This Supreme Court decision clarifies the tax obligations of international air carriers operating in the Philippines without direct flights. It establishes that these “offline” carriers, selling tickets through local agents, are considered resident foreign corporations doing business in the Philippines. While subject to income tax, their liability is capped at 1.5% of gross revenues under the Republic of the Philippines-Canada Tax Treaty, ensuring fair treatment and encouraging international commerce. This ruling balances the state’s right to tax and adherence to international agreements, promoting a stable investment climate for foreign entities.

Sky High Sales, Earth Bound Taxes: How Air Canada Navigated Philippine Revenue Rules

The case of Air Canada v. Commissioner of Internal Revenue revolves around the tax obligations of an international air carrier that sells passage tickets in the Philippines through a general sales agent, but does not operate flights to or from the country. Air Canada, a Canadian corporation, engaged Aerotel Ltd. Corp. as its general sales agent in the Philippines to sell its passage documents. From 2000 to 2002, Air Canada, through Aerotel, filed income tax returns and paid taxes on Gross Philippine Billings (GPB), totaling P5,185,676.77. However, Air Canada later filed a claim for a refund, arguing that it was not subject to tax on its GPB under Section 28(A)(3)(a) of the 1997 National Internal Revenue Code (NIRC). This section defines GPB as revenues from the carriage of passengers, excess baggage, cargo, and mail originating from the Philippines in a continuous and uninterrupted flight.

The Commissioner of Internal Revenue (CIR) denied the refund, arguing that Air Canada was a resident foreign corporation doing business in the Philippines and subject to the regular corporate income tax rate. The CIR relied on previous Supreme Court decisions, such as Commissioner of Internal Revenue v. American Airlines, Inc., which held that foreign airline companies selling tickets in the Philippines through local agents are considered resident foreign corporations engaged in trade or business in the country. The Tax Court upheld the denial of the refund, leading Air Canada to appeal to the Supreme Court.

At the heart of the matter was whether Air Canada, as an offline international carrier, should be taxed under Section 28(A)(1) as a resident foreign corporation or under Section 28(A)(3) as an international carrier. Section 28(A)(1) imposes a tax on the taxable income of resident foreign corporations from sources within the Philippines, while Section 28(A)(3) taxes international carriers at a rate of 2.5% on their Gross Philippine Billings. The definition of a “resident foreign corporation” hinges on whether the entity is “engaged in trade or business within the Philippines.”

The Supreme Court affirmed the Tax Court’s ruling that Air Canada was not liable for tax on Gross Philippine Billings under Section 28(A)(3) of the NIRC. The Court reasoned that the tax on GPB only applies to the carriage of passengers, excess baggage, cargo, and mail originating from the Philippines in a continuous and uninterrupted flight. Since Air Canada did not have flights to and from the Philippines, it was not subject to this tax. However, the Court also held that Air Canada was indeed a resident foreign corporation subject to income tax in the Philippines.

To determine whether Air Canada was “doing business” in the Philippines, the Court examined its activities through its general sales agent, Aerotel. The Court considered several factors, including the continuity of commercial dealings, the performance of acts or works, and the exercise of functions normally incident to commercial gain. It found that Aerotel’s activities, such as selling tickets, handling reservations, and promoting Air Canada’s services, were integral to Air Canada’s business. The appointment of Aerotel as a general sales agent, according to the court, constituted “doing business” in the Philippines, thereby classifying Air Canada as a resident foreign corporation.

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%). (Emphasis supplied)

The Court emphasized that the definition of “resident foreign corporation” had remained consistent throughout amendments to the NIRC, always referring to a foreign corporation engaged in trade or business within the Philippines. This classification subjected Air Canada to the regular corporate income tax, calculated as a percentage of its taxable income derived from sources within the Philippines.

However, the Court also considered the impact of the Republic of the Philippines-Canada Tax Treaty. Tax treaties are agreements between sovereign states designed to eliminate double taxation, prevent fiscal evasion, promote trade and investment, and ensure fair tax treatment. The Court recognized that the Philippines is bound to comply with its treaty obligations in good faith, adhering to the principle of pacta sunt servanda. This principle requires that treaty obligations be performed in good faith.

Under the Republic of the Philippines-Canada Tax Treaty, the Court examined whether Air Canada had a “permanent establishment” in the Philippines through its agent, Aerotel. The treaty defines a “permanent establishment” as a fixed place of business in which the business of the enterprise is wholly or partly carried on. Despite not having a fixed place of business, an enterprise may be deemed to have a permanent establishment if a person acts on its behalf under certain conditions. The Court found that Aerotel was a dependent agent of Air Canada, as Air Canada exercised comprehensive control and detailed instructions over Aerotel’s activities. Therefore, Air Canada was deemed to have a “permanent establishment” in the Philippines.

Ultimately, the Supreme Court ruled that while Air Canada was taxable as a resident foreign corporation under Section 28(A)(1) of the NIRC, its tax liability was capped at 1.5% of its gross revenues under Article VIII of the Republic of the Philippines-Canada Tax Treaty. Tax treaties, as part of the law of the land, take precedence over general laws, such as the NIRC, when they provide more specific rules. This outcome balanced the Philippines’ right to tax foreign corporations doing business within its borders with its commitment to international agreements and the avoidance of double taxation. The decision underscored the importance of considering tax treaties when determining the tax obligations of foreign entities operating in the Philippines.

This decision harmonizes domestic tax law with international treaty obligations, offering a balanced approach to taxing foreign corporations operating in the Philippines. By recognizing Air Canada as a resident foreign corporation, the Supreme Court affirmed the Philippines’ right to tax entities engaged in commercial activities within its borders. However, by limiting the tax rate to 1.5% of gross revenues under the tax treaty, the Court ensured that Air Canada received fair treatment and avoided double taxation. This approach aligns with the Philippines’ commitment to fostering a stable and attractive investment climate for foreign businesses, which is crucial for economic growth and international cooperation. The specific terms of agency agreements, alongside applicable tax treaties, are central to determining tax obligations for international entities operating within the Philippines.

FAQs

What was the key issue in this case?	The key issue was determining the correct tax treatment of an offline international air carrier selling tickets in the Philippines through a general sales agent. This involved deciding whether the carrier should be taxed as a resident foreign corporation or under the specific rules for international carriers.
What is Gross Philippine Billings (GPB)?	Gross Philippine Billings refers to the gross revenue derived from the carriage of persons, excess baggage, cargo, and mail originating from the Philippines in a continuous and uninterrupted flight. This definition is crucial for determining the tax base for international air carriers operating flights to and from the Philippines.
What is a resident foreign corporation?	A resident foreign corporation is a corporation organized under the laws of a foreign country that is engaged in trade or business within the Philippines. This classification subjects the corporation to income tax on its income derived from sources within the Philippines.
What does “doing business” in the Philippines mean?	“Doing business” in the Philippines includes soliciting orders, service contracts, opening offices, appointing representatives or distributors, and any other acts that imply a continuity of commercial dealings. This definition is critical in determining whether a foreign corporation is subject to Philippine income tax.
What is a tax treaty?	A tax treaty is an agreement between two countries designed to avoid double taxation, prevent fiscal evasion, promote mutual trade and investment, and accord fair tax treatment to foreign residents or nationals. These treaties often provide specific tax rates and rules that take precedence over general tax laws.
What is a “permanent establishment” under the Republic of the Philippines-Canada Tax Treaty?	Under the treaty, a “permanent establishment” is a fixed place of business in which the business of an enterprise is wholly or partly carried on. It can also include a dependent agent who has the authority to conclude contracts on behalf of the enterprise.
How does the Republic of the Philippines-Canada Tax Treaty affect Air Canada’s tax liability?	The treaty limits the tax imposed on Air Canada’s income derived from the operation of aircraft in international traffic to a maximum of 1.5% of gross revenues derived from Philippine sources. This rate is lower than the regular corporate income tax rate.
Why was Air Canada not entitled to a refund of the taxes it paid?	Although Air Canada was not liable for the tax on Gross Philippine Billings, the Court determined that it was liable for the regular corporate income tax. The amount of tax imposable under Section 28(A)(1) of the 1997 NIRC exceeded the maximum ceiling of 1 1/2% of gross revenues as decreed in Article VIII of the Republic of the Philippines-Canada Tax Treaty, hence, no refund was forthcoming.

This ruling underscores the complexities of international taxation and the importance of considering both domestic laws and international agreements. For businesses operating across borders, understanding the nuances of tax treaties and the definition of “doing business” is essential for ensuring compliance and optimizing tax outcomes.

For inquiries regarding the application of this ruling to specific circumstances, please contact ASG Law through contact or via email at frontdesk@asglawpartners.com.

Disclaimer: This analysis is provided for informational purposes only and does not constitute legal advice. For specific legal guidance tailored to your situation, please consult with a qualified attorney.
Source: Air Canada vs. CIR, G.R. No. 169507, January 11, 2016