“How friendly are the philippine skies?” by Dakila Elteen M. Napao (January 24, 2011)

SUITS THE C-SUITE By Dakila Elteen M. Napao
Business World (01/24/2011)

In an effort to enhance competition in an already vibrant airline industry, the Philippines is taking a major step towards easing restrictions within the commercial aviation sector. Government has announced that an executive order will be issued that will further liberalize the air transportation industry by allowing international airlines to use secondary gateways, a privilege previously exclusive to domestic carriers. Along with the increase in the number of stakeholders and the regulatory challenges, tax is certain to be an issue intertwined with flying in and out of the Philippine skies.

The taxation of revenues of international carriers, regardless of whether they have so-called “permanent establishments” in the Philippines, has been the subject of debate since the concept of Gross Philippine Billings was introduced by Presidential Decree (PD) 69 in 1972.

In the recent decision of South African Airways vs. Commissioner of Internal Revenue, G.R. No. 180356, promulgated Feb. 16, 2010, the Supreme Court held that “if an international air carrier maintains flights to and from the Philippines, it shall be taxed at the rate of 2.5% of its Gross Philippine Billings, while international air carriers that do not have flights to and from the Philippines but nonetheless earn income from other activities in the country will be taxed at the rate of 32% (now 30%) of such income.” In so ruling, the High Court dismissed claims that international carriers without landing rights in the Philippines are exempt from paying income tax. The Supreme Court effectively reiterated its ruling in the landmark 1987 case of British Overseas Airways Corp. that offline carriers with local general sales agents are considered resident foreign corporations doing business in the Philippines, thus tickets sales are subject to corporate income tax under Sec. 28 (A)(1) of the Tax Code.

Prior to the South African Airways case, the taxation rules on foreign carriers were not as clear. Under PD 1355, which amended the 1977 Tax Code, gross Philippine billings (GPB) include gross revenue derived from the sale of tickets in the Philippines covering the carriage of passengers from anywhere in the world and cargo or baggage originating in the Philippines. In the 1997 Tax Code, however, GPB was redefined to only include 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.”

This new concept had raised issues on the taxability of offline carriers on their income from the sale of tickets in the Philippines through their local agents. At first blush, it appears that since these carriers do not transport passengers and cargo from the Philippines, they are not subject to tax since they do not derive taxable GPB as defined under the 1997 Tax Code. This also meant that offline carriers cannot thus be considered as nonresident foreign corporations doing business in the Philippines.

However, in the case of Air Canada vs. Commissioner of Internal Revenue, CTA (First Division) Case No. 6572, promulgated Dec. 22, 2004, the CTA held that offline carriers are considered resident foreign corporations since they are doing business in the Philippines. Citing Supreme Court rulings, the CTA reasoned that a foreign airline selling tickets in the Philippines through its local agents shall be considered as engaged in trade or business, as these activities show continuity of commercial dealings performed in pursuit of business purpose. Such ruling was sustained by the CTA En Banc in the appeal made by Air Canada (CTA EB No. 86, promulgated Aug. 26, 2005).

The Supreme Court sustained the Air Canada ruling in the South African Airways decided in 2010.

In the South African Airways case, the Supreme Court noted that there are no specific criteria as to what constitutes doing business. The Supreme Court held that the term “engaged in business in the Philippines” implies “continuity of commercial dealings and arrangements” which includes the performance of acts pursuant to the purpose and object of the business organization, such as the appointment of a local agent. Since the sale of tickets — the activity which produces the income — is done in the Philippines even if the carriage of person, baggage, cargo or mail is done outside the Philippines, it is a Philippine-sourced income subject to tax.

From these rulings, it can be inferred that the courts steadfastly held to the source principle in Philippine income taxation, which contemplates the idea that an alien is subject to Philippine tax if he or she derives income from sources within the Philippines. This is not at all contradictory to the subject of tax on GPB because the situs of taxation is still the primary consideration. In case of airlines with landing rights in the Philippines, the determination of the situs of taxation is the service which is provided in the Philippines, i.e., the carriage of persons or cargo from the Philippines. For offline carriers, on the other hand, the determination of the status of tax is the place of sale of tickets, such that if the tickets are sold in the Philippines, the income from these sales is subject to tax.

International airlines that will take advantage of Government’s pocket open skies policy will be subject to the GPB tax regime since they would carry passengers from domestic locations and fly them to international destinations.

Now that the Supreme Court has clarified the rules on the taxability of foreign carriers, the willingness to open the market to cross-border investments could very well result in more revenues for Government, increased participation of foreign players and improved services from local airlines at competitive prices that will benefit the flying public.

>i>(Dakila Elteen M. Napao is a Tax Director of SGV & Co.)

This article was originally published in the BusinessWorld newspaper. It is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinion expressed above are those of the author and do not necessarily represent the views of SGV & Co.