Recent tax treaty developments

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NIMROD QUE

NIMROD QUE

Aside from the apparent purpose of Double Taxation Agreements (tax treaties) in eliminating double taxation, tax treaties facilitate the flow of investments. These agreements give territories a competitive edge and enhance transparency, helping foreign investors determine how much tax they will incur for income sourced from their host country and for repatriated profits.

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One may ask, where is the Philippines in comparison with other countries in terms of the number of existing tax treaties? Are these tax treaties being efficiently and effectively enforced as far as the availment of exemptions or preferential tax treaty rates are concerned?

Just recently, two new tax treaties – with Turkey and Qatar – came into force, bringing the Philippines’ total tax treaties to 42 (see https://dits.deloitte.com/#Jurisdiction/12 for the full list). This, however, pales in comparison with the number of tax treaties entered into by our neighbors in Southeast Asia.

For instance, Singapore has the widest treaty network in the region at 82 tax treaties, while Malaysia has concluded tax treaties with 72 countries. Both Vietnam and Indonesia have 64 tax treaties each, and Thailand has 59.

The Philippines is lagging behind in terms of the number of tax treaties. This may be one of the areas that need to be considered in order to make the country a more attractive destination for foreign investments. With the upcoming elections prompting businesses to adopt a ‘wait-and-see’ attitude for some of their strategic moves, having a tax treaty in place would be reassuring to foreign investors because of the fiscal stability and certainty that such treaties provide.

Regardless of the number of tax treaties in place, however, an effective and efficient implementation is essential lest the benefits derived from these agreements be rendered nugatory. Under Article 26 of the Vienna Convention on the Law of Treaties, every treaty in force is binding upon the parties to it and must be performed by them in good faith. The exacting imperative of this principle is such that a state may not invoke provisions in its Constitution or its laws as an excuse for failure to perform this duty (Art. 13, Declaration of Rights and Duties of States Adopted by the International Law Commission, 1949). The Philippine Constitution itself provides for the observance of the general principles of international law as part of the law of the land and, thus, tax treaties have the force and effect of law in the country.

Supposedly impervious to the mandate of the Constitution, the Bureau of Internal Revenue (BIR) issued Revenue Memorandum Order (RMO) No. 01-2000 and RMO 72-2010, which provide that there should be a Tax Treaty Relief Application (TTRA) prior to the availment of the exemption or preferential tax rates available in the tax treaties. It is, thus, the long-standing rule of the BIR that the benefits provided under a tax treaty are not automatic and should first be confirmed by their office by submission of an application and documentary requirements. Under the said issuances, failure to properly file a TTRA before the first taxable event (15 days before the transaction, under RMO 1-2000) would disqualify such TTRA.

This BIR rule, however, was challenged in the Supreme Court (SC) case of Deutsche Bank v. Commissioner of Internal Revenue (G.R. No. 188550, August 28, 2013), where the SC emphasized that the BIR should not be imposing additional requirements that would negate the availment of relief under tax treaties when the subject tax treaty itself does not provide for any prerequisite. The SC explicitly stated that “noncompliance with the 15-day period for prior application should not operate to automatically divest entitlement to the tax treaty relief especially in claims for refund.”

In this case, the SC allowed the refund to Deutsche Bank for its erroneous payment of taxes under the National Internal Revenue Code (NIRC) instead of using the preferential tax rate under the relevant tax treaty. The SC stressed further that the late filing of a TTRA by Deutsche Bank is in substantial compliance with RMO No. 1-2000. This decision was applied in the subsequent SC case of CBK Power Company Limited v. Commissioner of Internal Revenue (G.R. Nos. 193383-84. Jan. 14, 2015).

In the Deutsche Bank case, the question of whether filing the TTRA is still required in order to avail of the benefits of a tax treaty was not squarely addressed by the SC. Although the principles laid down by the SC in arriving at the decision to grant the tax refund to Deutsche may make it seem as though a tax ruling is no longer required, what was clear from the text was that the filing of the International Tax Affairs Division (ITAD) ruling application “15 days before the transaction” was invalidated by the SC. It should be noted also that there is a statement in the decision that Deutsche’s subsequent filing of an ITAD ruling application was deemed substantial compliance, taking note that Deutsche actually filed an ITAD ruling application after the mentioned 15-day requirement by the BIR.

It is interesting to cite a recent Court of Tax Appeals (CTA) case (Lufthansa German Airlines—Philippine Branch v. Commissioner of Internal Revenue, CTA Case No. 8601, March 21, 2016) where the Deutsche Bank ruling was also applied. The CTA held that the BIR’s denial of the taxpayer’s availment of the special tax rate under a tax treaty for failure to file a TTRA is without basis. However, the CTA held that since the taxpayer failed to file a TTRA, it (the CTA) shall carefully scrutinize the evidence presented to determine whether the taxpayer is indeed, entitled to the special tax rate under the tax treaty.

With the advent of the Deutsche Bank ruling, the BIR, to date, has not revoked RMO 01-2000 and RMO 72-2010. Accordingly, as it stands, the BIR still requires a TTRA before availment of any benefits under a tax treaty. This is evident from the number of TTRAs that the office of the BIR-ITAD is currently processing.

Given the seemingly conflicting position of the BIR with regard to the Deutsche case and in consideration of the recent CTA decision, it is apparent that at the administrative level (BIR level), there is a high probability that, without a TTRA filed with the BIR, the benefits under a tax treaty would not be allowed and the taxpayer may be the subject of a tax assessment. Thus, to avoid costs of litigation (i.e., docket fees, attorney’s fees, etc.), most taxpayers would just observe the procedures required by the BIR. With a TTTRA lodged and a tax ruling obtained, the taxpayer will have some measure of comfort on the availment of the exemption (for business profits/service income or capital gains) or preferential tax rates (on royalties, interest, or dividends) under a tax treaty, and will avoid future conflicts with the BIR with regard to the correct withholding tax rate on the relevant income payment.

If, however, the taxpayer has an appetite for litigation, it can choose to elevate the assessment by the BIR to the Courts, where there is a likelihood that the application of the tax benefits even without a TTRA would be sustained provided that sufficient evidence is presented to satisfy the Court that the taxpayer is indeed entitled to the preferential tax rates under the tax treaty.

From the foregoing discussion, one cannot truly say that the Philippines is faithfully implementing its tax treaties, what with the BIR still requiring a TTRA under the pain of tax assessment. Yes, it could be argued that a TTRA is not mandatory, but in the event of a BIR tax assessment, the taxpayer will be forced to fight it out in the Courts, which could prove costly and would necessarily involve a lengthy process. Now comes the remaining question: If not altogether effective, are the tax treaties being implemented efficiently at least? With the additional TTRA requirement and in further consideration of the belief that a taxpayer in the Philippines is already considered ‘blessed’ to obtain a Tax Ruling from the BIR in six months’ time, you tell me.

The author is a Manager with the Tax & Corporate Services division of Navarro Amper & Co., the local member firm of Deloitte Southeast Asia Ltd., a member firm of Deloitte Touche Tohmatsu Ltd.—comprising Deloitte practices operating in Brunei, Cambodia, Guam, Indonesia, Lao PDR, Malaysia, Myanmar, Philippines, Singapore, Thailand, and Vietnam.

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