After the Department’s partial victory of sorts in the Vodafone tax battle, recent decisions of various Tribunals holding that liaison offices are generally not subject to taxation come as much needed relief for MNCs.
This, however, is subject to a few qualifications. As the decision of the AAR in Ikea Trading v. Director of Income Tax, [2009] 308 ITR 422 illustrates, an MNC can avail of this benefit for its liaison office only if the scope of the latter’s commercial activity is extremely limited. A ticklish situation arises when the liaison office operates in conjunction with other units of the same enterprise, or when it is heavily involved in the procurement of goods or services. In the first case, the Department may seek to characterize it as a full-blown commercial undertaking masquerading as a liaison office. The second, more troublesome case, is one where the Department often argues that the liaison office is an ‘agent’ for the MNC, and therefore subject to taxation.
Ikea Trading falls into the second category. The IKEA Group, as is well known, is a multinational furniture retailer, and has established units all over the world. It allocates its operations in such a manner that each company in its group is responsible for sales of IKEA products in predefined geographically contiguous areas. For example, Ikea Trading (Hong Kong) Ltd. is responsible for sales of IKEA products in India. In this connection, a liaison office was set up in New Delhi to assist in selection of suppliers, quality control, collecting samples from manufacturers, monitoring with Indian exporters, ensuring that suppliers adhered to applicable environmental standards and so on. The question was whether this liaison office was liable to pay income tax on money received under Section 9(1)(i) of the Income Tax Act, 1961. Section 9(1)(i) states that any income that accrues or arises, even indirectly, through any “business connection” in India is deemed to accrue or arise in India for the purposes of the Act. Under Section 5(2) of the Act, the total income of a non-resident includes any income that is deemed to accrue or arise in India.
The Department argued that the liaison office is an ‘intermediate entity’ – an entity which gets ‘remuneration for services’ rendered by it in its capacity as an ‘agent’ of the wholesale companies of the IKEA Group. In other words, the Department suggested that a liaison office which assists in procurement is nothing but an agent for the company who benefits from its procurement activities. This contention, if accepted subsequently, has the potential to substantially widen the tax liability for liaison offices, since such offices typically assist in the purchase or sale of goods, although not engaging in commercial activity of their own. The AAR rejected this contention, holding that the activities of the liaison office are confined to the purchase of goods which are then exported by other entities. The AAR applied Explanation 1(b) to Section 9(1)(i), which states “in the case of a non-resident, no income shall be deemed to accrue or arise in India to him through or from operations which are confined to the purchase of goods in India for the purpose of export”.
This decision comes on the back of other rulings of Tribunals holding that liaison offices cannot be characterized as permanent establishments. A recent report suggests, however, that the Department has decided to challenge all these decisions, in a bid to get an authoritative ruling from the High Court that such transactions are subject to taxation under the Income Tax Act.