India has seen a huge influx of foreign Companies extending their businesses in the country. One such way of extending business is by the way of establishing a ‘Liaison office’ in a foreign country. A liaison office is a representative office for a ‘Head Office’ and its scope of Indian functions are limited by law.
The taxability of Liaison offices in India is broadly governed by provisions of Section 9(1) (i) of the Income Tax Act, 1961 (ITA). A ‘Liaison Office’ is a place of business which acts as a channel of communication between the Principal place of business or Head Office and entities in India but which does not undertake any commercial/trading /industrial activity, directly or indirectly, and maintains itself out of inward remittances received from abroad through normal banking channel.
Taxability of Liaison Offices in India as under Double Taxation Avoidance Agreement and Income Tax Act:
As mentioned earlier, the taxability Liaison offices in India is broadly governed by Section 9(1)(i) of the ITA along with Article 5 (on permanent establishment [PE]) read with Article 7 (on business profits) of the relevant Double Tax Avoidance Agreement (DTAA).
As per Section 9(1)(i) of ITA, a Liaison office would be liable to tax on its income in India in case it constitutes a ‘business connection’ with its Head Office. As per Article 5 read with Article 7 of the relevant DTAA, a Liaison office would be taxable in India, in case it constitutes a ‘permanent establishment’ with its foreign parent in India. Section 90 of ITA 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.
The Supreme Court of India in the case of Union of India v. U.A.E. Exchange Centre had held that no tax can be levied or collected from the Liaison office of a Company in India in respect of the primary business activities consummated by them in a Foreign Country. The Court clarified that the activities carried on by the Liaison office were permitted by the RBI and demonstrated activities of preparatory or auxiliary nature only. In that case, the deeming provisions in Sections 5 and 9 of the ITA can have no bearing whatsoever.
The company was engaged in offering remittance services for transferring amounts from UAE to various places in India. It had applied for a permission under Section 29(1) (a) of the Foreign Exchange Regulation Act, 1973 (FERA), pursuant to which the approval was granted by Reserve Bank of India (RBI)
The Company had been filing its returns of income in compliance with Section 139 of the ITA, showing NIL income since no income had accrued to it in India, both under the ITA, as well as, the agreement entered into between the Government of India and the Government of the UAE, which is known as Double Taxation Avoidance Agreement (DTAA).
Procedural Background of the Case:
The respondent filed an application under Section 245Q(1) of the ITA before the Authority for Advance Rulings (AAR) and sought ruling on the following question: -“Whether any income is accrued/deemed to be accrued in India from the activities carried out by the respondent in India?
AAR answered the question in the affirmative stating that the Income is deemed to accrue in India from the activity carried out by the liaison offices of the applicant in India.
The matter was taken before the High Court of Delhi where the Court noted that the Authority committed an error in interpreting Section 90 of ITA and the settled legal position that the DTAA ought to override the provisions of ITA. The tax liability of the respondent was required to be assessed on the basis of the provisions in the stated treaty, namely, DTAA.
The High Court was of the opinion that the Authority proceeded on a wrong premise by first examining the efficacy of Section 5(2)(b) and Section 9(1)(i) of ITA instead of applying the provisions in Articles 5 and 7 of the DTAA for ascertaining the respondent’s liability to tax. Further, the nature of activities carried on by the respondent-assessee in the liaison offices being only of preparatory and auxiliary character, were clearly excluded by virtue of deeming provision.
Issues discussed by the Supreme Court:
Whether the activities carried out by the Company would qualify the expression of preparatory or auxiliary character?
- The respondent was involved in activities of downloading particulars of remittances through electronic media and then printing cheques/drafts drawn on the banks in India, which, in turn, were couriered or dispatched to the beneficiaries in India, in accordance with the instructions of the NRI remitter. While doing so, the liaison office of the respondent in India was connected with its main server in UAE and the information residing thereat is accessed by the liaison office in India for the purpose of remittance of funds to the beneficiaries in India by the NRI remitters.
- The judicial consensus in India has been that Section 90 of ITA is specifically intended to enable and empower the Central Government to issue a notification for implementation of the terms of a DTAA. When that happens, the provisions of such an agreement, with respect to cases to which they apply, would operate even if it’s inconsistent with the provisions of the Income Tax Act.
- The conditions established for the respondents by RBI were clear that their offices in India cannot undertake any other activity of trading, commercial or industrial without prior permission of the RBI. The activities in question of the liaison office(s) of the respondent in India are circumscribed by the permission given by the RBI and were in the nature of preparatory or auxiliary character. That finding reached by the High Court is unexceptionable.
What type of income is deemed to accrue or arise in India?
- All income accruing or arising, whether directly or indirectly, through any business connection in India, or from any property in India, or through any asset or source of income in India, or through the transfer of a capital asset situate in India. Business connection includes any business activity carried out through a person who acts on behalf of a non-resident.
- An income accrued by a Company which habitually exercise their authority to conclude contact on behalf of a non-resident in India, unless the said activities are limited to purchase of goods or merchandise for the non-resident.
- An income accrued by a Company which habitually maintains a stock of goods or merchandise in India from which they regularly deliver goods or merchandise on behalf of a non-resident.
- An income accrued by a Company which habitually secures orders in India, mainly or wholly for a non-resident. It should be noted that these business connections should include business activity carried out through a broker, general commission agent or any other agent having an independent status.
Conclusion:
The Supreme Court has times and now cleared the difference between the expressions “business connection” and “business activity”. Even in the present case, this difference was well articulated. To summarise, even if the stated activity(ies) of a Liaison office of a Company in India is regarded as business activity, as noted earlier, the same being “of preparatory or auxiliary character”; by virtue of Article 5(3)(e) of the DTAA, the fixed place of business (Liaison office) of a Company in India otherwise a PE, is deemed to be expressly excluded from being so. And since by a legal fiction it is deemed not to be a PE of the said company, it is not amenable to tax liability in terms of Article 7 of the DTAA.
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