CTA Case No. 3441 (Decision)

lt!PUIILIC OP THE Hlt..&Pti�"�U COU T OF AX PPf.ALS QUEZON Clft / AIR INDIA, C.T .A. CAS E NO. 344 1 Petitioner, - versus - THE COMMISSIONER OF IN TERNAL REVENUE , Respondent . X- - - - - - - - - X DEC I S I 0 N This is an appea l from t he decisio n of respondent Com mi ssioner of Internal Reve nue holding petitioner, AIR I NDIA , li able for the payment of ?142,4 71.6 8 representing deficie'ncy income tax, inclusive o f 50~~ su rcharge and i nter ests, for willful neglect to fi le a retu rn as pro- vided under Sect i on 72 of the Tax Code f a~ the f~ scal year ending March 31, 1976, as international carrier, computed as follows: Gross Phi li ppine Billings - - - - ? 2,968 ,1 56.00 I ncome t ax due thereon - - - - - 74,204. 00 Add: 50% surch arge - - - 37,102.00 14% i nterest per annum (42 % . maximum) - - - - - - - - - 31,165 . 68 .. TOTAL AMOUNT DUE & COL LEC TIBLE - ? 142 471 .68 _______ ,!. _ _ _ __ _ Petition er AIR I NDIA , is a foreig n corporation, engaged in the business as international carrie r . It is not licens e d t o do business in th e Ph ilip pines as an i nterna tio nal carrier . Its airplanes do not operate l__ _ _ .

DECISION - CTA CA SE NO . 3441 - 2- within .the Philippi ne territorial j urisdic ti on, or other- wi se, its airpla ne s do not service p a ssengers emba r king f rom Philippine ports. Its s ales activ i ty in the Phi l ippines during t he f i scal year 1976 in question , I a nd covered by the a f oresaid assessment , was the s a le, thr ou gh PA L, of airplane tickets whic h were serviced by its airplanes entirely outside t he Ph i lippines . Its stat us i n t he Phil i ppines is that of an off-l ine inter - nat i ona l c arrie r, which as aforesaid, is not e ngaged in the bus i ness of air transporta t ion in t he Phil i ppines. Dur i ng the f i scal year end i ng March 31, 1976 , t he t ota l . sa l es of airplane t ickets s old b y PAL for petitio ne r amount e d to ?2 , 968 , 156 . 00 . Dur ing the period f or which � the PAL sold tickets for petitioner AIR INDIA , the latte r did not have a single airplane which operated within Ph i lipp i ne territory , or had otherwise lifted passenger and c argo an ywhere i n the wo r ld as an international carrier and do i ng business i n the Philippi nes . Petitioner ne ver engaged i tse l f i n business in the Philippines, as it did not se ll p a ssage doc ume nts of passenger , baggage or mail originating from the Ph il i ppi nes : Petitioner not being engaged i n bu si ness in the Phi lippines as a n int e rnational carrier, i t had no income in t he form of " Gross Philippi ne Billings." � All t he purchases of air- p l ane t~ ckets , through PAL, i n the tota l value of ?2,968, 1 56.00 ~ere i n fact for AIR INDIA airplane serviced 1 1~) l

DECISION - CTA CAS E NO . 3441 - 3- outside of the Ph ili ppines . Th ese bare fact s we re undis - puted by responden t. The two (2) is sue s r aise d in this case are: 1. Whether or not petit i oner , as an off- li ne int ernationa l carrier, is taxable und er Sec t i on 24 ( b)(2) of the Revenue Cod e ; a nd 2. Whet her or not petitioner i s lia b l e for the surch arge o F 50% fo r f ai lure to fi le an income ta x return. The f irst is s ue is not without precedent and we totally agr e e with dist ing uishe d counsel, an au t ho rity in t axation, when he cited correctly the proper app lic- a ti on , which are in all f ours with the c as e at bar , of ou r decisions in the prev i ous ca ses of Japan Airli nes , I n c. vs Co mmissioner of In ternal Revenue, C.T . A. Case No . 2480, Ja n. 15 , 1982; Br iti sh Overseas Airways Corp . vs Commissioner of Int ernal Revenue, C.T.A. Cases Nos. 2373 and 2561, Ja n. 26, 198 3; and Ame ri ca n Airlines vs Com- miss i one r of I nternal Rev enue , C.T .A. CQse No . 3046 , April 16, 1984 , which uniformly held that off-line inter- national car rier s sell i ng ti ckets i n t h e Philippines but s er viced ou tsi de thereo f, the i ncome from which are der ived from such sa les , are incomes derived excl usively fr om ser vices outside the Philippines and i s n ot taxable under Sect i on 24 (b ) (2) of t he Nat i onal Int e r nal Revenue Code. We quote at length the scho l ar ly presentation of distin~uished coun s el of p etitione r in h is reply mem o- ra ndu m ( pp . 106, 108-116, CTA rec. ) on th e mat ter regarding --~---

DECISION - CTA CASE NO. 3441 - 4- the first iss ue , wherein c oun sel said, and which we fully agree with and adopt as our own. 11 XXX XXX XXX By way of preliminary, foreign corpo rations are of two kinds, viz .: ( 1) resident f oreign corporations, those engaged i n tr ade or business in t he Philippines; and (2) non- resi dent foreign corporations, those not engaged in trade or business in the Philippines. Under the law , all foreign corporations, resi- dents or non-residents, a r. e c. ubjec t to income tax only with respect to income derive d fro m sources withi n the Philippines. /-See Sec. 24(b), sub-paragraphs ( 1) and (2); Sees. 16 and 60 Rev. Regs. No. 2~7 As regards foreign corporations , income from sources within the Philippines consists of two items , viz. : (1) income derived exclu- sively from sources within the Philippines , and (2) that portion of the income derived par tly within and partly without the Philip- pines which is allocable to sources within the Phi li ppines . (Sec. 152, Rev. Reg. No. 2) Non - resident foreign corporations are tax- able on their g ross inco me fro~ all s ources within t he Philippines under Section 24 (b) (1 ) of the Revenu e Code , while reside nt f oreign corporations are t axable under Sec . 24 (b) (2) on their net inc ome also from all sources with- in th e Philippines. In order that a foreign corporation may be taxed on net income under Section 24 ( b) (2) it is essential that the c orporation be engaged in trade or business in the Phil ippines. Specia l provision is made in Section 24 (b) (2) with respect to f oreign international carriers doing busin~ss in the Philippines which are made subject to a special t ax o f 2-1 I 29~ o f t h e i r " g r os s Ph i 1 i p p i ne b i 11- ings". For an international carrier to be taxed on " gross Philippine billings" it must be engaged, not in any kind of business; the busi ness engaged in must be the business of air tra nsportation. This i s evident from the pro visi on of Section 24 (b) ( 2) to the effect tnat the term "gross Philippine billings" re- fers to "gross rev enue real iz ed from uplifts anywhere in the world by any international 1I

DECISION - CTA CASE NO . 3441 - 5- carrier doing business i n the Phili pp ines of pass age documents sold therein , whethe1r for passenger , excess baggage or mail , pro- vided the ca rgo or mail originates fr om the Phil i ppines ." Petit i oner was not and i s not engaged in business in the Philippines as an i nternational carrier and has no income there- in in t he form o f " gross Phil i ppine bill i ngs. " And this is ad m itt~d by respondent i n his memorandum by declaring that petitioner is no engaged i n business as common c arrie r ! by air and , the refo re , not subject to the tax o n business as common c arrier under Secti on 207 of t he Revenue Code. In t he c ase of Japa n Air Line , Inc . v. Commissioner of Internal Revenue, C. T.A. Case No . 2480, Jan ua ry 1 5 , 1982 , which i s on al l f ours wit h the instan t case, this Honoryble Court, quo t ing from an earlier dec is ion , held : "~1/e find no merit i n respondent 1 s contention that international a i r trans- � portation c ompanies should be considered engage d in business wherever they derived fares or freight and are taxable as car - rier in said place , that i s, for pur - pose s of taxation , the situs is said place ." As in the case o f Japan Air Lines , Inc., supr a , petitione r in th i s case i s a n off-line internat i onal carrier not licensed to do busi - ness in the Philippines , whose sole act i vity i n t he Philippines was and is the sale of air - pl ane t i ckets which are serv ic ed by airplanes of pe tit i oner outside the Phili pp ines. There- fore, the rule laid down in the case of Japan Air Lines , Inc. equally applies to the instant case. I n fact, th e same rule has been applied i n the identical case of British Ov�erseas Air- ways Corpor at i on v. Commissioner of Internal Revenue, C.T , A. Cases Nos. 2373 & 2561 , January 26, 198 3 . 1 Japan Air Li ne s, I nc . v . Commiss i oner of I nt erna l Reven ue, C.T.A. Case No . 1634 Nov . 29, 1968 , cert . deni ed in L- 3 0041 , Feb . 3 , 1969 . 11o -- .J

DECISION - CTA CASE NO. 3441 - 6- It is c ontended, however, tha t the ruling in the cases of Japan Air Li nes, Inc. and British Overse a s Airways Corporation, supra, does not apply to the instant case beca use the said cases involved assessments prior t o the effectivity o f Re pu blic Act No. 5455 which enla rg ed the defin it i on of the term "doing business" i n the Ph i l i ppines . Wh il e respondent admits that off line internatio nal carriers are not en gaged i n business for purposes of the busi ne ss tax e s imp osed by Se es. 192(1) and 20 7 of t h e Na ti onal Internal Revenue Code, it is alleged that they are neverthe le ss consi- dered engaged in business fo r purposes of the t ax on i nc ome . This proposition is unwarranted, ill ogical . How can an off-li ne international carr ier be c on sidered enga ged in business for purposes o f the income tax and at the same tim e not engaged in bus i ness for purposes of the business taxes? The resulting conflict arising f r om responden~ ' s sta n ch is beyond co mpr ehen- sion. It is s ubm i tted that neither Rep ublic Act No . 5455 nor Rev . Regulation No. 3-76 has a lte red the cha r acter of of f- line in t ernati on al carri e rs as foreign c orporations not engaged ih the business of air transportation in the Phil i ppines . The p e rtinent port i o n of Republic Act No . 5455 reads as follows: " Sec. 1 - - - and the phrase, ' do- i ng busin e ss' shall include soliciting orders, pur chase, service contract s, open i ng off ices, whether called ' liais on' effices or branc hes; appo i nti ng represent- atives o r distributors who are do miciled in t h e Philippines or who in any calenda r year st ay in the Philippines fur a peri od or period s totalli ng one hundred ei ghty days o r mo re ; participat i n g in" the ma n ag e - ment , supervision o r c o ntrol of a ny d om estic busi ness fir m, entity or cor p orati on in the Philippi nes; a nd a ny other act or acts t hat imp l y a contin uity of com mercial dea l- ing s or arrange me n ts an d conte mp lates to tha t exte nt the performance of acts or wo r k s , or the ex er cise of s om e of, the functions normal l y i ncident to , and in pr og r e ssive pr osecut i on of, c ommercial gain or of t he purpose and object of t he busi ne ss or ganization ."

DECISION - CTA CA SE NO. 344 1 - 7- The definitio n o f the te rm "d oing busi ne ss" was further enlarged by Revenue Regula tio ns No . 3076 by pro vid ing that - "F or purposes of this de fin i - ti on, th e ph rase 'doing business in t he Philippines' includes the regular s al e of tickets i n the Ph il ippines by off -l ine airlines by themselves or through their agents." There is noth ing in Republic Act No. 5455 or in Rev. Re gs . No. 3-76 to show clear l y that the vari ou s act s or tra nsac tions enu merated ther ein constitute doing business as inter- nationa l carrie r . Rep. Ac t Na . 5455 mentions certain acts or transactions done or performed in the Ph ili pp i ne s whic h constitute doing b u si- ness in ge ne ral and fro m which income is derived. And while Rev . Regs. No . 3-76 specifically pro- vi des that t he regu lar sale of tickets in the Philippine s by of f- line in tern ational c ar rie r s is considered " d oing business" , the sa me does not re adily give rise t o the conclusion th at the sale of tickets by i nter na tional carriers c onstit utes the business of air tra ns portation. What may be considered as "d oing business" under t he r egula ti ons is t he sale of airpla ne ti ckets because that is the only acti vity in th e Philippines of off-line inte rna ti ona l car- riers. If at all, the tax t ha t ca n be levied on the "bus iness 11 of s e 11 in g tickets is a licens e tax f or the privilege enjoyed by off - line inte rnation al ca rri ers in se l ling airpla ne tickets in the Philippines. No inc om e tax may be i mp ose d because n o income is derived fro m the sale of s uch t ickets ; t he income derived from t he sale o f such tickets is derived fr om the service of trans port ing passengers or freight outside t he Ph ili pp ines . And as correctly stated by this Ho norab le Co u rt, the situs of the in come derived by foreign co rp oratio n s f r om labor or personal services i s deter~ined so le ly by the place where ser vice is rende re d. (See Japan Air Li ne s , I nc. v. Commissioner of I nt. Rev., supra; British Overseas Airwa ys Corp . v. Com mission er of In t. Rev., s up ra.) Ticke t s have no va lue except as ev i dence of p ayme nt . I t is qu ite clear t hat off -line inter n ation a l carriers can not be consi dered engaged in the bus in ess of air tnansportation i n the Phil ip- piries whe t her f or purpose s of the income tax

DECISION - CTA CASE NO. 3441 - 8- 7 /-Sec ~ 23 ( b ) (2), Rev . Code or for purposes of the business taxes / -Sees: 192 ( 1) and 207, id_7. If an off-line internationa l carrier was not engaged in the business of air transpprt- a ti on in the Ph il ippines solely by reason : of its sales of airplane tickets in the Philippines before the effectivity of Rep . Act No. 5455 ~nd Rev. Regs. No . 3-76, it can not be corsi- dered engaged in such business after the effect- ivity of said law and regulations. The fact remains that before and after the effectivity of said l aw and regulations, pe titioner, as an off-line international ~arrier , did not and has never operated any airplane service in the Philippines. The character of peti- tioner as a non-resident foreign corporation can not be altered by fi ction of law, much less by the exercise of regulatory power vested in an executive or administrative official. To construe Rep . Act No. 5455 and Rev. Regs. No. 3- 76 as converting non-resident foreign corpo- rations into resident foreign corporations would render said !aw and regulations oppres- sive, arbitrary and capricious. It has been held that a l aw enacted under and by virtue of the taxing power which is arbitrary and capricious violates the due process clause of the Constitution. (Heiner v. Donnan, 285, u.s. 312, 326 ) . Even assuming that off-line international car~iers may be considered engaged in the busi- ness of air tr ansportation in the Philippines by virtue of Rep. Act No. 5455 and Rev. Regs. No . 3-76, which is illusory, yet petitioner can � not be held liable for income tax on the proceeds of the sales of airplane tickets in the Philipp ine s because such income does not fall under the category of "gross Philippine billings". The term "gross Philippine bill- i ngs" is defined in Section 24 (b) (2) of the Revenue Code as including " gross revenue real- iz ed from uplifts anywhere in the world by any in ternational carrier doing business in the Philippines of passage 'documents sold therein, whethe r for passenger, excess baggage or mail, prpvided the cargo or mai l originates from the Philipp i nes." Cargo or mail originates from the Philippines with respect to a carrier that 1:.1

DECI S ION - CT A CASE NO. 344 1 - 9- carries the c argo or mail from the Ph ilippines to a f oreign port As far as petitioner ~ s concerned such cargo or mail or i ginates fr om the place outside t he Phi lippines where it is loaded on board an airplane of petitioner. This is so because any leg or portion of t he trips serviced by petitioner commenced outside the Philippines and terminate d also ou tside the Philippi ne s. Again, the ter m " gros s Ph il ipp ine bill- in gs " implies revenue derived partly within and par tly outside the Phil ippines. It can not inclu de i ncome derived exclusively outside t he Philippi nes . It has bee ;; held that the in- come derived by off-line internatio nal carrie rs fr om sales of airplane tickets in the Philippines bu t servi ced o utside the Ph ilippines is inco me derived e xclusive l y ou tsid e the Philippines; the sa me can not even be considered inc ome der- ived partly within and part ly withou t the Philipp i nes. (Se e Japan Air Lines, Inc. v . Co mmi ssi oner of Int. Rev ., s upra ; Brilish Over- seas Airways Corp . v. Commissioner of Int . Rev., sup ra. ) I t fo ll ow s tha t whether petitb ner is a .resident or non-resident forei gn corporati on it can not .be he ld liable for i ncome tax on t he proceed s of s ales of airplane tickets sold in the Phili pp ines but s ervice d outside the Phi l ippin es . There is another po int whi ch should not be overlo oked. As already adver te d to, a f or - eig ~ corp or ation is tax a b le only with r espect to ( a) i ncome derived e xc lusive ly from so u r~es within t he Philippines, and ( b ) that port i on of th e inc om e derived partly fr om sou rce s wit hin and . partly f rom sourc es ou t side the Phil i ppine s whic h is attributa bl e to s ources within the Phili ppines. I t is not t ax able on i ncome der- i v e d e x c 1u s i v e 1y ou t s i de t h e Ph i 1i p.p i ne s � Th i s is so not onl y because of the express provisions of the law (Se es . 24, 3 7, Na ti ona l Int. Rev. Code) but more on the basis of t he generally accepted principle of int er national law bindi ng up on all civ ilize d n ations. The reas on f or this princip l e is t ha t the l aws of one c ountry can n ot have extraterritorial operation. (51 Am. Jur. 88.) An d this has served as a limitation o~ the taxing power of t he le gi slatu re ; mo re so in this jurisd ict ion because our Consti tu t i on 1 ,..._., ,...,1

DECISION - CTA CAS E NO. 3441 - 10 provides that the generally accep ted princip les of i nternational law shall be part of the law of the land. (Sec. 3, Art. II, Constitution.) As succintly stated by the Supreme Court : "The approved doctrine is that no state may tax anyt hing not within ! its jurisdiction witho ut violating the due process cla use of the consti- tution. The taxing power of a state 1 does not exten d beyond its territorial limits , but with in such limits it may tax persons, property, income or busi - ne ss � If an interest if; taxed, the situs of either the property or in- terest must be found within the state . If an i ncome is taxed, the recipient there of mus t have a domicile within the state or the property or business of which the income issues must be situ- ated within the state so that the in- come may be said to have a sit us therein." (Manila Gas Corp. vs. Collector of Int. Rev. 62 Phil. 895, 900). Under the law, the situs of th e income derived fr om labor or performance of service is determined by the place where the labor is performed or the service ren dered , not by the place whe re paym ent is made. (S ec. 37, Nat. Int . Rev . Code.) It follows that the situs of the income derived by foreign international carriers from the business of air t ransport - atirrn is the place where the airplane servi ce is rendered or performed . Accordingly, to tax the income derived by petitioner from the trans- portation service rendered or performed outside the Philippines wou ld violate not only the National Internal Reve nue Code but also the due process clause o f the Constitution . "A state ha s power to fix the time at which property within its juris- diction ma y acqui re a taxab le situs, but it cannot fix the taxab le situs of a thi ng which has never come into the state or is perma rrently beyond its borders, and which it is without power to control . The financial exigencies of the state afford no j ustification l_ - - - - - - - -

DECISION - CTA CASE NO. 34 41 - 11 - for sustain ing a tax on a transaction beyond t he borders of the state." ( 5 1 Am. Jur. 457 ) . XXX XXX xxx. " Regarding the second issue, we fully agree with petitioner that it is not liable for surcharge of 50%, for which we once more quote the finA expositih n o f co u ns e 1 in be h a 1 f of petitione r in his rep 1 y memo r a 1-: dum � ( pp. 116-117, CTA rec.). The s econd issue whether or not petitio ner i s liabl e for t he surcharge of 50% of the alleged defi ciency income tax needs no e x- t ended discussion. The surcharge of 50% of the unpaid tax or def ic iency t ax is sought to be imposed in this case under Se ction 72 of the Revenue Code which provides that the said surcha rge is to be imposed- "In case of willful neglect to file the r eturn or list required under this Title within the ti me prescribed by law, or in case a false or fraud- ulent r eturn or list is willful~ade x x x. " (Unde rsco ring supplied . There is no claim or pretense that he rein petitioner willfu~ failed to file an inco me tax return f or the fiscal year 1976. Neither the repor t of the examiner nor the Amen ded Answer filed by respondent makes mention of any fact or circumstance to prove that the f ailure of petitioner to f i le the return was willfull. Petiti on 2r is charged merely with failure to f ile a return. Willfu l fail ure to file an income tax return which justifies the imposition of the 50% surcharge, or what is commonly called the fraud penalty , requires that the f ailure to file a return was due to an intent to evade pay ment of tax legally due, in other words an in t entio n to defraud the Government of lawful revenue. Mere failu re to f ile a retu rn i s 'I L

DECISION - CTA CA SE NO. 3441 - 12 - not in itse lf , standing alone, evidence of fra ud . As ap tly stated by the Supreme Court: 11 The fraud c on temp 1 ate d by 1 a w is ac tual and not co nstructive. It mu st be i nte nti o~al fraud, co n s ist- i ng o f deception willfully a nd del i berately do ne or resorted t o in order to ind u ce another to gi ve u p s om e legal right . Neglige nc e, whether sligh t or gross , is not eq uivalent to the fra ud with intent t o evade the tax contemplated by law. It must be intentional wrongdoing with the s ole obj ect of avuiding the tax. It nece ss arily follows that a mere mi sta ke ca nno t be c o nsidered as fra ud - ulent i ntent, and if both taxpayer and the Co mm issi oner of I n ternal Reven ue comm itted mistakes i n making entries i n the return and in th e assessme nt, it woul d be unf ai r to treat the mistake s o f t he tax-payer as taint ed with fraud a nd th ose o f the Commissioner as made i n g oo d faith . " ( Aznar v. Court of Tax Appeals, 58 SCRA 519 .) Pe tit ion er c an no t be charged with an i ntenti on to defraud t he Government because it hones tly and sincerely believes that it is not liable f or t he tax sought t o be imposed upon it." WHERE FORE , in vie w of the f o r egoing, the decision of th e res pondent Comm issi one r of In t ernal Revenue a ppeale d fr om holdi n g pe titio ne r liab l e for defic i ency i n c ome tax of ~142 , 4 71.6 8, plus surcharge a nd interest, i s h er e by set aside.

-- .. t. . � .. DECISION - CTA CASE NO. 34 41 - 13 - No pronouncement as to costs . SO ORDERED . Quezon City , Metro Manila, June 27 , 1985. - . ~UIN e Judge . WE CONCUR: AMANTE Presi di