Vishal Rajvansh* & Subhashni Kumari**
Introduction
With the incessant global growth, the relevance of Permanent Establishment (PE) in international taxation has become paramount. In simpler terms, the expression ‘Permanent Establishment’ means a fixed place of business through which the business of an enterprise is wholly or partly carried on. This concept aids to ascertain the tax liability between the contracting parties through the established legal position enshrined under Article 7 of the OECD Model Convention that the profits/income of an enterprise of one contracting state is taxable in the other contracting state only if the enterprise maintains a PE in the later state but only to the extent as is attributable to that PE. In this regard, the preparatory and auxiliary exclusions while labeling an organization as PE become indispensable. Recently, the Supreme Court rendered one of its most awaited decisions in the case of Union of India v. United Arab Emirates, making it a seminal judgment in dealing conundrum related to ‘preparatory and auxiliary’ exclusion. The Supreme Court of India, laid that a mere right to provide service vested with the liaison office without it having the permission to perform business activities cannot constitute a PE.
Background
In the above- mentioned case, the petitioner is a UAE based limited liability company having liaison offices in India. The company is engaged in offering remittance services to NRI in UAE by charging one-time fee and in return collects all the remittance funds from them. The collected funds are electronically remitted on behalf of its NRI customers to the beneficiaries in India through Indian liaison offices in either of the two modes: (i) Funds are remitted by telegraphic transfer through banking channels; (Mode A) or (ii) On the request of the NRI remitter, the petitioner sends instruments/cheques though its liaison offices to the beneficiaries in India designated by the NRI remitter (Mode B). The expenses incurred by the Indian liaison office to perform its activities are to be met exclusively out of the funds received from UAE. However, due to some doubts, UAE Exchange filed an application before the Authority for Advance Rulings (Income Tax) for a ruling on whether any income is accrued/deemed to be accrued in India from the activities carried out in India.
Decision of Authority of Advance Ruling
On the substratum of the above-mentioned established legal position, the Authority of Advance Ruling (AAR) decided that the Indian liaison office of U.A.E Exchange Company engaged in remittance services falls within the definition of PE under Article 5 of the Double Tax Avoidance Agreement (DTAA) along with having ‘business connection’ in India through continuous real and intimate relationship between the business of petitioner in UAE and the activities carried on by Indian liaison office. Having held that the income is deemed to accrue in India from activities carried out by the liaison office, AAR held the profits taxed under Section 2(24), 4 and 5 read with section 9 of Income Tax Act, 1961. By way of its judgment in 2009, the Delhi High court overruled the decision of AAR.
Decision of Delhi High Court
The AAR ruling was challenged by way of a writ petition in the Delhi High Court (‘High Court’). The High Court noted that the AAR had failed to consider the provision contained in section 90 of the Tax Act that states the overriding effect of tax treaties over domestic law provisions. Accordingly, the High Court rejected the applicability of IT Act provisions and based its decision on the relevant provisions i.e. Article 5 and 7of the India – UAE Tax Treaty.
Interestingly, the High Court while relying on the judgment of the Supreme Court in DIT v. Morgan Stanley & Co[1] held that albeit liaison office will be a place of business under Article 5(2)(c) of DTAA, it falls under the preparatory and auxiliary exclusion mentioned in Article 5(3)(e) of DTAA. The High Court relied on the meaning of the terms ‘preparatory’ and ‘auxiliary’ under Black’s law dictionary (i.e. activities which aid/support the main activity).[2]
Based on above analysis, the court quashed the ruling of AAR that the activity of the liaison office could not be held as ‘auxiliary’ in nature. The Delhi High Court insisted that the only activity of the disputed office under Mode B of transfer is simply to download information from UAE server based on which cheques are drawn on Indian banks and the same are couriered to the beneficiaries in India. This observation led the court to conclude that the instant activity is in ‘aid’, ‘support’ and ‘subsidiary’ to the main activity and therefore, would fall under Article 5(3)(e) of DTAA.
Decision of the Supreme Court
While affirming the decision of Delhi High Court, the apex court categorically held that an Indian liaison office of a UAE company engaged in remittance services did not constitute a PE in India. The apex Court apart from confirming the findings of the Delhi High Court endeavors to unleash another scenario wherein limited permission was granted by the RBI to the liaison office regarding the activities to be conducted by it in India. The concerned liaison offices were not allowed to take up any other activity of trading (industrial or commercial) or enter into any business contracts in its own name in India. Following these accentuating facts, the Apex court held that the nature of stated activities of liaison office as encompassed by the RBI regulation constitutes ‘preparatory and auxiliary’ in character and hence excludable from determination of PE.
Analysis
The major complication surrounding the concept of ‘preparatory and auxiliary’ exclusion is to distinguish between a company’s core business and its preparatory or auxiliary activities in order to assess the existence of PE in the source country. The suggestive decisive criterion to attract preparatory or auxiliary exclusion is the existence of a fixed place of business forming an essential and significant part of the activity of the enterprise as a whole.
Unlike Supreme Court, the tax tribunals through their decisions[3] throw light on the guidelines for the ‘preparatory and auxiliary’ test. The only closest judgment of Supreme Court in this regard is Morgan Stanley case[4] which in itself fails to offer any such more guidelines. Note that, currently India does not have any guideline neither through parliamentary discussions nor through judicial pronouncements as a tool to analyze whether an activity has a preparatory or auxiliary character. Furthermore, the language of tax treaties signed between India and other countries use phrases such as ‘for other activities’ rather than ‘for similar activities’ soon after the exhaustive list of PE exceptions that give wider platform for any activity to fit within the range of ‘preparatory or auxiliary’ exclusion which put Indian tax authorities out of the frying pan into the fire.
This major loophole in the Indian tax structure offers companies to create artificial avoidance of PE status through the specific activity exemptions. Companies ‘divide’ or ‘fragment’ their core business activities into several small operations that may be deemed to have a preparatory or auxiliary nature and could therefore claim this exception to avoid PE status.
Therefore, in the absence of any conceptualized guidelines, the honorable Supreme Court has an obligation to fight against such aggressive tax planning mechanisms by adopting Anti- Fragmentation Rules under which the company’s activities should be analyzed as a whole and not merely on an individual project level. In simpler terms, preparatory and auxiliary exception should only apply after assessing the overall activity of company and not on an activity by activity basis.
In the present case, the foundation of the Supreme Court decision that the Indian liaison office does not hold PE status because its activities fall under the preparatory and auxiliary exception was based on examination of different modes through which the activities of liaison office were performed and assessment of RBI approval regarding the activities to be conducted by the liaison office in India.
Hence, the holistic understanding is that the court’s approach towards the exception test hinged on analyzing individual project level rather than business activity as a whole. Against this background, it may be undisputable to say that we are still waiting for the landmark decision which will offer a more balanced system that will integrate restricted interpretation of preparatory and auxiliary exception, anti-fragmentation rules and guidelines for the application of the test of ‘preparatory and auxiliary’ activities.
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* 4th Year Student, BA.LLB, National University of Study and Research in Law, Ranchi.
** 4th Year Student, BA.LLB, National University of Study and Research in Law, Ranchi.
[1] DIT v. Morgan Stanley & Co, 2007(7) SCC 1.
[2] U.A.E Exchange Centre v. Union of India, WP (C) No. 14869/2004.
[3] Western Union Financial Services v. Additional Director of Income Tax, 16 101 TTJ 506; Angel Garments Ltd, In Re, 287 ITR 341.
[4] Id at 1.
(Articler is written
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