CIR VS SC JOHNSON & SON, INCS AND CA

G.R. No. 127105.  June 25, 1999

FACTS: Respondent, JOHNSON AND SON, INC a domestic corporation organized and
operating under the Philippine laws, entered into a license agreement with SC
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 SC 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 . For the use of the trademark or technology,  SC JOHNSON
AND SON, INC     was obliged to pay SC 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 1993.00 On
October 29, 1993,  SC JOHNSON AND SON, USA    filed with the International Tax
Affairs Division (ITAD) of the BIR a claim for refund of overpaid withholding tax on
royalties arguing that, since the agreement was approved by the Technology Transfer
Board, the preferential tax rate of 10% should apply to the respondent.  Respondent
submits that royalties paid to SC Johnson and Son, USA is only subject to 10%
withholding tax pursuant to the most-favored nation clause of the RP-US Tax Treaty in
relation to the RP-West Germany Tax Treaty. The Internal Tax Affairs Division of the
BIR ruled against SC Johnson and Son, Inc. and an appeal was filed by the former to
the Court of tax appeals.

The CTA ruled against CIR and ordered that a tax credit be issued in favor of SC
Johnson and Son, Inc. Unpleased with the decision, the CIR filed an appeal to the CA
which subsequently affirmed in toto the decision of the CTA. Hence, an appeal on
certiorari was filed to the SC.

ISSUE: WHETHER OR NOT SC JOHNSON AND SON, USA  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.

HELD: The concessional tax rate of 10 percent provided for in the RP-Germany Tax
Treaty could not apply to taxes imposed upon royalties in the RP-US Tax Treaty since
the two taxes imposed under the two tax treaties are not paid under similar
circumstances, they are not containing similar provisions on tax crediting.

The United States is the state of residence since the taxpayer, S. C. Johnson and Son,
U. S. A., is based there.  Under the RP-US Tax Treaty, the state of residence and the
state of source are both permitted to tax the royalties, with a restraint on the tax that
may be collected by the state of source.  Furthermore, the method employed to give
relief from double taxation is the allowance of a tax credit to citizens or residents of
the United States against the United States tax, but such amount shall not exceed the
limitations provided by United States law for the taxable year.  The Philippines may
impose one of three rates- 25 percent of the gross amount of the royalties; 15 percent
when the royalties are paid by a corporation registered with the Philippine Board of
Investments and engaged in preferred areas of activities; or 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.

Given the purpose underlying tax treaties and the rationale for the most favored
nation clause, the 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 RPGermany 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.

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.

What is the most favored nation clause?

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. It 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. 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.

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.

TAXATION RELATED TOPICS:

What is the purpose of a tax treaty? The purpose of these international agreements
is to reconcile the national fiscal legislations of the contracting parties in order to help
the taxpayer avoid simultaneous taxation in two different jurisdictions.

The goal of double taxation conventions would be thwarted if such treaties did not
provide for effective measures to minimize, if not completely eliminate, the tax burden
laid upon the income or capital of the investor. Thus, if the rates of tax are lowered by
the state of source, in this case, by the Philippines, there should be a concomitant
commitment on the part of the state of residence to grant some form of tax relief,
whether this be in the form of a tax credit or exemption. Otherwise, the tax which
could have been collected by the Philippine government will simply be collected by
another state, defeating the object of the tax treaty since the tax burden imposed upon
the investorwould remain unrelieved. If the state of residence does not grant some
form of tax relief to the investor, no benefit would redound to the Philippines, i.e.,
increased investment resulting from a favorable tax regime, should it impose a lower
tax rate on the royalty earnings of the investor, and it would be better to impose the
regular rate rather than lose much-needed revenues to another country.

What is international double taxation and the rationale for doing away with it?
International juridical double taxation is defined as the imposition of comparable taxes
in two or more states on the same taxpayer in respect of the same subject matter and
for identical periods; The apparent rationale for doing away with double taxation is to
encourage the free flow of goods and services and the movement of capital, technology
and persons between countries, conditions deemed vital in creating robust and
dynamic economies.

When is there double taxation? Double taxation usually takes place when a person
is resident of a contracting state and derives income from, or owns capital in, the other
contracting state and both states impose tax on that income or capital.

What are the methods of eliminating double taxation?

• First, it sets out the respective rights to tax of the state of source or situs and of
the state of residence with regard to certain classes of income or capital. In
some cases, an exclusive right to tax is conferred on one of the contracting
states; however, for other items of income or capital, both states are given the
right to tax, although the amount of tax that may be imposed by the state of
source is limited.
• The second method for the elimination of double taxation applies whenever the
state of source is given a full or limited right to tax together with the state of
residence. In this case, the treaties make it incumbent upon the state of
 residence to allow relief in order to avoid double taxation. In this case, the
treaties make it incumbent upon the state of residence to allow relief in
order to avoid double taxation.

What are the methods of relief under the second method?

There are two methods of relief—the exemption method and the credit method.
• Exemption method, the income or capital which is taxable in the state of source
or situs is exempted in the state of residence, although in some instances it
may be taken into account in determining the rate of tax applicable to the
taxpayer’s remaining income or capital.
• Credit method, although the income or capital which is taxed in the state of
source is still taxable in the state of residence, the tax paid in the former is
credited against the tax levied in the latter.
• The basic difference between the two methods is that in the exemption
method, the focus is on the income or capital itself, whereas the credit method
focuses upon the tax.

What is the rationale of reducing tax rates in negotiating tax treaties? 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.

What are tax refunds? Tax refunds are in the nature of tax exemptions, and 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.

Who has the burden of proof in tax exemption? The burden of proof is upon him
who claims the exemption in his favor and he must be able to justify his claim by the
clearest grant of organic or statute law.