Finally relieved

Treaties are covenants between or among sovereign states and international organizations. The principle of pacta sunt servanda demands for the observance of these solemn agreements in utmost good faith. Otherwise, international relations may greatly suffer be it in its political, legal or economic aspects.

Tax treaties are entered into primarily to prevent double taxation or at least mitigate its effects, hence they are usually called “agreement for the avoidance of double taxation”. These treaties also prevent tax evasion since there would be sharing of tax information between states, which enables the government to improve its revenue monitoring and collection.

In 2000, the Bureau of Internal Revenue (BIR), with its commitment “to collect taxes for nation-building”, issued Revenue Memorandum Order (RMO) No. 1-2000 providing the guidelines for the availment of preferential tax treatment under tax treaty provisions. Under the RMO, any availment of the benefits under a treaty should be preceded by a tax treaty relief application (TTRA). The taxpayer is required to file the TTRA at least 15 days before the transaction.

The BIR has denied TTRAs on several occasions for failure to comply with the RMO’s ‘prior application’ rule. Moreover, there are judicial decisions which affirmed the strict imposition of this rule. However, in the recent case of Deutsche Bank AG Manila vs. Commissioner of Internal Revenue, G.R. No. 188550, promulgated on Aug. 19, 2013, the Supreme Court confirmed the entitlement of the petitioner corporation to the preferential tax rate under the treaty, thereby granting its claim for refund despite its failure to file a TTRA prior to the remittance of the branch profits to the head office.

In this case, petitioner corporation withheld and remitted in 2003 branch profits remittance tax (BPRT) to the BIR at the rate of 15 percent of its regular banking unit net income. Realizing that it is entitled to preferential tax rate of 10 percent under the Phl-Germany Tax Treaty, it filed in 2005 a claim for refund or issuance of tax credit certificate and at the same time filed a TTRA with the BIR for the confirmation of its entitlement to the 10 percent preferential tax rate.

A judicial claim for refund was subsequently filed by petitioner alleging inaction on the part of BIR with respect to its claim. The Court of Tax Appeals (CTA) denied the claim on the ground that the petitioner failed to file the TTRA before the transaction, i.e. the remittance of the branch profits to its head office. In support of its decision, the CTA cited the Mirant case wherein the CTA en banc held that “a foreign corporation wishing to avail of the benefits of the tax treaty should invoke the provisions of the tax treaty and prove that indeed the provisions of the tax treaty applies to it, before the benefits may be extended to such corporation.”

Undaunted, the petitioner elevated the case to the Supreme Court (SC) which rendered a favorable judgment for the petitioner. The High Court held that those who are entitled to the benefit of a treaty cannot totally be deprived of the benefit on the sole ground of failure to file the TTRA before the transaction as required under RMO No. 1-2000.

The SC ruled that the Mirant case relied upon by the CTA is not a binding precedent since it is only a minute resolution. Also, even if the CTA was affirmed by the SC, the circumstances surrounding the Mirant case are different; hence, the same cannot be applied in the Deutsche case.

The SC explained that the BIR must not impose additional requirements in the availment of the relief under the treaty especially because the Phl-Germany Tax Treaty does not provide for any prerequisite for the same. The SC also noted that there is nothing in RMO No. 1-2000 that would indicate deprivation of entitlement to the relief for failure to comply with it. 

Although the SC recognized that the objective of RMO No. 1-2000 is to avert the consequences of any erroneous interpretation and/or application of the treaty provisions, it held that the obligation to comply with a tax treaty must take precedence over the objective of RMO No. 1-2000. According to the High Court, there could be other ways of achieving the objective of the RMO such as providing for penalty for failure to observe the rules, without depriving those who should be accorded with the benefits of the treaty.

Further, the SC explained that the very basis of the claim for refund is erroneous payment or there is excessive payment by applying the regular tax rate of 15 percent, not the preferential tax rate of 10 percent under the Phl-Germany Tax Treaty. Since the petitioner realized its entitlement to the preferential tax rate only after the remittance of the BPRT based on the regular rate, the taxpayer could not have filed the TTRA before the transaction. Thus, the objective of the BIR in requiring prior application under RMO No. 1-2000 becomes moot in refund cases. According to the SC, the petitioner could not have applied for a TTRA within the prescribed period precisely because it erroneously paid the BPRT, not on the basis of the Phl-Germany Tax Treaty but on the regular rate under Tax Code. Hence, invoking the provisions of the Phl-Germany Tax Treaty when it requested for a confirmation from the International Tax Affairs Division (ITAD) before filing the administrative claim for refund should be considered substantial compliance with the RMO.

The Deutsche case involves RMO No. 1-2000 which was the then governing issuance on the filing of TTRA. The BIR, however, issued RMO No. 72-2010 which superseded RMO No. 1-2000. RMO No. 72-2010 expressly provides for the disqualification to avail of tax treaty relief in case of failure to properly file the TTRA. No such provision is found in RMO No. 1-2000. Despite the absence of the penalty of disqualification, however, BIR has consistently taken the position that the non-observance of the 15-day prior application rule under RMO No. 1-2000 will result in the denial of the claim for tax treaty relief. The penalty under RMO No. 72-2010 is but a confirmation of the BIR’s strong position on the matter. On the other hand, in its decision in the Deutsche case, it would seem that the SC still recognizes the importance of the objective of the BIR in issuing the RMO, but it emphasized that a taxpayer cannot be deprived of its entitlement to the benefit of a tax treaty for failure to comply with the prior application rule in view of the time-honored international principle of pacta sunt servanda.

The decision of the SC in the Deutsche case could serve as an assurance of our country’s commitment to make our part of the bargain good. Furthermore, this may strengthen the Philippines’ relation with the international community by opening an avenue towards the tax relief. On the other hand, even though the SC decision is leaning towards the taxpayer, looking deeper into it would also reveal a favorable situation for the BIR as increase in investments means increase in the country’s revenue.

Alarice L. Yang is a supervisor from the tax group of Manabat Sanagustin & Co. (MS&Co.), the Philippine member firm of KPMG International.

This article is for general information purposes only and should not be considered as professional advice to a specific issue or entity.

The view and opinions expressed herein are those of the author and do not necessarily represent the views and opinions of KPMG International or MS&Co. For comments or inquiries, please email [email protected] or [email protected].