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 taken that the existence of a liaison office will not make any difference in taxability of the foreign company in India.
However the legal position as explained above may change if the activities of a liaison office are such that they create a “permanent establishment” or a “business connection” for the foreign company in India. For example, in case of UAE Exchange Center (268 ITR 9), while interpreting the tax treaty between India and UAE, the Authority for Advance Ruling held that the liaison office created both a permanent establishment in India as well as a business connection.
On the other hand, in case of Gutal Trading (278 ITR 643) the Authority, while interpreting the same treaty, held that liaison office neither created a “permanent establishment” nor any “business connection” although in both the cases liaison office was carrying on activities strictly in terms of the conditions specified by the RBI.
The Authority ruled “So long as the ‘liaison office” does not enter into negotiations with the customers in India for import or purchase of goods by the Indian customers from the principal company, it cannot be said an intimate relationship exists between the trading activity of the principal company outside India and the activities of the ‘liaison office’ within India. Therefore, the activities of the liaison office in India will not constitute a course of dealing or continuity of relationship and cannot be said to contribute directly or indirectly to the earning of income by the non-resident.
It may be clarified that where the liaison office creates a PE 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 above context a recent ruling of the Authority for Advance Ruling is very important (see IKEA Trading (Hong Kong) Ltd 308 ITR 422)
In the above case, a Hong Kong based foreign firm established a liaison office in India for undertaking liasioning activities in connection with purchase of goods from India. The Liaison office performed the following functions:
Enquiry into and consideration of potential suppliers for export, collecting information and samples doing quality check of the various products, co-ordinating and acting as the channel of communication between the foreign principal and the Indian exporters, follow up with the Indian exporters and doing social audit of the suppliers.
The questions raised before the Authority were:
1. Whether looking at the nature of activities to be carried on by the liaison office in India, will the foreign firm establish a business connection?
2. Whether any income would accrue or arise or be deemed to accrue or arise because of liaison office in 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.
In the light of the various cases as discussed above, a conclusion is irresistible that the role of liaison office is very dicey as far as Indian tax law is concerned. If proper care is taken regarding the activities a liaison office should perform, tax incidence can be avoided.
(Author is a Partner in S S Kothari Mehta & Co.)
