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CIR v. S.C. JOHNSON

FACTS:

In this case, S.C. Johnson & Son, Inc. entered into a license agreement with SC Johnson and Son, United States of America (USA), in which S.C. Johnson was granted the right to use the trademark, patents, and technology owned by the foreign corporation. S.C. Johnson paid royalties to the foreign corporation based on a percentage of net sales. The royalties were subjected to a 25% withholding tax, which S.C. Johnson argued should be reduced to 10% based on the most favored nation clause of the RP-US Tax Treaty. The Commissioner of Internal Revenue did not act on the claim for a refund of overpaid withholding tax, leading S.C. Johnson to file a petition for review with the Court of Tax Appeals. The Court of Tax Appeals ruled in favor of S.C. Johnson and ordered the Commissioner of Internal Revenue to issue a tax credit certificate. The Commissioner of Internal Revenue appealed the decision to the Court of Appeals, which affirmed the ruling. The Commissioner of Internal Revenue then filed a petition for review with the Supreme Court.

The primary issue in this case is the interpretation of Article 13 (2) (b) (iii) of the RP-US Tax Treaty, specifically pertaining to the tax rate on royalties received by a non-resident foreign corporation. The Bureau of Internal Revenue assessed S.C. Johnson for deficiency taxes, specifically the 35% withholding tax on royalty payments. S.C. Johnson argued that the correct tax rate should be 10% based on the RP-US Tax Treaty. The Court of Tax Appeals ruled in favor of S.C. Johnson, but the Court of Appeals reversed the decision. S.C. Johnson filed a Motion for Reconsideration before the Court of Appeals and concurrently filed a Petition for Review with the Supreme Court. The Commissioner of Internal Revenue opposed the petition, arguing that the most favored nation clause only applies to the payment of taxes, not the subject matter of taxation.

Regarding the procedural issue, the Supreme Court concluded that the certification against forum shopping should have been signed by S.C. Johnson herself. However, since S.C. Johnson is a government agency and was represented by the Office of the Solicitor General, the Court deemed the certification executed by the OSG as substantial compliance with the circular.

In addition to the RP-US Tax Treaty, S.C. Johnson also claims entitlement to a concessional tax rate of 10% on royalties based on the RP-Germany Tax Treaty. This provision allows for a 10% tax rate on royalties arising from the use of patents, trademarks, designs, and more, as long as the contract giving rise to such royalties has been approved by Philippine competent authorities. The RP-Germany Tax Treaty also allows for a tax credit of 20% of the gross amount of royalties against German income and corporation tax for taxes payable in the Philippines. Article 24 of the RP-Germany Tax Treaty provides for this tax credit.

ISSUES:

  1. Whether the phrase "paid under similar circumstances" in Article 13(2)(b)(iii) of the RP-US Tax Treaty refers to the payment of royalty or to the payment of tax.

  2. Whether the most favored nation clause in 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.

  3. Whether the taxpayer is entitled to a 10% rate on royalties under the RP-US Tax Treaty.

  4. Whether the absence of a matching tax credit of 20% for the taxes paid to the Philippines on royalties as allowed under the RP-West Germany Tax Treaty affects the entitlement to the 10% rate.

  5. Whether or not the tax on royalties under the RP-US Tax Treaty should be exempted

  6. Whether or not there is sufficient evidence to support the claim for refund of overpaid tax on royalties

RULING:

  1. The petition is meritorious. The phrase "paid under similar circumstances" in Article 13(2)(b)(iii) of the RP-US Tax Treaty refers to the payment of tax, not to the payment of royalty. The Court held that the construction adopted by the Court of Tax Appeals and the Court of Appeals failed to take into account the purpose animating the treaty provisions. The circumstances of payment of royalties are the same for all recipients, regardless of nationality. However, there is a dissimilarity in the provisions on relief from or avoidance of double taxation in different tax treaties, which is a matter of negotiation between the contracting parties.

  2. 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. The RP-US and RP-Germany Tax Treaties do not contain similar provisions on tax crediting. Therefore, the most favored nation clause in the RP-US Tax Treaty does not grant similar tax reliefs to residents of the United States as those allowed to their German counterparts under the RP-Germany Tax Treaty.

  3. The taxpayer is not entitled to a 10% rate on royalties under the RP-US Tax Treaty. The absence of a matching tax credit of 20% for the taxes paid to the Philippines on royalties, as allowed under the RP-West Germany Tax Treaty, affects the entitlement to the 10% rate.

  4. The Court ruled that the tax on royalties under the RP-US Tax Treaty is not exempted. The burden of proof lies with the party claiming the exemption, and there is no clear grant of exemption found in organic or statute law.

  5. The Court ruled that there is no sufficient evidence to support the claim for refund of overpaid tax on royalties.

PRINCIPLES:

  • Treaty provisions are to be interpreted in accordance with their purpose. (RP-US Tax Treaty)

  • The circumstances of payment of royalties are the same for all recipients, regardless of nationality.

  • Relief from or avoidance of double taxation may vary in different tax treaties and is a matter of negotiation between the contracting parties.

  • The purpose of international agreements is to reconcile the national fiscal legislations of the contracting parties to avoid double taxation.

  • The elimination of double taxation encourages the free flow of goods and services and the movement of capital, technology, and persons between countries.

  • Tax treaties establish the respective rights to tax of the state of source or situs and the state of residence with regard to certain classes of income or capital.

  • Relief from double taxation can be provided through the exemption method or the credit method.

  • The most favored nation clause in a tax treaty grants similar tax treatment to residents of a contracting state as those allowed to residents of another contracting state, but only if the taxes are imposed under similar circumstances.

  • The interpretation and application of tax treaties depend on the specific provisions contained in each treaty.

  • Treaties shall be interpreted in good faith in accordance with the ordinary meaning to be given to their terms, in their context, and in the light of their object and purpose.

  • The ultimate reason for avoiding double taxation is to encourage foreign investors to invest in the Philippines.

  • Double taxation treaties should provide effective measures to minimize, if not completely eliminate, the tax burden imposed upon the income or capital of the investor.

  • The most favored nation clause aims to grant treatment not less favorable than that granted to the most favored country.

  • Tax refunds are in the nature of tax exemptions and are construed strictissimi juris against the person or entity claiming the exemption.

  • The burden of proof lies with the party claiming the exemption.

  • Exemptions must be justified by the clearest grant of organic or statute law.

  • There must be sufficient evidence to support a claim for refund.