A liaison office which is only carrying on such activity of a “preparatory or auxiliary” character is not a PE – SC

Double taxation is the levy of tax by two or more countries on the same income, asset or financial transaction. This double liability is mitigated in many ways, one of them being a tax treaty between the countries in question. A tax treaty between two or more countries to avoid taxing the same income twice is known as Double Taxation Avoidance Agreement (DTAA). When a tax-payer resides in one country and earns income in another country, he is covered under DTAA, if those two countries have one in place.

If a person who is resident in India in any previous year, in respect of his income, accrued or arose outside India has paid tax on such income in any country outside India, he shall be entitled deduction from the Income Tax payable by him of a sum calculated on such doubly taxed income:

• Under section 90 of the Income Tax Act, if the country in which tax is paid has entered double taxation avoidance agreement with the Government of India.
• Under section 91 of the Income Tax Act, if the country in which tax is paid has not entered into any agreement with the Government of India.

Relief allowed under section 90/ 91 is lower of following accounts:

• Tax paid on double-taxed income outside India.
• Tax payable on double-taxed income under Income Tax Act.

Let us refer to the case of Union Of India vs UAE Exchange Centre (2020) (SC), where the main issue under consideration was whether a liaison office which is only carrying on such activity of a “preparatory or auxiliary” character is a Permanent Establishment in terms of Article 5 of the Double taxation Avoidance Agreement (chargeable to tax) or not.

Facts of the Case:

• The respondent is a limited company incorporated in the United Arab Emirates (UAE).
• It is engaged in offering, among others, remittance services for transferring amounts from UAE to various places in India.
• It had applied for a permission under Section 29(1)(a) of the Foreign Exchange Regulation Act, 1973, pursuant to which approval was granted by the RBI
• The activities carried on by the respondent from the said liaison offices were stated to be in conformity with the terms and conditions prescribed by the RBI.
• The entire expenses of the liaison offices in India were met exclusively out of funds received from UAE through normal banking channels.
• It was asserted by the respondent that its liaison offices undertook no activity of trading, commercial or industrial, as the case may be.
• The respondent had no immovable property in India otherwise than by way of lease for operating the liaison offices.
• No fee/commission was charged or received in India by any of the liaison offices for services rendered in India.
• It was claimed that no income accrued or arose or deemed to accrue or arise, directly or indirectly, through or from any source in India from liaison offices within the meaning of Section 5 or Section 9 of the Income Tax Act, 1961.
• Remittance services were offered by the respondent to NRIs in UAE.
• The contract pursuant to which the funds were handed over by the NRI to the respondent in UAE, was entered between the respondent and the NRI remitter in UAE.

• The funds are collected from the NRI remitter by the respondent in UAE by charging one-time fee.
• After collecting the funds from the NRI remitter, the respondent made an electronic remittance of the funds on behalf of its NRI customer.
• Assessee had filed its returns of income showing NIL income, on the ground that no income had accrued or deemed to have accrued to it in India, both under the 1961 Act, as well as, the agreement entered into between the Government of the Republic of India and the Government of the UAE i.e DTAA.
• Returns filed on regular basis were accepted by the Department.
• However certain doubt arose in respect of the mode of remittance through the liaison offices in India more particularly on account of the activity undertaken in the liaison office in India of downloading the particulars of remittances through electronic media and printing cheques/ drafts drawn on the banks in India, which, in turn, were couriered or dispatched to the beneficiaries in India, in accordance with the instructions of the NRI remitter.
• While doing this, the liaison office of the Assessee remained connected with its main server in UAE, as the information was contained in the main server there, which could be accessed by the liaison office in India for the purpose of remittance of funds to the beneficiaries in India by the NRI remitters.
• Hence Assessee filed an application before the Authority for Advance Rulings (AAR), and sought ruling on the question as to whether any income is accrued/deemed to be accrued in India from the activities carried out by the Company in India.

Proceedings of AAR

The Authority, vide its ruling answered the question in the affirmative, namely, “Income shall be deemed to accrue in India from the activity carried out by the liaison offices of the applicant in India.”

Following the ruling of AAR, the Department issued notices under Section 148. The Assessee, therefore, carried the matter before the High Court (HC) for quashing of the AAR ruling and quashing of reopening notices.

Proceedings of the HC

• The High Court, after adverting to indisputable facts, noted that the Authority committed manifest error in appreciating the relevant facts and materials on record and more particularly, misread the purport of Section 90 of the 1961 Act and the settled legal position that the DTAA ought to override the provisions of the Income Tax Act.
• In other words, the tax liability of the respondent was required to be assessed on the basis of the provisions in the DTAA
• The High Court eventually quashed the impugned ruling of the Authority and also the notices issued by the Department under Section 148 of the 1961 Act, since the notices were based on the ruling which was being set aside.
• The High Court, however, gave liberty to the appellants to proceed against the respondent on any other ground, as may be permissible in law
• Feeling aggrieved, the Department petitioned before the Supreme Court (SC)

Issue before the SC

The core issue that had to be answered in this appeal was whether the stated activities of the respondent-assessee would qualify the expression of preparatory or auxiliary character?

However, in the present case, the matter in issue will have to be answered on the basis of the stipulations in DTAA notified in exercise of powers conferred under Section 90

Observations of SC on having a PE

Based on the findings recorded by the HC, SC proceeded on the basis that the Assessee had a fixed place of business through which the business of the Assessee was being wholly or partly carried on.

That, however, would not be conclusive until a further finding was recorded that the Assessee had a PE, in terms of Article 5, situated in India, so as to attract Article 7 dealing with business profits to become taxable in India, to the extent attributable to the PE of the Assessee in India.

SC observed that Article 5(3) of the DTAA opened with a non- obstante clause and also contained a deeming provision.

It stated that notwithstanding the preceding provisions of the concerned article, which would mean clauses 1 and 2 of article 5, it would still not be a PE, if any of the clauses in article 5(3) were applicable.

For that, the functional test regarding the activity in question would be essential.

SC observed that since Assessee argued that the activities of the liaison offices were of preparatory or auxiliary character, the same would fall within the excepted category under Article 5(3)(e) of the DTAA.

Resultantly, it could not be regarded as a PE within the sweep of Article 7 of DTAA.

Observations of the SC on the permission provided by the RBI

• SC referred to the limited permission given by the RBI to the Assessee under section 29(1)(a) of FERA. From the stated permission, it was evident that the RBI had agreed for establishing a liaison office of the Assessee at Cochin, initially for 3 years to enable the Assessee to:
  1. respond quickly and economically to enquiries from correspondent banks with regard to suspected fraudulent drafts
  2. undertake reconciliation of bank accounts held in India
  3. act as a communication centre receiving computer (via modem) advices of mail transfer T.T. stop payments messages, payment details etc., originating from Assessee’s several branches in UAE and transmitting to its Indian correspondent banks
  4. printing Indian Rupee drafts with facsimile signature from the Head Office and counter signature by the authorized signatory of the Office at Cochin; and
  5. following up with the Indian correspondent banks.
• These were limited activities which the Assessee was permitted to carry on within India.

• This permission did not allow the Assessee to enter into a contract with anyone in India, but only to provide service of delivery of cheques/ drafts drawn on the banks in India.
• Notably, the permitted activities were required to be carried out by the Assessee subject to conditions specified in clause 3 of the permission, which included not to render any consultancy or any other service, directly or indirectly, with or without any consideration and further that the liaison office in India shall not borrow or lend any money from or to any person in India without prior permission of RBI.
• The conditions made it amply clear that the office in India would not undertake any other activity of trading, commercial or industrial, nor shall it enter into any business contracts in its own name without prior permission of the RBI.
• The liaison office of the Assessee in India could not even charge commission/fee or receive any remuneration or income in respect of the activities undertaken by the liaison office in India.
• From the stipulations specified by the RBI, SC opined that the activities in question of the liaison office(s) of the Assessee in India were restricted by the permission given by the RBI and were in the nature of preparatory or auxiliary character.

Observations of the SC on the tax liability of the Assessee

• SC was of the view that no income as specified in section 2(24) was earned by the liaison office in India and more so because, the liaison office was not a PE in terms of article 5 of DTAA (as it is only carrying on activity of a preparatory or auxiliary character).
• The resultant was that no tax could be levied or collected from the liaison office of the Assessee in India in respect of the primary business activities consummated by the Assessee in UAE.
• The activities carried on by the liaison office of the Assessee in India as permitted by the RBI, clearly demonstrated that the Assessee must steer away from engaging in any primary business activity and in establishing business connection as such.
• It could carry on activities of preparatory or auxiliary nature only.
• In that case, the deeming provisions in sections 5 and 9 could have no bearing whatsoever.
• The meaning of expressions “business connection” and “business activity” were articulated.
• However, even if the stated activities of the liaison office of the Assessee in India was regarded as business activity, as noted earlier, the same being “of preparatory or auxiliary character”; by virtue of Article 5(3)(e) of the DTAA, the fixed place of business (liaison office) of the Assessee in India otherwise a PE, was deemed to be expressly excluded from being so.
• Since by a legal fiction it was deemed not to be a PE of the Assessee in India, it was not amenable to tax liability in terms of article 7 of the DTAA.

Dismissing the appeal of the revenue SC held that the activities carried on by the liaison office of the non-resident in India as permitted by the RBI, demonstrated that the liaison office must steer away from engaging in any primary business activity and in establishing business connection as such. It can carry on activities of preparatory or auxiliary nature only. A liaison office which is only carrying on such activity of a “preparatory or auxiliary” character was not a PE in terms of Article 5 of the DTAA. The deeming provisions in Sections 5 and 9 could thus have no bearing whatsoever.

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