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Pitfalls in implementing tax treaties

Business World, Philippines

Pitfalls in implementing tax treaties

6 November 2008

By Susan T. Aquino

The recent ratification of the Japan-Philippines Partnership Economic Agreement, or JPEPA, and the modified RP-Japan tax treaty by the Philippine Senate has once again focused attention on these international agreements which grant reciprocal tax concessions to the contracting parties.

Their ultimate objectives are the promotion of foreign investments in their respective countries and the forging of closer economic ties between themselves.

Such agreements become all the more relevant in the light of the present global financial crisis where each country is coming up with its own national solutions to lighten the impact of this impending worldwide economic recession.

An important element of treaties, in general, and tax treaties, in particular, is the obligatory force of the provisions contained therein. International Law dictates that each party must comply with the treaty in good faith under the principle of pacta sunt servanda (roughly, pacts must be respected).

From a legislative perspective, Senate ratification of all treaties and international agreements is required under the 1987 Constitution to transform these provisions into law with the corresponding legal obligation to ensure compliance.

The obligatory character of international agreements is one of the reasons why, prior to its ratification, the JPEPA provisions were scrutinized by a number of concerned groups and hotly debated and lobbied against during the Senate deliberations. People are well aware that after ratification, treaties and provisions of international agreements become part of the law of the land unless declared unconstitutional. The Supreme Court has also recognized this when it ruled that "treaty engagements are not mere moral obligations" but they create a legally binding obligation on the part of both parties.

Tax treaties are of the same nature as that of a regular treaty or international agreement in that they have the same obligatory force between the parties.

The preferential tax rates imposed under a tax treaty offers assurance to either party that certain income payments such as royalties or branch profits will not be subject to double taxation and will likewise be subject to tax rates lower than the regular ones imposed under the Tax Code of either one of the host countries.

Under most tax treaties that the Philippines entered into, certain income payments (e.g., dividends or royalties) are subject of the preferential tax rate of 10% which is much lower than the regular income tax rates imposed under Philippine law.

Just like the benefits given to economic zone locators, the preferential tax rates under our tax treaties serve to entice foreign investors to set up their businesses here in the country.

However, the nature and purpose of tax treaties described above will be negated if agencies of the government impose additional conditions for the availment of the benefits under a tax treaty.

This is the reason why this writer is concerned about the prejudicial impact of recent court decisions which affirmed the Bureau of Internal Revenue’s (BIR) position that an application for a tax treaty relief is required prior to the availment of preferential tax treaty rates.

The root cause of the controversy lies in the provisions found in Revenue Memorandum Order (RMO) No. 1-2000 dated November 25, 1999, prescribing as a condition sine qua non the filing of an application for tax treaty relief before a taxpayer can avail of the preferential tax rates found in the tax treaties.

The Court of Tax Appeals (CTA) mirrored the opinion of the BIR recently when it denied a claim for refund of a bank which sought to claim the excess taxes paid over the preferential tax rates prescribed under a tax treaty. The CTA ruled that the taxpayer bank had no right to apply the lower tax rates on the branch profits since it failed to file an application for tax treaty relief with the International Tax Affairs Division (ITAD) of the BIR, as provided by RMO 1-2000.

It is quite perplexing that a RMO will have the effect of superseding a tax treaty provision which possesses the character of a law. One is even compelled to look into the provisions of the said RMO if it really mandates the application for a tax treaty relief before one can avail of the preferential rates.

RMOs, as described by Revenue Administrative Order No. 1-99, are mere directives or instructions outlining procedures, operations and work flow of the BIR, and as such they are not meant to implement a law or a treaty.

In addition, administrative issuances which serve the purpose of enforcing or implementing a law must be published in the Official Gazette or in a newspaper of general circulation before they can take effect, as provided in the Philippine Civil Code, which states that "laws shall take effect after 15 days following the completion of their publication in the Official Gazette or in a newspaper of general circulation in the Philippines, unless it is otherwise provided."

Moreover, such rules must be filed with the Office of the National Administrative Register at the UP Law Center.

I believe that clarifications are in order. As the taxpayers have the right to know the laws and rules which define the limits of their tax obligations and privileges, they also have the concomitant right to be clarified as to how the BIR reached this conclusion.

The author is a manager in Isla Lipana & Co., a member firm of PricewaterhouseCoopers organization.