Commissioner of Internal Revenue v. SC Johnson & Son, Inc.: Topic: Taxation

Commissioner of Internal Revenue v. SC Johnson & Son, Inc.
June 25, 1999

Ponente: Justice Gonzaga-Reyes
Topic: Taxation
PARTIES
 Petitioner: CIR
 Respondent: SC Johnson & Son, Inc. and CA
FACTS
 SC Johnson & Son, Inc. a domestic corporation organized and operating under PH laws, entered into a license agreement
with SC Johnson USA which granted the former the right to use the trademark, patents and technology owned by the
latter including right to manufacture, package and distribute products covered by the agreement.
 For the use of trademark or technology, SC Johnson was obliged to pay SC Johnson USA royalties based on a percentage
of net sales and subjected the same to 25% withholding tax on royalty payments paid for the period covering July 1992 to
May 1993.
 On October 1993, SC Johnson filed with the Intl’ 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 SC Johnson.
 The CIR did not act on said claim for refund; SC Johnson filed an appeal for review before the CTA.
 The CTA rendered a decision in favor or SC Johnson and ordered the CIR to issue a tax credit certificate in the amount
of P963,266 representing the overpaid withholding tax on royalty payments.
 The CIR filed a petition for review with the CA which rendered a decision affirming in toto the CTA decision.
 CIR contents that under Art. 13 (2) (b) (iii) of the RP-US Tax Treaty, the lowest rate of PH tax at 10% be imposed on
royalties derived by a resident of the US from sources within the PH only fit the circumstances of the resident of the US
are similar to those of the resident of West Germany.
 Since the PH-US Tax Treaty contains no “matching credit” provision as that provided under Article 24 of the RP-West
Germany Tax Treaty, the tax on royalties under the RP-US Tax Treaty is not paid under similar circumstances as those
obtaining in the RP-West Germany Tax Treaty.
 Even assuming that the phrase “paid under similar circumstances” refers to the payment of royalties, and not taxes, as
held by the Court of Appeals, still, the “most favored nation” clause cannot be invoked for the reason that when a tax
treaty contemplates circumstances attendant to the payment of a tax, or royalty remittances for that matter, these must
necessarily refer to circumstances that are tax-related. Finally, petitioner argues that since S.C. Johnson’s invocation of
the “most favored nation” clause is in the nature of a claim for exemption from the application of the regular tax rate of
25% for royalties, the provisions of the treaty must be construed strictly against it.
ISSUE:
 W/N the CA erred in ruling that 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.
HOLDING/RATIONALE
 YES. The phrase “paid under similar circumstances” is followed by the phrase “to a resident of a third state.”
 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.”
 In the case at bar, the state of source is the Philippines because the royalties are paid for the right to use property or
rights, i.e. trademarks, patents and technology, located within the Philippines. The United States is the state of residence
since the taxpayer, S.C.
 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 (in an appropriate amount based upon the taxes paid or accrued to the Philippines) against
the United States tax, but such amount shall not exceed the limitations provided by US law for the taxable year. Under
Article thereof, 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 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.
 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.
DOCTRINE
 The RP-US Tax Treaty is just one of a number of bilateral treaties which the PH has entered into for the avoidance of
double taxation. The purpose of these intl’ 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.
 More precisely, the tax conventions are drafted with a view towards the elimination of international juridical double
taxation or 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. (Obvious rationale: free flowing of goods and services and the movement of capital,
technology and persons between countries, conditions deemed vital in creating robust and dynamic economies).
 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.
In order to eliminate double taxation, a tax treaty resorts to several methods. 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.
 There are two methods of relief— the exemption method and the credit method. In the 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. On the
other hand, in the 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. 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

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Commissioner of Internal Revenue v. SC Johnson & Son, Inc.

June 25, 1999

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