Written by Sylvia B. Salvador, 4 April 2008
Attracting foreign direct investments (FDI) can be highly competitive among Southeast Asian countries.
Currently, the FDI index of the Philippines is several notches less than those of its neighbors, hence, every available tool to increase it must be utilized accordingly. One of them is through international agreements such as tax treaties, bilateral economic partnership agreements and the like.
In the era of globalization, the Most-Favored Nation (MFN) clauses in international agreements, like treaties, play a very significant role in giving effect to the so called "equality among states" which can be an initial starting point for prospective foreign investors. Its purpose is to grant contracting parties a tax treatment no less than favorable than that of another country which has been or may be granted a "most favored" tax rate under a treaty. (Salonga, Yap, Public International Law p.225).
With MFN treatment, the investors benefiting from a county’s MFN clause can generally be enticed to invest in the Philippines. Thus, it will avoid possible economic distortion that would occur through more selective country-by-country liberalization. (OECD Working Papers on International Investment Number 2004/2).
Under the Philippine setting, MFN clauses applying to certain income payments, e.g., royalties and revenue from international shipping and air transport operations, are provided not only in international tax treaties but also in international bilateral trade agreements.
In 1999, the Supreme Court (SC) in the case of Commissioner of Internal Revenue vs. S.C. Johnson and Sons, Inc. (SC Johnson), G.R. No. 127105, June 25, 1999, laid down the requisites for availment of the MFN treatment for royalties paid to a US resident under the RP-US Tax Treaty. In this case, SC Johnson, a US company, claimed 10% treaty rate on royalty earned from the Philippines under the RP-US Tax Treaty in relation to RP-Germany Tax Treaty granting such lower rate on royalty.
The MFN clause under the RP-US Tax Treaty provides that the Philippines as the source state (i.e., country where income was derived) can impose a tax not exceeding the lowest rate of Philippine tax that may be imposed on royalties of the same kind paid under similar circumstances to a resident of a third State.
Ruling on this issue, the SC stated that the MFN clause can only be applied if:
- The subject matter in taxation in the other tax treaty (e.g., RP-Germany Tax Treaty), in this case royalty, should be the same as that in the tax treaty under which the taxpayer is liable (e.g., RP-US Tax Treaty); and
- There should be similarity in the circumstances of payment of taxes and not royalties, which means that RP-US Tax Treaty grants similar tax relief to residents of the US with respect to taxes on royalties earned from the Philippines as those allowed to German residents under the RP-Germany Tax Treaty.
The second requisite was held to be wanting in this case since the RP-Germany Tax Treaty provided a tax sparing credit while the RP-US Tax Treaty did not. Tax sparing credit refers to allowing tax credit in a home country (e.g., Germany) with more tax than is actually paid in the host country (e.g., Philippines).
Recently, the Court of Tax Appeals (CTA) issued a very interesting decision relating to the application of the MFN clause provided under the RP-Denmark Tax Treaty in respect to revenue derived from international shipping and air transport operations in the Philippines by a resident of Denmark.
In the case of Maersk-Filipinas, Inc. on behalf of A.P. Moller-Maersk A/S vs. Commissioner of Internal Revenue, C.T.A. Case No. 6931, dated Jan. 9, 2008 a Danish shipping company claimed exemption from Philippine income tax on revenue earned from its international shipping operations in the Philippines applying the MFN clause under the RP-Denmark Tax Treaty in relation to the RP-Cyprus Merchant Shipping Agreement (RP-Cyprus MSA), which extends the same preferential tax treatment to residents of Cyprus on their revenue from international shipping operations in the Philippines.
The CTA denied the Danish company’s claim on the ground that the MFN requisites as laid down in the S.C. Johnson case was not satisfied since the subject matter in the RP-Cyprus MSA is not the same as that in the RP-Denmark Tax Treaty under which the taxpayer is liable.
Furthermore, the CTA also discussed the main differences between the RP-Denmark Tax Treaty and the RP-Cyprus MSA, as follows:
- RP-Denmark Tax Treaty is a treaty entered into between states creating rights and obligations while the RP-Cyprus MSA is more of limited in scope and lesser importance than a treaty since it usually covers technical and administrative matters which are not generally subject to ratification; and
- RP-Denmark Tax Treaty was entered into to avoid double taxation and prevent fiscal evasion with respect to taxes on income tax, while the RP-Cyprus MSA is a maritime agreement for economic and friendly relation between the parties in the field of merchant shipping.
Given these differences, the CTA concluded that there appears to be no similarity in the subject matter and in the manner of payment of taxes under the RP-Denmark Tax Treaty and RP-Cyprus MSA since the issues and fields covered under said treaties are entirely different from each other.
Accordingly, there is no basis to allow the availment of the MFN treatment under the RP-Denmark Tax Treaty in relation to the RP-Cyprus MSA.
With all due respect to the CTA’s decision, I believe that there may be grounds to support the availment of the MFN clause under the RP-Denmark Tax Treaty in this particular case. Basically, the two requisites for availment of the MFN privilege as laid down in the S.C. Johnson decision are satisfied in this case:
- The subject matter of taxation in the RP-Cyprus MSA is the same as that in the RP-Denmark Tax Treaty under which the Danish shipping company is liable; and
- There is similarity in the circumstances of payment of taxes since the tax relief allowed to residents of Denmark in respect to shipping revenue earned from the Philippines is effectively granted under the RP-Cyprus MSA which exempts from Philippine income tax shipping revenue earned by Cyprus residents from the Philippines.
Moreover, although the RP-Cyprus MSA is by nature an executive agreement and as such, not strictly a tax treaty, correlating said agreement with the RP-Denmark Tax Treaty for purposes of availing of the MFN clause provided in the latter is still proper. From the perspective of international law, no distinction is accorded between an executive agreement and a tax treaty since they are both equally binding upon the contracting states.
With still limited Philippine jurisprudence on interpretation of MFN clauses, evolving issues are still expected to come out. Enrichment of our jurisprudence, especially in the field of international law, is a significant tool to be properly attuned with the existing principles and interpretations of international law. And as the Philippines recognizes the importance of MFN clauses, proper judicial interpretation, hopefully will provide more meaningful effects on the purpose of the MFN clauses.
