It is quite common that 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 prior approval from Reserve Bank of India. Since the liaison office is not permitted to do any commercial activities, it is generally believed that the existence of a liaison office will not generate any taxable income in India.
It may be clarified that where the liaison office creates a permanent establishment or establishes a business connection, the foreign company would become liable to pay tax on the profits, which can be attributed to the liaison office. But if liaison office doesn’t create any of the aforesaid relationship, liaison office will not attract any income tax in India.
In the case of UAE Exchange Centre LLC, [2004] 268 ITR 9 (AAR), while interpreting Tax Treaty between India and UAE, a liaison office was held to be a permanent establishment.
However in a later case of Gutal Trading Est [2005] 278 ITR 643 (AAR), while interpreting the same treaty, liaison office has been held neither to create a permanent establishment nor any business connection, although in both cases liaison offices were carrying on activities strictly in terms of the conditions specified by RBI.
In the above context two more recent cases are worth noting:
In case of IKEA Trading (Hong Kong) Ltd. 308 ITR 422, a Hong Kong based foreign company established a liaison office in India for the purpose of undertaking liasioning activities in connection with purchase of goods from India.
The Authority ruled that since the activities of the liaison office were confined to purchase of goods in India for the purpose of exports, no income accrues or arises or is deemed to accrue or arise in India to the foreign company. Therefore, it is immaterial whether a business connection exists or not.
But in the recent case of Columbia Sportswear Company (AAR No. 862 of 2009), the Authority in its ruling dated 8th August, 2011 virtually took a different view. Referring to the case of IKEA, the Authority observed that what ultimately emerges from that decision is that it is a question of fact to be found as to whether the activities are confined to the purchase of goods in India. If they are not so confined, obviously the question will have to be considered with reference to the facts available in the given case.
It should be kept in mind that a permanent establishment is defined in article 5(1) of the tax treaties as a fixed place of business through which the business of an enterprise is wholly or partly carried on. Then article 5(2) enumerates certain establishments as included in the term “permanent establishment”.
Thereafter, sub-article (3) excludes certain establishments from within the term “permanent establishment”. According to the Authority, a liaison office does create a permanent establishment as per article 5(1) of the tax treaties because it creates a fixed place of business for the foreign company in India.
If this condition, i.e. article 5(1) is satisfied, there is no need to go into the question whether the establishment cannot be brought within the inclusive part of the definition in article 5(2).
Once condition of 5(1) is satisfied, the only enquiry is to see whether the establishment will be excluded by article 5(3). Since the activities of the establishment have to be tested with reference to the activities referred to in article 5(3), it essentially becomes a question of fact in each case whether a permanent establishment will be created or not.
In the light of the various cases discussed above, a conclusion is irresistible that the role of liaison office is very dicey as far as Indian tax law is concerned. A proper care is necessary regarding the activities a liaison office should perform in India. If activities are not properly planned, liaison office may result in creation of a permanent establishment in India.
The author is a senior partner at S S Kothari Mehta & Co
Email: hp.agrawal@sskmin.com
