Republic of the Philippines

SUPREME COURT
Manila

EN BANC

G.R. No. L-65773-74 April 30, 1987

COMMISSIONER OF INTERNAL REVENUE, petitioner,

vs.
BRITISH OVERSEAS AIRWAYS CORPORATION and COURT OF TAX APPEALS, respondents.

Quasha, Asperilla, Ancheta, Peña, Valmonte & Marcos for respondent British Airways.

MELENCIO-HERRERA, J.:

Petitioner Commissioner of Internal Revenue (CIR) seeks a review on certiorari of the joint Decision
of the Court of Tax Appeals (CTA) in CTA Cases Nos. 2373 and 2561, dated 26 January 1983,
which set aside petitioner's assessment of deficiency income taxes against respondent British
Overseas Airways Corporation (BOAC) for the fiscal years 1959 to 1967, 1968-69 to 1970-71,
respectively, as well as its Resolution of 18 November, 1983 denying reconsideration.

BOAC is a 100% British Government-owned corporation organized and existing under the laws of
the United Kingdom It is engaged in the international airline business and is a member-signatory of
the Interline Air Transport Association (IATA). As such it operates air transportation service and sells
transportation tickets over the routes of the other airline members. During the periods covered by the
disputed assessments, it is admitted that BOAC had no landing rights for traffic purposes in the
Philippines, and was not granted a Certificate of public convenience and necessity to operate in the
Philippines by the Civil Aeronautics Board (CAB), except for a nine-month period, partly in 1961 and
partly in 1962, when it was granted a temporary landing permit by the CAB. Consequently, it did not
carry passengers and/or cargo to or from the Philippines, although during the period covered by the
assessments, it maintained a general sales agent in the Philippines — Wamer Barnes and
Company, Ltd., and later Qantas Airways — which was responsible for selling BOAC tickets
covering passengers and cargoes. 1

G.R. No. 65773 (CTA Case No. 2373, the First Case)

On 7 May 1968, petitioner Commissioner of Internal Revenue (CIR, for brevity) assessed BOAC the
aggregate amount of P2,498,358.56 for deficiency income taxes covering the years 1959 to 1963.
This was protested by BOAC. Subsequent investigation resulted in the issuance of a new
assessment, dated 16 January 1970 for the years 1959 to 1967 in the amount of P858,307.79.
BOAC paid this new assessment under protest.

On 7 October 1970, BOAC filed a claim for refund of the amount of P858,307.79, which claim was
denied by the CIR on 16 February 1972. But before said denial, BOAC had already filed a petition
for review with the Tax Court on 27 January 1972, assailing the assessment and praying for the
refund of the amount paid.

G.R. No. 65774 (CTA Case No. 2561, the Second Case)
On 17 November 1971, BOAC was assessed deficiency income taxes, interests, and penalty for the
fiscal years 1968-1969 to 1970-1971 in the aggregate amount of P549,327.43, and the additional
amounts of P1,000.00 and P1,800.00 as compromise penalties for violation of Section 46 (requiring
the filing of corporation returns) penalized under Section 74 of the National Internal Revenue Code
(NIRC).

On 25 November 1971, BOAC requested that the assessment be countermanded and set aside. In a
letter, dated 16 February 1972, however, the CIR not only denied the BOAC request for refund in the
First Case but also re-issued in the Second Case the deficiency income tax assessment for
P534,132.08 for the years 1969 to 1970-71 plus P1,000.00 as compromise penalty under Section 74
of the Tax Code. BOAC's request for reconsideration was denied by the CIR on 24 August 1973.
This prompted BOAC to file the Second Case before the Tax Court praying that it be absolved of
liability for deficiency income tax for the years 1969 to 1971.

This case was subsequently tried jointly with the First Case.

On 26 January 1983, the Tax Court rendered the assailed joint Decision reversing the CIR. The Tax
Court held that the proceeds of sales of BOAC passage tickets in the Philippines by Warner Barnes
and Company, Ltd., and later by Qantas Airways, during the period in question, do not constitute
BOAC income from Philippine sources "since no service of carriage of passengers or freight was
performed by BOAC within the Philippines" and, therefore, said income is not subject to Philippine
income tax. The CTA position was that income from transportation is income from services so that
the place where services are rendered determines the source. Thus, in the dispositive portion of its
Decision, the Tax Court ordered petitioner to credit BOAC with the sum of P858,307.79, and to
cancel the deficiency income tax assessments against BOAC in the amount of P534,132.08 for the
fiscal years 1968-69 to 1970-71.

Hence, this Petition for Review on certiorari of the Decision of the Tax Court.

The Solicitor General, in representation of the CIR, has aptly defined the issues, thus:

1. Whether or not the revenue derived by private respondent British Overseas

Airways Corporation (BOAC) from sales of tickets in the Philippines for air
transportation, while having no landing rights here, constitute income of BOAC from
Philippine sources, and, accordingly, taxable.

2. Whether or not during the fiscal years in question BOAC s a resident foreign
corporation doing business in the Philippines or has an office or place of business in
the Philippines.

3. In the alternative that private respondent may not be considered a resident foreign
corporation but a non-resident foreign corporation, then it is liable to Philippine
income tax at the rate of thirty-five per cent (35%) of its gross income received from
all sources within the Philippines.

Under Section 20 of the 1977 Tax Code:

(h) the term resident foreign corporation engaged in trade or business within the
Philippines or having an office or place of business therein.
 (i) The term "non-resident foreign corporation" applies to a foreign corporation not
engaged in trade or business within the Philippines and not having any office or
place of business therein

It is our considered opinion that BOAC is a resident foreign corporation. 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 environmental circumstances. The term implies a continuity of commercial
dealings and 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 progressive prosecution of
commercial gain or for the purpose and object of the business organization. 2 "In order that a foreign
corporation may be regarded as doing business within a State, there must be continuity of conduct
and intention to establish a continuous business, such as the appointment of a local agent, and not
one of a temporary character. 3

BOAC, during the periods covered by the subject - assessments, maintained a general sales agent
in the Philippines, That general sales agent, from 1959 to 1971, "was engaged in (1) selling and
issuing tickets; (2) breaking down the whole trip into series of trips — each trip in the series
corresponding to a different airline company; (3) receiving the fare from the whole trip; and (4)
consequently allocating to the various airline companies on the basis of their participation in the
services rendered through the mode of interline settlement as prescribed by Article VI of the
Resolution No. 850 of the IATA Agreement." 4 Those activities were in exercise of the functions
which are normally incident to, and are in progressive pursuit of, the purpose and object of its
organization as an international air carrier. In fact, the regular sale of tickets, its main activity, is the
very lifeblood of the airline business, the generation of sales being the paramount objective. There
should be no doubt then that BOAC was "engaged in" business in the Philippines through a local
agent during the period covered by the assessments. Accordingly, it is a resident foreign corporation
subject to tax upon its total net income received in the preceding taxable year from all sources within
the Philippines. 5

Sec. 24. Rates of tax on corporations. — ...

(b) Tax on foreign corporations. — ...

(2) Resident corporations. — A corporation organized, authorized, or existing under

the laws of any foreign country, except a foreign fife insurance company, engaged in
trade or business within the Philippines, shall be taxable as provided in subsection
(a) of this section upon the total net income received in the preceding taxable year
from all sources within the Philippines. (Emphasis supplied)

Next, we address ourselves to the issue of whether or not the revenue from sales of tickets by
BOAC in the Philippines constitutes income from Philippine sources and, accordingly, taxable under
our income tax laws.

The Tax Code defines "gross income" thus:

"Gross income" includes gains, profits, and income derived from salaries, wages or
compensation for personal service of whatever kind and in whatever form paid, or
from profession, vocations, trades, business, commerce, sales, or dealings in
property, whether real or personal, growing out of the ownership or use of or interest
in such property; also from interests, rents, dividends, securities, or the transactions
of any business carried on for gain or profile, or gains, profits, and income derived
from any source whatever (Sec. 29[3]; Emphasis supplied)
The definition is broad and comprehensive to include proceeds from sales of transport documents.
"The words 'income from any source whatever' disclose a legislative policy to include all income not
expressly exempted within the class of taxable income under our laws." Income means "cash
received or its equivalent"; it is the amount of money coming to a person within a specific time ...; it
means something distinct from principal or capital. For, while capital is a fund, income is a flow. As
used in our income tax law, "income" refers to the flow of wealth. 6

The records show that the Philippine gross income of BOAC for the fiscal years 1968-69 to 1970-71
amounted to P10,428,368 .00. 7

Did such "flow of wealth" come from "sources within the Philippines",

The source of an income is the property, activity or service that produced the income. 8 For the
source of income to be considered as coming from the Philippines, it is sufficient that the income is
derived from activity within the Philippines. In BOAC's case, the sale of tickets in the Philippines is
the activity that produces the income. The tickets exchanged hands here and payments for fares
were also made here in Philippine currency. The site of the source of payments is the Philippines.
The flow of wealth proceeded from, and occurred within, Philippine territory, enjoying the protection
accorded by the Philippine government. In consideration of such protection, the flow of wealth
should share the burden of supporting the government.

A transportation ticket is not a mere piece of paper. When issued by a common carrier, it constitutes
the contract between the ticket-holder and the carrier. It gives rise to the obligation of the purchaser
of the ticket to pay the fare and the corresponding obligation of the carrier to transport the passenger
upon the terms and conditions set forth thereon. The ordinary ticket issued to members of the
traveling public in general embraces within its terms all the elements to constitute it a valid contract,
binding upon the parties entering into the relationship. 9

True, Section 37(a) of the Tax Code, which enumerates items of gross income from sources within
the Philippines, namely: (1) interest, (21) dividends, (3) service, (4) rentals and royalties, (5) sale of
real property, and (6) sale of personal property, does not mention income from the sale of tickets for
international transportation. However, that does not render it less an income from sources within the
Philippines. Section 37, by its language, does not intend the enumeration to be exclusive. It merely
directs that the types of income listed therein be treated as income from sources within the
Philippines. A cursory reading of the section will show that it does not state that it is an all-inclusive
enumeration, and that no other kind of income may be so considered. " 10

BOAC, however, would impress upon this Court that income derived from transportation is income
for services, with the result that the place where the services are rendered determines the source;
and since BOAC's service of transportation is performed outside the Philippines, the income derived
is from sources without the Philippines and, therefore, not taxable under our income tax laws. The
Tax Court upholds that stand in the joint Decision under review.

The absence of flight operations to and from the Philippines is not determinative of the source of
income or the site of income taxation. Admittedly, BOAC was an off-line international airline at the
time pertinent to this case. The test of taxability is the "source"; and the source of an income is that
activity ... which produced the income. 11 Unquestionably, the passage documentations in these cases were sold in the
Philippines and the revenue therefrom was derived from a activity regularly pursued within the Philippines. business a And even if the BOAC
tickets sold covered the "transport of passengers and cargo to and from foreign cities", 12 it cannot alter the fact that income from the sale of
tickets was derived from the Philippines. The word "source" conveys one essential idea, that of origin, and the origin of the income herein is
the Philippines. 13
It should be pointed out, however, that the assessments upheld herein apply only to the fiscal years covered by the questioned deficiency
income tax assessments in these cases, or, from 1959 to 1967, 1968-69 to 1970-71. For, pursuant to Presidential Decree No. 69,
promulgated on 24 November, 1972, international carriers are now taxed as follows:

... Provided, however, That international carriers shall pay a tax of 2-½ per cent on
their cross Philippine billings. (Sec. 24[b] [21, Tax Code).

Presidential Decree No. 1355, promulgated on 21 April, 1978, provided a statutory definition of the
term "gross Philippine billings," thus:

... "Gross Philippine billings" includes gross revenue realized from uplifts anywhere in
the world by any international carrier doing business in the Philippines of passage
documents sold therein, whether for passenger, excess baggage or mail provided
the cargo or mail originates from the Philippines. ...

The foregoing provision ensures that international airlines are taxed on their income from Philippine
sources. The 2-½ % tax on gross Philippine billings is an income tax. If it had been intended as an
excise or percentage tax it would have been place under Title V of the Tax Code covering Taxes on
Business.

Lastly, we find as untenable the BOAC argument that the dismissal for lack of merit by this Court of
the appeal in JAL vs. Commissioner of Internal Revenue (G.R. No. L-30041) on February 3, 1969,
is res judicata to the present case. The ruling by the Tax Court in that case was to the effect that the
mere sale of tickets, unaccompanied by the physical act of carriage of transportation, does not
render the taxpayer therein subject to the common carrier's tax. As elucidated by the Tax Court,
however, the common carrier's tax is an excise tax, being a tax on the activity of transporting,
conveying or removing passengers and cargo from one place to another. It purports to tax the
business of transportation. 14 Being an excise tax, the same can be levied by the State only when
the acts, privileges or businesses are done or performed within the jurisdiction of the Philippines.
The subject matter of the case under consideration is income tax, a direct tax on the income of
persons and other entities "of whatever kind and in whatever form derived from any source." Since
the two cases treat of a different subject matter, the decision in one cannot be res judicata to the
other.

WHEREFORE, the appealed joint Decision of the Court of Tax Appeals is hereby SET ASIDE.
Private respondent, the British Overseas Airways Corporation (BOAC), is hereby ordered to pay the
amount of P534,132.08 as deficiency income tax for the fiscal years 1968-69 to 1970-71 plus 5%
surcharge, and 1% monthly interest from April 16, 1972 for a period not to exceed three (3) years in
accordance with the Tax Code. The BOAC claim for refund in the amount of P858,307.79 is hereby
denied. Without costs.

SO ORDERED.

Paras, Gancayco, Padilla, Bidin, Sarmiento and Cortes, JJ., concur.

Fernan, J., took no part.

Separate Opinions
TEEHANKEE, C.J., concurring:

I concur with the Court's majority judgment upholding the assessments of deficiency income taxes
against respondent BOAC for the fiscal years 1959-1969 to 1970-1971 and therefore setting aside
the appealed joint decision of respondent Court of Tax Appeals. I just wish to point out that the
conflict between the majority opinion penned by Mr. Justice Feliciano as to the proper
characterization of the taxable income derived by respondent BOAC from the sales in the Philippines
of tickets foe BOAC form the issued by its general sales agent in the Philippines gas become moot
after November 24, 1972. Booth opinions state that by amendment through P.D. No.69, promulgated
on November 24, 1972, of section 24(b) (2) of the Tax Code providing dor the rate of income tax on
foreign corporations, international carriers such as respondent BOAC, have since then been taxed at
a reduced rate of 2-½% on their gross Philippine billings. There is, therefore, no longer ant source of
substantial conflict between the two opinions as to the present 2-½% tax on their gross Philippine
billings charged against such international carriers as herein respondent foreign corporation.

FELICIANO, J., dissenting:

With great respect and reluctance, i record my dissent from the opinion of Mme. Justice A.A.
Melencio-Herrera speaking for the majority . In my opinion, the joint decision of the Court of Tax
Appeals in CTA Cases Nos. 2373 and 2561, dated 26 January 1983, is correct and should be
affirmed.

The fundamental issue raised in this petition for review is whether the British Overseas Airways
Corporation (BOAC), a foreign airline company which does not maintain any flight operations to and
from the Philippines, is liable for Philippine income taxation in respect of "sales of air tickets" in the
Philippines through a general sales agent, relating to the carriage of passengers and cargo between
two points both outside the Philippines.

1. The Solicitor General has defined as one of the issue in this case the question of:

2. Whether or not during the fiscal years in question 1 BOAC [was] a resident foreign corporation
doing business in the Philippines or [had] an office or place of business in the Philippines.

It is important to note at the outset that the answer to the above-quoted issue is not determinative of
the lialibity of the BOAC to Philippine income taxation in respect of the income here involved. The
liability of BOAC to Philippine income taxation in respect of such income depends, not on BOAC's
status as a "resident foreign corporation" or alternatively, as a "non-resident foreign corporation," but
rather on whether or not such income is derived from "source within the Philippines."

A "resident foreign corporation" or foreign corporation engaged in trade or business in the

Philippines or having an office or place of business in the Philippines is subject to Philippine income
taxation only in respect of income derived from sources within the Philippines. Section 24 (b) (2) of
the National Internal Revenue CODE ("Tax Code"), as amended by Republic Act No. 2343,
approved 20 June 1959, as it existed up to 3 August 1969, read as follows:

(2) Resident corporations. — A foreign corporation engaged in trade or business with

in the Philippines (expect foreign life insurance companies) shall be taxable as
provided in subsection (a) of this section.
Section 24 (a) of the Tax Code in turn provides:

Rate of tax on corporations. — (a) Tax on domestic corporations. — ... and a like tax
shall be livied, collected, and paid annually upon the total net income received in the
preceeding taxable year from all sources within the Philippines by every corporation
organized, authorized, or existing under the laws of any foreign country: ... .
(Emphasis supplied)

Republic Act No. 6110, which took effect on 4 August 1969, made this even clearer when it
amended once more Section 24 (b) (2) of the Tax Code so as to read as follows:

(2) Resident Corporations. — A corporation, organized, authorized or existing under

the laws of any foreign counrty, except foreign life insurance company, engaged in
trade or business within the Philippines, shall be taxable as provided in subsection
(a) of this section upon the total net income received in the preceding taxable
year from all sources within the Philippines. (Emphasis supplied)

Exactly the same rule is provided by Section 24 (b) (1) of the Tax Code upon non-resident foreign
corporations. Section 24 (b) (1) as amended by Republic Act No. 3825 approved 22 June 1963, read
as follows:

(b) Tax on foreign corporations. — (1) Non-resident corporations. — There shall be

levied, collected and paid for each taxable year, in lieu of the tax imposed by the
preceding paragraph upon the amount received by every foreign corporation not
engaged in trade or business within the Philippines, from all sources within the
Philippines, as interest, dividends, rents, salaries, wages, premium, annuities,
compensations, remunerations, emoluments, or other fixed or determinative annual
or periodical gains, profits and income a tax equal to thirty per centum of such
amount: provided, however, that premiums shall not include reinsurance premiums. 2

Clearly, whether the foreign corporate taxpayer is doing business in the Philippines and therefore a
resident foreign corporation, or not doing business in the Philippines and therefore a non-resident
foreign corporation, it is liable to income tax only to the extent that it derives income from sources
within the Philippines. The circumtances that a foreign corporation is resident in the Philippines
yields no inference that all or any part of its income is Philippine source income. Similarly, the non-
resident status of a foreign corporation does not imply that it has no Philippine source income.
Conversely, the receipt of Philippine source income creates no presumption that the recipient foreign
corporation is a resident of the Philippines. The critical issue, for present purposes, is
therefore whether of not BOAC is deriving income from sources within the Philippines.

2. For purposes of income taxation, it is well to bear in mind that the "source of income" relates not
to the physical sourcing of a flow of money or the physical situs of payment but rather to the
"property, activity or service which produced the income." In Howden and Co., Ltd. vs. Collector of
Internal Revenue, 3 the court dealt with the issue of the applicable source rule relating to reinsurance
premiums paid by a local insurance company to a foreign reinsurance company in respect of risks
located in the Philippines. The Court said:

The source of an income is the property, activity or services that produced the
income. The reinsurance premiums remitted to appellants by virtue of the
reinsurance contract, accordingly, had for their source the undertaking to indemnify
Commonwealth Insurance Co. against liability. Said undertaking is the activity that
produced the reinsurance premiums, and the same took place in the Philippines. —
 [T]he reinsurance, the liabilities insured and the risk originally underwritten by
Commonwealth Insurance Co., upon which the reinsurance premiums and indemnity
were based, were all situated in the Philippines. —4

The Court may be seen to be saying that it is the underlying prestation which is properly regarded as
the activity giving rise to the income that is sought to be taxed. In the Howden case, that underlying
prestation was the indemnification of the local insurance company. Such indemnification could take
place only in the Philippines where the risks were located and where payment from the foreign
reinsurance (in case the casualty insured against occurs) would be received in Philippine pesos
under the reinsurance premiums paid by the local insurance companies constituted Philippine
source income of the foreign reinsurances.

The concept of "source of income" for purposes of income taxation originated in the United States
income tax system. The phrase "sources within the United States" was first introduced into the U.S.
tax system in 1916, and was subsequently embodied in the 1939 U.S. Tax Code. As is commonly
known, our Tax Code (Commonwealth Act 466, as amended) was patterned after the 1939 U.S. Tax
Code. It therefore seems useful to refer to a standard U.S. text on federal income taxation:

The Supreme Court has said, in a definition much quoted but often debated,
that income may be derived from three possible sources only: (1) capital and/or
(2) labor and/or (3) the sale of capital assets. While the three elements of this
attempt at definition need not be accepted as all-inclusive, they serve as useful
guides in any inquiry into whether a particular item is from "source within the United
States" and suggest an investigation into the nature and location of the activities or
property which produce the income. If the income is from labor (services) the place
where the labor is done should be decisive; if it is done in this counrty, the income
should be from "source within the United States." If the income is from capital, the
place where the capital is employed should be decisive; if it is employed in this
country, the income should be from "source within the United States". If the income is
from the sale of capital assets, the place where the sale is made should be likewise
decisive. Much confusion will be avoided by regarding the term "source" in this
fundamental light. It is not a place; it is an activity or property. As such, it has a situs
or location; and if that situs or location is within the United States the resulting
income is taxable to nonresident aliens and foreign corporations. The intention of
Congress in the 1916 and subsequent statutes was to discard the 1909 and 1913
basis of taxing nonresident aliens and foreign corporations and to make the test of
taxability the "source", or situs of the activities or property which produce the income
. . . . Thus, if income is to taxed, the recipient thereof must be resident within the
jurisdiction, or the property or activities out of which the income issue or is derived
must be situated within the jurisdiction so that the source of the income may be said
to have a situs in this country. The underlying theory is that the consideration for
taxation is protection of life and property and that the income rightly to be levied
upon to defray the burdens of the United States Government is that income which is
created by activities and property protected by this Government or obtained by
persons enjoying that protection. 5

3. We turn now to the question what is the source of income rule applicable in the instant case.
There are two possibly relevant source of income rules that must be confronted; (a) the source rule
applicable in respect of contracts of service; and (b) the source rule applicable in respect of sales of
personal property.
Where a contract for the rendition of service is involved, the applicable source rule may be simply
stated as follows: the income is sourced in the place where the service contracted for is rendered.
Section 37 (a) (3) of our Tax Code reads as follows:

Section 37. Income for sources within the Philippines.

(a) Gross income from sources within the Philippines. — The following items of gross
income shall be treated as gross income from sources within the Philippines:

xxx xxx xxx

(3) Services. — Compensation for labor or personal

services performed in the Philippines;... (Emphasis supplied)

Section 37 (c) (3) of the Tax Code, on the other hand, deals with income from sources without the
Philippines in the following manner:

(c) Gross income from sources without the Philippines. — The following items of
gross income shall be treated as income from sources without the Philippines:

(3) Compensation for labor or personal services performed without the Philippines; ...
(Emphasis supplied)

It should not be supposed that Section 37 (a) (3) and (c) (3) of the Tax Code apply only in respect of
services rendered by individual natural persons; they also apply to services rendered by or through
the medium of a juridical person. 6 Further, a contract of carriage or of transportation is assimilated in
our Tax Code and Revenue Regulations to a contract for services. Thus, Section 37 (e) of the Tax
Code provides as follows:

(e) Income form sources partly within and partly without the Philippines. — Items of
gross income, expenses, losses and deductions, other than those specified in
subsections (a) and (c) of this section shall be allocated or apportioned to sources
within or without the Philippines, under the rules and regulations prescribed by the
Secretary of Finance. ... Gains, profits, and income from (1) transportation or other
services rendered partly within and partly without the Philippines, or (2) from the sale
of personnel property produced (in whole or in part) by the taxpayer within and sold
without the Philippines, or produced (in whole or in part) by the taxpayer without and
sold within the Philippines, shall be treated as derived partly from sources within and
partly from sources without the Philippines. ... (Emphasis supplied)

It should be noted that the above underscored portion of Section 37 (e) was derived from the 1939
U.S. Tax Code which "was based upon a recognition that transportation was a service and that the
source of the income derived therefrom was to be treated as being the place where the service of
transportation was rendered. 7

Section 37 (e) of the Tax Code quoted above carries a strong well-nigh irresistible, implication that
income derived from transportation or other services rendered entirely outside the Philippines must
be treated as derived entirely from sources without the Philippines. This implication is reinforced by a
consideration of certain provisions of Revenue Regulations No. 2 entitled "Income Tax Regulations"
as amended, first promulgated by the Department of Finance on 10 February 1940. Section 155 of
Revenue Regulations No. 2 (implementing Section 37 of the Tax Code) provides in part as follows:
 Section 155. Compensation for labor or personnel services. — Gross income from
sources within the Philippines includes compensation for labor or personal services
within the Philippines regardless of the residence of the payer, of the place in which
the contract for services was made, or of the place of payment — (Emphasis
supplied)

Section 163 of Revenue Regulations No. 2 (still relating to Section 37 of the Tax Code) deals with a
particular species of foreign transportation companies — i.e., foreign steamship companies deriving
income from sources partly within and partly without the Philippines:

Section 163 Foreign steamship companies. — The return of foreign steamship

companies whose vessels touch parts of the Philippines should include as gross
income, the total receipts of all out-going business whether freight or passengers.
With the gross income thus ascertained, the ratio existing between it and the gross
income from all ports, both within and without the Philippines of all vessels, whether
touching of the Philippines or not, should be determined as the basis upon which
allowable deductions may be computed, — . (Emphasis supplied)

Another type of utility or service enterprise is dealt with in Section 164 of Revenue Regulations No. 2
(again implementing Section 37 of the Tax Code) with provides as follows:

Section 164. Telegraph and cable services. — A foreign corporation carrying on the
business of transmission of telegraph or cable messages between points in the
Philippines and points outside the Philippines derives income partly form source
within and partly from sources without the Philippines.

... (Emphasis supplied)

Once more, a very strong inference arises under Sections 163 and 164 of Revenue Regulations No.
2 that steamship and telegraph and cable services rendered between points both outside the
Philippines give rise to income wholly from sources outside the Philippines, and therefore not subject
to Philippine income taxation.

We turn to the "source of income" rules relating to the sale of personal property, upon the one hand,
and to the purchase and sale of personal property, upon the other hand.

We consider first sales of personal property. Income from the sale of personal property by the
producer or manufacturer of such personal property will be regarded as sourced entirely within or
entirely without the Philippines or as sourced partly within and partly without the Philippines,
depending upon two factors: (a) the place where the sale of such personal property occurs; and (b)
the place where such personal property was produced or manufactured. If the personal property
involved was both produced or manufactured and sold outside the Philippines, the income derived
therefrom will be regarded as sourced entirely outside the Philippines, although the personal
property had been produced outside the Philippines, or if the sale of the property takes place outside
the Philippines and the personal was produced in the Philippines, then, the income derived from the
sale will be deemed partly as income sourced without the Philippines. In other words, the income
(and the related expenses, losses and deductions) will be allocated between sources within and
sources without the Philippines. Thus, Section 37 (e) of the Tax Code, although already quoted
above, may be usefully quoted again:

(e) Income from sources partly within and partly without the Philippines. ... Gains,
profits and income from (1) transportation or other services rendered partly within
 and partly without the Philippines; or (2) from the sale of personal property produced
(in whole or in part) by the taxpayer within and sold without the Philippines, or
produced (in whole or in part) by the taxpayer without and sold within the
Philippines, shall be treated as derived partly from sources within and partly from
sources without the Philippines. ... (Emphasis supplied)

In contrast, income derived from the purchase and sale of personal property — i. e., trading — is,
under the Tax Code, regarded as sourced wholly in the place where the personal property is
sold. Section 37 (e) of the Tax Code provides in part as follows:

(e) Income from sources partly within and partly without the Philippines ... Gains,
profits and income derived from the purchase of personal property within and its sale
without the Philippines or from the purchase of personal property without and its sale
within the Philippines, shall be treated as derived entirely from sources within the
country in which sold. (Emphasis supplied)

Section 159 of Revenue Regulations No. 2 puts the applicable rule succinctly:

Section 159. Sale of personal property. Income derived from the purchase and sale
of personal property shall be treated as derived entirely from the country in which
sold. The word "sold" includes "exchange." The "country" in which "sold" ordinarily
means the place where the property is marketed. This Section does not apply to
income from the sale personal property produced (in whole or in part) by the
taxpayer within and sold without the Philippines or produced (in whole or in part) by
the taxpayer without and sold within the Philippines. (See Section 162 of these
regulations). (Emphasis supplied)

4. It will be seen that the basic problem is one of characterization of the transactions entered into by
BOAC in the Philippines. Those transactions may be characterized either as sales of personal
property (i. e., "sales of airline tickets") or as entering into a lease of services or a contract of service
or carriage. The applicable "source of income" rules differ depending upon which characterization is
given to the BOAC transactions.

The appropriate characterization, in my opinion, of the BOAC transactions is that of entering into
contracts of service, i.e., carriage of passengers or cargo between points located outside the
Philippines.

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 airline ticket in and of itself has no monetary value, even as scrap
paper. The value of 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 "purchaser" or
passenger from the one point to another outside the Philippines. The ticket is really the evidence of
the contract of carriage entered into between BOAC and the passenger. The money paid by the
passenger changes hands in the Philippines. But the passenger does not receive undertaken to be
delivered by BOAC. The "purchase price of the airline ticket" is quite different from the purchase
price of a physical good or commodity such as a pair of shoes of 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.

The characterization of the BOAC transactions either as sales of personal property or as purchases
and sales of personal property, appear entirely inappropriate from other viewpoint. Consider first
purchases and sales: is BOAC properly 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 manufactured by it? In a popular or journalistic sense, BOAC might be described as
"selling" "a product" — its service. However, for the technical purposes of the law on income
taxation, BOAC is in fact entering into contracts of service or carriage. The very existance 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. On a slighty more abstract level,
BOAC's income is more appropriately characterized as derived from a "service", rather than from an
"activity" (a broader term than service and including the activity of selling) or from the here involved
is income taxation, and not a sales tax or an excise or privilege tax.

5. The taxation of international carriers is today effected under Section 24 (b) (2) of the Tax Code, as
amended by Presidential Decree No. 69, promulgated on 24 November 1972 and by Presidential
Decree No. 1355, promulgated on 21 April 1978, in the following manner:

(2) Resident corporations. — A corporation organized, authorized, or existing under

the laws of any foreign country, engaged in trade or business within the Philippines,
shall be taxable as provided in subsection (a) of this section upon the total net
income received in the preceeding taxable year from all sources within the
Philippines: Provided, however, That international carriers shall pay a tax of two and
one-half per cent on their gross Philippine billings. "Gross Philippines of passage
documents sold therein, whether for passenger, excess baggege or mail, provide the
cargo or mail originates from the Philippines. The gross revenue realized from the
said cargo or mail shall include the gross freight charge up to final destination. Gross
revenues from chartered flights originating from the Philippines shall likewise form
part of "gross Philippine billings" regardless of the place of sale or payment of the
passage documents. For purposes of determining the taxability to revenues from
chartered flights, the term "originating from the Philippines" shall include flight of
passsengers who stay in the Philippines for more than forty-eight (48) hours prior to
embarkation. (Emphasis supplied)

Under the above-quoted proviso international carriers issuing for compensation passage
documentation in the Philippines for uplifts from any point in the world to any other point in the world,
are not charged any Philippine income tax on their Philippine billings (i.e., billings in respect of
passenger or cargo originating from the Philippines). Under this new approach, international carriers
who service port or points in the Philippines are treated in exactly the same way as international
carriers not serving any port or point in the Philippines. Thus, the source of income rule applicable,
as above discussed, to transportation or other services rendered partly within and partly without the
Philippines, or wholly without the Philippines, has been set aside. in place of Philippine income
taxation, the Tax Code now imposes this 2½ per cent tax computed on the basis of billings in
respect of passengers and cargo originating from the Philippines regardless of where embarkation
and debarkation would be taking place. This 2-½ per cent tax is effectively a tax on gross receipts or
an excise or privilege tax and not a tax on income. Thereby, the Government has done away with
the difficulties attending the allocation of income and related expenses, losses and deductions.
Because taxes are the very lifeblood of government, the resulting potential "loss" or "gain" in the
amount of taxes collectible by the state is sometimes, with varying degrees of consciousness,
considered in choosing from among competing possible characterizations under or interpretation of
tax statutes. It is hence perhaps useful to point out that the determination of the appropriate
characterization here — that of contracts of air carriage rather than sales of airline tickets — entails
no down-the-road loss of income tax revenues to the Government. In lieu thereof, the Government
takes in revenues generated by the 2-½ per cent tax on the gross Philippine billings or receipts of
international carriers.
I would vote to affirm the decision of the Court of Tax Appeals.

Separate Opinions

TEEHANKEE, C.J., concurring:

I concur with the Court's majority judgment upholding the assessments of deficiency income taxes
against respondent BOAC for the fiscal years 1959-1969 to 1970-1971 and therefore setting aside
the appealed joint decision of respondent Court of Tax Appeals. I just wish to point out that the
conflict between the majority opinion penned by Mr. Justice Feliciano as to the proper
characterization of the taxable income derived by respondent BOAC from the sales in the Philippines
of tickets foe BOAC form the issued by its general sales agent in the Philippines gas become moot
after November 24, 1972. Booth opinions state that by amendment through P.D. No.69, promulgated
on November 24, 1972, of section 24(b) (2) of the Tax Code providing dor the rate of income tax on
foreign corporations, international carriers such as respondent BOAC, have since then been taxed at
a reduced rate of 2-½% on their gross Philippine billings. There is, therefore, no longer ant source of
substantial conflict between the two opinions as to the present 2-½% tax on their gross Philippine
billings charged against such international carriers as herein respondent foreign corporation.

FELICIANO, J., dissenting:

With great respect and reluctance, i record my dissent from the opinion of Mme. Justice A.A.
Melencio-Herrera speaking for the majority . In my opinion, the joint decision of the Court of Tax
Appeals in CTA Cases Nos. 2373 and 2561, dated 26 January 1983, is correct and should be
affirmed.

The fundamental issue raised in this petition for review is whether the British Overseas Airways
Corporation (BOAC), a foreign airline company which does not maintain any flight operations to and
from the Philippines, is liable for Philippine income taxation in respect of "sales of air tickets" in the
Philippines through a general sales agent, relating to the carriage of passengers and cargo between
two points both outside the Philippines.

1. The Solicitor General has defined as one of the issue in this case the question of:

2. Whether or not during the fiscal years in question 1 BOAC [was] a resident foreign corporation
doing business in the Philippines or [had] an office or place of business in the Philippines.

It is important to note at the outset that the answer to the above-quoted issue is not determinative of
the lialibity of the BOAC to Philippine income taxation in respect of the income here involved. The
liability of BOAC to Philippine income taxation in respect of such income depends, not on BOAC's
status as a "resident foreign corporation" or alternatively, as a "non-resident foreign corporation," but
rather on whether or not such income is derived from "source within the Philippines."

A "resident foreign corporation" or foreign corporation engaged in trade or business in the

Philippines or having an office or place of business in the Philippines is subject to Philippine income
taxation only in respect of income derived from sources within the Philippines. Section 24 (b) (2) of
the National Internal Revenue CODE ("Tax Code"), as amended by Republic Act No. 2343,
approved 20 June 1959, as it existed up to 3 August 1969, read as follows:

(2) Resident corporations. — A foreign corporation engaged in trade or business with

in the Philippines (expect foreign life insurance companies) shall be taxable as
provided in subsection (a) of this section.

Section 24 (a) of the Tax Code in turn provides:

Rate of tax on corporations. — (a) Tax on domestic corporations. — ... and a like tax
shall be livied, collected, and paid annually upon the total net income received in the
preceeding taxable year from all sources within the Philippines by every corporation
organized, authorized, or existing under the laws of any foreign country: ... .
(Emphasis supplied)

Republic Act No. 6110, which took effect on 4 August 1969, made this even clearer when it
amended once more Section 24 (b) (2) of the Tax Code so as to read as follows:

(2) Resident Corporations. — A corporation, organized, authorized or existing under

the laws of any foreign counrty, except foreign life insurance company, engaged in
trade or business within the Philippines, shall be taxable as provided in subsection
(a) of this section upon the total net income received in the preceding taxable
year from all sources within the Philippines. (Emphasis supplied)

Exactly the same rule is provided by Section 24 (b) (1) of the Tax Code upon non-resident foreign
corporations. Section 24 (b) (1) as amended by Republic Act No. 3825 approved 22 June 1963, read
as follows:

(b) Tax on foreign corporations. — (1) Non-resident corporations. — There shall be

levied, collected and paid for each taxable year, in lieu of the tax imposed by the
preceding paragraph upon the amount received by every foreign corporation not
engaged in trade or business within the Philippines, from all sources within the
Philippines, as interest, dividends, rents, salaries, wages, premium, annuities,
compensations, remunerations, emoluments, or other fixed or determinative annual
or periodical gains, profits and income a tax equal to thirty per centum of such
amount: provided, however, that premiums shall not include reinsurance premiums. 2

Clearly, whether the foreign corporate taxpayer is doing business in the Philippines and therefore a
resident foreign corporation, or not doing business in the Philippines and therefore a non-resident
foreign corporation, it is liable to income tax only to the extent that it derives income from sources
within the Philippines. The circumtances that a foreign corporation is resident in the Philippines
yields no inference that all or any part of its income is Philippine source income. Similarly, the non-
resident status of a foreign corporation does not imply that it has no Philippine source income.
Conversely, the receipt of Philippine source income creates no presumption that the recipient foreign
corporation is a resident of the Philippines. The critical issue, for present purposes, is
therefore whether of not BOAC is deriving income from sources within the Philippines.

2. For purposes of income taxation, it is well to bear in mind that the "source of income" relates not
to the physical sourcing of a flow of money or the physical situs of payment but rather to the
"property, activity or service which produced the income." In Howden and Co., Ltd. vs. Collector of
Internal Revenue, 3 the court dealt with the issue of the applicable source rule relating to reinsurance
premiums paid by a local insurance company to a foreign reinsurance company in respect of risks
located in the Philippines. The Court said:

The source of an income is the property, activity or services that produced the
income. The reinsurance premiums remitted to appellants by virtue of the
reinsurance contract, accordingly, had for their source the undertaking to indemnify
Commonwealth Insurance Co. against liability. Said undertaking is the activity that
produced the reinsurance premiums, and the same took place in the Philippines. —
[T]he reinsurance, the liabilities insured and the risk originally underwritten by
Commonwealth Insurance Co., upon which the reinsurance premiums and indemnity
were based, were all situated in the Philippines. —4

The Court may be seen to be saying that it is the underlying prestation which is properly regarded as
the activity giving rise to the income that is sought to be taxed. In the Howden case, that underlying
prestation was the indemnification of the local insurance company. Such indemnification could take
place only in the Philippines where the risks were located and where payment from the foreign
reinsurance (in case the casualty insured against occurs) would be received in Philippine pesos
under the reinsurance premiums paid by the local insurance companies constituted Philippine
source income of the foreign reinsurances.

The concept of "source of income" for purposes of income taxation originated in the United States
income tax system. The phrase "sources within the United States" was first introduced into the U.S.
tax system in 1916, and was subsequently embodied in the 1939 U.S. Tax Code. As is commonly
known, our Tax Code (Commonwealth Act 466, as amended) was patterned after the 1939 U.S. Tax
Code. It therefore seems useful to refer to a standard U.S. text on federal income taxation:

The Supreme Court has said, in a definition much quoted but often debated,
that income may be derived from three possible sources only: (1) capital and/or
(2) labor and/or (3) the sale of capital assets. While the three elements of this
attempt at definition need not be accepted as all-inclusive, they serve as useful
guides in any inquiry into whether a particular item is from "source within the United
States" and suggest an investigation into the nature and location of the activities or
property which produce the income. If the income is from labor (services) the place
where the labor is done should be decisive; if it is done in this counrty, the income
should be from "source within the United States." If the income is from capital, the
place where the capital is employed should be decisive; if it is employed in this
country, the income should be from "source within the United States". If the income is
from the sale of capital assets, the place where the sale is made should be likewise
decisive. Much confusion will be avoided by regarding the term "source" in this
fundamental light. It is not a place; it is an activity or property. As such, it has a situs
or location; and if that situs or location is within the United States the resulting
income is taxable to nonresident aliens and foreign corporations. The intention of
Congress in the 1916 and subsequent statutes was to discard the 1909 and 1913
basis of taxing nonresident aliens and foreign corporations and to make the test of
taxability the "source", or situs of the activities or property which produce the income
. . . . Thus, if income is to taxed, the recipient thereof must be resident within the
jurisdiction, or the property or activities out of which the income issue or is derived
must be situated within the jurisdiction so that the source of the income may be said
to have a situs in this country. The underlying theory is that the consideration for
taxation is protection of life and property and that the income rightly to be levied
upon to defray the burdens of the United States Government is that income which is
created by activities and property protected by this Government or obtained by
persons enjoying that protection. 5
3. We turn now to the question what is the source of income rule applicable in the instant case.
There are two possibly relevant source of income rules that must be confronted; (a) the source rule
applicable in respect of contracts of service; and (b) the source rule applicable in respect of sales of
personal property.

Where a contract for the rendition of service is involved, the applicable source rule may be simply
stated as follows: the income is sourced in the place where the service contracted for is rendered.
Section 37 (a) (3) of our Tax Code reads as follows:

Section 37. Income for sources within the Philippines.

(a) Gross income from sources within the Philippines. — The following items of gross
income shall be treated as gross income from sources within the Philippines:

xxx xxx xxx

(3) Services. — Compensation for labor or personal

services performed in the Philippines;... (Emphasis supplied)

Section 37 (c) (3) of the Tax Code, on the other hand, deals with income from sources without the
Philippines in the following manner:

(c) Gross income from sources without the Philippines. — The following items of
gross income shall be treated as income from sources without the Philippines:

(3) Compensation for labor or personal services performed without the Philippines; ...
(Emphasis supplied)

It should not be supposed that Section 37 (a) (3) and (c) (3) of the Tax Code apply only in respect of
services rendered by individual natural persons; they also apply to services rendered by or through
the medium of a juridical person. 6 Further, a contract of carriage or of transportation is assimilated in
our Tax Code and Revenue Regulations to a contract for services. Thus, Section 37 (e) of the Tax
Code provides as follows:

(e) Income form sources partly within and partly without the Philippines. — Items of
gross income, expenses, losses and deductions, other than those specified in
subsections (a) and (c) of this section shall be allocated or apportioned to sources
within or without the Philippines, under the rules and regulations prescribed by the
Secretary of Finance. ... Gains, profits, and income from (1) transportation or other
services rendered partly within and partly without the Philippines, or (2) from the sale
of personnel property produced (in whole or in part) by the taxpayer within and sold
without the Philippines, or produced (in whole or in part) by the taxpayer without and
sold within the Philippines, shall be treated as derived partly from sources within and
partly from sources without the Philippines. ... (Emphasis supplied)

It should be noted that the above underscored portion of Section 37 (e) was derived from the 1939
U.S. Tax Code which "was based upon a recognition that transportation was a service and that the
source of the income derived therefrom was to be treated as being the place where the service of
transportation was rendered. 7
Section 37 (e) of the Tax Code quoted above carries a strong well-nigh irresistible, implication that
income derived from transportation or other services rendered entirely outside the Philippines must
be treated as derived entirely from sources without the Philippines. This implication is reinforced by a
consideration of certain provisions of Revenue Regulations No. 2 entitled "Income Tax Regulations"
as amended, first promulgated by the Department of Finance on 10 February 1940. Section 155 of
Revenue Regulations No. 2 (implementing Section 37 of the Tax Code) provides in part as follows:

Section 155. Compensation for labor or personnel services. — Gross income from
sources within the Philippines includes compensation for labor or personal services
within the Philippines regardless of the residence of the payer, of the place in which
the contract for services was made, or of the place of payment — (Emphasis
supplied)

Section 163 of Revenue Regulations No. 2 (still relating to Section 37 of the Tax Code) deals with a
particular species of foreign transportation companies — i.e., foreign steamship companies deriving
income from sources partly within and partly without the Philippines:

Section 163 Foreign steamship companies. — The return of foreign steamship

companies whose vessels touch parts of the Philippines should include as gross
income, the total receipts of all out-going business whether freight or passengers.
With the gross income thus ascertained, the ratio existing between it and the gross
income from all ports, both within and without the Philippines of all vessels, whether
touching of the Philippines or not, should be determined as the basis upon which
allowable deductions may be computed, — . (Emphasis supplied)

Another type of utility or service enterprise is dealt with in Section 164 of Revenue Regulations No. 2
(again implementing Section 37 of the Tax Code) with provides as follows:

Section 164. Telegraph and cable services. — A foreign corporation carrying on the
business of transmission of telegraph or cable messages between points in the
Philippines and points outside the Philippines derives income partly form source
within and partly from sources without the Philippines.

... (Emphasis supplied)

Once more, a very strong inference arises under Sections 163 and 164 of Revenue Regulations No.
2 that steamship and telegraph and cable services rendered between points both outside the
Philippines give rise to income wholly from sources outside the Philippines, and therefore not subject
to Philippine income taxation.

We turn to the "source of income" rules relating to the sale of personal property, upon the one hand,
and to the purchase and sale of personal property, upon the other hand.

We consider first sales of personal property. Income from the sale of personal property by the
producer or manufacturer of such personal property will be regarded as sourced entirely within or
entirely without the Philippines or as sourced partly within and partly without the Philippines,
depending upon two factors: (a) the place where the sale of such personal property occurs; and (b)
the place where such personal property was produced or manufactured. If the personal property
involved was both produced or manufactured and sold outside the Philippines, the income derived
therefrom will be regarded as sourced entirely outside the Philippines, although the personal
property had been produced outside the Philippines, or if the sale of the property takes place outside
the Philippines and the personal was produced in the Philippines, then, the income derived from the
sale will be deemed partly as income sourced without the Philippines. In other words, the income
(and the related expenses, losses and deductions) will be allocated between sources within and
sources without the Philippines. Thus, Section 37 (e) of the Tax Code, although already quoted
above, may be usefully quoted again:

(e) Income from sources partly within and partly without the Philippines. ... Gains,
profits and income from (1) transportation or other services rendered partly within
and partly without the Philippines; or (2) from the sale of personal property produced
(in whole or in part) by the taxpayer within and sold without the Philippines, or
produced (in whole or in part) by the taxpayer without and sold within the
Philippines, shall be treated as derived partly from sources within and partly from
sources without the Philippines. ... (Emphasis supplied)

In contrast, income derived from the purchase and sale of personal property — i. e., trading — is,
under the Tax Code, regarded as sourced wholly in the place where the personal property is
sold. Section 37 (e) of the Tax Code provides in part as follows:

(e) Income from sources partly within and partly without the Philippines ... Gains,
profits and income derived from the purchase of personal property within and its sale
without the Philippines or from the purchase of personal property without and its sale
within the Philippines, shall be treated as derived entirely from sources within the
country in which sold. (Emphasis supplied)

Section 159 of Revenue Regulations No. 2 puts the applicable rule succinctly:

Section 159. Sale of personal property. Income derived from the purchase and sale
of personal property shall be treated as derived entirely from the country in which
sold. The word "sold" includes "exchange." The "country" in which "sold" ordinarily
means the place where the property is marketed. This Section does not apply to
income from the sale personal property produced (in whole or in part) by the
taxpayer within and sold without the Philippines or produced (in whole or in part) by
the taxpayer without and sold within the Philippines. (See Section 162 of these
regulations). (Emphasis supplied)

4. It will be seen that the basic problem is one of characterization of the transactions entered into by
BOAC in the Philippines. Those transactions may be characterized either as sales of personal
property (i. e., "sales of airline tickets") or as entering into a lease of services or a contract of service
or carriage. The applicable "source of income" rules differ depending upon which characterization is
given to the BOAC transactions.

The appropriate characterization, in my opinion, of the BOAC transactions is that of entering into
contracts of service, i.e., carriage of passengers or cargo between points located outside the
Philippines.

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 airline ticket in and of itself has no monetary value, even as scrap
paper. The value of 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 "purchaser" or
passenger from the one point to another outside the Philippines. The ticket is really the evidence of
the contract of carriage entered into between BOAC and the passenger. The money paid by the
passenger changes hands in the Philippines. But the passenger does not receive undertaken to be
delivered by BOAC. The "purchase price of the airline ticket" is quite different from the purchase
price of a physical good or commodity such as a pair of shoes of 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.

The characterization of the BOAC transactions either as sales of personal property or as purchases
and sales of personal property, appear entirely inappropriate from other viewpoint. Consider first
purchases and sales: is BOAC properly 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 manufactured by it? In a popular or journalistic sense, BOAC might be described as
"selling" "a product" — its service. However, for the technical purposes of the law on income
taxation, BOAC is in fact entering into contracts of service or carriage. The very existance 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. On a slighty more abstract level,
BOAC's income is more appropriately characterized as derived from a "service", rather than from an
"activity" (a broader term than service and including the activity of selling) or from the here involved
is income taxation, and not a sales tax or an excise or privilege tax.

5. The taxation of international carriers is today effected under Section 24 (b) (2) of the Tax Code, as
amended by Presidential Decree No. 69, promulgated on 24 November 1972 and by Presidential
Decree No. 1355, promulgated on 21 April 1978, in the following manner:

(2) Resident corporations. — A corporation organized, authorized, or existing under

the laws of any foreign country, engaged in trade or business within the Philippines,
shall be taxable as provided in subsection (a) of this section upon the total net
income received in the preceeding taxable year from all sources within the
Philippines: Provided, however, That international carriers shall pay a tax of two and
one-half per cent on their gross Philippine billings. "Gross Philippines of passage
documents sold therein, whether for passenger, excess baggege or mail, provide the
cargo or mail originates from the Philippines. The gross revenue realized from the
said cargo or mail shall include the gross freight charge up to final destination. Gross
revenues from chartered flights originating from the Philippines shall likewise form
part of "gross Philippine billings" regardless of the place of sale or payment of the
passage documents. For purposes of determining the taxability to revenues from
chartered flights, the term "originating from the Philippines" shall include flight of
passsengers who stay in the Philippines for more than forty-eight (48) hours prior to
embarkation. (Emphasis supplied)

Under the above-quoted proviso international carriers issuing for compensation passage
documentation in the Philippines for uplifts from any point in the world to any other point in the world,
are not charged any Philippine income tax on their Philippine billings (i.e., billings in respect of
passenger or cargo originating from the Philippines). Under this new approach, international carriers
who service port or points in the Philippines are treated in exactly the same way as international
carriers not serving any port or point in the Philippines. Thus, the source of income rule applicable,
as above discussed, to transportation or other services rendered partly within and partly without the
Philippines, or wholly without the Philippines, has been set aside. in place of Philippine income
taxation, the Tax Code now imposes this 2½ per cent tax computed on the basis of billings in
respect of passengers and cargo originating from the Philippines regardless of where embarkation
and debarkation would be taking place. This 2-½ per cent tax is effectively a tax on gross receipts or
an excise or privilege tax and not a tax on income. Thereby, the Government has done away with
the difficulties attending the allocation of income and related expenses, losses and deductions.
Because taxes are the very lifeblood of government, the resulting potential "loss" or "gain" in the
amount of taxes collectible by the state is sometimes, with varying degrees of consciousness,
considered in choosing from among competing possible characterizations under or interpretation of
tax statutes. It is hence perhaps useful to point out that the determination of the appropriate
characterization here — that of contracts of air carriage rather than sales of airline tickets — entails
no down-the-road loss of income tax revenues to the Government. In lieu thereof, the Government
takes in revenues generated by the 2-½ per cent tax on the gross Philippine billings or receipts of
international carriers.

I would vote to affirm the decision of the Court of Tax Appeals.

Narvasa, Gutierrez, Jr., and Cruz, JJ., dissent.

Republic of the Philippines

SUPREME COURT
Manila

THIRD DIVISION

G.R. No. 71122 March 25, 1988

COMMISSIONER OF INTERNAL REVENUE, petitioner,

vs.
ARNOLDUS CARPENTRY SHOP, INC. and COURT OF TAX APPEALS, respondents.

The Solicitor General for petitioner.

Generoso Jacinto for respondents.

CORTES, J.:

Assailed in this petition is the decision of the Court of Tax Appeals in CTA case No. 3357 entitled "ARNOLDUS CARPENTRY SHOP, INC. v.
COMMISSIONER OF INTERNAL REVENUE."

The facts are simple.

Arnoldus Carpentry Shop, Inc. (private respondent herein) is a domestic corporation which has been
in existence since 1960. It has for its secondary purpose the "preparing, processing, buying, selling,
exporting, importing, manufacturing, trading and dealing in cabinet shop products, wood and metal
home and office furniture, cabinets, doors, windows, etc., including their component parts and
materials, of any and all nature and description" (Rollo, pp. 160-161). These furniture, cabinets and
other woodwork were sold locally and exported abroad.

For this business venture, private respondent kept samples or models of its woodwork on display
from where its customers may refer to when placing their orders.

Sometime in March 1979, the examiners of the petitioner Commissioner of Internal Revenue
conducted an investigation of the business tax liabilities of private respondent pursuant to Letter of
Authority No. 08307 NA dated November 23, 1978. As per the examination, the total gross sales of
private respondent for the year 1977 from both its local and foreign dealings amounted to
P5,162,787.59 (Rollo. p. 60). From this amount, private respondent reported in its quarterly
percentage tax returns P2,471,981.62 for its gross local sales. The balance of P2,690,805.97, which
is 52% of the total gross sales, was considered as its gross export sales (CTA Decision, p. 12).

Based on such an examination, BIR examiners Honesto A. Vergel de Dios and Voltaire Trinidad
made a report to the Commissioner classifying private respondent as an "other independent
contractor" under Sec. 205 (16) [now Sec. 169 (q)] of the Tax Code. The relevant portion of the
report reads:

Examination of the records show that per purchase orders, which are hereby
attached, of the taxpayer's customers during the period under review, subject
corporation should be considered a contractor and not a manufacturer. The
corporation renders service in the course of an independent occupation representing
the will of his employer only as to the result of his work, and not as to the means by
which it is accomplished, (Luzon Stevedoring Co. v. Trinidad, 43 Phil. 803). Hence, in
the computation of the percentage tax, the 3% contractor's tax should be imposed
instead of the 7% manufacturer's tax. [Rollo, p. 591 (Emphasis supplied.)

xxx xxx xxx

As a result thereof, the examiners assessed private respondent for deficiency tax in the amount of
EIGHTY EIGHT THOUSAND NINE HUNDRED SEVENTY TWO PESOS AND TWENTY THREE
CENTAVOS ( P88,972.23 ). Later, on January 31, 1981, private respondent received a letter/notice
of tax deficiency assessment inclusive of charges and interest for the year 1977 in the amount of
ONE HUNDRED EIGHT THOUSAND SEVEN HUNDRED TWENTY PESOS AND NINETY TWO
CENTAVOS ( P 108,720.92 ). This tax deficiency was a consequence of the 3% tax imposed on
private respondent's gross export sales which, in turn, resulted from the examiners' finding that
categorized private respondent as a contractor (CTA decision, p.2).

Against this assessment, private respondent filed on February 19, 1981 a protest with the petitioner
Commissioner of Internal Revenue. In the protest letter, private respondent's manager maintained
that the carpentry shop is a manufacturer and therefor entitled to tax exemption on its gross export
sales under Section 202 (e) of the National Internal Revenue Code. He explained that it was the 7%
tax exemption on export sales which prompted private respondent to exploit the foreign market
which resulted in the increase of its foreign sales to at least 52% of its total gross sales in 1977 (CTA
decision, pp. 1213).

On June 23, 1981, private respondent received the final decision of the petitioner stating:

It is the stand of this Office that you are considered a contractor an not a
manufacturer. Records show that you manufacture woodworks only upon previous
order from supposed manufacturers and only in accordance with the latter's own
design, model number, color, etc. [Rollo p. 64] (Emphasis supplied.)

On July 22, 1981, private respondent appealed to the Court of Tax Appeals alleging that the decision
of the Commissioner was contrary to law and the facts of the case.

On April 22, 1985, respondent Court of Tax Appeals rendered the questioned decision holding that
private respondent was a manufacturer thereby reversing the decision of the petitioner.

Hence, this petition for review wherein petitioner raises the sole issue of. Whether or not the Court of
Tax Appeals erred in holding that private respondent is a manufacturer and not a contractor and
therefore not liable for the amount of P108,720.92, as deficiency contractor's tax, inclusive of
surcharge and interest, for the year 1977.

The petition is without merit.

1. Private respondent is a "manufacturer" as defined in the Tax Code and not a "contractor" under
Section 205(e) of the Tax Code as petitioner would have this Court decide.

(a) Section 205 (16) [now Sec. 170 (q)] of the Tax Code defines "independent
contractors" as:

... persons (juridical and natural) not enumerated above (but not including individuals
subject to the occupation tax under Section 12 of the Local Tax Code) whose activity
consists essentially of the sale of all kinds of services for a fee regardless of whether
or not the performance of the service calls for the exercise or use of the physical or
mental faculties of such contractors or their employees. (Emphasis supplied.)

Private respondent's business does not fall under this definition.

Petitioner contends that the fact that private respondent "designs and makes samples or models that
are 'displayed' or presented or 'submitted' to prospective buyers who 'might choose' therefrom"
signifies that what private respondent is selling is a kind of service its shop is capable of rendering in
terms of woodwork skills and craftsmanship (Brief for Petitioner, p. 6). He further stresses the point
that if there are no orders placed for goods as represented by the sample or model, the shop does
not produce anything; on the other hand, if there are orders placed, the shop goes into fall
production to fill up the quantity ordered (Petitioner's Brief, p. 7).

The facts of the case do not support petitioner's claim. Petitioner is ignoring the fact that private
respondent sells goods which it keeps in stock and not services. As the respondent Tax Court had
found:

xxx xxx xxx

Petitioner [private respondent herein] claims, and the records bear petitioner out,
that it had a ready stock of its shop products for sale to its foreign and local buyers.
As a matter of fact, the purchase orders from its foreign buyers showed that they
ordered by referring to the models designated by petitioner. Even purchases by local
buyers for television cabinets (Exhs. '2 to13', pp. 1-13, BIR records) were by orders
for existing models except only for some adjustments in sizes and accessories
utilized.

With regard to the television cabinets, petitioner presented three witnesses its
bookkeeper, production manager and manager who testified that samples of
television cabinets were designed and made by petitioner, from which models the
television companies such as Hitachi National and others might choose, then
specified whatever innovations they desired. If found to be saleable, some television
cabinets were manufactured for display and sold to the general public. These
cabinets were not exported but only sold locally. (t.s.n., pp. 2235, February 18,1982;
t.s.n., pp. 7-10, March 25, 1982; t.s.n., pp. 3-6, August 10, 1983.)

xxx xxx xxx

 In the case of petitioner's other woodwork products such as barometer cases, knife
racks, church furniture, school furniture, knock down chairs, etc., petitioner's above-
mentioned witnesses testified that these were manufactured without previous
orders. Samples were displayed, and if in stock, were available for immediate sale to
local and foreign customers. Such testimony was not contradicted by respondent
(petitioner herein). And in all the purchase orders presented as exhibits, whether
from foreign or local buyers, reference was made to the model number of the product
being ordered or to the sample submitted by petitioner.

Respondent's examiners, in their memorandum to the Commissioner of Internal

Revenue, stated that petitioner manufactured only upon previous orders from
customers and "only in accordance with the latter's own design, model number,
color, etc." (Exh. '1', p. 27, BIR records.) Their bare statement that the model
numbers and designs were the customers' own, unaccompanied by adequate
evidence, is difficult to believe. It ignores commonly accepted and recognized
business practices that it is not the customer but the manufacturer who furnishes the
samples or models from which the customers select when placing their orders, The
evidence adduced by petitioner to prove that the model numbers and designs were
its own is more convincing [CTA decision, pp. 6-8.] (Emphasis supplied)

xxx xxx xxx

This Court finds no reason to disagree with the Tax Court's finding of fact. It has been consistently
held that while the decisions of the Court of Tax Appeals are appealable to the Supreme Court, the
former's finding of fact are entitled to the highest respect. The factual findings can only be disturbed
on the part of the tax court [Collector of Intern. al Revenue v. Henderson, L-12954, February 28,
1961, 1 SCRA 649; Aznar v. Court of Tax Appeals, L-20569, Aug. 23, 1974, 58 SCRA 519;
Raymundo v. de Joya, L-27733, Dec. 3, 1980, 101 SCRA 495; Industrial Textiles Manufacturing Co.
of the Phils. , Inc. v. Commissioner of Internal Revenue, L-27718 and L-27768, May 27,1985,136
SCRA 549.]

(b) Neither can Article 1467 of the New Civil Code help petitioner's cause. Article 1467 states:

A contract for the delivery at a certain price of an article Which the vendor in the ordinary course of
his business manufactures or procures for the - general market, whether the same is on hand at the
time or not, is a contract of sale, but if the goods are to be manufactured specially for the customer
and upon his special order, and not for the general market, it is a contract for a piece of work.

Petitioner alleged that what exists prior to any order is but the sample model only, nothing more,
nothing less and the ordered quantity would never have come into existence but for the particular
order as represented by the sample or model [Brief for Petitioner, pp. 9-101.]

Petitioner wants to impress upon this Court that under Article 1467, the true test of whether or not
the contract is a piece of work (and thus classifying private respondent as a contractor) or a contract
of sale (which would classify private respondent as a manufacturer) is the mere existence of the
product at the time of the perfection of the contract such that if the thing already exists, the
contract is of sale, if not, it is work.

This is not the test followed in this jurisdiction. As can be clearly seen from the wordings of Art. 1467,
what determines whether the contract is one of work or of sale is whether the thing has been
manufactured specially for the customer and upon his special order." Thus, if the thing is specially
done at the order of another, this is a contract for a piece of work. If, on the other hand, the thing is
manufactured or procured for the general market in the ordinary course of one's business, it is a b
contract of sale.

Jurisprudence has followed this criterion. As held in Commissioner of Internal Revenue v.

Engineering Equipment and Supply Co. (L-27044 and L-27452, June 30, 1975, 64 SCRA 590, 597),
"the distinction between a contract of sale and one for work, labor and materials is tested by the
inquiry whether the thing transferred is one not in existence and which never would have existed but
for the order of the party desiring to acquire it, or a thing which would have existed and has been the
subject of sale to some other persons even if the order had not been given." (Emphasis supplied.)
And in a BIR ruling, which as per Sec. 326 (now Sec. 277) of the Tax Court the Commissioner has
the power to make and which, as per settled jurisprudence is entitled to the greatest weight as an
administrative view [National Federation of Sugar Workers (NFSW) v. Ovejera, G.R. No. 59743, May
31, 1982, 114 SCRA 354, 391; Sierra Madre Trust v. Hon. Sec. of Agriculture and Natural
Resources, Nos. 32370 and 32767, April 20, 1983,121 SCRA 384; Espanol v. Chairman and
Members of the Board of Administrators, Phil. Veterans Administration, L-44616, June 29, 1985, 137
SCRA 3141, "one who has ready for the sale to the general public finished furniture is a
manufacturer, and the mere fact that he did not have on hand a particular piece or pieces of furniture
ordered does not make him a contractor only" (BIR Ruling No. 33-1, series of 1960). Likewise,

xxx xxx xxx

When the vendor enters into a contract for the delivery of an article which in the
ordinary course of his business he manufactures or procures for the general market
at a price certain (Art. 1458) such contract is one of sale even if at the time of
contracting he may not have such article on hand. Such articles fall within the
meaning of "future goods" mentioned in Art. 1462, par. 1. [5 Padilla, Civil Law: Civil
Code Annotated 139 (1974)

xxx xxx xxx

These considerations were what precisely moved the respondent Court of Tax Appeals to rule that
'the fact that [private respondent] kept models of its products... indicate that these products were for
sale to the general public and not for special orders,' citing Celestino Co and Co. v. Collector of
Internal Revenue [99 Phil, 841 (1956)]. (CTA Decision, pp. 8-9.)

Petitioner alleges that the error of the respondent Tax Court was due to the 'heavy albeit misplaced
and indiscriminate reliance on the case of Celestino Co and Co. v. Collector of Internal Revenue [99
Phil. 841, 842 (1956)] which is not a case in point' 1 Brief for Petitioner, pp. 14-15). The
Commissioner of Internal Revenue made capital of the difference between the kinds of business
establishments involved a FACTORY in the Celestino Co case and a CARPENTRY SHOP in this
case (Brief for Petitioner, pp. 14-18). Petitioner seems to have missed the whole point in the former
case.

True, the former case did mention the fact of the business concern being a FACTORY, Thus:

xxx xxx xxx

... I cannot believe that petitioner company would take, as in fact it has taken, all the
trouble and expense of registering a special trade name for its sash business and
then orders company stationery carrying the bold print "Oriental Sash Factory
(Celestino Co and Company, Prop.) 926 Raon St., Quiapo, Manila, Tel. No. 33076,
Manufacturers of all kinds of doors, windows, sashes furniture, etc. used season
 dried and kiln-dried lumber, of the best quality workmanship" solely for the purpose of
supplying the need for doors, windows and sash of its special and limited customers.
One will note that petitioner has chosen for its trade name and has offered itself to
the public as a FACTORY, which means it is out to do business in its chosen lines on
a big scale. As a general rule, sash factories receive orders for doors and windows of
special design only in particular cases but the bulk of their sales is derived from
ready-made doors and windows of standard sizes for the average home. [Emphasis
supplied.]

xxx xxx xxx

However, these findings were merely attendant facts to show what the Court was really driving at —
the habituality of the production of the goods involved for the general public.

In the instant case, it may be that what is involved is a CARPENTRY SHOP. But, in the same vein,
there are also attendant facts herein to show habituality of the production for the general public.

In this wise, it is noteworthy to again cite the findings of fact of the respondent Tax Court:

xxx xxx xxx

Petitioner [private respondent herein] claims, and the records bear petitioner out,
that it had a ready stock of its shop products for sale to its foreign and local buyers.
As a matter of fact, the purchase orders from its foreign buyers showed that they
ordered by referring to the models designed by petitioner. Even purchases by local
buyers for television cabinets... were by orders for existing models. ...

With regard to the television cabinets, petitioner presented three witnesses... who
testified that samples of television cabinets were designed and made by petitioner,
from which models the television companies ... might choose, then specified
whatever innovations they desired. If found to be saleable, some television cabinets
were manufactured for display and sold to the general public.

xxx xxx xxx

In the case of petitioner's other woodwork products... these were manufactured

without previous orders. Samples were displayed, and if in stock, were available for
immediate sale to local and foreign customers. (CTA decision, pp. 6-8.1 [Emphasis
supplied.]

(c) The private respondent not being a "contractor" as defined by the Tax Code or of the New Civil
Code, is it a 'manufacturer' as countered by the carpentry shop?

Sec. 187 (x) [now Sec. 157 (x)] of the Tax Code defines a manufacturer' as follows:

"Manufacturer" includes every person who by physical or chemical process alters the
exterior texture or form or inner substance of any raw material or manufactured or
partially manufactured product in such manner as to prepare it for a special use or
uses to which it could not have been in its original condition, or who by any such
process alters the quality or any such raw material or manufactured or partially
manufactured product so as to reduce it to marketable shape or prepare it for any of
 the uses of industry, or who by any such process combines any such raw material or
manufactured or partially manufactured products with other materials or products of
the same or different kinds and in such manner that the finished product of such
process or manufacture can be put to a special use or uses to which such raw
material or manufactured or partially manufactured products in their original condition
would not have been put, and who in addition alters such raw material or
manufactured or partially manufactured products, or combines the same to produce
such finished products for the purpose of their sale or distribution to others and not
for his own use or consumption.

It is a basic rule in statutory construction that when the language of the law is clear and unequivocal,
the law must be taken to mean exactly what it says [Banawa et al. v. Mirano et al., L-24750, May 16,
1980, 97 SCRA 517, 533].

The term "manufacturer" had been considered in its ordinary and general usage. The term has been
construed broadly to include such processes as buying and converting duck eggs to salted eggs
('balut") [Ngo Shiek v. Collector of Internal Revenue, 100 Phil. 60 (1956)1; the processing of
unhusked kapok into clean kapok fiber [Oriental Kapok Industries v. Commissioner of Internal
Revenue, L-17837, Jan. 31, 1963, 7 SCRA 132]; or making charcoal out of firewood Bermejo v.
Collector of Internal Revenue, 87 Phil. 96 (1950)].

2. As the Court of Tax Appeals did not err in holding that private respondent is a "manufacturer,"
then private respondent is entitled to the tax exemption under See. 202 (d) and (e) mow Sec. 167 (d)
and (e)] of the Tax Code which states:

Sec. 202. Articles not subject to percentage tax on sales. The following shall be
exempt from the percentage taxes imposed in Sections 194, 195, 196, 197, 198,
199, and 201:

xxx xxx xxx

(d) Articles shipped or exported by the manufacturer or producer, irrespective of any

shipping arrangement that may be agreed upon which may influence or determine
the transfer of ownership of the articles so exported.

(e) Articles sold by "registered export producers" to (1) other" registered export
producers" (2) "registered export traders' or (3) foreign tourists or travelers, which are
considered as "export sales."

The law is clear on this point. It is conceded that as a rule, as argued by petitioner, any claim for tax
exemption from tax statutes is strictly construed against the taxpayer and it is contingent upon
private respondent as taxpayer to establish a clear right to tax exemption [Brief for Petitioners, p.
181. Tax exemptions are strictly construed against the grantee and generally in favor of the taxing
authority [City of Baguio v. Busuego, L-29772, Sept. 18, 1980, 100 SCRA 1161; they are looked
upon with disfavor [Western Minolco Corp. v. Commissioner Internal Revenue, G.R. No. 61632, Aug.
16,1983,124 1211. They are held strictly against the taxpayer and if expressly mentioned in the law,
must at least be within its purview by clear legislative intent [Commissioner of Customs v. Phil.,
Acetylene Co., L-22443, May 29, 1971, 39 SCRA 70, Light and Power Co. v. Commissioner of
Customs, G.R. L-28739 and L-28902, March 29, 1972, 44 SCRA 122].

Conversely therefore, if there is an express mention or if the taxpayer falls within the purview of the
exemption by clear legislative intent, then the rule on strict construction will not apply. In the present
case the respondent Tax Court did not err in classifying private respondent as a "manufacturer".
Clearly, the 'latter falls with the term 'manufacturer' mentioned in Art. 202 (d) and (e) of the Tax
Code. As the only question raised by petitioner in relation to this tax exemption claim by private
respondent is the classification of the latter as a manufacturer, this Court affirms the holding of
respondent Tax Court that private respondent is entitled to the percentage tax exemption on its
export sales.

There is nothing illegal in taking advantage of tax exemptions. When the private respondent was still
exporting less and producing locally more, the petitioner did not question its classification as a
manufacturer. But when in 1977 the private respondent produced locally less and exported more,
petitioner did a turnabout and imposed the contractor's tax. By classifying the private respondent as
a contractor, petitioner would likewise take away the tax exemptions granted under Sec. 202 for
manufacturers. Petitioner's action finds no support in the applicable law.

WHEREFORE, the Court hereby DENIES the Petition for lack of merit and AFFIRMS the Court of
Tax Appeals decision in CTA Case No. 3357.

SO ORDERED.