AIR CANADA, PETITIONER, VS. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Air Canada versus Commissioner of Internal Revenue

The Case

This is a petition for review brought by Air Canada against the Commissioner of Internal Revenue, asking the Supreme Court to reverse the denial of its claim for refund of income taxes it says it paid by mistake. Air Canada is an offline international air carrier, meaning it has no flights originating from or coming to the Philippines and operates no airplane here, but it sells passage documents in the country through a general sales agent. The case matters because it settles, in one clean framework, how an offline foreign air carrier is taxed: not on Gross Philippine Billings, but as a resident foreign corporation on income from sources within the Philippines, subject always to the ceiling fixed by an applicable tax treaty.

Procedural History

Air Canada filed a written claim for refund before the Bureau of Internal Revenue, Revenue District Office Number 47, East Makati. To prevent the running of the prescriptive period, it then filed a petition for review before the Court of Tax Appeals. The Court of Tax Appeals First Division denied the petition and the claim for refund, holding that Air Canada was engaged in business in the Philippines through a local agent and should be taxed as a resident foreign corporation at the regular rate of 32 percent, and that it had established a permanent establishment under the tax treaty. Air Canada moved for reconsideration; the motion was denied, with the First Division clarifying that while Air Canada was not liable on Gross Philippine Billings, it was liable to the 32 percent corporate income tax on income from the sale of airline tickets within the Philippines. Air Canada appealed to the Court of Tax Appeals En Banc, which affirmed the First Division and dismissed the petition for lack of merit. Hence, this petition for review before the Supreme Court.

Facts

Air Canada is a foreign corporation organized and existing under the laws of Canada. On April 24, 2000, the Civil Aeronautics Board granted it authority to operate as an offline carrier, subject to certain conditions, for a period of five years, expiring on April 24, 2005. As an offline carrier, it does not have flights originating from or coming to the Philippines and does not operate any airplane in the Philippines. On July 1, 1999, it engaged the services of Aerotel as its general sales agent in the Philippines, and Aerotel sells Air Canada's passage documents here.

For the period from the third quarter of 2000 to the second quarter of 2002, Air Canada, through Aerotel, filed quarterly and annual income tax returns and paid income tax on Gross Philippine Billings in the total amount of 5,185,676.77 pesos. On November 28, 2002, it filed a written claim for refund of alleged erroneously paid income taxes before the Bureau of Internal Revenue, finding basis in the revised definition of Gross Philippine Billings under the 1997 National Internal Revenue Code.

The Commissioner resisted, arguing that Air Canada was a resident foreign corporation doing business in the Philippines, taxable at 32 percent, and that the amount it paid was in fact still short of the tax due. The Court of Tax Appeals agreed with the Commissioner, and the case reached the Supreme Court.

Issues

• Whether or not Air Canada, as an offline international carrier selling passage documents through a general sales agent in the Philippines, is a resident foreign corporation within the meaning of Section 28(A)(1) of the 1997 National Internal Revenue Code.
• Whether or not Air Canada is subject to the two and one-half percent tax on Gross Philippine Billings under Section 28(A)(3), and if not, whether it may be subject to the regular corporate income tax of 32 percent on taxable income under Section 28(A)(1).
• Whether or not the Republic of the Philippines and Canada Tax Treaty applies, specifically whether it is enforceable, and whether the appointment of a local general sales agent falls under the definition of permanent establishment under the treaty.
• Whether or not Air Canada is entitled to the refund of 5,185,676.77 pesos allegedly paid erroneously as tax on Gross Philippine Billings.

Applicable Provisions

Section 28(A)(1) of the 1997 National Internal Revenue Code, on the general tax on resident foreign corporations, provides:

SEC. 28. Rates of Income Tax on Foreign Corporations. -(A) Tax on Resident Foreign Corporations. -(1) In General. - Except as otherwise provided in this Code, a corporation organized, authorized, or existing under the laws of any foreign country, engaged in trade or business within the Philippines, shall be subject to an income tax equivalent to thirty-five percent (35%) of the taxable income derived in the preceding taxable year from all sources within the Philippines: Provided, That effective January 1, 1998, the rate of income tax shall be thirty-four percent (34%); effective January 1, 1999, the rate shall be thirty-three percent (33%); and effective January 1, 2000 and thereafter, the rate shall be thirty-two percent (32%).

This is the provision under which Air Canada is taxed as a resident foreign corporation doing business in the Philippines.

Section 28(A)(3) of the same Code, on international carriers, provides:

SEC. 28. Rates of Income Tax on Foreign Corporations. -(A) Tax on Resident Foreign Corporations. -. . . .(3) International Carrier. - An international carrier doing business in the Philippines shall pay a tax of two and one-half percent (2 1/2%) on its 'Gross Philippine Billings' as defined hereunder:(a) International Air Carrier. - 'Gross Philippine Billings' refers to the amount of gross revenue derived from carriage of persons, excess baggage, cargo and mail originating from the Philippines in a continuous and uninterrupted flight, irrespective of the place of sale or issue and the place of payment of the ticket or passage document: Provided, That tickets revalidated, exchanged and/or indorsed to another international airline form part of the Gross Philippine Billings if the passenger boards a plane in a port or point in the Philippines: Provided, further, That for a flight which originates from the Philippines, but transshipment of passenger takes place at any port outside the Philippines on another airline, only the aliquot portion of the cost of the ticket corresponding to the leg flown from the Philippines to the point of transshipment shall form part of Gross Philippine Billings.

This is the provision Air Canada paid under, and the Court holds it inapplicable because the tax attaches only to carriage originating from the Philippines in a continuous and uninterrupted flight.

Section 3(d) of Republic Act No. 7042, the Foreign Investments Act of 1991, defines doing business:

d. the phrase "doing business" shall include soliciting orders, service contracts, opening offices, whether called "liaison" offices or branches; appointing representatives or distributors domiciled in the Philippines or who in any calendar year stay in the country for a period or periods totalling one hundred eighty (180) days or more; participating in the management, supervision or control of any domestic business, firm, entity or corporation in the Philippines; and any other act or acts that imply a continuity of commercial dealings or arrangements, and contemplate to that extent the performance of acts or works, or the exercise of some of the functions normally incident to, and in progressive prosecution of, commercial gain or of the purpose and object of the business organization: Provided, however, That the phrase "doing business" shall not be deemed to include mere investment as a shareholder by a foreign entity in domestic corporations duly registered to do business, and/or the exercise of rights as such investor; nor having a nominee director or officer to represent its interests in such corporation; nor appointing a representative or distributor domiciled in the Philippines which transacts business in its own name and for its own account.

This guides the Court in finding that Air Canada, through Aerotel, is doing business in the Philippines.

Ruling

On the first issue, the Court holds that Air Canada is a resident foreign corporation for income tax purposes. The definition of resident foreign corporation has not substantially changed through the amendments of the Code; all versions refer to a foreign corporation engaged in trade or business within the Philippines. Following the British Overseas Airways Corporation case, the Court finds that Air Canada is doing business here through Aerotel, whose activities bring direct receipts or profits to Air Canada, and there is nothing on record to show that Aerotel solicited orders alone and for its own account. Aerotel cannot enter into any contract on behalf of Air Canada without the latter's express written consent, and it must perform its functions according to Air Canada's standards. The Civil Aeronautics Board authority to operate as an offline carrier for five years further confirms the continuity of the commercial arrangement.

On the second issue, the Court affirms that Air Canada is not liable for the two and one-half percent tax on Gross Philippine Billings, because the tax attaches only when the carriage of persons, excess baggage, cargo, and mail originated from the Philippines in a continuous and uninterrupted flight, and Air Canada has no flights to and from the Philippines. But this does not exempt it from the general rule. As held in the South African Airways case, if Section 28(A)(3)(a) does not apply, an international air carrier is liable for the tax under Section 28(A)(1).

On the third issue, the Court holds that the tax treaty must be taken into consideration to determine the proper tax rate. A tax treaty is an agreement between sovereign states for eliminating double taxation on income and capital, preventing fiscal evasion, promoting mutual trade and investment, and according fair and equitable tax treatment to foreign residents or nationals. Under the treaty with Canada, Air Canada may be imposed a maximum tax of one and one-half percent of its gross revenues earned from the sale of its tickets in the Philippines. The Court thus rejects the 32 percent rate as applied to Air Canada.

On the fourth issue, since Air Canada paid taxes on Gross Philippine Billings, which was the wrong basis, and since the treaty limits the imposable tax to one and one-half percent of gross revenues, the Court resolves the refund accordingly, subject to the treaty ceiling.

Doctrine

An offline international air carrier selling passage tickets in the Philippines through a general sales agent is a resident foreign corporation doing business in the Philippines. As such, it is taxable under Section 28(A)(1) of the 1997 National Internal Revenue Code, and not under Section 28(A)(3), subject to any applicable tax treaty to which the Philippines is a signatory. The two and one-half percent tax on Gross Philippine Billings applies only where carriage originates from the Philippines in a continuous and uninterrupted flight; where it does not, the general 32 percent rate on taxable income applies. But a tax treaty, which is part of the law of the land, may cap that rate; under the Republic of the Philippines and Canada Tax Treaty, the maximum is one and one-half percent of gross revenues from the sale of tickets in the Philippines.

Disposition

The petition was granted in part; the Court held Air Canada liable as a resident foreign corporation but limited the tax to one and one-half percent of its gross revenues from ticket sales in the Philippines under the tax treaty, and ordered the corresponding refund of the excess.

Remember This

Memorize this line: an offline international carrier selling tickets through a general sales agent is a resident foreign corporation taxable under Section 28(A)(1), not on Gross Philippine Billings, but the applicable tax treaty may cap the rate. Examiners use this case to test the interplay of the general corporate income tax, the special international carrier tax, and treaty relief, and to test whether a general sales agent constitutes doing business.