By Deepak Manoharan & Nathansha Dilip, Chartered Accountants, Chennai – India
In a landmark ruling, the Delhi bench of the Income Tax Appellate Tribunal has concluded that a liaison office could be treated as a permanent establishment of a foreign entity in India.
Following the Court rulings in Rolls Royce, GE Energy, Motorola, and others, this 17 September ruling of the tax tribunal determines that the liaison office set up in India by Hitachi High Technologies Singapore Pte Ltd (HHT Singapore) is a permanent establishment of HHT Singapore in India.
The Indian tax law, read with the tax treaty entered between India and Singapore, defines what a permanent establishment is. A permanent establishment is nothing but an arm of the foreign entity doing business in India. Once a unit fits in the definition of an Indian permanent establishment, it attracts profit attribution, and then subsequently tax liabilities on the profits attributable to such permanent establishment.
Nevertheless, this is a highly controversial aspect of Indian taxation as it is a fact-based exercise to determine the existence of a permanent establishment.
Further, there is a vast difference in the scope of activities a liaison office can undertake from that of a branch office.
A liaison office, merely being a channel of communication between the head office abroad and the parties in India, is not brought within the ambit of taxation. On the other hand, a branch office, being another arm of the parent entity carrying business operations in India, is required to pay taxes in India.
Case of Hitachi High Technologies Singapore Pte Limited
HHT Singapore, a wholly-owned subsidiary of Hitachi High Technologies Corporation, Japan, established a liaison office in India to carry out preparatory and auxiliary services, including market research and liaison activities.
The Indian tax authorities conducted a thorough examination of the liaison office through tax survey proceedings conducted at the premises of the liaison office in India. Statements of the employees were obtained by the tax authorities, who also extracted copies of e-mail exchanges between the liaison office, head office in Singapore, the customers, and the tax consultants.
Based on these data, the tax authorities concluded that the scope of work carried out by liaison office far exceeded the limited purpose for which it was set up, and that the office was actually involved in commercial activities of HHT Singapore.
Hence, the liaison office was deemed to be a permanent establishment of HHT Singapore in India and certain taxable profits were attributed to such liaison office.
India branch versus liaison office
The case reached the tax tribunal after going through various channels of litigation. The tax tribunal analyzed the facts of the case with the law and made certain intricate observations, on which its decision is based.
It was observed by the tax tribunal that the liaison office of HHT Singapore was engaged in activities beyond that of just being a communication channel. The law in India is strict in the sense of the activities to be carried out by a liaison office. In fact, as per the tax treaty between India and Singapore, maintenance of a fixed place of business in India solely for the purpose of advertisement or supply of information, or similar activities, which are merely in the nature of providing support, will not create a permanent establishment.
In the case of HHT Singapore, it was observed that the employees in the Indian liaison office were engaged into activities beyond those of a liaison office, including marketing, sales promotion, market research, price negotiation, ascertaining customer requirement, obtaining purchase orders, following up on delivery of material and payments.
It could be understood, from the way that the work was carried out, that, the liaison office was doing everything except raising invoices or receiving payments. While a liaison office is supposed to be a communication channel between the office abroad and the Indian customers, in the present case, the liaison office was held to be a fully functioning arm of the Singaporean entity.
Another interesting observation which took the litigation to an exciting turn was the e-mail exchanges between the employees of the liaison office and the tax consultant. It was observed that the employees of liaison office had indicated that the liaison office was involved in commercial activities and that the tax consultant had flagged the risk of litigation post survey operations in the premises of the liaison office.
Hence, based on the nature of the activities carried out by the liaison office as unearthed during the survey operations conducted by the tax authorities in the premises of the liaison office, the tax tribunal upheld that it resulted in a permanent establishment and should be taxed accordingly.
However, the tax tribunal made it clear that the department had erred in attributing profits at an absurd proportion to such permanent establishment and bringing huge amounts to tax. It accordingly directed the department to benchmark the profits based on the average net profit percentage within the industry, taking into account the routine and limited functions undertaken by the liaison office.
Takeaway
Since the dawn of industrial development and customer service, there has always been a controversy as to what a liaison office should or should not do. This ruling serves to be guidance in determining the taxability of a foreign entity’s Indian arm.
While the terms set out in the written agreement between overseas company and the Indian arm would be pertinent to determine the extent of the activities the Indian arm would be involved in, the parties should also take care and adhere in practice to the clauses provided in the agreement.
It would be of utmost importance to note that irrespective of the clauses set out in the agreement, the Indian tax authorities could still undertake a factual examination to determine the existence of permanent establishment.
It has been a conventional practice for the Indian tax authorities to conduct surveys and examine the transactional documents in the premises of the taxpayers to determine actual actions on the ground and to test whether they are really consistent with the agreement terms.
Hence, sufficient documentation needs to be continuously maintained to establish factually that a liaison office is not involved in active commercial activities, but provides mere administrative support. Adequate housekeeping should demonstrate that whatever is stated in the agreement is what is actually carried out.
The views expressed in this article are the personal views of the authors.
Deepak Manoharan and Nathansha Dilip are Chartered Accountants located in Chennai, India.
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