Written by Adrian V. Bancoro, 9 March 2007
The Philippines has existing tax treaties with various countries which provide for tax relief on income derived by residents of the Philippines and the foreign country from sources within their respective territories. The tax relief include tax exemption or entitlement to preferential tax rates on certain types of income, e.g., royalties, interest, dividends.
Availment of tax treaty relief is not, however, automatic in the sense that taxpayers are required under existing BIR rules and regulations to comply with certain formalities before the said tax relief can be enjoyed.
Thus, to streamline the processing of the applications, the BIR issued Revenue Memorandum Order (RMO) No. 1-2000, which provides that it is to the best interest of both the taxpayer and the BIR that any availment of treaty benefits be preceded by an application for tax treaty relief. The tax treaty relief is in the form of a ruling from the BIR confirming that the tax treaty relief (whether tax exemption or preferential tax rate) availed of properly applies to the particular transaction involved.
Securing a tax treaty relief ruling requires the filing of a formal request with the International Tax Affairs Division (ITAD) of the BIR stating the nature, mechanics and conditions of the specific transaction applied for together with various supporting documents which include documents executed abroad and thus requires certification and authentication of the concerned Philippine consulate abroad.
The processing of the application would normally take less than six (6) months although a longer timetable may apply if additional documents are requested in the course of the evaluation of the application.
For these reasons, securing a tax treaty relief ruling does not appeal to most taxpayers who view this condition, which is not provided under the tax treaties, merely as an additional burden imposed by the Government.
Thus, the issue usually raised is whether a tax treaty relief is a mandatory requirement for availment of treaty benefits such that one must be secured for each and every transaction and failure to do so would invalidate the treaty relief availed of in case of an audit.
Legally, it may be argued that the tax treaty relief ruling is not a mandatory requirement because neither the law nor the tax treaty provide for such requirement. Whether a certain income payment to a foreign entity is tax exempt or entitled to preferential tax rate is a question of fact, and is not dependent on a ruling to that effect by the BIR. For as long as the taxpayer is able to show through facts and evidence that the conditions for tax relief as set forth in the treaty provisions have been complied with, the BIR should allow the tax relief whether or not a treaty ruling has been secured.
Thus, non-compliance with the documentary requirements in RMO Order No. 01-2000 does not preclude a taxpayer to claim tax relief on the basis of the treaty provisions. The Court of Tax Appeals (CTA) has in fact made this pronouncement in the case of Jardine Davies Insurance Brokers, Inc. and JMIB Holdings BV vs. Commissioner of Internal Revenue, CTA Case No, 5140,1997. Moreover, securing a tax treaty relief ruling may no longer be necessary if there are already existing BIR-ITAD rulings that can be used as a precedents in cases involving similar facts, transactions and issue.
The issue on the mandatory nature of the treaty relief ruling was again brought to light in the very recent case of Mirant Operations (Philippines) Corp vs. Commissioner of Internal Revenue, CTA EB No. 40, June 7, 2005.
However, in this case, the CTA appears to have taken a different view. The CTA En Banc ruled that an entity wishing to avail of treaty benefits should invoke specific treaty provisions and prove that indeed such provisions apply to it before the benefits may be extended to such entity.
The petitioner in this case quoted various BIR and ITAD rulings issued to several corporations in support of its position but were ignored by the CTA for the reason that said rulings did not specifically apply to the petitioner. Effectively therefore, the CTA has considered the tax treaty ruling a mandatory requirement before a taxpayer may avail of tax relief under a tax treaty.
Although the Mirant decision appears to be questionable as it imposes an additional requirement that is not provided under the treaty or the law, there are, however, practical considerations which make compliance with RMO No. 01-2000 essential.
In practice, securing treaty relief tends to be most critical when payments are to be made to a foreign recipient by a Philippine entity required to withhold tax. The reason is that failure to withhold the correct taxes can result in the assessment of deficiency withholding taxes, a 25% surtax, 20% per annum interest and compromise penalties of up to P25,000. In addition, payments that have not been subject to the correct withholding taxes are non-deductible under Section 34(K) of the Tax Code. The potential penalties for non-compliance with withholding requirements are severe. It is prudent, therefore, to comply with RMO No. 01-2000.
Moreover, even if withholding will not be an issue, it may still be worthwhile to seek a confirmatory ruling from the BIR. The reason is that ruling applications are dealt with by the ITAD of the BIR, which has experience with the application of treaty provisions. Were a treaty issue to be dealt with in the context of an audit instead, it is far less likely that the Revenue Examiner will have the experience to deal with the issue properly. The foreign entity concerned could then face administrative difficulties bringing correct application of the treaty to bear.
By and large therefore, although the tax treaty relief ruling would seem to be an added administrative burden to taxpayers, compliance with said requirement might ultimately prove to be useful as it ensures to avoid the negative consequences that might arise from any erroneous interpretation and/or application of the treaty provisions.
