CIR VS SC JOHNSON & SON, INCS AND CA
the allowance of a tax credit to citizens or residents of
FACTS: Respondent, JOHNSON AND SON, INC a
domestic corporation organized and operating under the
Philippine laws, entered into a license agreement with
SC Johnson and Son, United States of America (USA), a
non-resident foreign corporation based in the U.S.A.
pursuant to which the [respondent] was granted the right
to use the trademark, patents and technology owned by
the latter including the right to manufacture, package
and distribute the products covered by the Agreement
and secure assistance in management, marketing and
production from SC Johnson and Son, U. S. A.
The said License Agreement was duly registered with
the Technology Transfer Board of the Bureau of Patents,
Trade Marks and Technology Transfer under Certificate
of Registration No. 8064 . For the use of the trademark
or technology, SC JOHNSON AND SON, INC was
obliged to pay SC Johnson and Son, USA royalties
based on a percentage of net sales and subjected the
same to 25% withholding tax on royalty payments which
respondent paid for the period covering July 1992 to
May 1993.00 On October 29, 1993, SC JOHNSON AND
SON, USA filed with the International Tax Affairs
Division (ITAD) of the BIR a claim for refund of overpaid
withholding tax on royalties arguing that, since the
agreement was approved by the Technology Transfer
Board, the preferential tax rate of 10% should apply to
the respondent. Respondent submits that royalties paid
to SC Johnson and Son, USA is only subject to 10%
withholding tax pursuant to the most-favored nation
clause of the RP-US Tax Treaty in relation to the RP-
West Germany Tax Treaty. The Internal Tax Affairs
Division of the BIR ruled against SC Johnson and Son,
Inc. and an appeal was filed by the former to the Court of
tax appeals.
The CTA ruled against CIR and ordered that a tax credit
be issued in favor of SC Johnson and Son, Inc.
Unpleased with the decision, the CIR filed an appeal to
the CA which subsequently affirmed in toto the decision
of the CTA. Hence, an appeal on certiorari was filed to
the SC.
ISSUE: WON SC Johnson and Son, USA is entitled to
the most favored nation tax rate of 10% on royalties as
provided in the RP-US Tax Treaty in relation to the RP-
WEST GERMANY Tax Treaty.
RULING: No. The concessional tax rate of 10 percent
provided for in the RP-Germany Tax Treaty could not
apply to taxes imposed upon royalties in the RP-US Tax
Treaty since the two taxes imposed under the two tax
treaties are not paid under similar circumstances, they
are not containing similar provisions on tax crediting.
The United States is the state of residence since the
taxpayer, S. C. Johnson and Son, U. S. A., is based
there. Under the RP-US Tax Treaty, the state of
residence and the state of source are both permitted to
tax the royalties, with a restraint on the tax that may be
collected by the state of source. Furthermore, the
method employed to give relief from double taxation is
the United States against the United States tax, but such
amount shall not exceed the limitations provided by
United States law for the taxable year. The Philippines
may impose one of three rates: 1.) 25 percent of the
gross amount of the royalties; 2.) 15 percent when the
royalties are paid by a corporation registered with the
Philippine Board of Investments and engaged in
preferred areas of activities; or 3.) 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.
Given the purpose underlying tax treaties and the
rationale for the most favored nation clause, the Tax
Treaty should apply only if the taxes imposed upon
royalties in the RP-US Tax Treaty and in the RP-
Germany Tax Treaty are paid under similar
circumstances. This would mean that private
respondent must prove that the RP-US Tax Treaty
grants similar tax reliefs to residents of the United States
in respect of the taxes imposable upon royalties earned
from sources within the Philippines as those allowed to
their German counterparts under the RP-Germany Tax
Treaty. The RP-US and the RP-West Germany Tax
Treaties do not contain similar provisions on tax
crediting. Article 24 of the RP-Germany Tax Treaty,
expressly allows crediting against German income and
corporation tax of 20% of the gross amount of royalties
paid under the law of the Philippines. On the other hand,
Article 23 of the RP-US Tax Treaty, which is the
counterpart provision with respect to relief for double
taxation, does not provide for similar crediting of 20% of
the gross amount of royalties paid.
At the same time, the intention behind the adoption of
the provision on relief from double taxation in the two tax
treaties in question should be considered in light of the
purpose behind the most favored nation clause.
What is the most favored nation clause?
The purpose of a most favored nation clause is to grant
to the contracting party treatment not less favorable than
that which has been or may be granted to the “most
favored” among other countries. It is intended to
establish the principle of equality of international
treatment by providing that the citizens or subjects of the
contracting nations may enjoy the privileges accorded by
either party to those of the most favored nation. The
essence of the principle is to allow the taxpayer in one
state to avail of more liberal provisions granted in
another tax treaty to which the country of residence of
such taxpayer is also a party provided that the subject
matter of taxation, in this case royalty income, is the
same as that in the tax treaty under which the taxpayer
is liable.
The RP-US Tax Treaty does not give a matching tax
credit of 20 percent for the taxes paid to the Philippines
on royalties as allowed under the RP-West Germany
Tax Treaty, private respondent cannot be deemed
entitled to the 10 percent rate granted under the latter
treaty for the reason that there is no payment of taxes on
royalties under similar circumstances.
TAXATION RELATED TOPICS:
What is the purpose of a tax treaty?
The purpose of these international agreements is to
reconcile the national fiscal legislations of the contracting
parties in order to help the taxpayer avoid simultaneous
taxation in two different jurisdictions.
The goal of double taxation conventions would be
thwarted if such treaties did not provide for effective
measures to minimize, if not completely eliminate, the
tax burden laid upon the income or capital of the
investor. Thus, if the rates of tax are lowered by the state
of source, in this case, by the Philippines, there should
be a concomitant commitment on the part of the state of
residence to grant some form of tax relief, whether this
be in the form of a tax credit or exemption. Otherwise,
the tax which could have been collected by the
Philippine government will simply be collected by
another state, defeating the object of the tax treaty since
the tax burden imposed upon the investorwould remain
unrelieved. If the state of residence does not grant some
form of tax relief to the investor, no benefit would
redound to the Philippines, i.e., increased investment
resulting from a favorable tax regime, should it impose a
lower tax rate on the royalty earnings of the investor, and
it would be better to impose the regular rate rather than
lose much-needed revenues to another country.
What is international double taxation and the
rationale for doing away with it?
International juridical double taxation is defined as the
imposition of comparable taxes in two or more states on
the same taxpayer in respect of the same subject matter
and for identical periods; The apparent rationale for
doing away with double taxation is to encourage the free
flow of goods and services and the movement of capital,
technology and persons between countries, conditions
deemed vital in creating robust and dynamic economies.
When is there double taxation?
Double taxation usually takes place when a person is
resident of a contracting state and derives income from,
or owns capital in, the other contracting state and both
states impose tax on that income or capital.
What are the methods of eliminating double
taxation?
 First, it sets out the respective rights to tax of the
state of source or situs and of the state of
residence with regard to certain classes of
income or capital. In some cases, an exclusive
right to tax is conferred on one of the contracting
states; however, for other items of income or
capital, both states are given the right to tax,
although the amount of tax that may be imposed
by the state of source is limited.
 The second method for the elimination of double
taxation applies whenever the state of source is
given a full or limited right to tax together with
the state of residence. In this case, the treaties
make it incumbent upon the state of residence to
allow relief in order to avoid double taxation. In
this case, the treaties make it incumbent upon
the state of residence to allow relief in order to
avoid double taxation.
What are the methods of relief under the
second method?
There are two methods of relief—the exemption
method and the credit method.
 Exemption method, the income or capital which
is taxable in the state of source or situs is
exempted in the state of residence, although in
some instances it may be taken into account in
determining the rate of tax applicable to the
taxpayer’s remaining income or capital.
 Credit method, although the income or capital
which is taxed in the state of source is still
taxable in the state of residence, the tax paid in
the former is credited against the tax levied in
the latter.
 The basic difference between the two
methods is that in the exemption method, the
focus is on the income or capital itself, whereas
the credit method focuses upon the tax.
What is the rationale of reducing tax rates in
negotiating tax treaties?
In negotiating tax treaties, the underlying rationale for
reducing the tax rate is that the
Philippines will give up a part of the tax in the
expectation that the tax given up for this particular
investment is not taxed by the other country.
What are tax refunds?
Tax refunds are in the nature of tax exemptions, and as
such they are regarded as in derogation of sovereign
authority and to be construed strictissimi juris against the
person or entity claiming the exemption.
Who has the burden of proof in tax exemption?
The burden of proof is upon him who claims the
exemption in his favor and he must be able to justify his
claim by the clearest grant of organic or statute law.
 CIR v. JOHN L. MANNING
FACTS: In 1952 the MANTRASCO had an authorized
capital stock of P2,500,000 divided into 25,000 common
shares; 24,700 of these were owned by Julius S. Reese,
and the rest, at 100 shares each, by the three
respondents.
On February 29, 1952, in view of Reese's desire that
upon his death MANTRASCO and its two subsidiaries,
MANTRASCO (Guam), Inc. and the Port Motors, Inc.,
would continue under the management of the
respondents, a trust agreement on his and the
respondents' interests in MANTRASCO was executed
by and among Reese (therein referred to as OWNER),
MANTRASCO (therein referred to as COMPANY), the
law firm of Ross, Selph, Carrascoso and Janda (therein
referred to as TRUSTEES), and the respondents
(therein referred to as MANAGERS).
On October 19, 1954 Reese died. The projected
transfer of his shares in the name of MANTRASCO
could not, however, be immediately effected for lack of
sufficient funds to cover initial payment on the shares.
On February 2, 1955, after MANTRASCO made a partial
payment of Reese's shares, the certificate for the 24,700
shares in Reese's name was cancelled and a new
certificate was issued in the name of MANTRASCO. On
the same date, and in the meantime that Reese's
interest had not been fully paid, the new certificate was
endorsed to the law firm of Ross, Selph, Carrascoso and
Janda, as trustees for and in behalf of MANTRASCO.
On December 22, 1958, at a special meeting of
MANTRASCO stockholders, the following resolution was
passed:
"RESOLVED, that the 24,700 shares in the Treasury be
reverted back to the capital account of the company as a
stock dividend to be distributed to shareholders of record
at the close of business on December 22, 1958, in
accordance with the action of the Board of Directors at
its meeting on December 19, I958 which action is hereby
approved and confirmed."
On November 25, 1963 the entire purchase price of
Reese's interest in MANTRASCO was finally paid in full
by the latter. On May 4, 1964 the trust agreement was
terminated and the trustees delivered to MANTRASCO
all the shares which they were holding in trust.
Meanwhile, on September 14, 1962, an examination of
MANTRASCO's books was ordered by the Bureau of
Internal Revenue. On the basis of their examination, the
BIR examiners concluded that the distribution of Reese's
shares as stock dividends was in effect a distribution of
the "asset or property of the corporation as may be
gleaned from the payment of cash for the redemption of
said stock and distributing the same as stock dividend.
The respondents unsuccessfully challenged the
foregoing assessments and, failing to secure a favorable
reconsideration, appealed to the Court of Tax Appeals.
On October 30, 1967 the CTA rendered judgment
absolving the respondents from any liability for receiving
the questioned stock dividends on the ground that their
respective one-third interest in MANTRASCO remained
the same before and after the declaration of stock
dividends and only the number of shares held by each of
them had changed.
ISSUES:
1. WON the shares are treasury shares?
2. WON Manning, McDonald and Simmons should
pay for the deficiency income taxes?
RULING:
1. No. Treasury shares are stocks issued and fully
paid for and re-acquired by the corporation either by
purchase, donation, forfeiture or other means.
Treasury shares are therefore issued shares, but being
in the treasury they do not have the status of outstanding
shares. Consequently, although a treasury share, not
having been retired by the corporation reacquiring it,
may be re-issued or sold again, such share, as long as it
is held by the corporation as a treasury share,
participates neither in dividends, because dividends
cannot be declared by the corporation to itself, nor in the
meetings of the corporation as voting stock, for
otherwise equal distribution of voting powers among
stockholders will be effectively lost and the directors will
be able to perpetuate their control of the corporation,
though it still represents a paid-for interest in the
property of the corporation. The foregoing essential
features of a treasury stock are lacking in the questioned
shares. The manifest intention of the parties to the
trust agreement was, in sum and substance, to treat
the 24,700 shares of Reese as absolutely
outstanding shares of Reese's estate until they were
fully paid. Such being the true nature of the 24,700
shares, their declaration as treasury stock dividend
in 1958 was a complete nullity and plainly violative
of public policy. A stock dividend, being one payable
in capital stock, cannot be declared out of outstanding
corporate stock, but only from retained earnings.
2. Yes. The ultimate purpose which the parties to the
trust instrument aimed to realize is to make the
respondents the sole owners of Reese's interests in
MANTRASCO by utilizing the periodic earnings of that
company and its subsidiaries to directly subsidize their
purchase of the said interests, and by making it appear
outwardly, through the formal declaration of non-existent
stock dividends in the treasury, that they have not
received any income from those firms when, in fact, by
that declaration they secured to themselves the means
to turn around as full owners of Reese's shares. In other
words, the respondents, using the trust instrument as a
convenient technical device, bestowed unto themselves
the full worth and value of Reese's corporate holdings
with the use of the very earnings of the companies.
Such package device, obviously not designed to carry
out the usual stock dividend purpose of corporate
expansion - reinvestment, e.g. the acquisition of
additional facilities and other capital budget items, but
exclusively for expanding the capital base of the
respondents in MANTRASCO, cannot be allowed to
deflect the respondents' responsibilities toward our
income tax laws. The conclusion is thus ineluctable that
whenever the companies involved herein parted with a
portion of their earnings "to buy" the corporate holdings
of Reese, they were in ultimate effect and result making
a distribution of such earnings to the respondents. All
these amounts are consequently subject to income tax
as being, in truth and in fact, a flow of cash benefits to
the respondents. Consequently, those earnings, which
we hold, under the facts disclosed in the case at bar, as
in effect having been distributed to the respondents,
should be taxed for each of the corresponding years
when payments were made to Reese's estate on
account of his 24,700 shares.

With regard to payments made with MANTRASCO

earnings in 1958 and the years before, while indeed
those earnings were utilized in those years to gradually
pay off the value of Reese's holdings in MANTRASCO,
there is no evidence from which it can be inferred that
prior to the passage of the stockholders' resolution of
December 22, 1958 the contributed equity of each of the
respondents rose correspondingly. It was only by virtue
of the authority contained in the said resolution that the
respondents actually, albeit illegally, appropriated and
partitioned among themselves the stockholders' equity
representing Reese's interests in MANTRASCO. As
those payments accrued in favor of the respondents in
1958 they are and should be liable, for income tax
purposes, to the extent of the aggregate amount paid,
from 1955 to 1958, by MANTRASCO to buy off Reese's
shares. Under the NIRC, income tax is assessed on
income received from any property, activity or service
that produces income. The Tax Code stands as an
indifferent, neutral party on the matter of where the
income comes from.