Tax Implications of Liaison Office in India

The activities of liaisoning per se should not result in any tax implication in India. However, when such activities cross the threshold of liaisoning, they would constitute Permanent Establishment and proportionate profits attributable to its activities in India may be subjected to tax. Several cases by Tribunals, Courts and AAR have been decided and in this Article, various aspects concerning taxability of liaison offices have been dealt with.

1.0 Introduction

1.1 Meaning of the term ‘Liaison’

A ‘Liaison Office’ (LO) is a representative office set up primarily to explore and understand the business and investment climate. Such office is not permitted to undertake any commercial/trading/industrial activity, directly or indirectly, and is required to maintain itself out of inward remittances received from the parent company through normal banking channels.

1.2 Meaning of the term ‘Liaison Office’ as per FEMA

Clause 2(e) of the Notification No. FEMA 22/2000-RB, dated 3rd May 2000 pertaining to Foreign Exchange Management (Establishment in India of Branch or Office or other Place of Business) Regulations, 2000 defines ‘Liaison Office’ as under:

“ ‘Liaison Office’ means a place of business to act as a channel of communication between the Principal place of business or Head Office by whatever name called 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.”

Schedule II of the said Notification lists activities which are permitted to a Liaison Office in India as follows:

(i) Representing in India the parent company/group companies;

(ii) Promoting export import from/to India;

(iii) Promoting technical/financial collaborations between parent/group companies and companies in India;

 (iv) Acting as a communication channel between the parent company and Indian companies.

Thus, in essence, a ‘Liaison Office’ (LO) is nothing but a representative office of the non-resident entity in India, whose activities are confined to dissemination of information, facilitate/promote trade and/or to act as a communication channel between group companies and Indian companies. A liaison office is not supposed to undertake activities which cross the threshold of doing business in India, such as raising invoice, effecting delivery of goods, conclusion of contracts, etc. But when such activities are carried on, they may result in tax incidence.

2.0 Taxability of Liaison Office under the provisions of the Income-tax Act, 1961

The ambit of clause (i) of section 9(1) is wide enough to cover “all income accruing or arising, whether directly or indirectly, through or from any business connection in India or through or from any property in India, or through or from any asset or source of income in India, or through the transfer of a capital asset situate in India”.

Of all the different incidences of income covered by section 9(1)(i) above, the following are most relevant for our discussion:

— Income arising through “business connection in India”; and
— Income arising through any source of income in India.

Certain activities of an LO would not attract any tax liability in view of the specific exemptions provided u/s.9, which are as follows:

9(1)(i) Expl. 1. (b) : Activities which are confined to the purchase of goods in India for the purpose of export; Expl. 2 : Activities which do not qualify the test of ‘Business Connection’ (This explanation defines ‘Business Connection’ on the lines of ‘Agency PE’ under Tax Treaty Provisions).

2.1 Business Connection (BC)

(a) Maintaining a branch office in India for the purchase or sale of goods or transacting other business.

(b) Appointing an agent in India for the systematic and regular purchase of raw materials or other commodities, or for sale of the non-resident’s goods, or for other business purposes.

(c) Erecting a factory in India where the raw produce purchased locally is worked into a form suitable for export abroad.

(d) Forming a local subsidiary company to sell the products of the non-resident parent company.

(e) Having financial association between a resident and a non-resident company.”

The Circular further states that wherever the transactions are on a principal-to-principal basis, as well as on arm’s-length basis, between a subsidiary and a parent company, the same cannot result into BC. In other words, the concept of BC carves out an exception in respect of transactions between the principal and independent agent.

The Apex Court in the case of R. D. Aggarwal and Co. held that the expression ‘Business Connection’ means something more than a business, that it pre-supposes an element of continuity between the business of the non-resident and the activity in the taxable territory, though a sporadic or isolated transaction may not be construed as such, for the connection may take several forms, like carrying on a part of the main business or activity incidental to the non-resident through an agent or it may merely be a relation between the business of the non-resident and the activity in the taxable territory which facilitates or assists in the carrying on of that business. Applying this test in the case of Western Union Financial Services Inc., (2007) 291 ITR (A.T.) 176, wherein the assessee (Western Union) was engaged in the business of transfer of monies in India from abroad through various agents (including Department of Post, NBFCs, banks, travel agents, etc.), the Delhi Tribunal held that there exists BC in India.

The Supreme Court in the case of Anglo-French Textile Co. Ltd. v. CIT, (1953) 23 ITR 101 (SC), held that where there was a continuity of business relationship between the person in India, who helps to make the profits and the person outside India who receives the profits, BC exists.

In the case of GVK Industries Ltd. v. CIT, (1997) 228 ITR 564 (AP), the Andhra Pradesh High Court enumerated the following principles in respect of BC after examining various case laws:

(i) “Whether there is a business connection between an Indian company and a non-resident (company) is a mixed question of fact and law which has to be determined on the facts and circumstances of each case;

(ii)    the expression ‘business connection’ is too wide to admit any precise definition; however, it has some well-known attributes;

(iii)    the essence of ‘business connection’ is the existence of close, real, intimate relationship and commonness of interest between the Non-Resident Company (NRC) and the Indian person;

(iv)    where there is control of management or finances or substantial holding of equity shares or sharing of profits by the NRC with the Indian person, the requirement of principle (iii) is ful-filled;

(v)    to constitute ‘business connection’, there must be continuity of activity or operation of the NRC with the Indian party and a stray or isolated transaction is not enough to establish a business connection.”

From the above legal analysis it is clear that if the activities of an LO are such that they constitute BC, there would be incidence of tax in India. However, if the activities of the LO are confined to purchase of goods in India for the purpose of export [as per section 9(1) (i) Expl. 1(b)], then there will be no tax incidence in India. Let us examine, under what circumstances, activities of the LOs were held to be covered by the exclusion of section 9.

2.2    Activities confined to purchases from India for the purpose of exports

Cases in favour of assessee
2.2.1 In a number of decisions, viz. Angel Garments Ltd., [287 ITR 341 AAR; (2006) 157 Taxman 195 (AAR)], Gutal Trading Est., [278 ITR 63 (AAR)], Ikea Trading (Hong Kong) Ltd., [2008 TIOL 23 (AAR); (2009) 308 ITR 0422 (AAR)], and DDIT v. Nike Inc., [2009 TIOL 143 (Bang. ITAT)], ADIT (IT) v. Fabrikant & Sons Ltd., (2011 TII 46 ITAT-Mum.-Intl.), it has been held that where the activities of the Liaison Office in India are confined to purchase of goods in India for the purpose of export, the income therefrom cannot be brought to tax in India.

Cases against assessee
2.2.2 The Delhi Tribunal made interesting observations in case of Linmark International (Hong Kong) Ltd., [2011 TII 05 ITAT-Del-Intl], wherein it held that the purchase exclusion [section 9(1)(i) Expl. 1(b)] only scales down the extent of incomes that are deemed to accrue or arise in India. Such a limitation cannot be read into the provision which deals with income that accrues or arises in India. In this case it was found that the Indian LO was doing substantial business activities on behalf of a BVI company which was a non-functional entity. The Tribunal placed reliance on the Supreme Court decision in the case of Performing Rights Society Ltd. & Another v. CIT & Others wherein it was held that, where income has actually accrued in India, there is no requirement to further examine whether the income is covered by the provision that deems income to accrue or arise in India.

2.2.3 In case of Columbia Sportswear Company, (2011) 337 ITR 0407 (AAR) (applicant), on the facts of the case, the AAR held that there was a Business Connection, observing that “in the matter of manufacturing of products as per design, quality and in implementing policy, the liaison office is actually doing the work of the applicant. The activities of the liaison office are not confined to India. It also facilitates the doing of business by the applicant with entities in Egypt and Bangladesh. A person in the business of designing, manufacturing and selling cannot be taken to earn a profit only by sale of goods”.

Two interesting observations made by AAR in the case of Columbia Sportswear are:

(i)    All activities (including purchase) other than actual sale cannot be divorced from the business of manufacture; and
(ii)    If the activities of the Indian LO supports businesses in other countries as well (in the present case it was Egypt and Bangladesh), then it cannot be stated that the operations of the applicant in India are confined to the purchase of goods in India for the purpose of export.

2.2.4 Nokia Networks OY, Finland (NOY), [No. 2005 TIOL 103 ITAT Del-SB; 95 ITD 269 (SB) (Del. Tribunal)], is a tax resident of Finland. NOY had a liaison office (‘LO’) in India. Further, NOY had a 100% subsidiary in India by name Nokia India (P) Ltd. (NPL). NOY entered into an agreement with an Indian Company for supply of telecom equipment (hardware with software embedded therein). NPL, the Indian subsidiary of NOY, entered into an agreement for installation of the said equipment supplied by NOY.

It was held that NOY had a Business Connection under the Act, not because NOY had liaison office in India, but because it had its own subsidiary (NPL) in India and there was intimate business connection based on facts. There was a service agreement and a technical support agreement between NOY and NPL and other Indian Cos. which support the NOY’s activity of supplying telecom equipments. NPL having a live link with NOY, was held to be the business connection in India.

2.3    Activities in addition to or incidental to purchases
Many a time, activities of LOs extend beyond merely purchases. In such a scenario, can the assessee take shelter under the exclusion of section 9(1)(i) Expl. 1(b)? By and large, the Tribunals/AAR/Courts have held that if other activities are incidental to the activity of purchases for the purpose of exports, then there will not be any incidence of deemed income u/s.9 of the Act.

The table below shows what kind of activities were held to be incidental to purchases and which were not so:
 

3.0    Taxability of Liaison Office under the provisions of DTAA

Under Article 5 of the DTAA if the activities of an LO are considered to be PE in India, then under Article 7, the income of the non-resident attributable to such PE in India would be liable to tax in India.

Article 5 of the UN and OECD Model Conventions deals with the definition of a Permanent Establishment (PE). Paragraph 4 of Article 5 contains a list of exclusions i.e., activities, which will not constitute a PE.

The following activities are not regarded as PE:

(a)    the use of facilities solely for the purpose of storage, display, of goods or merchandise belonging to the enterprise;

(b)    the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of storage, display;

(c)    the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of processing by another enterprise;

(d)    the maintenance of a fixed place of business solely for the purpose of purchasing good or merchandise or of collecting information, for the enterprise;

(e)    the maintenance of a fixed place of business solely for the purpose of carrying on, for the enterprise, any other activity of a preparatory or auxiliary nature;

(f)    the maintenance of a fixed place of business solely for any combination of activities, men-tioned in sub-paragraphs (a) to (e), provided that the overall activity of the fixed place of business resulting from this combination is of a preparatory or auxiliary nature.

It may be noted that in respect of activities mentioned in paragraph (a) and (b) above, the scope of the OECD Model Convention is wider than UN MC in that “the use of facilities or the maintenance of stock of goods or merchandise for the purpose of delivery” would not constitute a PE. In the case of UN MC, delivery of goods or merchandise would constitute PE.

The OECD Model Commentary makes it clear that a fundamental feature of these activities is that they are all of a preparatory or auxiliary nature.

3.1    Meaning of preparatory or auxiliary services

Paragraph 4 of Article 5 on PE, in both the MCs, list activities which are excluded from the definition of PE. Besides specific exclusions (e.g., maintenance of stock of goods, facilities used for storage, display, fixed place of business solely for the purpose of purchasing goods or collecting information, etc.), clauses (e) and (f) of the said paragraph provide that the maintenance of a fixed place of business would not result in PE, if the activities of the enterprise are of a preparatory or auxiliary in nature. However, which of the activities would constitute of preparatory or auxiliary in nature and which would not, is difficult to determine at times for the reason that it would also depend upon the facts and circumstances of each case.

The main and indeed, the decisive criterion would be whether or not the activity of the fixed place of business by itself forms an essential and significant part of the activity of the enterprise, as a whole. If the activities of the fixed place are identical with the general purpose and object of its parent, then such activities cannot be regarded as preparatory or auxiliary in nature, e.g., the parent company is engaged in the business of supply of auto components and its fixed base, too, is the engaged in supply of auto components, then such activity of PE cannot be regarded as of auxiliary or preparatory in nature.

It would be worth noting that preparatory or auxiliary activities, which are exclusively for the enterprise by itself, would not result in PE. “If the same are rendered for a consideration and for third parties, then they may constitute the enterprise’s main object and the corresponding facilities may well be PE.” (Klaus Vogel on Double Taxation Conventions — M. No. 116 a — page 321)

The AAR in the case of UAE Exchange ascertained the nature of activities carried on by Indian liaison office by interpreting the term ‘auxiliary’ as used in common English usage, meaning, “helping, assisting or supporting the main activity.”

The Special Bench of the Delhi Tribunal in case of Motorola Inc. v. DCIT, Non-Resident Circle, 95 ITD 269 (Delhi Tribunal), held that the activities carried on by the employees of Motorola, Sweden, through the office of its Indian subsidiary were of preparatory or auxiliary in nature. These activities were carried on prior to commencement of business in India. Activities included such as market survey, industry analysis, economy evaluation, furnishing of product information, ensuring distributorship and their warranty obligations, ensuring technical presentations to potential users, development of market opportunities, providing services and support information, procurement of raw materials for Motorola, accounting and finance services, etc. for a period of one year.

If the activities of the LO are confined to preparatory or auxiliary, then it would not result in PE. Fundamentally, as per FEMA provisions LOs are not supposed to cross the threshold of preparatory or auxiliary activities as they are barred from carrying on any activities of commercial or industrial in nature. They are supposed to restrict themselves to the activities of liaisoning, dissemination of information, export promotion, etc. etc. However, in actual practice when it is found that LOs have crossed this limit, they have been held to be PE in India.

3.2  Can LO be regarded as PE?

Let us examine the various case laws on this aspect:

Cases where it was held not to be PE

3.2.1 In IAC v. Mitsui and Co. Ltd., (1991) 39 ITD 59, Special Bench, ITAT Delhi, has held that the LO cannot be regarded as a PE and a similar view was taken by the Delhi Bench in BKI/Ham V. O. F. v. Additional CIT, (2001) 70 TTJ 480.

3.2.2 In the case of Western Union Financial Services Inc. the Delhi Tribunal held that since the assessee did not have an outlet of its own in India, there was no fixed place of business and therefore there is no PE. It further held that installation of software, use of credit cards or display of names of the Principal by its agents in India does not give rise to a PE.

3.2.3 In the case of K. T. Corporation v. DIT, [23 DTR 361 (AAR) (2009) 180 Taxman 395 (Bom.)], the AAR held that as per provisions of Article 5(4)(d) [Article 5(4)(d) of the India-Korea Tax Treaty reported at 165 ITR (St). 191], collecting information for an enterprise by an LO located abroad is considered an auxiliary activity, unless the collecting of information is the primary purpose of the enterprise. Accordingly, preparation of reports dealing with India’s market scenario in mobile as well as broadband segments, etc., which were in the nature of ‘aid’ or ‘support’ of the main activities, were held to be preparatory and auxiliary activities. While holding on to the facts stated by the applicant that there is no PE, the AAR added a caveat that if the activities of the LO are enlarged beyond the parameters fixed by RBI or if the Department lays its hands on any concrete materials which substantially impact on the veracity of the applicant’s version of facts, it is open for the Department to take appropriate steps under law. Even though the last observations by the AAR were not warranted, it shows that activities of LO are always under close radar of the Income-tax Department.

Cases where it was held to be a PE

3.2.4 In the case of Nokia Networks OY (NOY) (supra) its subsidiary was held to be a PE in India because Nokia virtually projected itself in India through Nokia India Private Ltd. (NPL), as NOY was able to monitor its activities in India through NPL.

3.2.5 The AAR in the UAE Exchange Centre LLC, (2004) 268 ITR 09, held that the Indian LO is the PE of the UAE Enterprise. On the facts of the case, the AAR held that an activity of printing cheques/drafts in India and dispatching the same to the addresses of the beneficiaries by the Indian LO could not be said to be of an auxiliary nature.

3.2.6 In case of Columbia Sportswear Company, (2011) 337 ITR 0407 (AAR), the AAR held that “if an establishment satisfies provisions of Article 5.1 of a DTAA which defines a PE to mean a fixed place of business through which the business of an enterprise is wholly or partly carried on, there is no need to go into the question whether the establishment cannot be brought within the inclusive part of the definition in sub-article 2. Once the definition in Article 5.1 is satisfied, the only inquiry to be undertaken is to see whether it is one of those establishments excluded by sub-article 3”. The AAR held that the LO constituted a fixed place of business within the meaning of Article 5.1 of the India-US DTAA and considering the nature of activities of the LO, it held that the LO would constitute PE in India. The AAR observed that the LO was practically involved in all the activities connected with the business of the applicant, except the actual sale of the products outside the country.

3.2.7 The Karnataka High Court in case of Jebon Corporation India, [2011 TII 15 HC-Kar-Intl], on the facts of the case held that the LO was carrying on the commercial activities of procuring purchase orders, identifying the buyers, negotiating and agreeing on the price, ensuring material dispatch to the customers, following up payments from customers and also offering after sales support. Consequently, the High Court held that the Indian LO is a PE under Article 5 of the India-Korea tax treaty. Some of the interesting observations made by the High Court are as follows :

(i)    The mere fact that buyers placed orders and made payments directly to HO and the HO directly sent goods to the buyers is not sufficient to establish that there is no PE;

(ii)    When the facts clearly showed that the LO was engaged in trading activity and therefore entering into business transactions/contracts, the mere fact of them being not signed by the LO would not absolve it of liability;

(iii)    Just because RBI did not take any action against the LO for carrying on the alleged commercial activities, would not render the findings, recorded by the Income-tax Authorities under the Act, as erroneous or illegal.

4.0    Conclusion
The activities of LOs are under Income-tax Department’s scanner for quite some time now. Even though RBI permits restricted activities for the LO, in actual practice, it has been found that some LOs are crossing the threshold of liaisoning and carries on full-fledged business activities in India.

RBI generally, relies on the CA certificate about the nature of activities carried on by LOs in India. Thus, a CA certifying that LO’s activities are confined to what is permitted by RBI assumes colossal responsibility. In case of Jebon Corporation (where it was found that the LO was engaged in the trading activity), the Karnataka High Court observed that the facts revealed on investigation will be forwarded to the RBI for appropriate action in accordance with law. In the light of these developments, we, CAs, need to be more vigilant and careful in issuing certificates about the activities of LOs. The clients should be advised to convert their LO in to a branch/subsidiary, if so warranted, as undertaking non-permitted activities would result in penal consequences, in a addition to tax implications, in India.