Liaisoning invites tax in India

FOREIGN ENTERPRISES

In a large number of cases foreign companies planning to do business in India set up a liaison office for undertaking promotional work as a prelude to actual commercial activities.

A liaison office needs a prior approval from the Reserve Bank of India (RBI). The RBI grants approval on the condition that the expenses of the liaison office are to be met exclusively out of foreign exchange to be remitted from a foreign country.

The liaison activities must be restricted for promotional work only and for promotion of exports from India. Manufacturing or trading or execution of projects or contracts is not permitted through the liaison office.

Since the liaison office is not permitted to do any commercial activities, it is generally taken that existence of a liaison office will not make any difference in taxability of the foreign company in India.

The activity of liaison office being of a "preparatory or auxiliary character" will neither create a "business connection" nor a "permanent establishment" of the foreign company in India.

These issues were recently raised before the Authority for Advance Rulings (268 ITR 9). A company incorporated in the United Arab Emirate (UAE) set up liaisoning offices in India for undertaking the following activities as approved by the RBI:-

Undertaking reconciliation of bank accounts;

Acting as a communication centre receiving computer advices of mail transfer from the UAE and transmitting to Indian correspondent banks;

Printing drafts and dispatching the same to the addressees; and

Following up with the Indian correspondent banks;

The UAE company claimed that they were carrying on the activities strictly in terms of the conditions specified by the RBI. The entire expenses of the liaison offices in India are met exclusively out of funds received from the UAE.

The liaison offices undertake no activity of trading, commercial or industrial nature. No fee or commission is charged or received in India by any of the liaison offices for services rendered in India. Therefore, no income accrues or arises or deemed to accrue or arise in India.

It was also pleaded that the liaison office does not create any "permanent establishment" in India because its activities are only supportive and auxiliary in nature. Therefore, the business profits of the UAE company cannot be taxed in India by virtue of existence of the liaison office.

The authority debated in details whether a liaison office would establish a "business connection" in India. It was ruled by the authority that there was a real relation between the business carried on by the applicant for which it received commission in the UAE.

There was also continuity between the business of the applicant in the UAE and the activities carried on by the liaison offices. Therefore, the income shall be deemed to accrue or arise from "business connection" in India.

In regard to "permanent establishment" it was held that "the activities of the liaison offices in the second mode of remittance cannot be said to be work of auxiliary character. It is indeed a significant part of the main work of the UAE establishment". Therefore, the liaison offices in India would establish a "permanent establishment".

Thus, the profits attributable to the liaison offices in India were held to be liable to tax in India both under Section 9 of the Income Tax Act as well as under the double-taxation avoidance agreement between India and the UAE.

In view of the aforesaid ruling, a liaison office in India can no longer be considered as a benign centre of activities without any tax implication at all.

agar@nda.vsnl.net.in