Taxability of Liaison Offices in India

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.

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?
  1. 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.
  2. 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.
  3. 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.