April 14, 2005 BIR RULING [DA-158-05] 28 (A) (3) (a); 118 (A); RR 15-02; 120-86; DA-209-04 SGV

& Co. 6760 Ayala Avenue Makati City Attention: J.A. Osana Tax Division Gentlemen : This refers to your letter dated March 10, 2005 requesting on behalf of your client, Air France, for a confirmation of your opinion that as an off-line airline, Air France is not subject to the 2 1/2 % Gross Philippine Billing Tax, the 3% common carrier's tax (CCT) and the 32% regular corporate income tax, 2% Minimum Corporate Income Tax (MCIT) on revenues generated from the sale of Air France tickets within the Philippines. HScDIC It is represented that Air France is a corporation organized and existing under the laws of France; that it is engaged in the international airline business; that in 2004, Air France acquired the shares of stock of KLM in exchange for Air France shares; that pursuant to the terms of the Transaction Agreement, after the acquisition of KLM, Air France was renamed Air France-KLM and all its assets were contributed to a new operating company (new Air France) in exchange for the latter's shares; that thus, the original Air France, renamed Air France-KLM, became a holding company, owning both the KLM and the new Air France operating companies; that although the two airlines, Air France and KLM, are now part of the same group, they continue to exist as separate entities; that the decision to keep the airlines as separate entities took into account the existing flying rights of Air France and KLM under the respective Air Transport Agreements of France and of The Netherlands with other countries, under which, the respective flag carriers of the Contracting States are authorized to carry specific flights; that nonetheless, in countries where both Air France and KLM operate, it has been decided that only one airline will continue to have flight operations; that in other words, one airline will continue to carry flights to and from that country, while the other airline will cease its flight operations in that country; that thus, in some countries, Air France will continue to have flight operations while KLM's flight operations will cease; in others, it will be the other way around; that in any case, the airline (either Air France or KLM) which will continue to have flight operations in any country will carry the banner Air France-KLM and will honor any Air France or KLM tickets. It is further represented that in the Philippines, both Air France and KLM currently operate their respective branches; that in view, however, of the global integration of the airline operations of Air France and KLM, it was decided that Air France's flights to and from the Philippines be terminated; that consequently, Air France flights to and from the Philippines ceased effective November 1, 2004; that on October 28, 2004, Air France officially informed the Civil Aeronautics Board (CAB) of the cessation of its Philippine flights; that notwithstanding the cessation of Air France's Philippine flight

operations, travel agents will continue to sell Air France tickets in the Philippines; that since Air France no longer has passenger and/or cargo flights to and from the Philippines beginning November 1, 2004, KLM, under the banner Air France-KLM, services the leg of the flight covered by Air France tickets originating from Manila up to the country where Air France continues to fly; that in other words, for the said tickets sold in the Philippines, Air France airplanes service the flights only beginning at transshipment points outside of the Philippines and on flight legs that originate elsewhere; that KLM will accordingly report as part of gross Philippine billings for Gross Philippine Billings Tax and CCT purposes, the revenue corresponding to the leg of the flights covered by Air France tickets originating from Manila up to the transshipment point outside of the Philippines. AaHcIT In reply, please be informed of the following: 1. Gross Philippine Billings Tax

Section 28(A)(3)(a) of the Tax Code of 1997 provides: SEC. 28. Rates of Income Tax on Foreign Corporations. xxx xxx xxx

(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. It is clear from the afore-quoted provision that the 2 1/2% Gross Philippine Billings Tax is imposed only on revenues derived by international air carrier from flights originating from any port or point in the Philippines in a continuous and uninterrupted flight, irrespective of the place where the passage documents are sold or issued. In this connection, Article 8 of the RP-France Tax Treaty provides for a lower rate of tax (1 1/2%) on profits derived from the operation of ships or aircraft in international traffic, viz: ARTICLE 8 SHIPPING AND AIR TRANSPORT 1. Profits derived by an enterprise of a Contracting State from the operation of ships or aircraft shall be taxable only in that State.

2. Notwithstanding the provisions of paragraph 1, profits from sources within a Contracting State derived by an enterprise of the other Contracting State from the operation of ships or aircraft in international traffic may be taxed in the first-mentioned State but the tax so charged shall not exceed the lesser of (a) one and one-half per cent of the gross revenues derived from sources in the first-mentioned State; and (b) the lowest rate of Philippine tax imposed on such profits derived by an enterprise of a third State. . . xxx xxx xxx

Air France, having become an off-line carrier effective November 1, 2004 when it ceased its passenger and cargo flight operations in the Philippines, will not derive any Gross Philippine Billings or revenues from flights, originating from the Philippines effective said date. cdll In this connection, Revenue Regulations No. 15-02 dated May 30, 2002 clarified the taxation of revenues generated from sale of tickets within the Philippines by an off-line carrier, to wit: SEC. 3. Foreign Airline Companies Without Flights Starting From Or Passing Through Any Point In The Philippines. An off-line airline having a branch office or a sales agent in the Philippines which sells passage documents for compensation or commission to cover off-line flights of its principal or head office, or for other airlines covering flights originating from Philippine ports or off-line flights, is not considered engaged in business as an international air carrier in the Philippines and is, therefore, not subject to Gross Philippine Billings Tax provided for in Section 28(A)(3)(a) of the Code nor to the three percent (3%) common carrier's tax under Section 118(A) of the same Code. . . For this purpose, RR 15-02 defines an "off-line carrier" as "an international air carrier having no flight operations to and from the Philippines", and "off-line flights" as referring to "flight operations carried out or maintained by an international air carrier between ports or points outside the territorial jurisdiction of the Philippines, without touching a port or point situated in the Philippines, except when in distress or due to force majeure." Moreover, in BIR Ruling No. [DA-209-04] dated April 12, 2004, this Office has confirmed that the revenues generated by an off-line carrier from the sale of tickets in the Philippines, shall not be subject to income tax on Gross Philippine Billings. In the said ruling, it was represented that United Airlines, Ltd. (UAL) ceased passenger and cargo flights originating from the Philippines. However, because of the interline arrangement of UAL with Aerotel and other airlines, UAL tickets continued to be sold in the Philippines and serviced by UAL airplanes beginning on transshipment points outside the Philippines and on flight legs that originated elsewhere. This Office held that under the definition of "Gross Philippine Billings" under Section 28(A)(3)(a) of the Tax Code of 1997, for passenger and cargo revenues to form part of Gross Philippine Billings, such revenues must be derived from the carriage of persons and of cargo originating from the Philippines in a continuous and uninterrupted flight. This rule applies irrespective of the place of sale or issue and the place of payment of the tickets or passage documents.

Based on the foregoing, any revenues derived by Air France beginning November 1, 2004 when it became an off-line carrier, from the sale of tickets within the Philippines for off-line flights are not subject to the 2 1/2% Gross Philippine Billings Tax provided for in Section 28(A)(3)(a) of the Tax Code of 1997 reduced to 1 1/2% income tax on Gross Philippine Billings under Section 8 of the RP-France Tax Treaty. 2. Common Carrier's Tax

Gross Philippine Billings, which is the basis for computing the 2 1/2% Gross Philippines Billings Tax, is likewise used as basis in computing for the 3% CCT imposed on international air carriers under Section 118(A) of the Tax Code of 1997. Section 10 of RR 15-02 provides: SEC. 10. Common Carrier's Tax Liability Of International Airline Companies. For purposes of determining the Common Carrier's Tax liability of international airline companies pursuant to Section 118 of the Code, gross receipts shall be the same as the tax base for computing Gross Philippine Billings Tax as prescribed by these Regulations. IEHaSc Accordingly, the 3% CCT also applies where the international carrier is subject to the 2 1/2% Gross Philippine Billings Tax. Conversely, if the 2 1/2% Gross Philippine Billings tax is not applicable, the 3% common carrier's tax will also not apply. Moreover, as stated earlier, Section 3 of RR 15-02, provides that "an off-line airline is not considered engaged in business as an international air carrier in the Philippines and is, therefore, not subject to Gross Philippine Billings Tax provided for in Section 28(A)(3)(a) of the Code nor to the three percent (3%) common carriers tax under Section 118(A) of the same Code." In BIR Ruling No. [DA-209-04] dated April 12, 2004 cited above, this Office also confirmed that an offline carrier shall not be subject to the 3% CCT. For purposes of imposing the CCT, this Office has consistently ruled that CCT on international air carriers is imposed on gross receipts derived from outgoing freight and passenger service, in other words, originating from the Philippines. (Ibid., citing BIR Ruling No. 120-86 dated July 22, 1986; BIR Ruling No. 019, s. 1968.) In view of the foregoing, any revenues derived by Air France from the sale of tickets for off-line flights should also not be subject to the 3% CCT provided for in Section 118(A) of the Tax Code of 1997. 3. Regular Corporate Income Tax/Minimum Corporate Income Tax

A resident foreign corporation, like an international carrier such as Air France, is subject to income tax only on income derived from sources within the Philippines. (Section 28(A)(1) of the Tax Code of 1997.) This is the precise reason why the term "Gross Philippine Billings" which is the basis of the Gross Philippine Billings Tax of 2 1/2% (reduced to 1 1/2% under applicable tax treaties) to which international carriers are subject, is defined to mean "gross revenue derived from carriage of persons, excess baggage and mail originating from the Philippines in a continuous and uninterrupted flight . . ." It is only when flights originate from the Philippines that services can be considered to

have been rendered in the Philippines and the income therefrom derived from Philippine sources. ICTcDA Moreover, in BIR Ruling No. [DA-209-04], this Office also opined that since the amount of passenger and freight charges paid to an off-line airline for its sale of tickets in the Philippines are not subject to income tax, the payments made to the airline in respect of said charges are likewise not subject to any creditable withholding income tax, to wit: Anent your request for confirmation that such gross revenue of off-line international air carriers are not subject to creditable withholding tax under Section 57 of the 1997 Tax Code and Revenue Regulations No. 2-98, as amended, Revenue Regulations No. 2-98, as amended by Revenue Regulations Nos. 6-01 and 12-01, in relation to Section 57 of the 1997 Tax Code generally requires payors to withhold a creditable income tax from its income payments to persons residing in the Philippines. However from the time UAL became an off-line cargo carrier, its freight or cargo revenues do not form part of its Gross Philippine Billings. Thus, such revenues are not subject to income tax. Consequently, there is no liability to pay the 1 1/2% (under the RP-US Tax Treaty) income tax on Gross Philippine Billings if the carriage of persons, excess baggage, cargo and mail does not originate from the Philippines in a continuous and uninterrupted flight. Thus, passenger and freight charges paid to UAL are not subject to income tax and therefore, should not be subject to any creditable withholding income tax. Hence, no deductions for such creditable withholding taxes should be made from the passenger and cargo charges due to UAL. (Underscoring ours). cIDHSC Since passenger and freight charges paid to an off-line airline are "not subject" to income tax and consequently to the creditable withholding tax, then clearly, Air France cannot be held liable for the 32% regular corporate income tax or the 2% MCIT, in lieu of the Gross Philippine Billings Tax. To reiterate, we confirm your opinion that being an off-line airline, Air France shall not be subject to the 2 1/2% Gross Philippine Billings Tax or the 1 1/2% income tax on Gross Philippine Billings under Section 8 of the RP-France Tax Treaty, the 3% CCT, and the 32% regular corporate income tax/2% MCIT on revenues generated from the sale of Air France tickets within the Philippines. DCSTAH This ruling is being issued on the basis of the foregoing facts as represented. However, if upon investigation, it will be disclosed that the facts are different, then this ruling shall be considered null and void. HcTDSA Very truly yours, (SGD.) JOSE MARIO C. BUAG Deputy Commissioner Legal & Inspection Group