Liaison Office Not Restricted to Purchase of Goods Subject to Permanent Establishment Exposure: AAR
The Authority for Advance Rulings (“AAR”) has recently held, in the case of Columbia Sportswear Company’s (“Applicant”), that its Indian liaison office, which was engaged in activities not confined to purchase of goods from India for export, would lead to constitution of a permanent establishment (“PE”) of the Applicant under the India-USA tax treaty (“Treaty”). Consequentially, the income attributable to the activities of the liaison office of the Applicant was held taxable in India.
This ruling of the AAR (“Ruling”) becomes noteworthy in view of the nature of activities undertaken by the liaison offices of foreign companies, including co-ordination with purchasers outside India, merchandising, production management, quality control etc.
The Applicant, a company incorporated under the laws of the USA, is engaged in the business of outwear manufacture and selling skiwear. The Applicant has a liaison office in Chennai, India (“LO”). The LO, besides co-coordinating for purchase of goods from India, Egypt and Bangladesh was engaged in activities relating to other purchase functions of the Applicant like vendor identification, quality control, uploading prices on internal product data management etc. The goods procured by the LO are directly sold outside India.
With the above background, the Applicant sought an advance ruling as regards the taxability of its income in India under the provisions of the Income Tax Act, 1961 (“ITA”) and the Treaty. The main contentions of the Applicant were as below.
The Applicant stated before the AAR that the LO’s India centric activities included purchase of goods but no products were sold in India. Hence, the Applicant did not undertake any revenue generating activities in India. Therefore, the activities of the LO should not lead to any tax incidence under the ITA. The Applicant specifically relied on the Explanation 1(c) of Section 9(1)(i) of ITA which provides that no income of a non-resident shall be deemed to accrue or arise in India, through or from operations which are confined to the purchase of goods in India for purpose of export.
Further, the Applicant stated that since the activities of the LO were excluded from the purview of a PE under
(i) Article 5(3)(d) of the Treaty, which applies to the case of a fixed place of business solely for the purpose of purchasing goods or merchandise, or of collecting information, for the non-resident entity, and
(ii) Article 5(3)(e) of the Treaty which applies to the case of a fixed place of business solely for the purpose of advertising, for supply of information, for scientific research or other activities which are preparatory or auxiliary in character.
On the other hand, the tax department contented that if the argument of the Applicant that no income accrues from the activity of purchase was to be accepted, the Explanation 1(b) of Section 9(1)(i) of ITA would become redundant because if no income accrues on purchase, there would be no question of excluding the same. The tax department also contended that the LO was carrying on the business of the Applicant from a fixed set up in India and hence constituted the Applicant’s ‘business connection’ under the ITA, and a PE under the Treaty.
In view of the activities of the LO, and the relevant provisions of the ITA, the AAR observed that a person engaged in the business of manufacturing and selling cannot be taken to earn profits only from the sale of goods and that it would be unrealistic to take a view that all activities other than the actual sale are not integral to the business. For this purpose, the AAR sought support from the Supreme Court of India ruling in Anglo-French Textile Compnay Ltd. v. CIT, Madras (23 ITR 101 SC). Further, the AAR held that since the activities of the LO were wider than mere purchase of goods in India, it was not protected under the Explanation 1(c) of Section 9(1)(i) of ITA since that Explanation only sought to exclude income from activities limited to purchase of goods in India. The AAR also held that since the activities of the LO extended to Applicant’s affairs in territories outside India, viz. Egypt and Bangladesh, it was not possible to hold that its operations were ‘confined’ to the purchase of goods in India for export.
The AAR further held that the activities of the LO constituted a PE under the Treaty, since it amounted to a ‘fixed place of business’ of the Applicant in India, through which its business was carried out. The AAR, citing the wide variety of activities undertaken by the LO (i.e. identifying a competent manufacturer, negotiating a competitive price, helping in choosing the material used etc.) rejected the contention of the Applicant that the activities of the LO were excluded from the purview of PE due to the specific exclusion of Article 5(3)(d). For similar reasons, the AAR also held that the case of the LO was not covered by Article 5(3)(e) of the Treaty since the LO was not solely involved in advertising, supply of information, scientific research or other activities which are preparatory or auxiliary in character, and that its activities ranged beyond all of the above.
Finally, the AAR held that the activities, functions and operations of the LO lead to constitution of a PE of the Applicant in India, and hence its income attributable to the operation carried out in India are taxable in India.
It is significant to note that a liaison office of a non-resident may be established in India pursuant to the Foreign Exchange Management (Establishment in India of branch or office or other place of business) Regulations, 2000 as amended from time to time (“Regulations”). As per the Regulations a liaison office can undertake only liaison activities, i.e. it can act as a channel of communication between head office abroad and parties in India. Further, the Regulations permit liaison office to only undertake the following activities:
1. Representing in India the parent company / group companies.
2. Promoting export / import from / to India.
3. Promoting technical/financial collaborations between parent/group companies and companies in India.
4. Acting as a communication channel between the parent company and Indian companies.
It seems that the permitted activities, as listed above, are generic in nature and it should be possible to argue that liaison offices are permitted to undertake activities which in furtherance of the above. Also, from a practical perspective, activities like communicating with various parties, ensuring broad compliance with internal policy and procedures, quality check of the goods procured, essential merchandising etc. seem indispensable for purchase of goods and other permitted activities of a liaison office. Hence, the AAR seems to have adopted a narrow interpretation of law as regards the activities of the LO. Additionally, in its previous rulings, the AAR has held that the activities of a liaison office did not amount to a PE in India1. However, in the present Ruling, the AAR seems to have taken a different view, primarily due to the additional activities of the LO.
Interestingly, liaison offices are not allowed to undertake any business activity in India and cannot earn any income in India2. To this extent there seems to be a divergence between the regulatory and taxation regimes.
Finally, the Ruling may have a far reaching impact on many foreign companies, which have set up liaison office in India where the liaison officer undertake wide activities ranging from coordination, collection of information, engaging employees in India, marketing, implementing company policies etc. While AAR rulings are applicable only to the parties in question, it is possible that the tax department may take a view that the wide nature of activities undertaken by such liaison offices lead to the creation of a permanent establishment of the foreign company in India, and hence an Indian tax incidence.
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1 IKEA Trading (Kong Kong) Ltd., AAR No. 771 of 2008; Angel Garments Ltd., 287 ITR 341
2 Reserve bank of India, Master Circular on Establishment of Liaison / Branch / Project Offices in India by Foreign Entities, RBI/2011-12/3 Master Circular No.03/2011-12 dated July 1, 2011