A liaison office of a foreign company which identifies a manufacturer in India, negotiates the price, helps in choosing raw material to be used, ensures compliance with quality, acts as go-between, between the petitioner, ensuring compliance with Foreign Companies policies and the relevant laws of India by the suppliers and the seller or the manufacturer and gets material tested is not a ‘permanent establishment’ under Article 5 of India-USA DTAA.
Facts of the case:
- The petitioner is a company incorporated in the United State of America (USA) and is a tax resident of the USA and it is a multinational company engaged in the business of designing, developing, marketing and distributing outdoor apparel with operations in North America, Europe and Asia.
- The petitioner’s centralized sourcing group located outside India is responsible for all key purchase functions including (a) choosing the producing country; (b) Vendor Selection (c) Co-ordination of global production management and planning and (d) global quality assurance and strategy and policy development.
- With the permission of the Reserve Bank of India, the petitioner established a liaison office in Chennai in 1995 for undertaking liaison activities in connection with purchase of goods from India.
- The Indian liaison office is involved only in activities relating to purchase coordination for the petitioner. It does not supervise, direct or control the production facilities of the Indian Vendors. Consistent with the RBI approval, accorded to it, the India liaison office does not undertake any activity of trading, commercial or Industrial nature. It has no revenue streams and it does not source products to be sold locally in India.
Issue put before (Karnataka High Court):
Whether the Indian liaison office involves a permanent arrangement for the application under Article 5.1 of the DTAA?
Whether any portion of the income attributable to the liaison office on account of the activity of vendors co-operation of global production management and planning and equitable quality assurance strategy, quality development and is liable to tax?
Contention by Petitioner:
- No income can be deemed to accrue or arise in India under Section 9(1) of the Act as the petitioner does not have a business connection in India since the activities of the India liaison office are strictly restricted to purchase function.
- No income would be deemed to accrue or arise in India through or from operations which are confined to the purchase of goods for the purpose of exports as per the exceptions carved out in Explanation 1(b) of Section 9(1) (i) of the Act.
- There is no permanent establishment that exists in India under the agreement for avoidance of double taxation and prevention of fiscal evasion with respect to taxes on income and capital gains entered into between the Government of India and the Government of USA.
- In the alternative, they submitted that even if a permanent establishment was said to exist for the petitioner, no profits could be attributed to the common head establishment by reason of mere purchase by that permanent establishment of goods or merchandise for the enterprise by virtue of article 4 of Article 7 under the Treaty.
- In view of Section 9(1) (i) explanation (1) (b) of the Income tax Act, 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. Therefore, it carves out an exception to Section 9, which deals with income deemed to have been accrued or arisen in India.
- Article 7 of the Total Taxation Treaty entered into between India and USA provides for taxation in respect of the profits of an enterprise in the other State, but only so much of them as is attributable to that permanent establishment and sales in the other State of goods or merchandise of the same or similar kind as those sold through the permanent establishment or other business activities carried on in the other State of the same or similar kind as those effected through that permanent establishment.
- Permanent establishment is concerned; he refers to Article 5(3) (d), which provides that notwithstanding the provision under this Article, the term “permanent establishment” shall be deemed not to include the maintenance of a fixed place of business solely for the purpose of purchasing goods or merchandise, or of collecting information, for the enterprise.
Contention by Revenue:
- designing and manufacturing were obviously carried out by the petitioner itself in India in relation to products purchased by them in India and therefore, opined that a portion of the income relating thereto accrued to the petitioner in India. Further they held that the India liaison office constitutes a permanent establishment of the petitioner in India under Article 5 of the Treaty and that in terms of Article 7 of the Treaty, income is attributable to the India liaison office from activities and that the same would be taxable in India.
- Petitioner is not engaged only in purchasing goods. They are identifying the manufacturers. They are instructing him about the requirements of an outside purchaser and therefore, even if the income is received outside India, it is deemed to have accrued in India liable to tax in view of Section 5(2) of the Act and therefore, he submits that though the entire amount is not taxable, a portion of it is attributable to liaison office and therefore, it is taxable in India.
Ruling of Honorable Karnataka High Court:
- Explanation 1(b) to the Section 9 carves out an exception. It provides that 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.
- Therefore, it is clear that when a non-resident purchases goods in India for the purpose of export, no income accrues or arises in India for such non-resident for it to be taxed.
- If a permanent establishment carries on business of sales in India or other business activities of the same or similar kind through that permanent establishment, then only, the profits of the enterprise will be taxed.
- The term “permanent establishment” means a fixed place of business through which the business of an enterprise is wholly or partly carried on. It is an inclusive definition of what is included in the term ‘permanent establishment’ which is clearly set out in sub-article (2).
- It makes it clear that the term ‘permanent establishment’ shall be deemed not to include any one or more of the following as set out in sub-article (3).
- If the permanent establishment is established for the purpose of purchasing goods or merchandise for the purpose of collecting information for the enterprise, it is not a permanent establishment as defined under Article 5(1) read with Article 7.
- The impugned order is unsustainable.
- Writ petition is allowed.
- The substantial question of law framed is answered in favour of the assessee/petitioner and against the Revenue/respondent.
Key Take Away
A liaison office of a foreign co which identifies a manufacturer in India, negotiates the price, helps in choosing raw material to be used, ensures compliance with quality and gets material tested is not a ‘permanent establishment’ under Article 5 of India-USA DTAA.