Case Law Details
RELEVANT PARAGRAPH
16. We have heard both the parties. The Hon’ble Apex Court in the case of CIT v. P V A L Kulandagan Chettiar 267 ITR 654 had an occasion to consider the impact of double taxation avoidance agreement provisions of Income Tax Act. The Hon’ble Apex Court held that where liability to tax arises under the local enactment, the provisions of sections 4 and 5 of the Act provide for taxation of globle income of an assessee chargeable to tax there under, then it is subject to the provisions of an agreement entered into between the Central Government and the Government of a foreign country for avoidance of double taxation as envisaged u/s 90 to the contrary, if any and such an agreement will act as an exception to or modification of sections 4 and 5 of the Income Tax Act. The provisions of such agreement cannot fasten a tax liability where liability is not imposed by a local Act. where tax liability is imposed by the Act, the agreement may be resorted to either for reducing the tax liability or altogether avoiding the tax liability. In case of any conflict between the provisions of the agreement and the Act, the provisions of the agreement would prevail over the provisions of the Act as is clear from the provisions of section 90(2) of the IT Act. Hence we have to see first as to whether any tax liability is imposed on the non-resident assessee under the Income-Tax Act.
22. The Korean Company is engaged in the trading of semi-conductor components manufactured by various companies across the world. The trading activity will include identification of the customers, requirement of the customers with respect of number and specification, identifying the sources from which such items can be procured, negotiating the purchase price, negotiating the sale price with the customers and thereafter procuring order from the customer. In the instant case, part of the trading activity in respect of supplies made to Indian customers is done by the LO and is in continuation of the trading activity of the South Korean Company. This show that there is a business connection and therefore any income accruing or arising from such business connection is taxable in the hands of the South Korean Company as per the provisions of section 9(l)(i) of the I T Act. As per Explanation 1(a), only that part of the income which can be reasonably attributable to the operations carried out in India will be taxable in the hands of the South Korean Company. Explanation 1(b) provides that no income shall be deemed to accrues or arise in India through or from operations which are confined to the purchase of goods in India for the purpose of export. It means, the Legislature was fully aware that in a trading activity there is always a profit element attached to the purchase of the goods as the entire trading profit cannot be attributed to the activity of sale. Trading activity consists of various steps and profit can be attributed to each such step of trading activity. The profit element in a trading activity depends on various operations of the trading activity and if there is only purchase in India, then such profit was not to be included as per section 9(1) of the IT Act. Explanation 1(c) also provided an exception that income will not be deemed to accrue or arise in India from activities which are confined to the collection of news and views in India for transmission out of India in respect of a person engaged in the business of running a news agency or of publishing newspapers. Thus, the profit element from the collection of news and views has been made excludible as per section 9(1) of the I T Act. Collection of specifications and requirements of the customers is one of the parts of the trading activity and it cannot be said that no profit element can be attached to it and that is why an exception was provided in Explanation 1(c) of section 9(1). Hence, for the asst. years prior to asst. year 2004-05, it is held that there is a business connection in respect of source of income in India of the non-resident assesste and therefore, the income from such activity is to be deemed to accrue or arise in India and will therefore is taxable
23. Article 7 of the DTAA between India and South Korea (available at 165 ITft 191 St.) deals with tax ability of business profit. Article 7 reads as under:-
1. The profits of an enterprise of a Contracting State shaft be taxable only in that State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein. If the enterprise carries on business as aforesaid, the profits of the enterprise may be taxed in the other State but only so much of them as is attributable to that permanent establishment
2. Subject to the provisions of paragraph 3t where an enterprise of Contracting State carries on business in the other Contracting State through a permanent establishment situated therein, there shall in each Contracting State be attributed to that permanent establishment the profits which it might be expected to make if it were 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.
3. In the determination of the profits of a permanent establishment, there shall be allowed as deductions expenses which are incurred for the purposes of the permanent establishment including executive and general administrative expenses so incurred, whether in the State in which the permanent establishment is situated or elsewhere, which are allowed under the provisions of the domestic law of the Contracting State in which the permanent establishment is situated.
4. No profits shall be attributed to a permanent establishment by reason of the mere purchase by that permanent establishment of goods or merchandise for the enterprise.
5. For the purposes of the preceding paragraphs, the profits to be attributed to the permanent establishment shall be determined by the same method year by year unless there is good and sufficient reason to the contrary.
6. Where income or profits include items of income which are dealt with separately in other Articles of this Convention, then the provisions of those Articles shall not be affected by the provisions of this Article.
The business profit of the South Korean Company can be taxed in India in case the South Korean Company is having a permanent establishment.
26. As per Article 5, permanent establishment means a fixed place of business through which the business of an enterprise is wholly or partly carried on. Looking to flow chart of the LO, it is clear that the business of the South Korean Company is partly carried on by the LO. As per Article 5(2), it is mentioned that the permanent establishment shall include especially an office. The office is not defined either under the Income Tax Act or under the DTAA. LO is an office and cannot be excluded from the word ‘office1 as contained in Article 5(2). Hence, as per Article 5(2), LO becomes a permanent establishment. However, certain exception has been provided in Article 5(4) vide which permanent establishment is deemed not to include the offices which carry on specific activities as mentioned in Article 4(a) to (f). The learned AR has argued before us that the case of the assessee is covered under Article 4(e). It has been submitted that the LO is supplying information and is doing preparatory or auxiliary activities in the trade or business of the enterprise. The word ‘solely’ has been used in Article 4(e). The activities of the LO should be strictly restricted to the activities mentioned in Article 5(4)(e). In order to see as to whether the activities carried on by the LO are solely restricted to the activities mentioned in Article 5(4Xe) of the DTAA, we have to understand the activities carried on by the LO. The revenue has conducted survey and statement of Shri V Natarajan, Country Manager was recorded. In question no.3, Shri V Natarajan was asked to explain the modus operandi of operations carried out by the Indian LO. Shri V Natarajan replied as under:-
“The establishment in India consisting of a Liaison Office in Bangalore alone was established in 1998. Here it consists of five employees as of now, three of them directly related to sales (including me) and two administrative assistants. We have three divisions – viz. product lines – Printed Circuit Board, Liquid Crystal Displays, Electronic Component and thermal printers in order to promote the marketing and sales of the above products. We generate inquiries by way of telephone calls to prospective customers and also make cold calls to elicit response and identify the correct prospect.
We also identify the new customers by way of our past experiences in the field of sales and sometimes the customers themselves will inquire with us regarding our products based on the market information. Once this is done, we fix an appointment with the right person in the organization and try to identify the exact requirement and also to explain the availability of products. After this, the customer will give his requirement based on the products available with us. This requirement will include complete specifications, quantity required, delivery requirement etc. The customer expects our sales personnel to quote within a reasonable time. After this, the same enquiry is converted into request for quotation format to the head office staff responsible for purchase activities from our suppliers in Korea and China. As soon as we get the Request for Quotation format fully filled up with price, delivery and specification in Bangalore through E-Mail, the salesperson who is responsible for generating the enquiry will reply to the customer with a quotation adding the sales margin. We have a thumb rule to calculate the sales margin depending upon the end-use of the product and the competition in the market and the volumes. We get only the buying price from our head office and, margins are decided by the sales team based in Bangalore on a case-to-case basis depending upon the merits of the case. After this there will be negotiation for each enquiry between the customers and the sales personnel of this office and in some cases, we are able to close the order to the satisfaction of our customer and the head office. In other cases, if the customer is not happy with the price and if he asks for more discount our personnel at Korea will discuss the same with our suppliers to request for more discount in the price. If the supplier agrees for giving more discount then accordingly we quote a new discounted price to the customers and close the deal. Sometimes, the deal might not materialize at all because of the competition offering better price and delivery terms to the customers. After this if the deal is through we get the purchase order from the customer and we have to process the order (we fill the details in the Order Processing Chart) and send the same to Head Office (a sample copy of this is given) through E-Mail as an attachment. The Purchase Team at the Head Office will process and place the order to the supplier and then wait for the goods to be ready. Once the goods are ready, they will be inspected by the Quality Control Team at the headquarters to ensure that the specifications are properly met After that the goods are packed and shipped to the freight forwarder appointed by the customer. The same will be shipped directly to the customer by the first available flight or sea. Our Head office will send a copy of the commercial invoice, packing list and House Airway Bill/Bill of Landing to this office at Bangalore by E-Mail/Fax. We, in turn, send these three .documents to the customer. Then the responsibility of getting the goods cleared lies with the customers. The payments will be made by the customer through telegraphic transfer through bank to our head office account at Korea. Our work also involves following up of payments from the customers and offer after sales support if necessary”.
29. The case of the assessee would have been covered under Article 5(4)(e) if the LO is maintained solely for the purpose of advertising, supply of information, scientific research or any other activity if it has a preparatory or auxiliary character in the trade or business of the enterprise. The dictionary meaning of auxiliary is “providing extra help and support” while the dictionary meaning of preparatory is “done in order to prepare for something”. We have already mentioned various aspects of the trading activity. The preparatory activity may be the activity like identifying the customers. Supply of information in respect of requirement in number and specification is also a preparatory exercise in trading activity. In the instant case, the LO is having a freedom to fix the sale price and to conclude the contract provided the sale prices are within the band of profit margin communicated by the HO. Such an activity cannot be termed as a preparatory or auxiliary character. Hence, it cannot be said that the LO is solely for the purpose of supply of information or doing a preparatory or auxiliary character in the trade or business.
Even as per Regulation of FEMA, the LO in India can have the following permitted activities:
i) Representing in India the parent company/group companies
ii) Promoting export import from/to India
iii) Promoting technical/financial collaborations between parent/group companies and companies in India
iv) Acting as a communication channel between the parent company and Indian companies.
Thus, the LO can participate in promotion of import to India and in the instant case, the LO is engaged in such activities by procuring purchase orders after negotiation of the deal. Hence, we hold that the AO was justified in holding that LO is a permanent establishment and therefore, income attributable to LO will be taxable as per Article 7 of the DTAA.
30. The Hon’ble Delhi High Court in the case of UAR Exchange Center Ltd. v Union of India 2009-TIOL-84- HC-DEL-IT had an occasion to consider as to whether the income of the non-resident is taxable in India in view of having a LO at 5 places in India. The exclusionary clause found in that case was similar to Article 5(4)(e) of the agreement between India and South Korea The Hon’ble High Court observed that the plain meaning of the word ‘auxiliary’ is found in Black Law Dictionary, 7th Edition at page 130 which reads as “aiding or supporting, subsidiary”. In that case, the only activity of the LO in India was simply to download information, which was contained in the main servers located in UAE based on which cheques drawn on banks in India where upon the said cheques were couriered or dispatched to the beneficiaries in India keeping in mind the instructions of the NRI remitter. Such an activity was held as an activity in aid or support of the main activity. The Hon’ble Delhi High Court further observed that the activity carried on by the LO in India did not in nay manner, whatsoever contribute directly or indirectly to the earning of profits or gains by the petitioner in UAE. Commission for the services of remittance offered by the petitioner was also earned in UAE. Now from the above it is clear that if the activity carried out in India contributes directly or indirectly to the earning of profits or gains by the non-resident then extent of contribution is to be taxed in India In the instant case, HO was giving the cost of the item to be supplied and was also giving the option to conclude contract between the minimum and maximum margin of profit. Negotiations were being done by the LO in India They were having complete freedom to negotiate between the price band and therefore such an activity was contributing to the income of the non-resident assessee. Hence activities carried on by LO in India were to be considered for the purpose of income accruing to the non-resident in India The quantum is to be ascertained on the basis of the profit attributable to such LO.
31. The Kolkata Bench in the case of Sojitz Corporation, Kolkata v ADI 2008-TTOL-451- ITAT-KOL also had an occasion to consider the tax ability of income in India on account of the non-resident having a LO in India. While deciding in favor of the ossessee, the Hon’ble Tribunal observed as under:-
“The AO as well as CIT(A) have not pointed out any other activity other than chimed by the assessee in which these Liaison Offices indulged, though they referred to huge expenditure incurred by the assessee on these liaison offices and the organizational set up of these liaison offices, to treat these liaison offices as permanent establishment of the assessee in India. It is also not the case of the revenue that liaison offices were having powers of concluding contracts on behalf of the assessee and were carrying on any other activities wherein they assumed decision making authority on behalf of the HO”.
In the instant case, the LO was having decision making authority on behalf of the HO. They were also empowered to conclude the contract and to secure purchase orders. Hence considering the activities carried on by the LO as found by the department in course of survey, it is clear that LO is to be treated as permanent establishment and will not be excluded from the definition of permanent establishment as per Article 5(4)(e) of DTAA.
