(The Hon’ble Supreme Court, in UOI & Anr. v. U.A.E. Exchange Centre (Civil Appeal No. 9775 of 2011), held that the activities carried out by a liaison office as per the RBI approval do not constitute a permanent establishment of the taxpayer in India.)
Liaison Office (LO) in India faces the risk of being considered as a ‘Business Connection’ of its parent/ group company in terms of section 9(1)(i) of the Income-tax Act, 1961 (‘the Act’). Alternatively, it could also be treated as a ‘Permanent Establishment’ of its Parent/group company, in view of Article 5 (Permanent Establishment) of the relevant tax treaty.
The standard argument by LOs’ is that since they do not undertake any commercial or business activity in India and their operations in India are limited to the extent of approval granted in the Reserve Bank of India’s approval letter, no profits earned by their foreign parent should be attributable to the activities undertaken by the LO in India.
Recently, the Hon’ble Supreme Court of India, in UOI Vs U.A.E Exchange Centre Civil Appeal No. 9775 of 2011, dealt with the issue of whether activities carried out by an LO in India, constituted a PE of its parent company in India.
Brief facts of the case
U.A.E Exchange Centre (“Taxpayer”), a company in UAE, was engaged in providing remittance services to its customers/Non-Resident Indians (‘NRIs’) for remitting funds from UAE to India. The Reserve Bank of India (RBI) had granted permission to set up LO to carry out certain activities However, the RBI prohibited LO to carry out the following activities:
- Not carry on any trading, commercial or industrial activity;
- No charge of any commission / fees by LO; and
- All expenses should be met out of the funds received from foreign parent company.
The activities carried out by the LO were always in accordance with the terms and conditions mentioned in the RBI approval letter. The Taxpayer entered into contracts with its NRI customers for providing services i.e remittance of funds to India for a fee. Subsequent to collection of funds from the NRI customers/remitters, the Taxpayer made remittance of the said funds to India either by telegraphic transfer through bank channels or on the request of the NRI remitter, it sent cheques through it’s LO to the beneficiaries in India.
The expenses of the LO in India were met entirely out of funds received from UAE through normal banking channels.
Authority for Advance Rulings (AAR)
The Taxpayer had always been filing its return of income in India showing NIL income, and it was always accepted by the tax department. However, in order to obtain advance ruling, the assessee sought a ruling from AAR as to whether any of its income accrued/was deemed to accrue in India from the activities carried out in India. The AAR observed that the activities of the LO are a significant part of the main activities carried out by the taxpayer in India and hence, they cannot be deemed to be preparatory and auxiliary in nature. Accordingly, it was held that the LO in India constitutes a PE in terms of India-UAE tax treaty.
Writ Petition before Delhi High Court (HC)
The Delhi HC ruled in favour of the Taxpayer and observed that no income had accrued or could be deemed to have accrued in India. The Delhi HC held that since the activities carried out by the LO in India were preparatory / auxiliary in nature, these were covered by the exclusions from the scope of PE as per India UAE tax treaty.
Special Leave Petition before Supreme Court (SC) filed by the Tax Department
The Hon’ble SC observed that the LO qualified to be a fixed place of business of the Taxpayer in India through which the Taxpayer wholly or partly carried on the business. Hence, the LO would be termed as “Permanent Establishment” as per Article 5(2) of the India-UAE tax treaty. However, Article 5(3) of the India-UAE tax treaty provides that notwithstanding the preceding provisions of the concerned Article ( which would mean Article 5(1) and 5(2)), if any of the sub-clauses in Article 5(3) are applicable, PE would not be created. Article 5(3)(e) clearly provides that if the activities carried on in the fixed place of business are in the nature of preparatory and auxiliary activities, such fixed place of business would not be considered as a PE.
The activities carried out by the LO were in accordance with the conditions mentioned in the RBI approval. LO was not carrying out any activities that were prohibited in the RBI approval i.e. the LO would not enter into any business contracts or carry out any trading, commercial or industrial activity or provide any consultancy services. Further, the LO shall not charge commission/fee or receive any remuneration or income for the activities undertaken by it in India. Accordingly, the SC concluded that the activities of the LO in India were preparatory and auxiliary in nature.
Thus, the activities carried out by the LO in India did not qualify as a ‘PE’ of the Taxpayer as per Article 5 of the India-UAE tax treaty.
This is a welcome ruling by the Hon’ble SC on PE exposure for LOs set up in India by foreign companies and entangled in similar litigation. This ruling does not offer blanket immunity from PE risk to every LO in India, however, it does provide a line of direction/guidance. Each LO would have to assess their activities to determine PE exposure in India.
The key takeaway would be to restrict the activities of the LO to preparatory and auxiliary. The LO should not be engaged in activities which could be viewed as commercial activities undertaken on behalf of the foreign parent company. If done, not only could the LO trigger a PE risk in India, but it could also be seen as going beyond the permissions granted by the RBI. Therefore, suitable documentation should be maintained to show that the activities of the LO are preparatory and auxiliary in nature.
This ruling provides tax certainty and framework for LOs to operate in India without triggering a PE risk.
By: Suparna Sachar (Senior Partner)
O.P. Khaitan & Co