AIR CANADA, Petitioner, vs. COMMISSIONER OF INTERNAL REVENUE, Respondent.

(G.R. No. 169507; January 11, 2016)

Taxation Law (Debt)

FACTS:

 Air Canada is an offline air carrier selling passage tickets in the Philippines, through a general sales
agent, Aerotel. As an off-line carrier, [Air Canada] does not have flights originating from or
coming to the Philippines [and does not] operate any airplane [in] the Philippines[.]
 Air Canada filed a claim for refund for more than 5 million pesos. It claims that there was
overpayment, saying that the applicable tax rate against it is 2.5% under the law on tax on
Resident Foreign Corporations (RFCs) for international carriers. It argues that, as an international
carrier doing business in the Philippines, it is not subject to tax at the regular rate of 32%.
 Air Canada also claims that it is not taxable because its income is taxable only in Canada because
of the Philippines-Canada Treaty (treaty). According to it, even if taxable, the rate should not
exceed 1.5% as stated in said treaty.
 However, the CTA ruled that Air Canada was engaged in business in the Philippines through a local
agent that sells airline tickets on its behalf. As such, it should be taxed as a resident foreign
corporation at the regular rate of 32%.
 The CTA also said that Air Canada cannot avail of the lower tax rate under the treaty because it
has a "permanent establishment" in the Philippines. Hence, Air Canada cannot avail of the tax
exemption under the treaty.

ISSUES:

 [1] Is Air Canada, an offline international carrier selling passage documents through Aerotel, a
RFC?
 [2] As an offline international carrier selling passage documents, is Air Canada subject to 2.5% tax
on Gross Philippine Billings or to the regular 32% tax?
 [3] Can Air Canada benefit from the treaty's elimination of double taxation in favor of Canada or
the preferential rate of 1.5%?
 [4] Can Air Canada validly refuse to pay its tax deficiency on the ground that there is a pending
tax credit proceeding it has filed?
 [5] Is Air Canada entitled to the tax refund claimed at more than 5 million pesos?

HELD:

 [1] Yes, Air Canada is a resident foreign corporation. Although there is no one rule in determining
what "doing business in the Philippines" means, the appointment of an agent or an employee is
a good indicator. This is especially true when there is effective control, similar to that of employer-
employee relationship. This is true between Air Canada and Aerotel. Hence, Air Canada is a RFC.
 [2] No, because the 2.5% tax on Gross Philippine Billings applies only to carriers maintaining
flights to and from the Philippines. Air Canada's appointment of a general sales agent, Aerotel,
 here is only for the purpose of selling passage documents. However, this is not the complete
answer since the treaty is the latter law that prevails in this case.
 [3] Air Canada cannot avail of the elimination of double taxation in favor of Canada since the
treaty expressly excludes Canadian carriers with "permanent establishment." Through the
appointment of Aerotel as its local sales agent, petitioner is deemed to have created a
"permanent establishment" in the Philippines as defined under the Republic of the Philippines-
Canada Tax Treaty.
 This is especially true since Aerotel has no "independent status" beacuse Air Canada exercises
comprehensive control and detailed instructions over the means and results of the activities of
the former.
 [4] No, it cannot. Even if Air Canada succeeds in claiming tax refund, the general rule prevails
that there can be not setting off of taxes since the Government and the taxpayer are not
creditors and debtors of each other.
 [5] No, Air Canada is not entitled to refund. The P5,185,676.77 Gross Philippine Billings tax paid
by petitioner was computed at the rate of 1 ½% of its gross revenues amounting to
P345,711,806.08149 from the third quarter of 2000 to the second quarter of 2002. It is quite
apparent that the tax imposable under Section 28(A)(l) of the 1997 National Internal Revenue
Code [32% of taxable income, that is, gross income less deductions] will exceed the maximum
ceiling of 1 ½% of gross revenues as decreed in Article VIII of the Republic of the Philippines-
Canada Tax Treaty. Hence, no refund is forthcoming.

At the outset, we affirm the Court of Tax Appeals' ruling that petitioner, as an offline international carrier
with no landing rights in the Philippines, is not liable to tax on Gross Philippine Billings under Section
28(A)(3) of the 1997 National Internal Revenue Code:chanRoblesvirtualLawlibrary

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.

Petitioner, an offline carrier, is a resident foreign corporation for income tax purposes. Petitioner falls
within the definition of resident • foreign corporation under Section 28(A)(1) of the 1997 National Internal
Revenue Code, thus, it may be subject to 32%53 tax on its taxable income:

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%54).