ITAD Ruling No. 130-03

August 18, 2003 ITAD RULING NO. 130-03 Article 8, Philippines-Australia Tax Treaty Article 31, Vienna Convention on the Law of Treaties Sections 28 (A) (3) & 118 (A), Tax Code of 1997 Mr. Moises M. Visperas, Jr. Certified Public Accountant 10 Suha Street corner Rambutan Street Phase II, Town and Country Executive Village, Marcos Highway, Barrio Mayamot, Antipolo City S i r : This refers to your letters dated April 1 and August 28, 2002 requesting confirmation, that Qantas Airways , an international air carrier operating flights between Australia and the Philippines, and vice versa, is duly qualified and covered under Article 8 of the Agreement between the Government of the Republic of the Philippines and the Government of Australia for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income, which provides: "Article 8 SHIPPING 1. The tax payable in a Contracting State by a resident of the other Contracting State in respect of profits from the operation of ships in international traffic shall not exceed the lesser of a) one and one-half per cent of the gross revenues derived from sources in that State; and b) the lowest rate of Philippine tax that may be imposed on profits of the same kind derived under similar circumstances by a resident of a third State. xxx xxx xxx" Applying Article 8, profits from the operation of ships in international traffic derived by a resident of Australia in the Philippines shall be taxable in the Philippines at a rate not exceeding 1 percent of the gross amount of such profits, or at the lowest rate of Philippine tax imposed on such profits derived under similar circumstances by a resident of a third State. According to you, ships subject to preferential taxation under this article include not only ships ordinarily construed as vessels employed in water navigation, but also aircraft such as those operated by Qantas. In reply, please be informed that paragraph 1, Article 31 (General Rule of Interpretation), Section 31 (Interpretation of Treaties) of the Vienna Convention on the Law of Treaties , to which the Philippines is a signatory, clearly states that: "a treaty shall be interpreted in good faith in accordance with the ordinary meaning to be given to the terms of the treaty in their context and in the light of its object and purpose." An interpretation of a term consistent with its ordinary meaning refers to such meaning or meanings generally attributed to a term while taking into account the context and purpose for which the term is used and intended by the drafters of the treaty. The following dictionaries define the term "ships," vis: Bouvier's Law Dictionary "1. A vessel employed in navigation. 2. The word comprehends every description of a vessel navigating on any sea or channel, lake or river, to which the provisions of revised statutes, title 'Merchant Marine' may be applicable. 3. A vessel with three masts employed in navigation. Funk & Wagnall's Standard Desk Dictionary: "1. Any vessel suitable for deep-water navigation . . . 2. A Large seagoing sailing vessel with at least three masts, carrying square-rigged sail on all three. 3. An airship, airplane or spacecraft. The Grolier International Dictionary: "1. Any vessel of considerable size adapted for deep-water navigation. A three-masted sailing vessel with square mainsails on all masts. 2. Maritime Law. A vessel intended for marine transportation. 3. An airplane; airship. Webster's Third New International Dictionary: "1. (a) Any large, seagoing boat; (b) A sailing boat having a bowsprit and usually a square-rigged foremast, mainmast, and mizzenmast each composed of a lower mast, is topmast, a topgallant mast, and sometimes higher masts. 2. (a) a boat intended or used for navigation and propelled by power or sail; (b) a boat or structure used for purposes of navigation or intended or used for transportation on a river, sea, ocean, or other navigable waters without regard to its form or means of propulsion. 3. Airship, airplane. The Wordsworth Concise English Dictionary: "1. A large vessel, especially a three-masted square-rigged sailing vessel. 2. Sometimes any floating craft. 3. An aircraft. 4. A spaceship. Based on the foregoing definitions, the term ship generally construed as vessels employed in water navigation is the ordinary meaning of the term. On the other hand, the term ship , taken as aircraft, airplane, airship, or spaceship , is not the ordinary meaning of the term but is understood as a special meaning or a cross-reference 1 of the term. It should be noted that this special meaning is not even used in Bouvier's Law Dictionary and in most other legal dictionaries. Also, to understand the term ships in the context and purpose for which it is used in tax treaties will reveal that the taxation of ships and aircraft in international traffic is specifically governed by an article under the title Shipping and Air Transport, which article simultaneously and unambiguously mentions ships and aircraft and their specific tax treatment thereunder. This is bolstered by the fact that in the Philippines-India tax treaty, the subject matter is even divided into two articles Shipping and Air Transport to deal separately with each of these means of transportation. Thus, where Article 8 ( Shipping ) of the Philippines-Australia tax treaty mentions only ships in the accompanying provisions of the particular article, it is clear that the drafters intended to limit the scope of this article (namely, preferential source-State taxation) solely to ships. If the intention was otherwise, the term aircraft would have been mentioned or a supplementary protocol would have been prepared for the purpose. The same conclusion is drawn by perusing the provisions on ships and aircraft of other existing Australian tax treaties. In the case of Australia-Belgium treaty (signed on October 13, 1977) and Australia-Netherlands treaty (signed on March 17, 1976), the relevant article is titled Shipping and Air Transport and the words ships and aircraft are separately mentioned in the succeeding paragraphs thereof which provide that income from the operation of ships and aircraft in international traffic may be taxed in the source-State at a rate not exceeding 5 percent of the amount of such income net of rebates. In the case of Australia-New Zealand treaty (signed on November 8, 1972), the relevant article is titled Shipping and Air Transport and the words ships and aircraft are separately mentioned in the succeeding paragraphs thereof which provide that income from the operation of ships and aircraft in international traffic shall be exempt from tax in the source-State. In the case of Australia-France treaty (signed on April 13, 1976), the relevant article is titled Shipping and the word ship only is mentioned in the succeeding paragraphs thereof which provide that income from the operation of ships, in international traffic may be taxed in the source-State at a rate not exceeding 5 percent of the amount of such income net of rebates. And in the case of Australia-Singapore treaty (signed on February 11, 1969) the relevant article though untitled mentions separately the words ships and aircraft in the succeeding paragraphs thereof which provide that income from the operation of ships in international traffic may be taxed in the source-State at a rate not exceeding 50 percent of the prevailing rate of tax in that State, and which provide that income from the operation of aircraft in international traffic shall be exempt from tax in that State. The provisions of a treaty for the avoidance of double taxation is in the nature of a law granting tax exemption (whether partial or full) and, as far as Philippine jurisprudence is concerned, such law should be construed in strictissimi juris. In this connection, the Supreme Court declared in the case of Virginia Amor, et al vs. Commissioner of Internal Revenue (G.R. No. L-16137 dated April 29, 1961) that ". . . it is a well-settled rule that exemptions from taxation are highly disfavored in law; and he who claims an exemption must be able to justify his claim by the clearest grant of organic or statute law. An exemption from a common burden cannot be permitted to exist upon vague implication. " (emphasis ours) Inasmuch as the Philippines-Australia tax treaty and all other Philippine tax treaties do not define the term ship , then such term shall, "unless the context otherwise requires, have the meaning which it has under the law of the Contracting State relating to the taxes to which the treaty applies (paragraph 4, General Definitions article). The Philippines, being the Contracting State imposing source-State taxation on ships in this case, would construe the meaning of the term with reference primarily to the National Internal Revenue Code of 1997 (Tax Code) and the Commercial Law. In this light, Sections 28(A)(3) and 118 of the Tax Code treat separately international air carrier (aircraft) and international shipping (ships) with respect to income tax on gross Philippine billings and gross receipts tax imposed on these carriers. Ships relevant to these Sections are evidently ships taken as vessels employed in water navigation, and no as aircraft, airplane and the like. Also, as used in Commercial Law, ships are generally construed as vessels employed in water navigation, to which the terms maritime commerce, ship owner, ship agent, shipwreck, etc., are relevant. As regards paragraphs 1(k) 2 and 3 3 of the General Definitions article of the Philippines-Australia tax treaty, please be informed that the presence of the word aircraft in these paragraphs does not necessarily imply that aircraft can be assimilated to ships subject to preferential taxation under Article 8. As far as the Philippines is concerned, paragraph 1(k) simply differentiates between operation of ships and aircraft in international traffic (traffic originating in a Contracting State and terminating in the other Contracting State) and operation of ships and aircraft in domestic traffic (traffic originating and terminating in places in the same Contracting State). With this in mind, it is understood that profits from the operation of ships in international traffic is subject to the preferential tax rate of 1 percent under Article 8, while profits from the operation of aircraft in international traffic is subject to the regular tax rate of 2 percent under Section 28(A)(3)(a) of the Tax Code. In support of this, certain tax treaties between adjacent and landlocked countries in Europe, the United States, and Canada, extend the concept of international traffic to other means of transportation such as motor vehicles, trucks, railways, and inland waterways. On the other hand, paragraph 3 simply treats as operation of ships and aircraft in domestic traffic the carriage of passengers, livestock, mail, goods or merchandise in different places in the same State. With this in mind, it is understood that profits derived from such operation is subject not to the 1 percent preferential tax rate in the case of ships to the 2 percent regular tax rate in the case of aircraft, but to the 32 percent tax rate imposed on a resident or a nonresident foreign corporation. As regards paragraph 4 4 of the General Definitions article of the Philippines-Australia tax treaty, please be informed that, as previously mentioned, the purpose of this paragraph is to enable a Contracting State to give meaning to a term or terms that are not defined in the tax treaty. You have argued that we should no longer utilize the mechanism of this paragraph in defining ships and aircraft since, according to you, such terms are already defined or may have been defined in paragraphs 1(k) 5 and 3 6 of the General Definitions article. However the phrase international traffic , and not ship and aircraft , is defined in the tax treaty; such being the case, paragraph 4 of the General Definitions article of the tax treaty permits us to define the terms in issue in accordance with the meaning ordinarily given them by Philippine jurisprudence. As regards subparagraph (a) of Article 28 ( Miscellaneous ) 7 of the tax treaty, please be informed that his subparagraph merely seeks the Philippines to grant to air transport enterprises of Australia full exemption from the prevailing 2 percent income tax on gross Philippine billings of airline companies once such exemption is granted by the Philippines to a resident of a third State. Contrary to your opinion, this subparagraph is not based on the premise that the Philippines, upon the signing of the Philippines-Australia tax treaty, granted to air transport enterprises of Australia the preferential 1 percent tax on gross Philippine billings, such that the Philippines would grant full exemption to such Australian enterprises once such exemption is accorded to air transport enterprises of other countries. In view of all the foregoing, the question might arise whether the 2 percent income tax presently imposed on air transport enterprises of Australia like Qantas has legal basis considering that aircraft is not explicitly or implicitly covered under Article 8 of the tax treaty. In reply to this question, it should be noted that taxation of profits of an enterprise is governed in general by the Permanent Establishment and Business Profits articles of the tax treaty, except if such profits are treated in other articles of the treaty (e.g., real property income, dividends, interest, royalties, capital gains). Under the Business Profits article, profits of an enterprise of a Contracting State derived in the other Contracting State may be taxed in the other State if they are attributable to a permanent establishment 8 which the enterprise has in that other State. Otherwise, such profits are exempt from tax in the other State. Profits from the operation of aircraft in international traffic, which are not covered by the Shipping article of the tax treaty or by other articles thereof would be normally considered profits taxable under the Business Profits article. However, paragraph 6 of the Business Profits article categorically excludes such profits from the scope of this article as it mentions: "For the purposes of this Article, the profits of an enterprise do not include income from the operation of aircraft in international traffic. . . " (emphasis ours) This being the case, profits from the operation of aircraft in international traffic, a category of income excluded from the application of the Philippines-Australia tax treaty as a whole, are consequently covered by the domestic taxation laws of the respective Contracting States. As far as the Philippines is concerned, such profits are subject to the regular 2 percent tax on gross Philippine billings. For your information and guidance. Very truly yours, (SGD.) GUILLERMO L. PARAYNO, JR. Commissioner of Internal Revenue Footnotes 1. The term "cross-reference" refers to various word relationships that matter at one place in a dictionary which show special awareness of the subject matter at another place. (Webster's Third New International Dictionary) 2. The term "international, traffic," in relation to the operation of ships or aircraft by a resident of one off the Contracting States, moans operations of ships or aircraft other than operations of ships or aircraft confined solely to places in the other Contracting State. 3. For the purposes of this Agreement, the carriage of passengers, livestock, mail, goods or merchandise shipped in one of the Contracting States for discharge at another place in that State shall be treated as operations of ships or aircraft confined solely to places in that State. 4. In the application of this Agreement by a Contracting State, any term not defined in this Agreement shall, unless the context otherwise requires, have the meaning which it has under the laws of that Contracting State relating to the taxes to which this Agreement applies. 5. The term "international traffic," in relation to the operation of ships or aircraft by a resident of one of the Contracting States, means operations of ships or aircraft other than operations of ships or aircraft confined solely to places in the other Contracting State. 6. For the purposes of this Agreement, the carriage of passengers, livestock, mail, goods or merchandise shipped in one of the Contracting States for discharge at another place in that State shall be treated as operations of ships or aircraft confined solely to places in that State. 7. If, under any agreement or Convention concluded by the Philippines, a resident of any other country, is exempt from a) the Philippine income tax on gross billings relating to the, operation of aircraft in international traffic; or b) the Philippine business tax on gross receipts relating to the operation of ships or aircraft international traffic, the Philippines will grant a corresponding exemption to residents of Australia and Australia will grant a corresponding exemption to residents of the Philippines. 8. The term "permanent establishment" means a fixed place of business through which the business of an enterprise is wholly or partly carried on. The term includes especially a place of management, a branch, an office, a factory, a workshop, etc. (Paragraphs 1 and 2, Permanent Establishment article)