AIR CANADA, PETITIONER, VS.
COMMISSIONER OF INTERNAL
REVENUE, RESPONDENT.
G.R. No. 169507, January 11, 2016
FACTS:
Air Canada is a foreign airline corporation based in Canada. It has no branch office in the
Philippines but appointed Aerotel Ltd. Corp. as its Passenger General Sales Agent (GSA) in
the country.
A Passenger General Sales Agent (GSA) is a local company or corporation that represents a
foreign airline in a country where the airline itself does not maintain a branch office.
For Air Canada, since it has no branch in the Philippines, it appoints Aerotel Ltd. Corp. as its
GSA.
Here’s what a Passenger GSA generally does:
Functions of a Passenger GSA
1. Ticket Sales & Reservations – The GSA sells tickets for the airline’s flights and handles
booking and reservations on its behalf.
2. Marketing & Promotion – It promotes the airline’s services in the local market,
ensuring visibility and competitiveness.
3. Customer Service – The GSA assists passengers with inquiries, reservations, refunds,
flight changes, and related services.
4. Collection of Payments – It collects ticket fares and remits them to the foreign airline.
5. Legal Representation – The GSA may serve as the local point of contact for legal or
administrative matters (e.g., complaints, coordination with regulators).
6. Liaison with Government/Agencies – It coordinates with the Civil Aeronautics Board
(CAB), airports, and other authorities for compliance with local aviation rules.
Under their General Sales Agency Agreement, Aerotel was authorized to:
Promote and sell Air Canada’s tickets;
Arrange reservations and distribute fare sheets;
Submit annual sales plans for Air Canada’s approval;
Use Air Canada’s name, logo, and comply with its business policies.
Aerotel earned commissions from ticket sales but worked under Air Canada’s control and
supervision, performing essential activities for its business operations.
Air Canada paid 2.5% Gross Philippine Billings (GPB) tax under Section 28(A)(3) of the
NIRC but later filed a claim for refund, arguing that:
Under Article VIII of the RP-Canada Tax Treaty, it should be taxed only 1.5% on
gross revenues from international air carriage originating from the Philippines;
GPB tax was inapplicable because Air Canada had no flights originating from the
Philippines — ticket sales were for flights connecting through Hong Kong or other
points.
The Court of Tax Appeals (CTA) held that:
Air Canada was not liable for GPB tax, since there were no flights originating from the
Philippines;
However, Air Canada was liable for regular corporate income tax under Section 28(A)
(1) of the NIRC because Aerotel constituted a permanent establishment of Air Canada
in the Philippines;
The refund claim was denied because the amount refundable would be offset by Air
Canada’s liability for corporate income tax.
Air Canada elevated the case to the Supreme Court, insisting that Aerotel was an independent
agent and that it had no taxable presence in the Philippines.
ISSUES:
1. Whether Air Canada is liable for Gross Philippine Billings (GPB) tax under Section
28(A)(3) of the NIRC.
2. Whether Aerotel, as Air Canada’s GSA, constituted a “permanent establishment”
in the Philippines under the RP-Canada Tax Treaty.
3. Whether Air Canada is liable for regular corporate income tax under Section 28(A)
(1) of the NIRC.
4. Whether Air Canada is entitled to a refund of the GPB tax it paid.
RULING — Detailed explanation
1) Air Canada is NOT liable for Gross Philippine Billings (GPB) tax (Section
28(A)(3), NIRC).
Rule. The GPB tax targets international carriers on gross revenue “derived from carriage …
originating from the Philippines in a continuous and uninterrupted flight,” regardless of where
the ticket was sold.
Why the Court held this. Air Canada did not operate flights that originated in the Philippines
during the period in question (it was an offline carrier). The GPB tax element — carriage
originating in the Philippines — therefore did not exist for Air Canada.
Application to the facts. Air Canada’s revenue in the Philippines was generated through ticket
sales by its local agent (Aerotel) for flights that did not begin in the Philippines. Because the
statutory trigger for the GPB tax (a Philippine-originating continuous flight) was absent, Section
28(A)(3) simply did not apply to Air Canada.
2) Aerotel constituted a “permanent establishment” of Air Canada (treaty
analysis).
Rule. Under Article V of the RP–Canada Tax Treaty, a foreign enterprise has a permanent
establishment in the other State where it carries on business through a “fixed place” or through a
person acting on its behalf who is not an agent of independent status (i.e., a dependent agent who
habitually exercises authority to conclude contracts or is economically dependent on the
principal). Dependent-agent status is shown by control, exclusivity, required standards, and the
agent’s performance of core business functions.
Why the Court held this. The Passenger General Sales Agency agreement showed that Aerotel:
acted for the sole benefit of Air Canada in matters covered by the agreement;
had to follow Air Canada’s manual and written instructions and submit annual sales
plans for Air Canada’s approval;
used Air Canada’s trade name/logo subject to Air Canada’s standards;
performed core airline functions (ticket sales, promotion, reservation handling) that were
central to Air Canada’s business rather than merely preparatory tasks;
could not contract on Air Canada’s behalf without Air Canada’s consent, yet was
effectively conducting the airline’s Philippine sales outlet and exposing Air Canada to
third-party liabilities.
These features established dependence and control (not independent, arms-length
agency).
Application to the facts. Because Aerotel performed core revenue-generating activities
under Air Canada’s control and standards, the Court treated Aerotel as a dependent agent
that created a taxable presence (permanent establishment) for Air Canada in the
Philippines under the treaty.
3) Air Canada is liable for regular corporate income tax (Section 28(A)(1),
NIRC) as a resident foreign corporation (subject to any applicable treaty
limitation).
Rule. Section 28(A)(1) taxes a resident foreign corporation — i.e., a foreign corporation
engaged in trade or business in the Philippines — on taxable income from Philippine sources
(the rate at the relevant time was 32%). However, where a tax treaty applies, the treaty’s special
rules (and any applicable ceilings) must be observed.
Why the Court held this. Because the Aerotel relationship constituted a permanent
establishment, Air Canada was properly characterized as a foreign corporation engaged in
business in the Philippines and thus a resident foreign corporation for income tax purposes. That
placed Air Canada within Section 28(A)(1) territory (tax on taxable income).
Application to the facts. The sale of tickets via Aerotel constituted Philippine-source business
activity attributable to Air Canada. Thus under domestic law Air Canada became taxable on its
Philippine-source income — but the Court also examined whether the bilateral tax treaty limited
that tax.
Important treaty note (how it affects the tax): the RP–Canada Tax Treaty (Article VIII, read
with Article VII) treats profits from the international operation of aircraft and provides a limit —
the tax chargeable in the taxing State shall not exceed 1½% of gross revenues derived from
sources in that State. That treaty ceiling is a constraint on how much tax the Philippines may
lawfully collect from a Canadian carrier on income from air transport in international traffic.
4) Air Canada is NOT entitled to a refund of the GPB tax it paid.
Rule. In refund cases the Court of Tax Appeals (and ultimately the judiciary) must determine
whether the tax return was correct and, if not, what the correct tax liability is; a refund cannot be
granted where the taxpayer is in fact liable for another tax equal to or greater than the amount
claimed as refund. Also, taxes cannot be the subject of legal compensation/set-off against claims
the taxpayer may have against the government.
Why the Court held this. Although the GPB tax itself did not properly attach, the CTA (and the
Supreme Court on review) determined that Air Canada had liability under Section 28(A)(1) (as a
resident foreign corporation through a PE) and that, on the CTA’s calculations, the proper tax
owed would exceed the GPB sums Air Canada sought to recover. Because the determination of
the correct tax liability is necessary to resolve whether a refund should be awarded, the CTA
properly refused the refund. Granting the refund without resolving the correct tax liability would
risk unjust enrichment of the taxpayer and multiplicity of proceedings for the government to
recover any deficiency later.
Application to the facts. Air Canada claimed it had erroneously paid GPB tax and sought
recovery. The CTA examined whether the return was correct and whether Air Canada instead
owed other taxes. The CTA found Air Canada liable to tax under Section 28(A)(1); this finding
meant that the purported GPB refund would be offset by Air Canada’s other tax liability.
Therefore no refund was awarded. The Supreme Court agreed.
Also: the Court reiterated established doctrine that taxpayers cannot simply offset taxes due with
claims against the government — legal compensation/set-off is not available for internal revenue
taxes (Republic v. Mambulao Lumber Co.; Francia v. IAC and subsequent cases).
LEGAL BASIS — explanation of the controlling provisions
and principles
1. Section 28(A)(1), NIRC (1997) — Tax on resident foreign corporations.
o Tax base: taxable income from Philippine sources. At the time of the case the
applicable corporate rate was 32%.
o Relevance: If a foreign corporation is “doing business” in the Philippines (e.g.,
through a PE), it falls under this provision.
2. Section 28(A)(3), NIRC (1997) — International carrier / Gross Philippine Billings
(GPB) tax.
o Tax base: gross revenue from carriage originating from the Philippines in a
continuous/uninterrupted flight (the statutory text focuses on origin of carriage).
o Relevance: This provision was inapplicable because Air Canada had no flights
originating in the Philippines.
3. Articles V, VII and VIII of the RP–Canada Tax Treaty — Permanent establishment;
business profits; special rule for shipping & air transport.
o Article V (Permanent Establishment): defines PE and treats a dependent agent
(who habitually exercises authority to conclude contracts or acts under detailed
direction) as creating a PE.
o Article VII (Business Profits): business profits of an enterprise are taxable in the
other State only if the enterprise carries on business there through a permanent
establishment.
o Article VIII (Shipping and Air Transport): provides a special rule for profits
from operation of ships/aircraft in international traffic and includes a ceiling on
tax (the tax on such profits shall not exceed 1½% of gross revenues derived from
sources in that State).
o Relevance: The Treaty determines how much tax the Philippines may impose on a
Canadian carrier’s international air operations once a permanent establishment is
shown.
4. Treaty supremacy and interpretation principles
o Tax treaties, once duly ratified, have the force of law and will modify or limit
domestic statutory taxation to the extent they apply (pacta sunt servanda; treaties
are specific constraints on domestic law). The Court applies treaty provisions
when they govern the issue.
5. Judicial principle on refund claims and CTA powers
o The CTA may determine the correct tax category and liability as an incidental
issue in a refund claim. A refund will not be granted where the taxpayer is
actually liable for other taxes equal to or exceeding the amount claimed.
6. Article 1278, Civil Code & jurisprudence (Republic v. Mambulao Lumber Co.;
Francia v. IAC, Philex, Caltex) — Legal compensation not available for taxes.
o Relevance: Supports the rule that taxes owed to the government cannot be set off
against a taxpayer’s claims against the government.
