PE Concerns surrounding taxation of Liaison offices in India
by Parul Aggarwal
With the opening up of Indian economy in early 90s, many foreign Companies started extending their businesses in India. Indian regulations provide a choice of corporate structures to such MNCs to plan their business set up on Indian land. One such structure that does not technically fall under definition of foreign company’s business in India is a Liaison office. A liaison office enjoys the status of a representative office whose scope of Indian functions are limited by law. Taxability of Liaison office has remained capricious since many decades now with an array of diametrically opposite views being expressed by judiciary on more than one occasions. This article aims at discussing the issues surrounding taxability of Liaison office and recent judicial developments on it in the post BEPS economic environment.
Need for setting up Liaison Office
Generally liaison office represents the foreign companies planning to set up shop in India. Liaison office is suitable for testing and gaining an understanding of the Indian markets. Most Liaison offices are set up for the limited purposes of doing limited research and development work in India in order to gain a better understanding of the Indian market. The governing body to provide license md monitor a liaison office is reserve Bank of India (‘RBI’).
Liaison office is a temporary office of a foreign company in India that is set up for carrying out liaising activities for its business in India without any exchange of commercial value. Since a liaison office does not earn any income from Indian, all the expenses of carrying on a Liaison office in India is borne from the foreign remittance received from its overseas head office. Further, Liaison offices are instrumental in promoting technical/ financial collaborations between its parent group companies and Indian companies through acting as a communication channel between the two. Usually, certain eligibility criterion should be met by a foreign company aspiring to set up a liaison office in India namely a profitable track record of minimum 3 years in its home country and meeting the prescribed criteria of threshold net worth duly certified by a registered accounting practitioner.
Permanent establishment concerns in taxation of Liaison office in India
The taxability of Liaison offices in India is broadly governed by provisions of section 9(1)(i) of the Income Tax Act, 1961 (Act). Further, the relevant tax treaty articles applicable to a Liaison office are Article 5 read with Article 7 of the relevant Double Tax Avoidance Agreement (DTAA) entered into by India with the other contracting tax jurisdiction. Section 90 of the Act provides the flexibility to the assessee to choose to apply the provisions of either the Act or the relevant tax treaty, whichever is more beneficial to it.
India follows a hybrid taxation model whereby business profits of a non-resident entity is taxed on the basis of degree of permanence of operations of such non-resident entity in India, duly described as business connection. Accordingly, the only condition on which a Liaison office shall be liable to tax on its income in India is when it constitutes a business connection of its foreign parent in India. In other words, where a Liaison office (‘LO’) constitutes as a Permanent establishment (‘PE’) of its foreign parent in India, such LO shall be taxable in India. There are certain exceptions to the aforesaid deemed income accrual criteria cited under both the Act[1] and the DTAA[2] namely purchase of goods in India for the purpose of export etc.
Further, even on being held as extension of foreign company’s business in India, only so much of the profits of the LO shall be taxable in India as are attributable to its operations carried out in India.
According to the above analysis, there is a tax exposure to the tune of LO constituting a taxable entity in India due to such LO being viewed as having a business connection in India. However, LOs maintain a consistent stand that since their activities in India are limited to the extent of approvals granted in the RBI’s approval letter, they do not undertake any commercial or business activity in India and accordingly no profits of earned by their foreign Group company should be attributable to the activities undertaken by them in India. The maze of judgements on the issue fail to provide any clarity on the issue due to inconsistent approach followed and opposite views expressed in the judgements.
Judicial pronouncements
The Delhi "E" Bench of the Tribunal in the case of Metal One Corpn.[3] for the Assessment Year 2008-09 considered the issue whether M/s Metal One Corporation had a P.E. in India. In the aforesaid case, since Assessing Officer failed to bring any material on record showing that any substantive business activity was carried on by assessee in India which was beyond limit prescribed by RBI, it was to be concluded that LO of assessee did not constitute its PE in India. Accordingly, the presumption that Indian LO does not constitute a PE as no violation noticed by RBI should be rebutted by the AO through placing material on record to substantiate that business activity was actually carried out by the LO in India.
On the other hand, in case of Nike Inc.[4], The Hon’ble Karnataka HC held that where the object of the opening up the liaison office was to purchase goods in India for the purposes of exports from India, the income derived therefrom shall not be deemed to be an income under section 9. In the present case, the LO was required to propose and give opinion about reasonability of price and all related issues etc. On the other hand, the decisions pertaining to price, quantity and quality were in the hands of US office though the LO kept a close watch on the progress, quality etc. at the manufacturing workshop in India. It was held that Nike USA was not carrying on any business in India since the activities of LO were not taxable in India under section 5 as well as section 9 of the Act.
In case of Jebon Corporation India[5], the Karnataka High Court held that the LO of Korean Company performing functions such as customer, price negotiations etc. would be treated as PE of the Korean Company in India as defined under Article 5 of India Korean Tax Treaty. In this case, it was found from material on record that the activities carried out by LO were not confined to liaison work only but the LO performed functions such as identifying new customers, pursuit and follow up of customers, price negotiations and finalization, securing orders, making payment for material and providing post-sales support. Accordingly, it was held that the LO was carrying on commercial activities. Such activities fell under Article 5 of India Korean tax treaty and created PE exposure for the LO. Merely because RBI did not take any action against the LO, the findings of the tax authorities was not rendered erroneous.
The above view was seconded in case of Brown and Sharpe[6], Delhi tax tribunal held that Liaison Office was taxable in India on account of promoting sales activity of its foreign parent company in India. The Hon’ble Tribunal observed that the LO filed its tax return in India declaring loss thereby clearly indicating that it derived its income from business and profession in India. Further, the employees of LO were entitled to sales incentives on successfully meeting the defined sales targets. The performance of aforesaid employees was measured on the basis of orders secured by the Brown and Sharpe Inc. in India. This evidenced that LO was promoting sales activity in India and accordingly, the LO did not fall under the specific exclusions namely ‘preparatory and auxiliary activities’ as defined in para 4 exclusion to Article 5. Hence, it was held that the tax authorities were justified in holding that the LO be taxable in India.
In yet another case of Tesco International Sourcing Ltd.[7], the Karnataka HC held that the LO of foreign company engaged in purchase of goods in India for the purpose of export falls under the purview of Explanation 1(b)[8] to section 9(1)(i) of the Income Tax Act, 1961. In this case, the assessee company was engaged in the business of providing services in respect of purchase of various accessories in the name of Tesco International Sourcing Ltd., Hongkong established in Hongkong. Tesco International Sourcing Limited India Liaison Office was established in the year 2001 to act as a buying agent for Tesco Group Companies. The LO acted as a communication channel between Tesco, Hongkong and the manufacturers in sourcing apparels from India and undertook liaising activities like co-ordinating with the manufacturers and Head Office. Since the activities of LO were limited to acting as a communication channel between Tesco Hongkong and the Indian apparel manufacturers and no income was derived by the Tesco Hongkong from Indian operations of LO, the Hon’ble HC set aside the orders of the Appellate Tribunal and decided in favour of the assessee.
Recent Developments
In its euphoric support for the BEPS initiative, India has yet again introduced a unilateral statutory insertion through Finance Act 2018, thereby enhancing the discretionary power in the hands of tax authorities and unsettling a principles concluded in the above judicial precedents around business connection and formation of PE in India.
Following clause (a) shall be substituted for the existing clause (a) of Explanation 2 to clause (i) of sub-section (1) of section 9 by the Finance Act, 2018, w.e.f. 1-4-2019 :
……‘business connection’ shall include any business activity carried out through a person who, acting on behalf of the non-resident…
(a) has and habitually exercises in India, an authority to conclude contracts on behalf of the non-resident or habitually concludes contracts or habitually plays the principal role leading to conclusion of contracts by that non-resident and the contracts are—
(i) in the name of the non-resident; or
(ii) for the transfer of the ownership of, or for the granting of the right to use, property owned by that non-resident or that non-resident has the right to use; or
(iii) for the provision of services by the non-resident;
The stated amendment is framed on the lines of Base Erosion and Profit Shifting (‘BEPS’) Action Plan 7 that includes in within the scope of agency PE, an agent having authority to conclude contracts or plays a principal role leading to conclusion of contracts. Further, India is also signatory to Multilateral Instruments (‘MLI’) wherein Article 12 of MLI also incorporates the modified definition of agency PE. Though the term ‘principal role’ has not yet been defined in the Indian income tax act, the way we understand and interpret ‘agency PE’ shall undergo a shift with the changed clause (a) of Explanation 2 defining business connection in India.
The above analysis arrives at the irresistible conclusion that the issues surrounding taxation of Liaison office are far from settling down. This coupled with the recent amendments in definition of DAPE in section 9 through Finance Act 2018 on the lines of BEPS MLI provisions lays a perfect breeding ground for future litigation for LOs in India.
(Parul Aggarwal is a Delhi based Chartered Accountant. Views expressed are personal. Parul can be reached at [email protected])
[1] Explanation 1(b) of section 9(1)(i)
[2] Article 5(4) - maintenance of fixed place of business solely for the purposes of purchasing of goods/ merchandise or for collection of information for the Non-resident
[3] 22 taxmann.com 77 (2012)[Delhi ITAT]
[4] 34 taxmann.com 170 (2013)[Karnataka HC]
[5] 19 taxmann.com 119 (2012) [Karnataka HC]
[6] 41 taxmann.com 345 (2014)[Delhi Tribunal]
[7] 56 taxmann.com 112 (2015)[Karnataka HC]
[8] Explanation 1(b) provides that in the case of a non-resident, no income shall be deemed to accrue or arise in India to him through or from operations which are confined to the purchase of goods in India for the purpose of export