Taxwise Or Otherwise
Shiela Mae S. Lucas
When tax laws are implemented stringently, the Exchange of Notes between two governments could provide investors relief from tax liability. This agreement avoids double taxation in different jurisdictions while promoting commerce and investment among party-states.
On June 11, 1987, an Exchange of Notes was executed covering the grant by the Government of Japan for the construction and implementation of a Coal-Fired Thermal Power Plant Project. Under the tax clause of the Exchange of Notes, the Philippine government, by itself or through its executing agency, undertook to assume all taxes imposed by the Philippines on Japanese contractors engaged in the project. By its nature, the Exchange of Notes was not a treaty but a binding agreement between two governments, providing conditions on tax assumption, rather than a tax exemption. This implies that the obligation or liability remains, and is merely passed on to a different taxable entity. Comparably, the concept of an assumption is therefore different from an exemption, the latter being the freedom from a duty, liability or other requirement, or a privilege given to a judgment debtor by law, allowing the retention of certain property without liability.
To implement the project, an executing government agency of the Philippines, entered into a contract with a Japanese contractor for the engineering, supply, construction, installation, testing, and commissioning of a steam generator, auxiliaries, and associated civil works for the project. The contract indicated the Philippine agency’s undertaking to pay any and all forms of taxes that are directly imposable under the project.
Upon the completion and final acceptance of the project in 1998, with the contractor paying the Bureau of Internal Revenue (BIR) both its income tax (IT) and branch profit remittance tax (BPRT) for branch profits remitted to its head office in Japan out of its income for the fiscal year that ended on March 31, 1998.
Since all taxes are assumed by the Philippine government agency, the Japanese contractor filed an administrative claim for a refund with the BIR on June 30, 2000 to recover the IT and BPRT erroneously paid. Relying on Revenue Memorandum Circular (RMC) No. 42-99, the BIR denied the request on grounds that the proper remedy of the Japanese contractor, who previously paid the taxes directly to the BIR, is to recover from the executing government agency.
On appeal, the Court of Tax Appeals (CTA) Division ruled in favor of the Japanese contractor and ordered the BIR to refund the taxes erroneously paid. Since the RMC took effect a year after the taxpayer filed its return, it would be inequitable to apply it retroactively to the taxpayer. The BIR moved for reconsideration, but was denied.
Thereafter, the case was elevated to the CTA En Banc, which reversed the previous decision based on the following reasons: (1) the taxpayer failed to establish that its tax payments were “erroneous” under the law to justify the refund, adding that the BIR has no power to grant a refund under Section 229 of the Tax Code in the absence of any grant for tax exemption under the Exchange of Notes; (2) the Exchange of Notes cannot be read as a treaty validly granting tax exemption considering the lack of Senate concurrence as required under Article VII, Section 21 of the Constitution; and (3) RMC No. 42-99 applies since it was already in effect when the taxpayer filed its administrative claim for refund in 2000.
Seeking relief from the unfavorable decision, the taxpayer elevated the case to the Supreme Court (SC) which eventually reversed the decision of the appellate court and ruled in favor of the taxpayer (docketed as G.R. No. 175722 dated 5 June 2017).
The SC ruled that it is fairly apparent that the subject taxes were erroneously collected from the taxpayer, considering that the obligation to pay had already been assumed by the Philippine government by virtue of the Exchange of Notes with the Japanese government. The tax clause provision of the Exchange of Notes provides for a tax “assumption” and not a tax “exemption.” Case law explains that an exchange of notes is considered an executive agreement, which is binding on the State even without the Senate’s concurrence.
I believe that the decision of the SC clarifies the BIR’s role as tax law implementer from the right perspective. The SC stressed valid points regarding the RMCs of the BIR. While administrative rulings have persuasive effect on the courts, they remain mere interpretations that may be disregarded if judicially found to be incorrect. Administrative issuances that override, instead of remaining consistent and in harmony with the law they seek to implement, are not tolerated by the courts.
Thus, the RMC instructing the taxpayer to directly claim the refund from the executing government agency cannot prevail over Sections 204 and 229 of the Tax Code granting taxpayers the right to refund erroneously paid taxes from the BIR. The reasons cited by the CTA En Banc in its decision failed to take cognizance of the tax laws in the executed Exchange of Notes, pertinent provisions of the Tax Code, and case law doctrines of the SC. Since this case is about tax assumption, not tax exemption, the SC’s decision for the BIR to collect the subject taxes from the Philippine executing agency as the proper party that assumed petitioner’s tax liability was on point.
In an era where transactions are, at times, opportunistic and crafty in tenor, staying true to one’s bargain is esteemed. Those who take the easy path, however, find themselves at a disadvantage. To renege on one’s palabra de honor (word of honor) diminishes one’s sense of dignity, sincerity, and integrity. On a global level, it scars a nation’s reputation in dealing with other states, leaving ramifications often too deep to erase.
The views or opinions expressed in this article are solely those of the author and do not necessarily represent those of Isla Lipana & Co. The content is for general information purposes only, and should not be used as a substitute for specific advice.
Shiela Mae S. Lucas is a senior consultant at the Tax Services Department of Isla Lipana & Co., the Philippine member firm of the PwC network.
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