Liaison Office engaged identifying buyers, negotiating and agreeing pricing and procuring purchase orders would constitute a PE of the Head Office under the India-Korea tax treaty

JEBON CORPORATION INDIA – 2011-TII-15-HC-KAR-INTL (Karnataka –High Court)

Facts

• The assessee, Jebon Corporation is a South Korean enterprise engaged in the business of manufacture of Printed Circuit Boards, Liquid Crystal Displays and Switch Mode Power Supplies in its factory in China. It had set up a Liaison Office (“LO”) in Bangalore with the permission of the Reserve Bank of India (“RBI”). This was being renewed by the RBI from time to time.
• The LO comprised five employees and their role was limited to finding out prospective buyers for the assessee’s products, obtaining inquiries in that regard and passing it on to the Head Office (“HO”) in Korea. After obtaining the quotations for the products from the HO, the LO would communicate the same to the intending buyers. At times, the HO would indicate a price band for each of the products to enable the LO to persuade the intending buyers to offer the best price within the permitted range. Eventually, the customers would place orders directly to the HO and not on the LO. Invoices would be raised by the HO while the LO would follow up and monitor the realization.
• As per the assessee, since it was not carrying on any business in India and the role of the LO was limited to acting as a communication channel as permitted by the RBI, the assessee had no income liable for taxation in India and thus, did not file any tax returns in India.
• A survey was conducted on the premises of the LO by the tax authorities during which statements of various employees of the LO were recorded apart from collecting details with regard to sales and expenses. The Additional Director (International Taxation), Circle-1, Bangalore subsequently issued a notice under Section 1 48 of the Income-tax Act, 1961 (“the Act”) for the years 2001-02 to 2005-06 and notice under Section 1 42 of the Act for the year 2006-07 requiring the LO to file a return of income. However, no return was filed.
• Based on the statements of the Country Manager, the Assessing Officer (“AO”) recorded a finding that the LO was not at all into liaising, rather it was into full-fledged business activities. The final pricing and margin was decided at the Indian end without reference to the South Korean end. The conclusion of the contract was done exclusively by the LO sales personnel. The HO simply obtained the purchase price from the supplier and left the actual price determination, negotiation and conclusion of the deal to the LO. The LO identified, pursued and followed up with customers, negotiated and finalized prices, processed orders and provided payment & post-sale support. The sales personnel of the LO were involved at all stages of procurement and supply. Though the HO received orders, raised invoices on and received payment from customers, the entire process was constantly monitored and followed up by the LO. Therefore, the LO was held to be a permanent establishment (“PE”) of the assessee in India under the India-Korea tax treaty and directed to pay tax on the income earned by PE.
• On appeal, the Commissioner (Appeals) came to the conclusion that the LO has only a limited flexibility in fixing its own margin subject to the condition within the minimum and maximum margins fixed by the HO, which in turn is dependent on the models, their unit price and set up charges. Therefore, the findings cannot be arrived at purely on the basis of the Country Manager’s deposition wherein he has remarked that the HO has no role in deciding the sales margin unless it is suitably backed by incontrovertible evidence, which is not the case. Therefore, the income cannot be deemed to accrue or arise in India through or from any business connection in India since it does not constitute a business activity carried out by the LO on behalf of the HO by habitually exercising an authority to conclude contracts on behalf of the non-resident within the meaning of clause (a) of Explanation 2 to Section 9(1)(i) of the Act. Hence the order passed by the AO was set aside.
• Aggrieved, the Revenue preferred an appeal to the Tribunal. The Tribunal reversing the judgment of the Commissioner (Appeals) held that the LO is engaged in promotion of import in India by procuring purchase orders after negotiating the deal and therefore the AO was justified in holding that the LO is a PE. Therefore, the income attributable to the LO will be taxable as per Article 7 of the India-Korea tax treaty. Aggrieved by the said order of the Tribunal, the assessee filed the appeal before High Court.

Contentions of the assessee

• The LO was carrying on its activities strictly in conformity with the permission granted by RBI. The LO had no authority to conclude the contract between the assessee and the customers in India. The purchase orders were placed by the customers directly with the HO, supplies were made from Korea to customers and the amount was paid directly to the HO. The only job of the LO was to make inquires, communicate with the HO the price quoted by the customers and after conclusion of the contract, to see that the material is supplied and also that the payment is made. This was purely liaison work and did not involve any commercial activity and therefore, the LO could not be considered as a PE as per Article 5 of the India-Korea tax treaty.
• Since the RBI has not taken any action on the LO for breaching the terms and conditions of the permission to establish LO, thus the conclusion that LO is engaged in commercial activities is not justified.

Contentions of the revenue

• The nature of activities carried out by the LO and its employees working therein makes it clear that they were actually selling the products and promoting business of the assessee in India. Merely because the HO directly received orders from the customers would not absolve the liability and based on the finding recorded by the AO, the LO should be treated as a PE under Article 5 of the India-Korea tax treaty.

Observations and Ruling of the High Court

• On the basis of the material available on record the Tribunal has held that the activities carried on by the LO are not confined only to the liaison work. The LO was actually carrying on the commercial activities of procuring purchase orders, identifying buyers, negotiating price, coordinating material dispatch to customers, payment follow up and after sales support. Even though the buyers place orders and make payment directly to the HO and it is the HO which directly ships goods to the buyers, this would not be sufficient to hold that the work done is only liaison activity.
• The material on record clearly establishes that the LO is undertaking trading activity, entering into business contracts and fixing price for sale of goods. Merely because the officials of the LO are not signing any written contract would not absolve them from liability.
• The fact that no action is initiated by RBI till today would not render the findings recorded by the authorities under the Act as erroneous or illegal.
• Upholding the order of the Tribunal, it was held that the LO is a PE under Article 5 of India-Korea tax treaty and therefore, the business profits earned in India through this LO are liable for tax.

Conclusion

The High Court has held that the LO would be considered as a PE under the India-Korea tax treaty once the material on record establishes that it is undertaking trading activity, entering into business contracts and fixing price for sale of goods. Merely because the officials of the LO are not signing any written contract would not absolve the liability.