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try using gsub on $0 of file2

OK. It seems that file2 has some white-space before and/or after the data. Try this:
awk 'FNR==NR{a[toupper($1)]=1;next}(FNR!=1 && ($3 in a))||FNR==1' file2 file1

little bit shorter.... :)


awk 'FNR==NR{a[toupper($0)]=1;next}($3 in a)||FNR==1' file2 file1

awk 'FNR==NR{a[toupper($0)]=1;next}(FNR!=1 && ($3 in a))||FNR==1' file2 file1