resident foreign corporation doing business in the Philippines, is not a

G.R. No. 60714. October 4, 1991. *

relevant consideration under the statutory provisions here involved, as they

COMMISSIONER OF INTERNAL REVENUE, existed during the taxable years from 1959 through to 1963. Whether a
petitioner, vs. JAPAN AIR LINES, INC., and THE COURT OF foreign corporation be a resident one doing business in the Philippines, or
TAX APPEALS, respondents. a non-resident not doing business in the Philippines, is subject to
Philippine income tax only in respect of its Philippine-source income. The
Taxation; For the source of income to be considered as coming critical issue, in other words, is always whether or not JAL was, during the
from the Philippines, it is sufficient that the income is derived from taxable years involved, deriving income from sources within the
activities within this country regardless of the absence of flight operations Philippines.
within Philippine territory.—The above ruling was adopted en toto in the Same; Same; For purposes of income taxation, the source of
subsequent case of Commissioner of Internal Revenue vs. Air India and income relates not to the physical sourcing of a flow of money or the
the Court of Tax Appeals (G.R. No. 72443, January 29, 1988, 157 SCRA physical sites of payment but rather to the property, activity or service
648) holding that the revenue derived from the sales of airplane ticket which produced the income.—The tax involved here is the tax on
through its agent Philippine Air Lines, Inc., here in the Philippines, must income: we are not concerned with a sales tax nor with an excise or
be considered taxable income, and more recently, in the case of privilege tax. For purposes of income taxation, I respectfully submit, the
Commissioner of Internal Revenue vs. American Airlines, Inc. and Court "source of income" relates not to the physical sourcing of a flow of money
of Tax Appeals (G.R. No. 67938, December 19, 1989, 180 SCRA 274), it or the physical situs of payment, but rather to the "property, activity or
was likewise declared that for the source of income to be considered as service which produced the income".
coming from the Philippines, it is sufficient that the income is derived
from activities within this country regardless of the absence of flight PETITION for review of the decision of the Court of Tax Appeals.
operations within Philippine territory. Filler, J.
Same; Same; In order that a foreign corporation may be regarded The facts are stated in the opinion of the Court.
as doing business within a State, there must be continuity of conduct and
intention to establish a continuous business.—There is no specific criterion
     Felicisimo R. Quiogue and Felipe T. Dumpit for private
as to what constitutes 'doing' or 'engaging in' or 'transacting' business. Each respondent.
case must be judged in the light of its peculiar environmental
circumstances. The term implies continuity of commercial dealings and PARAS, J.:
arrangements, and contemplates, to that extent, the performance of acts or
works or the exercise of some of the functions normally incident to, and in
This petition for review seeks the reversal of the decision  of the**

progressive prosecution of commercial gain or for the purpose and object

of the business organization (The Mentholatum Co., Inc., et al. vs. Court of Tax Appeals in CTA Case No. 2480 promulgated on
Anacleto Mangaliman, et al., 72 Phil. 524 (1941); Section 1, R.A. No. January 15, 1982 which set aside petitioner's assessment of
5455). In order that a foreign corporation may be regarded as doing deficiency income tax inclusive of interest and surcharge as well
business within a State, there must be continuity of conduct and intention as compromise penalty for violation of bookkeeping regulations
to establish a continuous business, such as the appointment of a local charged against respondent.
agent, and not one of a temporary character. The antecedent facts of the case are as follows:
_______________
Respondent Japan Air Lines, Inc. (hereinafter referred to as
_______________
*
 EN BANC.

451  Penned by Presiding Judge Amante Filler and concurred in by Associate

**

Judges Constante C. Roaquin and Alex Z. Reyes.

VOL. 202, OCTOBER 4, 1991 453
Commissioner of lnternal Revenue vs. Japan Air Lines, Inc. VOL. 202, OCTOBER 4, 1991
Same; Same; Same;  There being no dispute that JAL constituted
PAL as local agent to sell its airline tickets, there can be no conclusion Commissioner of Internal Revenue vs. Japan Air Lines, Inc.
other than that JAL is resident foreign corporation doing business in the JAL for brevity), is a foreign corporation engaged in the business
Philippines.—There being no dispute that JAL constituted PAL as local of international air carriage. From 1959 to 1963, JAL did not have
agent to sell its airline tickets, there can be no conclusion other than that planes that lifted or landed passengers and cargo in the Philippines
JAL is a resident foreign corporation, doing business in the Philippines. as it had not been granted then by the Civil Aeronautics Board
Indeed, the sale of tickets is the very lifeblood of the airline business, the (CAB) a certificate of public convenience and necessity to operate
generation of sales being the paramount objective.
Same; The willful neglect to file the required tax return or the
here. However, since mid-July, 1957, JAL had maintained an
fraudulent intent to evade the payment of taxes, considering that the same office at the Filipinas Hotel, Roxas Boulevard, Manila. Said office
is accompanied by legal consequences cannot be presumed.—Nowhere in did not sell tickets but was maintained merely for the promotion of
the records of the case can be found that JAL deliberately failed to file its the company's public relations and to hand out brochures,
income tax returns for the years covered by the assessment. There was not literature and other information playing up the attractions of Japan
even an attempt by petitioner to prove the same or justify the imposition of as a tourist spot and the services enjoyed in JAL planes.
the 50% surcharge. All that petitioner did was to cite the provision of law On July 17, 1957, JAL constituted the Philippine Air Lines
upon which the surcharge was based without explaining why it was (PAL), as its general sales agent in the Philippines. As an agent,
applicable to respondent's case. Such cannot be countenanced for mere
allegations are definitely not acceptable. The willful neglect to file the
PAL, among other things, sold for and in behalf of JAL, plane
required tax return or the fraudulent intent to evade the payment of taxes, tickets and reservations for cargo spaces which were used by the
considering that the same is accompanied by legal consequences, cannot be passengers or customers on the facilities of JAL.
presumed (CIR vs. Air India, supra). The fraud contemplated by law is On June 2, 1972, JAL received deficiency income tax
actual and constructive. It must be intentional fraud, consisting of assessment notices and a demand letter from petitioner
deception willfully and deliberately done or resorted to in order to induce Commissioner of Internal Revenue (hereinafter) referred to as
another to give up some legal right. Commissioner for brevity), all dated February 28, 1972, for a total
Same; Same; Negligence whether slight or gross is not equivalent amount of P2,099,687.52 inclusive of 50% surcharge and interest,
to the fraud with intent to evade the tax contemplated by the law.—
Negligence, whether slight or gross, is not equivalent to the fraud with
for years 1959 through 1963, computed as follows:
intent to evade the tax contemplated by the law. It must amount to   1959 1960 1
intentional wrongdoing with the sole object of evading the tax (Aznar v.
Court of Tax Appeals, G.R. No. L-20569, August 23, 1974, 58 SCRA Net income per investigation P472,025.16 P476,671.48 P734
519). This was not proven to be so in the case of JAL as it believed in good Tax due thereon 133,608.00 135,001.00 212
faith that it need not file the tax return for it had no taxable income then.
The element of fraud is lacking. At most, only negligence may be imputed Add: 50% surch. 66,804.00 67,500.50 106
to JAL for not ascertaining the dispensability of filing the tax returns. As      1/2% mo. int.
such, JAL may be subjected only to the 25% surcharge prescribed by the
aforequoted law.      (3 yrs.) 24,049.44 24,300.18 38
Total due P224,461.44 P226,801.68 P356
FELICIANO, J., dissenting opinion 454
454 SUPREME COURT REPORTS ANNO
Taxation; Whether a foreign corporation be a resident one doing
business in the Philippines or a non-resident not doing business in the Commissioner of lnternal Revenue vs. Japan Air Lines, Inc.
452
  1962 1963 SUM
452 SUPREME COURT REPORTS ANNOTATED Y
Commissioner of lnternal Revenue vs. Japan Air Lines, Inc. Net income per P1 , P1 , P224
Philippines is subject to Philippine income tax only in respect of its investigation 065,641.63 550,230.48
Philippine-source income.—Whether or not Japan Air Lines (JAL) is a
 reading of the section will show that it does not state that it is an
Tax due thereon 311,692.00 457,069.00 allinclusive enumeration, and that no other kind of income may be so
Add: 50% surch 155,846.00 228,534.50 considered (British Traders Insurance Co., Ltd. vs. Commissioner of
Internal Revenue, 13 SCRA 719 [1965]).
1/2% mo. int. "x x x      x x x
(3 yrs.) 56,104.56 82,272.42 "The absence of flight operations to and from the Philippines is not
determinative of the source of income or the situs of income taxation. x x x
Total due P 523,642.56 P 767,875.92 P2,099,687.52
The test of taxability is the 'source'; and the source of an income is that
Compromise Penalty activity x x x which produced the income (Howden & Co., Ltd. vs.
Collector of Internal Revenue, 13 SCRA 601 [1965]). Unquestionably, the
On June 19, 1972, JAL protested said assessments alleging that as
passage documentations in these cases were sold in the Philippines and the
a non-resident foreign corporation, it was taxable only on income revenue therefrom was derived from a business activity regularly pursued
from Philippine sources as determined under Section 37 of the Tax within the Philippines. x x x The word 'source' conveys one essential idea,
Code, and there being no such income during the period in that of origin, and the origin of the income herein is the Philippines
question, it was not liable for the deficiency income tax liabilities (Manila Gas Corporation vs. Collector of Internal Revenue, 62 Phil.
assessed (Rollo, pp. 53-55). The Commissioner resolved otherwise 895 [1935])."
and in a letter-decision dated December 21, 1972, denied JAL's The above ruling was adopted en toto in the subsequent case of
request for cancellation of the assessment (Ibid., p. 29). Commissioner of Internal Revenue vs. Air India and the Court of Tax
Appeals (G.R. No. 72443, January 29, 1988, 157 SCRA 648) holding that
JAL therefore, elevated the case to the Court of Tax Appeals
the revenue derived from the sales of airplane tickets through its agent
which, in turn, reversed the decision (Ibid., pp. 51-76) and Philippine Air Lines, Inc., here in the Philippines, must be considered
thereafter denied the motion for reconsideration filed by the taxable income, and more recently, in the case of Commissioner of Internal
Commissioner (Ibid., p. 77). Hence, this petition. Revenue vs. American Airlines, Inc. and Court of Tax Appeals (G.R. No.
Petitioner raises two issues in this wise: 67938, December 19, 1989, 180 SCRA 274), it was likewise declared that
for the source of income to be considered as coming from the Philippines,
it is sufficient that the income is derived from activities within this country
1. 1.WHETHER OR NOT PROCEEDS FROM SALES regardless of the absence of flight operations within Philippine territory.
OF JAPAN AIR LINES TICKETS SOLD IN THE Verily, JAL is a resident foreign corporation under Section 84 (g) of
PHILIPPINES ARE TAXABLE AS INCOME FROM the National Internal Revenue Code of 1939. Definition of what a resident
SOURCES WITHIN THE PHILIPPINES. foreign corporation is was likewise reproduced under Section 20 of the
2. 2.WHETHER OR NOT JAPAN AIR LINES IS A 1977 Tax Code.
FOREIGN CORPORATION ENGAGED IN TRADE The BOAC Doctrine has expressed in unqualified terms:
"Under Section 20 of the 1977 Tax Code;
OR BUSINESS IN THE PHILIPPINES. "(h) the term 'resident foreign corporation' applies to a foreign corporation
engaged in trade or business within the Philippines or having an office or place of
business therein.
The petition is impressed with merit. "(i) the term 'non-resident foreign corporation' applies to a foreign corporation
The issues in the case at bar have already been laid to rest in not engaged, in trade or business within the Philip
no less than three cases resolved by this Court. Anent the first
issue, the landmark case of Commissioner of Internal Revenue vs. 457
British Overseas Airways Corporation (G.R. Nos.-65773-74, April VOL. 202, OCTOBER 4, 1991
30, 1987, 149 SCRA 395) has categorically ruled:
455
Commissioner of lnternal Revenue vs. Japan Air Lines, Inc.
pines and not having any office or place of business therein."
VOL. 202, OCTOBER 4, 1991 "x x x. There is no specific criterion as to what constitutes 'doing' or 'engaging
in' or 'transacting' business. Each case must be judged in the light of its peculiar
Commissioner of lnternal Revenue vs. Japan Air Lines, Inc. environmental circumstances. The term implies continuity of commercial dealings
"The Tax Code defines 'gross income' thus: and arrangements, and contemplates, to that extent, the performance of acts or works
" 'Gross income' includes gains, profits, and income derived from or the exercise of some of the functions normally incident to, and in progressive
prosecution of commercial gain or for the purpose and object of the business
salaries, wages or compensation for personal service of whatever kind and
organization (The Mentholatum Co., Inc., et al. vs. Anacleto Mangaliman, et al., 72
in whatever form paid, or from profession, vocations, trades, business, Phil. 524 (1941); Section 1, R.A. No. 5455). In order that a foreign corporation may
commerce, sales, or dealings in property, whether real or personal, be regarded as doing business within a State, there must be continuity of conduct and
growing out of the ownership or use of or interest in such property; also intention to establish a continuous business, such as the appointment of a local agent,
from interests, rents, dividends, securities, or the transaction of any and not one of a temporary character (Pacific Micronesian Line, Inc. vs. Del Rosario
business carried on for gain or profit, or gains, profits and income derived and Peligon, 96 Phil. 23, 30, citing Thompson on Corporations, Vol. 8, 3rd ed., pp.
from any source whatever" (Sec. 29(3); Italics supplied) 844-847 and Fisher's Philippine Law of Stock Corporation, p. 415).
'The definition is broad and comprehensive to include proceeds from
There being no dispute that JAL constituted PAL as local agent to sell
sales of transport documents. The words 'income from any source
its airline tickets, there can be no conclusion other than that JAL is a
whatever' disclose a legislative policy to include all income not expressly
resident foreign corporation, doing business in the Philippines. Indeed, the
exempted within the class of taxable income under our laws. Income
sale of tickets is the very lifeblood of the airline business, the generation of
means 'cash received or its equivalent'; it is the amount of money coming
sales being the paramount objective (Commissioner of Internal Revenue
to a person within a specific time x x x; it means something distinct from
vs. British Overseas Airways Corporation, supra). The case of CIR vs.
principal or capital. For, while capital is a fund, income is a flow. As used
American Airlines, Inc. (supra) sums it up as follows:
in our income tax law, 'income' refers to the flow of wealth (Madrigal and
"x x x, foreign airline companies which sold tickets in the Philippines through their
Paternol vs. Rafferty and Concepcion, 38 Phil. 414 [1918]). local agents, whether called liaison offices, agencies or branches, were considered
"x x x      x x x resident foreign corporations engaged in trade or business in the country. Such
"x x x      x x x activities show continuity of commercial dealings or arrangements and performance
"The source of an income is the property, activity or service that of acts or works or the exercise of some functions normally incident to and in
produced the income. For the source of income to be considered as coming progressive prosecution of commercial gain or for the purpose and object of the
from the Philippines, it is sufficient that the income is derived from business organization."
activity within the Philippines. In BOAC's case, the sale of tickets in the
Under Section 24 of Commonwealth Act No. 466 otherwise known,
Philippines is the activity that produces the income. The tickets exchanged
as the "National Internal Revenue Code of 1939", the applicable law in the
hands here and payments for fares were also made here in Philippine
case at bar, resident foreign corporations are taxed thirty percentum (30%)
currency. The situs of the source of payments is the Philippines. The flow
upon the amount by which their total net income exceed one hundred
of wealth proceeded from, and occurred within, Philippine territory,
thousand pesos. JAL is liable to pay 30% of its total net income for the
enjoying the protection accorded by the Philippine government. In
years 1959
consideration of such protection, the flow of wealth should share the
burden of supporting the government. 458
"x x x      x x x
"True, Section 37(a) of the Tax Code, which enumerates items of 458 SUPREME COURT REPORTS ANNOTATED
gross income from sources within the Philippines, namely: (1) interest, (2)
dividends, (3) service, (4) rentals and royalties, (5) sale of real property,
Commissioner of lnternal Revenue vs. Japan Air Lines, Inc.
and (6) sale of personal property, does not mention income from the sale of through 1963 as contradistinguished from the computation arrived at by
tickets for international transportation. However, that does not render it the Commissioner as shown in the assessment. Apparently, the
less an income from sources within the Philippines. Section 37, by its Commissioner failed to specify the tax base on the total net income of JAL
language does not intend the enumeration to be exclusive. It merely directs in figuring out the total income due, i.e., whether 25% or 30% level.
that the types of income listed therein be treated as income from sources Having established the tax liability of respondent JAL, the only thing
within the Philippines. A cursory left to determine is the propriety of the 50% 'surcharge imposed by
petitioner. It appears that this must be answered in the negative. As held in
456 the case of CIR vs. Air India (supra):
"The 50% surcharge or fraud penalty provided in Section 72 of the National Internal
456 SUPREME COURT REPORTS ANNOTATED Revenue Code is imposed on a delinquent taxpayer who willfully neglects to file the
required tax return within the period prescribed by the law, or who willfully files a
Commissioner of lnternal Revenue vs. Japan Air Lines, Inc. false or fraudulent tax return, x x x.
"x x x      x x x
 "On the other hand, the same Section provides that if the failure to file the
required tax return is not due to willful neglect, a penalty of 25% is to be added to the  
amount of the tax due from the taxpayer."
196 1,065,641. 319,692.48 79,923.1       399
Nowhere in the records of the case can be found that JAL deliberately 2 63 2
failed to file its income tax returns for the years covered by the assessment.
There was not even an attempt by petitioner to prove the same or justify  
the imposition of the 50% surcharge. All that petitioner did was to cite the
provision of law upon which the surcharge was based without explaining 196 1,550,230. 465,069.14 116,267.       581
why it was applicable to respondent's case. Such cannot be countenanced 3 48 28
for mere allegations are definitely not acceptable. The willful neglect to
file the required tax return or the fraudulent intent to evade the payment of  
taxes, considering that the same is accompanied by legal consequences,
                                                    P1, 703
cannot be presumed (CIR vs. Air India, supra). The fraud contemplated by
law is actual and constructive. It must be intentional fraud, consisting of    
deception willfully and deliberately done or resorted to in order to induce Accordingly, private respondent is liable for unpaid taxes and charges
another to give up some legal right. Negligence, whether slight or gross, is in the total amount of ONE MILLION SEVEN HUNDRED THREE
not equivalent to the fraud with intent to evade the tax contemplated by the THOUSAND ONE HUNDRED SEVENTY SEVEN AND FORTY
law. It must amount to intentional wrongdoing with the sole object of CENTAVOS (P1,703,177.40) The dismissal for lack of merit by this Court
evading the tax (Aznar v. Court of Tax Appeals, G.R. No. L-20569, of the appeal in JAL v. Commissioner of Internal Revenue (G.R. No. L-
August 23, 1974, 58 SCRA 519). This was not proven to 30041) on February 3, 1969 is not res judicata to the present case. The Tax
Court ruled in that case that the mere sale of tickets, unaccompanied by the
459 physical act of carriage of transportation, does not render the taxpayer
VOL. 202, OCTOBER 4, 1991 therein subject to the common carrier's tax. The common carrier's tax is an
excise tax, being a tax on the activity of transporting, conveying or
Commissioner of lnternal Revenue vs. Japan Air Lines, Inc. removing passengers and cargo from one place to another. It purports to
be so in the case of JAL as it believed in good faith that it need not file the tax the business of transportation. Being an excise tax, the same can be
tax return for it had no taxable income then. The element of fraud is levied by the State only when the acts, privileges or businesses are done or
lacking. At most, only negligence may be imputed to JAL for not performed within the jurisdiction of the Philippines (Commissioner of
ascertaining the dispensability of filing the tax returns. As such, JAL may Internal Revenue v. British Overseas Airways Corporation, supra).
be subjected only to the 25% surcharge prescribed by the aforequoted law. The subject matter of the case under consideration is income tax, a
As to the 1/2% interest per month, the same finds basis in Section direct tax on the income of persons and other entities "of whatever kind
51(d) of the Tax Code then in force which states: and in whatever form derived from any source." Since the two cases treat
"(d) Interest on deficiency. Interest upon the amount determined as a deficiency shall of a different subject matter, the decision in G.R. No. L-30041 cannot
be assessed at the same time as the deficiency and shall be paid upon notice and be res judicata with respect to this case.
demand from the Commissioner of Internal Revenue; and shall be collected as a part PREMISES CONSIDERED, (a) the petition is GRANTED; (b) the
of the tax, at the rate of six per centum per annum from the date prescribed for the
payment of the tax x x x; PROVIDED, That the maximum amount that may be
decision of the Court of Tax Appeals in CTA Case No. 2480
collected as interest on deficiency shall in no case exceed the amount corresponding
to a period of three years, the present provisions regarding prescription to the contrary 461
notwithstanding." VOL. 202, OCTOBER 4, 1991
The 6% interest per annum is the same as 1/2% interest per month and Commissioner of lnternal Revenue vs. Japan Air Lines, Inc.
petitioner correctly computed such interest equivalent to three years which is SET ASIDE; and (c) private respondent JAL is ordered to pay the
is the maximum set by the law. amount of P1,703,177.40 as deficiency taxes for the fiscal years 1959 to
On the other hand, the compromise penalty amounting to P1,500.00 1963 inclusive of interest and surcharges.
for violation of bookkeeping regulations appears to be without support. SO ORDERED.
The particular provision in the said regulations allegedly violated was not      Fernan (C.J.), Melencio-Herrera,  Padilla,  Bidin,  Sarmiento, G
even specified. Furthermore, the term "compromise penalty" itself is not riño-Aquino,  Medialdea and Regalado, JJ., concur.
found among the penal provisions of the Bookkeeping Regulations      Narvasa,  Gutierrez, Jr., Cruz and Davide, JJ., Join Justice
(Revenue Regulations No. V-1, as amended, March 17, 1947, pp. 836-837, Feliciano's dissent in the BOAC case.
Revenue Regulations Updated by Prof. Eustaquio Ordono, 1984). The      Feliciano, J., Please see dissenting opinion.
compromise penalty is therefore, improperly imposed.      Gancayco, J., Retired.
In sum, the following schedule as recomputed illustrates the total tax
liability of the private respondent for the years 1959 through 1963—
FELICIANO, J.:  Dissenting
460
As my learned brother Mr. Justice Paras has indicated in his opinion
460 SUPREME COURT REPORTS for the majority in this case, the basic issues raised by this case were dealt
ANNOTATED with in Commissioner of Internal Revenue v. British Overseas Airways
Corp. (BOAC) (149 SCRA 397 [1987]), a decision reached en banc. The
Commissioner of lnternal Revenue vs. Japan Air majority rule in BOAC has been reiterated in two (2) cases: Commissioner
of Internal Revenue v. Air India (157 SCRA 648 [1988]),  decided by the
Lines, Inc.
1

First Division of the Court; and Commissioner of Internal Revenue v.

  Net 30% of Net Add 25% Add 6% American
Summary of Air Lines, et al. (180 SCRA 274 [1989]), rendered by the
Second Division of the Court. Since the case at bar appears to be the
Income Income as surcharg interest Total Tax Duebanc case raising the same questions as BOAC, I would like to
first en
Income Tax e under per reiterate, in very summary fashion, the principal points made in my
dissenting opinion in BOAC.  Since these points were developed at some
2

Due under Sec. 72 annum Private length in the BOAC dissent, there is no necessity for once more referring to
or quoting the detailed statutory bases of the conclusions here reiterated
Secs. 24(a) and NIRC for a (i.e., provisions of the National Internal Revenue Code [NIRC] and
(b)(2) NIRC of of 1939 maximu Revenue Regulations No. 2 issued by the Secretary of Finance).
_______________
1939 m of 3
years  While Air India referred to the BOAC case, the tax involved in Air lndia was not the regular
1

corporate income tax but the 2.5% gross receipts or excise tax imposed by P.D. No. 1355 which
amended Section 24 (b) (2), NIRC.
under Se  In which dissent, Narvasa, Gutierrez, and Cruz, JJ., joined.
2

c. 51(d)
462
NIRC of 462 SUPREME COURT REPORTS ANNOTATED
1939
Commissioner of lnternal Revenue us. Japan Air Lines, Inc.
195 P472,025. P141, 607.54 P35,401. P25,489.
9 16 88 35 1. 1.Whether or not Japan Air Lines (JAL) is a resident foreign
corporation doing business in the Philippines, is not a relevant
  consideration under the statutory provisions here involved, as
196 476,671.48 143,001.44 35,750.3 25,740.2 they existed during the taxable years from 1959 through to
1963. Whether a foreign corporation be a resident one doing
0 6 5 business in the Philippines, or a non-resident not doing
business in the Philippines, is subject to Philippine income
  tax only in respect of its Philippine-source income. The
196 734,812.77 220,443.83 55,110.9 39,679.8 critical issue, in other words, is always whether or not JAL
1 5 8
 was, during the taxable years involved, deriving income from aviation fuel, the salaries of the pilots and cabin crew
sources within the Philippines. members, landing fees, interest paid on borrowed capital, etc.
2. 2.The tax involved here is the tax on income: we are not In other words, the price paid for the "airline ticket"—even
concerned with a sales tax nor with an excise or privilege after deducting the cost of printing the documents and the
tax. For purposes of income taxation, I respectfully submit, salaries of the sales personnel—is far from pure profit. I
the "source of income" relates not to the physical sourcing of believe this is the very reason why the law in respect of
a flow of money or the physical situs of payment, but rather taxation of international carriers was changed from taxation
to the "property, activity or service which produced the of net income (involving normal income tax rates of 25%-
income" (Howden and Co. Ltd. v. Collector of Internal 35%) to a gross receipts or excise or privilege tax of 2.5% on
Revenue, 13 SCRA 601 [1965]; British Traders Insurance Co. "gross Philippine billings," i.e., to avoid unfairness to
Ltd. v. Commissioner of Internal Revenue, 13 SCRA international carriers and to cure what appeared to be a
719 [1965]; and Commissioner of Internal Revenue v. conspicuous lack of economic realism.
Phoenix Assurance Co. Ltd. 14 SCRA 52 [1965]. Also: 8 2. 6.Finally, we should note the provisions of the Convention
Mertens, Law of Federal Income Taxation, Section 45.27 between the Philippines and the United States of America
[1957]). with respect to taxes on income, signed on 1 October 1976
3. 3.The problem is, therefore, one of appropriate characterization (Text in 7 Philippine Treaty Series 523) and which went into
of the transactions involved, that is, identifying or force and effect on 16 October 1982, upon ratification by both
determining "the activity or service which produced the governments and exchange of instruments of ratification.
income" and the situs or physical location of such activity or Under Article 9 of the RP-US Tax Convention, profits
service. derived by a resident of one of the Contracting State from
sources within the other Contracting State "from the operation
of ships in international traffic" or "from operation of aircraft
In my view, the activity or service giving rise to income, in the
in international traffic" may be taxed. Article 4, entitled
present case, is not the sale of personal property (so-called "sale of airline
"Source of Income", of the Convention provides as follows:
tickets") the generative activity is rather entering into and performing a
contract of service or carriage from one point of the globe (outside the
Philippines) to another point in the globe (also outside the Philippines). "(7) Gross revenue from the operation of ships or aircraft in international traffic shall
This was explained in the BOAC dissenting opinion in the following terms: be treated as income from sources within a Contracting State to the extent they are
"The appropriate characterization, in my opinion, of the BOAC transactions is that of derived from outgoing traffic originating in that State." (Italics supplied)
entering into contracts of service, i.e., carriage of passengers or cargo between points
located outside the Philippines. 465
The phrase 'sale of airline tickets,' while widely used in popular parlance, does
not appear to be correct as a matter of tax law. The
VOL. 202, OCTOBER 4, 1991
Baguio vs. NLRC
463
It seems to me that the foregoing reflects the understanding of both
VOL. 202, OCTOBER 4, 1991 States Parties as to the correct source rule applicable for income taxation of
revenues derived from the operation in international traffic of aircraft: that
Commissioner of lnternal Revenue vs. Japan Air Lines, Inc. is, that they are sourced within a contracting state only to the extent that
airline ticket in and of itself has no monetary value, even as scrap paper. The value of such revenues arise "from outgoing traffic originating in that state," or, in
the ticket lies wholly in the right acquired by the 'purchaser'—the passenger—to
demand a prestation from BOAC, which prestation consists of the carriage of the
terms of the present case, only to the extent that they are derived from
'purchaser' or passenger from one point to another outside the Philippines. The ticket passengers and cargo transported from the Philippines to some other part
is really the evidence of the contract of carriage entered into between BOAC and the of the world. This is entirely in line with the view respectfully submitted in
passenger. The money paid by the passenger changes hands in the Philippines. But the BOAC dissenting opinion and here reiterated.
the passenger does not receive in the Philippines the consideration therefor—the I vote to deny the Petition for Review and to affirm the Decision of
service undertaken to be delivered by BOAC. The 'purchase price of the airline ticket' the Court of Tax Appeals in CTA Case No. 2480.
is quite different from the purchase price of a physical good or commodity such as a Petition granted. Decision set aside.
pair of shoes or a refrigerator or an automobile; it is really the compensation paid for
the undertaking of BOAC to transport the passenger or cargo outside the Philippines.
Note.—International airlines are taxed on the income they derive
(Underscoring in the original) from Philippine sources. (Commissioner of lnternal Revenue vs. American
The characterization of the BOAC transactions either as sales of personal Airlines Inc., 180 SCRA 274.)
property or as purchases and sales of personal property, appear entirely inappropriate
from another viewpoint. Consider first purchases and sales; is BOAC properly
——o0o——
regarded as engaged in trading—in the purchase and sale of personal
property? Certainly, BOAC was not purchasing tickets outside the Philippines and
selling them in the Philippines. Consider next sales: can BOAC be regarded as
'selling' personal property produced or manucfatured by it? In a popular or
journalistic sense, BOAC might be described as 'selling' 'a product'—its services.
However, for the technical purposes of the law on income taxation, BOAC is in fact
entering into contracts of service or carriage. The very existence of 'source rules'
specifically and precisely applicable to the rendition of services must preclude the
application here of 'source rules' applying generally to sales, and purchases and
sales of personal property which can be invoked only by the grace of popular
language. x x x" (149 SCRA 421-422; italics supplied)

1. 4.When the BOAC and JAL transactions are appropriately

characterized as contracts of carriage or service, the ordinary
"source rule" under our NIRC and Revenue Regulations No. 2
relating to contracts of service or carriage—that the income
generated IS sourced or earned in the place where the contract
act is performed—becomes applicable. Applying this "source
rule," it will be seen that the income earned by BOAC or JAL
by transporting persons and goods between two (2) points
both outside the Philippines, must be regarded as non-
Philippine source income, and hence not taxable to a foreign
corporation.
2. 5.The unfairness arising from characterizing the transactions
here as sales of personal property is obvious, when one

464
464 SUPREME COURT REPORTS ANNOTATED
Commissioner of lnternal Revenue vs. Japan Air Lines, Inc.

1. recalls that a corporate tax payer subject to income taxation is

entitled to deduct business expenses necessarily incurred in
carrying out the activity or service generating the
income. If the issuance of airline passage documents is
properly determined as a sale of personal property, then all
the tax payer Can deduct are logically the cost of paper and
printing of the air passage documents, as well as the salaries
of the sales personnel, office rentals, cost of utilities and
similar items. But what about the cost of rendering the service
that the carrier becomes bound to deliver "to the buyer" of the
"airline ticket," the depreciation of the aircraft, the cost of
aircraft maintenance and repairs, the cost of high octane