[Dibya Prakash Behera is a 5th Year BA. LLB (Corporate Law Hons.) student at National University of Study and Research in Law, Ranchi]
In September this year, the Income Tax Appellate Tribunal, Delhi delivered a landmark judgement in Hitachi High Technologies Ltd v. The Dy. Commissioner of Income Tax. The Tribunal held that the liaison office (LO) of Hitachi High Technologies Singapore Pte Ltd. in India constitutes its permanent establishment (PE) in India, thereby allowing for taxation of income attributable to its PE in India. While rendering its judgement, the Tribunal adopted a proactive approach by drawing a thin line between the interpretations of similar terms arising in different tax treaties that India has entered into.
In Hitachi High Technologies, the taxpayer is a company incorporated in Singapore. It is engaged in operations across ASEAN countries and carries out sourcing and trading operations in respect of various products and equipment. The taxpayer had established a LO in India for rendering preparatory and auxiliary services, including market research and liaison activities.
Imperative to note here is that the Reserve Bank of India (RBI) had permitted the taxpayer to post a representative at its LO under section 29 (1) (a) of the extant Foreign Exchange Regulation Act, 1973. However, the permission came with certain caveats with a bar on the taxpayer from engaging itself in any sort of trading, commercial or industrial activity. The taxpayer was also restrained from entering into business contracts on its own without prior permission. Moreover, the taxpayer was mandated not to charge any commission or earn any income in lieu of the provision of liaison activities or services rendered by it. The taxpayer later on obtained permission for setting up a branch office in India in the year 2007.
Empowered by section 133A of the Income Tax Act, 1962, the Assessing Officer (AO) conducted a survey operation at the premises of the branch office of the taxpayer in Delhi. Surprisingly, it obtained certain documents that turned out to be email exchanges among the representatives at the LO, tax consultants and employees of Hitachi High Technologies. It was only on a considerate perusal of the documents that the AO proceeded to treat the LO as a PE resulting in the attribution of profits. Thereafter, the AO went ahead to frame a draft assessment order under section 144 C of the Act by computing the income in the hands of the PE by applying the global profit margin of the taxpayer to the sales made in India.
Aggrieved by such order, the taxpayer approached the Tribunal after failing to get a favourable order from the Dispute Resolution Panel (DRP). The taxpayer therein contended that the LO was only acting as a communication channel in relation to the activities undertaken by it in India. The taxpayer also relied on the permission granted by the RBI to contend that there has been no violation in the nature of the activities carried out by the LO. The taxpayer also vehemently argued that there is no common thread of interest between the LO and the business of the taxpayer. No part of the core activity of the taxpayer was carried out in India. Moreover, the taxpayer emphatically argued that the communication activities carried out by the LO are of only auxiliary and preparatory nature, and thereby they shall be afforded the benefit of exclusionary clause of article 5 (7) (e) of the India-Singapore Double Tax Avoidance Agreement (the “India-Singapore DTAA”).
However, the Tribunal relied on the email exchange between two employees of the taxpayer, wherein they had acknowledged the fact that the representative office was actively involved in commercial activities and it might give rise to tax implications for the taxpayer. Moreover, the oldest employee of the taxpayer during survey operations conducted by the AO affirmed the position that there has been no change of activity after the conversion of the same to a branch office. Rejecting the contention of the taxpayer on grounds of admissibility of such statements, the Tribunal opined that statements of key employees along with documentary evidences in the form of email exchanges provide ample support to the stand of the revenue that the taxpayer was engaged in marketing, sales promotion, and market research.
The taxpayer contended there is no common thread of interest between the business of the LO and business of the taxpayer. The Tribunal proceeded to address this issue by explaining the scope of the term “business connection” as decided in Commissioner of Income-Tax v. R.D. Aggarwal and Co.. The case inter alia held that business connection includes within its ambit carrying on a part of the main business activity or activity incidental to the main business of the non-resident through an agent. Reliance was placed on the said decision by the Tribunal to conclusively determine that the activities of the LO clearly had a business connection with the business of the taxpayer, especially when at least six employees were engaged in advertisement and marketing, sales promotion, market research and administration activities in India.
Moving on to the next contention of the taxpayer that such activities shall be afforded the protection of Article 5(7)(e) of the India-Singapore DTAA, the Tribunal held otherwise. Article 5(7)(e) reads as follows:
Notwithstanding the preceding provisions of this Article, the term “permanent establishment” shall be deemed not to include:
(e) the maintenance of a fixed place of business solely for the purpose of advertising, for the 45 supply of information, for scientific research, or for similar activities which have a preparatory or auxiliary character, for the enterprise.”
The Tribunal adopted a proactive and pragmatic approach to interpreting the term “similar activities” as appearing in the provision. The taxpayer relied on the term ‘similar activities’ to bring the activities carried out by its LO in India within the ambit of the exclusionary clause. However, the Tribunal decided to interpret the term in light of the specific words ‘advertising, for the supply of information, for scientific research’ appearing just before the term. It relied on the double tax avoidance agreements entered into between India and the United States of America and India and Canada (the “India-USA/Canada DTAA”) to distinguish between the corresponding provisions. It is noteworthy here that the said agreements resort to the usage of the term “other activities” as against “similar activities” mentioned in the India-Singapore DTAA. The Tribunal interpreted the term “other activities” as appearing in India-USA/Canada DTAA to read as “Besides that”. In essence, the Tribunal endorsed the view that the said treaties provide for a host of other activities other than the ones explicitly mentioned in the provision itself.
Drawing a distinction therein, the Tribunal held that in the instant matter the usage of the term “similar activities” shall be read as business solely used for the purpose of advertising, for the supply of information, for scientific research or for similar activities. The rule of ejusdem generis was made applicable to resort to such a restrictive scope of the provision. In the light of such interpretation, the Tribunal went on to differentiate all the cases that the taxpayer relied on and to hold that the activities of the LO of the taxpayer in India viz actively involved in ascertaining customer requirements, price negotiation, obtaining of purchase orders, following up on delivery of material and payments by no stretch of imagination constitute activity in the nature of preparatory or auxiliary character. Finally, the Tribunal decided to rule that the LO of the taxpayer in India constituted its PE in India, thereby making its income attributable to its PE and taxable in India.
Nonetheless, in a sigh of relief for the taxpayer, the Tribunal could not find itself on the same ground as that of the AO and DRP in computing the attribution of profits. Pertinently, Article 7(2) of the India-Singapore DTAA requires that the PE of a non- resident enterprise be treated as a distinct and separate enterprise engaged in the same or similar activities under the same or similar conditions and dealing wholly independently with the enterprise of which it is a permanent establishment. However, the DRP in a rather abnormal method computed the attribution of profit of its PE in India to be effective within the range of 163% to 2357%. The Tribunal, relying on the decision of the Supreme Court in DIT (International Taxation) v. Morgan Stanley & Co., Inc., ruled that the LO is performing routine and limited functions and is operating in a risk immune environment. In light of the Article 7(2) of the India-Singapore DTAA, the Morgan Stanley case and the routine and limited functions of the LO, the Tribunal held that the allocation of profit should be carried out by applying the transactional net margin method as the most appropriate method.
The ruling holds much significance for the non-resident entities engaging in business activity in India either through their branch office, liaison office or representative office. The Tribunal’s ruling is a welcome in plugging the loopholes existing in the Indian tax regime. The Tribunal has adopted a proactive method to differentiate the treaties and their corresponding provisions, thereby bringing much clarity into the process. Moreover, the fact that the ruling was based on email exchanges between the employees, such documents have now attained critical value and must be taken seriously, for they might give rise to tax litigation. The ruling encourages LOs operating in India to demarcate their boundaries.
– Dibya Prakash Behera