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March 2, 2021

Artificial juridical persons are not natural persons but separate entities under law, hence no GST – AAAR

by CA Jessica Nagaonkar in GST

Artificial juridical persons are not natural persons but separate entities under law, hence no GST – AAAR

A Liaison Office means a place of business to act as a channel of communication between the principal place of business or Head Office or by whatever name called and entities in India but which does not undertake any commercial /trading/ industrial activity, directly or indirectly, and maintains itself out of inward remittances received from abroad through normal banking channel. Liaison offices (LOs) are a popular option for foreign investors exploring the Indian market for the first time, and unsure of how the country’s liberalizing FDI caps will affect their business.

In contrast to other business structures, LOs allow foreign companies to establish a light footprint in India while keeping their financial, legal, and administrative commitments low. Foreign companies can open a liaison office in India to facilitate and promote the parent company’s business activities, and act as a communications channel between the foreign parent company and Indian companies.

Let us refer to the case of Fraunhofer-Gesellschaft ZurForderung der angewandten Forschung (GST AAAR Karnataka), where the issue under consideration was whether liaison offices are liable to GST or not.

Facts of the Case:

  • The Appellant was an organisation incorporated in Germany and was engaged in promoting applied research and development for the benefit of industry and society.
  • The Appellant had established a Liaison Office (LO) in Bengaluru which was an extended arm of the Head Office (HO) to carry out activities as permitted by the Reserve Bank of India.
  • The Annexure to the RBI permission letter stipulated a number of conditions for establishment of liaison office in India and one such condition was that the liaison office would not generate income in India and would not engage in any trade/commercial activity.
  • The Appellant has also obtained a Chartered Accountant’s certificate affirming that the Appellant had undertaken only those activities that have been specifically permitted by the RBI and had complied with the terms and conditions specified therein.
  • The LO only receives reimbursement of expenses from head office in order to meet its daily expenses in running the LO.

Issue raised before Authority of Advance Ruling (AAR)

Appellant approached the AAR seeking a ruling on the following questions:

  • Whether the activities of a liaison office amount to supply of services?
  • Whether liaison office is required to be registered under CGST Act?
  • Whether liaison office is liable to pay GST?

Order of Authority of Advance Ruling (AAR)

AAR held that:

  • The liaison activities being undertaken by the applicant (LO) in line with the conditions specified by RBI amounts to supply under Section 7 (1) (c) of the CGST Act.
  • The applicant (LO) is required to be registered under CGST Act.
  • The applicant (LO) is liable to pay GST if the place of supply of services is India.

Aggrieved by the ruling given by the AAR, the Appellant filed an appeal before the Appellate Authority of Advance Ruling (AAAR)

Observations of AAAR on provisions of FEMA

  • The core issue before AAAR was whether the activities of the Liaison Office would amount to a supply in terms of the GST law and whether such liaison office is liable to be registered for payment of GST.
  • Establishment of a liaison office in India by foreign entities is regulated in terms of Section 6(6) of the Foreign Exchange Management Act (FEMA), 1999.
  • The FEMA defines Liaison Office as “a place of business to act as a channel of communication between the Principal place of business or Head Office by whatever name called and entities in India but which does not undertake any commercial / trading / industrial activity, directly or indirectly, and maintains itself out of inward remittances received from abroad through normal banking channel”.
  • A body corporate incorporated outside India (including a firm or other association of individuals) desirous of opening a liaison office in India has to obtain permission from the Reserve Bank of India under the provisions of FEMA, 1999.
  • In this case, the Appellant was granted permission by RBI to act as a liaison office for its Head office in Germany.
  • As per the RBI permission, the liaison office shall undertake only permissible activities as mentioned in Schedule II of FEMA Notification No 22/2000 RB dated 3rd May 2000 as amended.
  • The activities permitted as per the said Schedule II of FEMA regulation is as follows:
  • Representing in India the parent company.
  • Promoting export / import from / to India.
  • Promoting technical/financial collaborations between parent/group companies and companies in India.
  • Acting as a communication channel between the parent company and Indian companies.

Observations of AAAR on the conditions provided in the RBI permission

  • The RBI permission was subject to the condition that the liaison office will not generate income India and will not engage in any trade/commercial activity.
  • Except for the liaison work, the office in India shall not undertake any activity of a trading, commercial or industrial nature nor shall it enter into any business contracts in its own name without RBI permission.
  • No commission/fees shall be charged or any other renumeration received / income earned by the office in India for the liaison activities/services rendered by it or otherwise in India.
  • The entire expenses of the office in India will be met exclusively out of the funds received from abroad through normal banking channels.
  • The liaison office in India will not render any consultancy or any other services directly/indirectly with or without any consideration.
  • The liaison office will not have signing / commitment powers, except than those which are required for normal functioning of the office, on behalf of the Head office.
  • The liaison office can maintain only one bank account at any given point of time, with the designated Authorised Dealer category / Bank in India and permits only the following credits and debits to be made from the account:
  • Funds received from Head Office through normal banking channels for meeting the expenses of the office.
  • Refund of security deposits, paid from LO account or directly by the Head Office through normal banking channels.
  • Refund of taxes, duties, etc received from tax authorities paid from LO bank account.
  • Sale proceeds of assets of the LO where the assets are disposed of at a price equal to or less than the book value as on date of sale, supported by a valuer’s / CA’s certificate.
  • Debits – Only for meeting the local expenses of the office.

Observations of AAAR on applicability of GST

  • The liability to GST arises when there is a supply of either goods or services or both.
  • According to Section 7(1)(a) of CGST Act, 2017, the expression “supply” includes all forms of supply of goods or services or both such as sale, transfer, barter, exchange, licence, rental, lease or disposal made or agreed to be made for a consideration by a person in the course or furtherance of business.
  • For an activity to be termed as a ‘supply’ within the ambit of Section (a), it must be an activity which is done by a person, for a consideration and the activity should be in the course or furtherance of business.
  • Applying the above parameters to the facts is of this case, AAAR wanted to see whether the Appellant’s LO in India was a `person’ who is performing an activity ‘for a consideration’ which was in ‘the course or furtherance of business’.
  • AAAR found that the RBI and FEMA regulations permitted the Liaison Office in India to operate entirely out of the inward remittances received from its Head Office in Germany.
  • The liaison office was not allowed to undertake any business activity in India or enter into any business contracts in its name or work for any indirect entry into services and could not earn any income in India either by way of commission/fee or any renumeration.
  • It could only act as a channel of communication between the HO in Germany and parties in India.
  • The inward remittance in foreign exchange received by the liaison office from its head office for maintaining the office in India could not be termed as a consideration for the liaison activity.
  • This removed the coverage of the activities of the liaison office from the scope of Section 7(1)(a) of the CGST Act.
  • The concept of supply under GST also includes within its scope certain activities specified in Schedule I of the CGST Act which are made or agreed to be made without a consideration.
  • One such activity is the supply of goods or services or both between related persons or between distinct persons as defined in Section 25 of the CGST Act, when made in the course or furtherance of business.
  • AAR had held that the liaison office and its head office in Germany are deemed to be related persons in terms of clause (c) of Explanation to Section 15 of the CGST Act.
  • The Appellant’s Head office in Germany is no doubt a ‘person’ by virtue of Section 2(84)(h) of the CGST Act.
  • However, the liaison office was not recognised as a separate legal entity in India.
  • Under the Companies Act, 2013, every foreign entity establishing its place of business in India by way of a liaison office shall be treated as a foreign company as defined under Section 2(42) of the Companies Act, 2013.
  • The liaison office was registered with the Registrar of Companies in the same name as the parent foreign company. It did not have a separate legal existence in law.
  • The concept of related person arose only when there were two `persons’ in existence as per law.
  • In this case, there was only one legal entity i.e., the company in Germany and the liaison office in India was only an extension of the foreign company having no separate identity in India.
  • AAAR disagreed with the findings of the AAR that the liaison office is an ‘artificial juridical person’ and that the business conducted by it came within the purview of the definition of business stated in Section 2(17) of the CGST Act.
  • Artificial juridical persons are not natural persons but separate entities under law.
  • LO was merely an extension of the parent company in Germany. When the LO was not a ‘person’ recognised as per law, the question of being a related person to the parent company did not arise.
  • Therefore, the liaison activity performed by the Appellant for the parent company was in the nature of a service rendered to self
  • A service rendered to oneself does not come within the purview of ‘supply’ under GST.

Therefore, AAAR held that the activities of the Appellant as a liaison office did not amount to a supply of service. The activities of the liaison office were not a ‘supply’ under Section 7(1)(a) of the CGST Act and would also not be covered under the ambit of clause 2 of Schedule I of the said Act.

As AAAR had already held that the activities of the liaison office did not amount to a ‘supply’ under GST, hence, there was no taxable supply and there is no requirement for obtaining a GST registration or payment of GST. When the liaison office was not required to be registered under GST, the question of whether they were a distinct person or establishment of distinct person was irrelevant.

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