-US Tax Treaty, which 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. xxx xxx xxx (Emphasis supplied)" According to the petitioner, under the aforequoted provision, the royalties derived by a resident of the United States from sources within the Philippines shall be based at the lowest rate that may be imposed by the Philippines on royalties of the same kind paid under similar circumstances to a resident of a third state. Corollary, Article 12(2)(b) of the RP-West Germany Tax Treaty states: "(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 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. "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." Obviously, the foregoing treaty allows a 10% tax rate to royalties of the same kind paid to a West German resident. But the preferential 10% tax rate on royalties given under the RP-West Germany Tax Treaty cannot be made applicable to those covered under the RP-U.S. Tax Treaty simply because under the latter treaty, there is no such "matching credit" allowed by the USA on the Philippine tax paid on royalties. The RP-Germany Tax Treaty, specifically Article 24 (2)(b)(dd) and (c)(cc) provides that the Philippine tax paid on income arising in the Philippines is allowed as a credit against German income and corporation tax. In the case of royalties for which the tax is reduced to 10% or 15% according to paragraph 2 of Article 12 of the RP-West Germany Tax Treaty, the Philippine Tax shall be deemed to be 20% of the gross amount of such royalties. In other words, the Philippine tax of 10% or 15% is credited against the German tax as 20%. In effect, West Germany allows a "matching credit" of 10% or 5% as the case may be, in addition to the Philippine tax of 10% or 15%, which softens the impact of double taxation by two jurisdictions on the same income. Conversely, the RP-US Tax Treaty does not allow a "matching credit" on the Philippine tax paid on royalties. Hence, the royalties paid to a West German resident, on the one hand, and the royalties paid to a US resident, on the other hand, are not paid under similar circumstances because the tax consequence of said payments are entirely different. This was the position taken by the Commissioner of Internal Revenue in Revenue Memorandum Circular No. 39-92 dated July 1, 1992, which is entitled to great weight and respect. There, IBM Corporation was adjudged not to be 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 as that paid to a resident of Germany since there is a matching credit in Germany (20%) for royalties while there is no such similar credit granted by the United States. cdll In sum, since the royalties due to CPC Asia are not paid under similar circumstances as the royalties due to a resident of West Germany, respondent CMC, as withholding agent of CPC Asia, cannot invoke the "most favored nation" clause of the RP-US Tax Treaty in relation to the RP-West Germany Tax Treaty, to justify the 10% tax rate. Hence, respondent CMC is not entitled to the refund. Upon the other hand, it is the contention of respondent CMC that the CTA is correct in deciding that CPC International (Asia) Ltd. 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. As held by the CTA in the case of IBM Philippines , Inc . vs . Commissioner of Internal Revenue (CTA Case No. 4308, March 31, 1993) and which the Commissioner did not appeal, the applicability of the most favored nation clause as provided in the RP-US Tax Treaty in relation to the RP-West Germany Tax Treaty is in order. The argument raised by the Commissioner that the phrase "paid under similar circumstances" under Art. 13(2)(b)(iii) of the RP-US Tax Treaty is not applicable under the given circumstances due to the fact that under the said tax treaty there is no "matching credit" allowed by the USA on the Philippine Tax paid on royalties, unlike in the RP-Germany Tax Treaty which allowed matching credit is without merit. Common sense and logic would lead to the conclusion that the aforesaid phrase refers to a royalty paid and not to tax paid, since the recipient of tax is the government, not a citizen or resident. In the same manner, the cross reference by the petitioner to Article 24 "Relief from Double Taxation" is misplaced since it pertains to a relief from double taxation and not the tax on royalties which has a specific portion, Article 12(2)(b) of the RP-West Germany Tax Treaty. prcd Further, the respondent agrees that while the Commissioner's opinion should be given great weight and respect, the underlying condition is that said opinion must be correct, which is not so in this case upon the finality of the IBM case. Likewise, while the government is not bound by the errors committed by its agents in the performance of its governmental functions, still the argument is inapplicable in the case at bench, since there is no finding that Revenue Officer Espiritu committed an error in the performance of his duties. Lastly, the respondent alleges that it is entitled to the whole refund of P14,095,336.50 considering that the claim for refund for the period January 1, 1992 to September 30, 1993 has not yet prescribed having been filed on December 28, 1994, or months before the 2-year prescriptive period expiring on April 13, 1995. The petition is impressed with merit. As held in the recent landmark case of Commissioner of Internal Revenue vs . S . C . Johnson and Son , Inc ., and Court of Appeals (G.R. No. 127105, June 25, 1999), 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 RP-Germany Tax Treaty are paid under similar circumstances. This would mean that anyone who wants to claim for refund 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. However, this is not the situation in the case at bench and as discussed in the aforestated case, to wit: "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. 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 or 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. . . ." "The reason for construing the phrase "paid under similar circumstances" as used in Article 13 (2)(b)(iii) of the RP-US Tax Treaty as referring to taxes is anchored upon a logical reading of the text in the light of the fundamental purpose of such treaty which is to grant an incentive to the foreign investor by lowering the tax and at the same time crediting against the domestic tax abroad a figure higher than what was collected in the Philippines." Such being the case, respondent CMC cannot avail of the "most favored nation" clause which 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. 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, then respondent CMC 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. To grant otherwise would defeat the purpose underlying tax treaties and the rationale for the most favored nation clause. LLpr Finally, tax exemptions (and we might add, refunds in the nature of exemptions) must be strictly considered against the taxpayer and liberally in favor of the State ( Magsaysay Lines , Inc . vs . Court of Appeals , 260 SCRA 513, 5257. Therefore, a claimant has the burden of proof to establish the factual basis of his or her claim for tax credit or refund ( Citibank , N . A . vs . Court of Appeals , 280 SCRA 459, 471) and since the respondent failed to rebut the presumption in the clear absence of a "matching credit" under the RP-US Tax Treaty, then the claim for the entire refund must be denied. WHEREFORE, the instant petition is GRANTED. The decision dated June 27, 1997 of the Court of Tax Appeals is hereby REVERSED and SET ASIDE. SO ORDERED. Elbinias and Cosico, JJ . , concur.