We have discussed on several occasions the extent to which a liaison office of an MNC is taxed, and more generally, the concept of a “permanent establishment”. A series of decisions in 2009 has introduced some clarity in the analysis of what constitutes a permanent establishment and what does not. To briefly recapitulate, although s. 9(1) of the Income Tax Act, 1961, enumerates circumstances where income is “deemed to accrue or arise” in India, primarily through a business connection test, several DTAAs provide that income earned in one Contracting State may be taxed in the other Contracting State only if it is attributable to a permanent establishment in that State. Permanent establishment is invariably defined in these treaties, but often excludes entities that only perform “auxiliary activities” in the taxable State. It is thus important to determine what legal principle distinguishes an “auxiliary activity” from other activities, and this question arose most prominently in the context of the taxation of liaison offices.
In February 2009, the Delhi High Court held in UAE Exchange Centre v. Union of India (313 ITR 94) that the exclusionary clause of auxiliary activities must be construed broadly. In that case, the parent company, incorporated in UAE, performed remittance services for NRIs in UAE, where it transferred funds to the NRI’s family in India, on the payment of a fee. The contract was concluded in UAE and payment was received by the company in UAE, denominated in local currency. However, the company also used liaison offices in India to effect the transfer, and the liaison offices consequently had access to the company’s server in the UAE. The liaison office would then download the particulars of the remittance, make the necessary demand draft and despatch it in accordance with the instructions of the remitter. The Revenue argued that the contract was in effect performed by the liaison office – for the essence of the contract was the remittance of money – and that this could consequently not be regarded as “auxiliary”. The AAR had accepted this contention. The Delhi High Court quashed this order, and observed that “but-for” test is inappropriate in construing the exclusionary clause – in other words, the fact that the contract could not have been performed without the aid of the liaison office’s activities is not determinative of its status as an “auxiliary” activity or otherwise. The Court held that the test is broader, and that it was auxiliary because it was in “support” of the main activity entered into in the UAE, for payment in the UAE. In what is likely to be of some importance in subsequent cases, the court also observed that “[o]rganisations and companies operate transnationally. There is an eagerness to bring to tax by States income, by employing deeming fictions so that incomes which ordinarily do not accrue or arise within the taxing State are brought within the States’ tax net. It is in this context that the expression “permanent establishment” appearing in the DTAA has to be viewed.” The case is also important for the proposition that the AAR constitutes a “Tribunal” for the purposes of Art. 227 of the Constitution.
This view has been followed. In Cable and Wireless Networks (315 ITR 72), decided in July, a branch office of a UK corporation performed network designing, network management services and other support activities. The AAR held that it did not constitute a permanent establishment since the activity is auxiliary. Similarly, in KT Corporation (181 Taxman 94), a Korean corporation opened a liaison office in New Delhi for the purpose of communicating with Indian banks and other commercial entities. The AAR referred to the OECD Model Commentary’s analysis that the activity must form an “essential and significant part of the enterprise as a whole” and held that the LO did not constitute a PE, relying on Morgan Stanley as well as UAE Exchange. In Hyosung Corporation (314 ITR 343), the AAR reached a tentative conclusion to the same effect.
These decisions are of some importance in enumerating the circumstances under which the head office may be liable to tax exposure on account of the activities of the liaison office. Moreover, the line that the cases have taken – of construing the exclusionary clause of auxiliary activities – appears to be correct and in consonance with the intention of the parties to the DTAA.