Liaison Office in India? Beware of permanent establishment issues!
Recently, the Indian income tax authorities pronounced two rulings on the establishment of a permanent establishment (‘PE’) in India of Korean entities which have set up liaison offices (‘LO’) in India. The India-Korea Tax Treaty includes the term ‘office’ within the definition of a PE, which would include a liaison office set up in India. However, tax treaty carves out an exception for a place which is used primarily for advertising, supply of information, or any other activity which is considered to be auxiliary and preparatory in nature and therefore, not actual business of the company in India. A liaison office set up in India, in accordance with the provisions of the exchange control regulations, is required to restrict its activities to acting as a channel of communication between the company and Indian parties; there is a specific prohibition for liaison offices to undertake activities which are of commercial, trading or industrial nature.
A summary of two rulings in this regard are provided below.
K.T. Corporation’s case
K.T.Corporation, a telecom carrier/ reseller company incorporated in Korea (‘Applicant’), had set up an LO in India, to act as a communication channel for the Applicant. The LO did not have any authority to conclude any contracts, or procure orders from any potential customers or conclude negotiations for the Applicant in India. The LO in India was involved primarily in collecting information, holding seminars and receiving trade enquiries, feedback etc. Pursuant to setting up of the LO, the Applicant entered into a Reciprocal Carrier Services Agreement (‘RCSA’) with Vodafone Essar South Limited (‘VESL’), an Indian company, for provision of certain services. The LO was not involved in the pre-bid survey and did not undertake technical analysis for the same. In the backdrop of such facts, the Applicant approached the Authority for Advance Rulings (‘AAR’) to opine whether the LO would constitute a PE of the Applicant in India in terms of the India-Korea Tax Treaty.
The AAR relied upon the provisions of the India-Korea Tax Treaty and the OECD Model Commentary in this behalf to conclude that the LO did not constitute a PE of the Applicant in India. The AAR studied the activities undertaken by the LO in India to reason that the activities in India were restricted to only supporting the main business of the Applicant and that the activities were in essence auxiliary and preparatory in nature.
Joben Corporation’s case
Joben Corporation, a company incorporated in South Korea (‘HO’), is engaged in the trading of semi-conductor components manufactured by various companies across the globe. Joben Corporation opened an LO in India. The operations of the LO included promotion, marketing and sales of electronic components. The LO engineers identified customers on basis of their past sales experience and coordinated with the HO for communication to the customer of the purchase price, technical details, availability and lead time. The LO also had the complete discretion to add the appropriate sales margin to the purchase price communicated by the HO and provide the same to the customers in India. In fact, the LO was given annual sales target for the sales based on the forecasts given by the LO to the HO. The payment for the goods however, was made directly to the HO by the customers.
On assessment, the Assessing Officer ('AO') concluded that the LO constituted a PE of Jebon Corporation in India, which allegation was rejected by the CIT (A) and an appeal was preferred to the Tribunal.
At the Tribunal, the tax authorities highlighted the fact that the LO had a free hand in deciding the selling price of the products to the customers in India. The HO merely prescribed the purchase price and the range for sales margin for the products and the LO engineers had the authority to charge any amount within the sales margin, in accordance with their own assessment and discretion. The Assessee vehemently claimed that its activity in India was only preparatory and auxiliary in nature and therefore, was covered under the exception provided under Article 5(4) (e) of the India-Korea Tax Treaty.
The Tribunal made a systematic analysis of the activities undertaken by the LO in India against the thresholds of business connection, under the domestic tax laws, and permanent establishment under the India-Korea Tax Treaty. The Tribunal concluded that the LO in reality was involved in the process of securing orders from customers in India, as its activities ranged from identification of customers to the finalization of the orders and negotiating the selling price. The Tribunal observed that the functions of the LO traveled beyond the being auxiliary and preparatory and this was most evident in the authority of the engineers at the LO in the matter of fixing the sale price of the products and therefore, the LO would constitute a PE of the Jebon Corporation in India.
This ruling by the Tribunal would have adverse consequences for LOs of foreign companies which have transgressed the fine line between auxiliary-preparatory services and actual commercial and trading activity. A foreign company setting up an LO in India should take care to define the scope of activities and operations of their LO in India. This is important from a tax perspective as also from an exchange control perspective, as the approval granted by the RBI restricts a liaison office from engaging in commercial or trading activities. A breach of the terms of the approval would also result in penalties under the exchange control regulations.