CTA reverses ruling on tax treaties

Following the decision of the Supreme Court in the landmark case of Deutsche Bank AG Manila Branch vs. Commissioner of Internal Revenue, the Court of Tax Appeals (CTA) reverses its previous rulings on the issue of the application of tax treaties. Prior to the Deutsche Bank case, the CTA has consistently upheld the mandatory application of Revenue Memorandum Order (RMO) 1-2000 which requires the filing of an application for a tax treaty relief with the Bureau of Internal Revenue (BIR) at least 15 days before the transaction i.e. payment of dividends, royalties, etc., accompanied by supporting documents justifying the relief. Non-compliance with the requirements under RMO 1-2000 warrants the denial of the claim for tax refund or tax credit.

In the Deutsche Bank case, the Supreme Court reversed the decision of the CTA and upheld the provisions of the tax treaty over a BIR administrative issuance. This is following the time-honored international law principle of pacta sunt servanda which in English means “agreements must be kept”.  This principle demands that all states that enter into treaties must perform its treaty obligations in good faith.

The Supreme Court recognized that the Constitution provides that the general principles of international law form part of the law of the land and must therefore, be complied with. Treaties have the force and effect of laws.  As such, laws and issuances must be interpreted in a way that will ensure that the reliefs granted under the tax treaties can be availed by the parties that are entitled to it. Additional requirements under administrative issuances must not be imposed to negate the availment of the tax reliefs under treaty. In Deutsche Bank, the Court High also held that in cases of tax refund, the requirement of prior application with the BIR becomes moot, as the very basis of the claim is that there is an erroneous or excessive payment arising from the non-availment of a tax relief under a treaty. Since the taxes have already been paid, the prior application requirement becomes illogical.

The wisdom of the Supreme Court in the Deutsche Bank case finally found its way to the tax court through the recent case of Commissioner of Internal Revenue vs. Penn Philippines, Inc. The case stemmed from the assessment made by the BIR demanding that respondent corporation pay P15 million representing final withholding tax deficiency on management and consultancy fee it paid to its parent company in Spain. Among other issues, the respondent claimed that it is not required to withhold a final income tax on the management and consultancy fee because the income received by the foreign company is exempt under the “RP-Spain Tax Treaty” as the latter does not maintain a permanent establishment in the Philippines.  On the other hand, the CIR questions the applicability of the treaty due to its non-compliance with RMO 1-2000. The respondent corporation failed to present any evidence that it filed the necessary application for tax treaty relief with the BIR.

Applying the decision of the Supreme Court in the Deutsche Bank case, the CTA en banc acknowledged that tax treaties take precedence over an administrative issuance such as RMO 1-2000. It declared that the required 15-day period for the application for tax relief under a treaty is not enforceable. The CTA went further to state that “the Supreme Court’s ruling dispensing compliance with RMO 1-2000 on tax treaty relief application before the BIR pursuant to the Deutsche Bank case, is binding and must be duly observed”.

There are notable differences between the Deutsche Bank case and the Penn Philippines case. In Deutsche Bank, the bank filed with the BIR an administrative claim for refund on the same date that it requested from the BIR a confirmation of its entitlement to the preferential tax rate under the RP-Germany Tax Treaty. In Penn Philippines, the taxpayer did not present any evidence that it filed any application for a tax treaty relief to avail the benefits of the RP-Spain Tax Treaty.

The Deutsche Bank case involves a tax refund where the Supreme Court found that a prior application requirement would be illogical because it could not have applied for a tax treaty relief within the period prescribed. It is precisely because the bank erroneously paid the tax not based on the preferential tax rate under the tax treaty. As such, the belated filing by the bank of an application for a tax treaty relief can be considered as substantial compliance to RMO 1-2000.  In the Penn Philippines case, what is involved is a tax assessment.  Instead of paying at the regular rate, Penn Philippines automatically availed the exemption under the RP-Spain Tax Treaty without prior application with the BIR.  The CTA admitted the defense of the tax treaty even without any form of compliance to the said RMO.

Considering the differences in the factual circumstances between the two cases, it could be said that the CTA decision in Penn Philippines has in effect expanded the application of the Deutsche Bank case to those cases wherein no application for a tax treaty relief was filed. This results in the automatic application of the tax treaty without need of prior approval from the BIR.

The Commissioner of Internal Revenue filed a Motion for Reconsideration on the Penn Philippines case before the CTA which is currently pending before the court. With all the foregoing, it would be interesting to know the final decision in the Penn Philippines case as it affects many taxpayers who may be entitled to the benefits of some tax treaties, but failed to comply with the administrative issuance. It may be noted that following the ruling in the Penn Philippines case, the CTA has also applied the Deutsche Bank principle in a more recent decision. It appears therefore that there may be a trend now to allow taxpayers to avail of the benefits of tax treaties even without strict compliance with the regulation.

Elaine P. de Guzman is a supervisor from the tax group of R.G. Manabat & Co. (RGM&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 views and opinions expressed herein are those of the author and do not necessarily represent the views and opinions of KPMG International or RGM&Co. For comments or inquiries, please email [email protected] or [email protected].

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