By Olivier D. Aznar (Reported from Business World’s Let’s Talk Tax, September 5, 2011)
The Bureau of Internal Revenue (BIR) is currently intensifying its tax assessment efforts to raise revenues for the government, and a commonly disputed tax finding is the deficiency on final withholding tax as a result of a taxpayer’s failure to apply for a tax treaty relief ruling with the bureau before using a preferential tax treaty rate.
To illustrate, take for example a domestic corporation that pays royalties to a foreign corporation. Under the Philippine Tax Code, in the absence of a tax treaty, what will be applied to such transaction is a 30% (rate effective beginning Jan. 1, 2009) final tax to be withheld by the domestic corporation-payor. Thus, if there is a tax treaty between the Philippines and the country of that foreign corporation, and the tax treaty provides for an exemption or for a lower tax rate (preferential tax rate), then such preferential tax rate could be used.
Unfortunately, though, BIR imposed a strict condition before the above-mentioned preferential tax rate could be used. The condition is that there must be “prior” application for a tax treaty relief ruling with the BIR [see Revenue Memorandum Order (RMO) No. 01-00 and No. 72-10]; otherwise, the taxpayer will be disqualified to avail of the preferential tax rate. Consequently, the domestic corporation-payor — being the tax withholding agent in the Philippines — will be assessed for tax deficiency if it used the preferential tax rate without said prior application. Furthermore, disqualification of the taxpayer from using the preferential tax rate will bar it from any future claim for refund if, later on, it could be found out that the transaction of the taxpayer is covered by the preferential tax rate, and the only flaw was non-submission of prior application of tax treaty relief ruling.
To recall, as stated in RMO No. 01-00 issued by the BIR in 2000, the bureau conceived that the requirement of prior application will avert any erroneous interpretation and/or application of treaty provisions. Then, in 2010, RMO 72-10 was issued providing for more detailed/updated rules while retaining the condition on prior application for tax treaty relief ruling. But, could the BIR validly impose such condition even if the Philippines, itself and the foreign country counterpart did not actually specify any condition precedent on the use of the preferential tax treaty rate? Is there really a categorical Philippine Tax Code provision which will support the said authority of the BIR?
In a Court of Tax Appeals (CTA) case decided in 2010, the CTA, in upholding RMO No. 01-00, referred to Section 6 of the Tax Code, without pointing to the specific subsection thereof. It was said then, that Section 6 of the National Internal Revenue Code of 1997 duly grants the Commissioner the power to make assessments and prescribe additional requirements for tax administration and enforcement.
A cautious reading of Section 6 of the Tax Code will show that the nearest subsection was Section 6(H) — Authority of the Commissioner to Prescribe Additional Procedural or Documentary Requirements, which provides the following:
“The Commissioner may prescribe the manner of compliance with any documentary or procedural requirement in connection with the submission or preparation of financial statements accompanying the tax returns.” [emphasis supplied]
Now, based on the above section, is the condition of “prior application for tax treaty relief” embraced in the above provision? Is the provision broad enough to dictate what condition to be complied with before a proviso of an international agreement (i.e., tax treaty) could take effect?
BIR might say that there was already a resolution issued by the Supreme Court in 2008 (Mirant case) which favors implementation of the rule on prior application for tax treaty relief. In this case, however, careful analysis will show that such resolution was just a minute resolution issued by the Clerk of Court and not a Supreme Court (SC) decision certified by the SC Chief Justice.
In a CTA case decided in 2010, the CTA explained that a minute resolution may amount to final action on the case but it is not a precedent, and cannot bind non-parties to the action. Therefore, the said minute resolution does not bind all others (not being parties to the Mirant case) who may come to question the validity of the rule on prior application.
Is there really an underpinning support from the Tax Code on the validity of the rule on prior application for tax treaty relief?
Leaving the question hanging and assuming, without admitting, that the rule on prior application is in accord with the Tax Code, the consequence of totally disqualifying a taxpayer from using the preferential tax rate just because of noncompliance with a procedural imposition of the BIR could be perceived to be onerous.
Remember that RMO No. 01-00 has the basic objective of averting any erroneous interpretation and/or application of treaty provisions. Thus, if there was really no erroneous interpretation and/or application of treaty provisions in using the preferential tax treaty rate, and that the only fault of the taxpayer was non-submission of prior application for tax treaty relief, then the evil sought to be avoided by the RMO is still not present.
After all, we know that the BIR has its means, during tax assessments, of determining whether a transaction is indeed qualified to be covered by a preferential tax treaty rate. BIR could easily make this determination even after the transaction has taken place.
Could the BIR somehow tone down the consequence of not strictly complying with the “prior application” rule? Instead of totally disqualifying a taxpayer from using the preferential tax treaty rate, could the penalty be just an administrative one if it would be found out that the transaction of the taxpayer indeed falls within the tax treaty provisions? Certainly, a review of the “prior application” rule could raise quite a number of questions, and it is just unfortunate that this present rule adds to the burden of domestic tax withholding agents who are the ones dealing with BIR examiners.
The author is a senior manager with Punongbayan & Araullo’s Tax Advisory & Compliance Division.