2011 (8) TMI 30 - AAR - Income Tax

US-India Tax Case: Liaison Office Income Taxable in India

The ruling pronounced in this case determined that a portion of the income from the business operations of a US-based company, operating a liaison office ... DTAA between India and USA - Permanent establishment - Liaison office - The activity of purchase is one that involves expenditure and is in no way related to generation of revenue. No revenue generating activity takes place in India and consequently there can be no question of any right to receive income arising in India - The approval by the Reserve Bank of India for setting up the liaison office is relied on in support. Article 5(3) (d) of the DTAA is referred to in support of the exclusion - whether the activities undertaken by the liaison office on behalf of the applicant are activities limited to or confined to the purchase of goods in India by the applicant - There is, thus, clear authority for the position that all activities other than the actual sale cannot be divorced from the business of manufacture and sale especially in a case like the present, where the sale is of a branded product, designed and got made by the applicant under supervision, under a brand owned by the applicant - There cannot be much doubt in such circumstances that the liaison office would be a permanent establishment of the applicant within the meaning of article 5.1. of the DTAA In terms of Article 5 of DTAA, the applicant has a permanent establishment in India, the applicant is liable to be taxed in India in terms of Article 7(1) of the DTAA on so much of the profits as is attributable to the permanent establishment or to other business activities carried on in India of the same or similar kind as those effected through that permanent establishment - The Indian Liaison Office involves a “Permanent Establishment‟ for the applicant under Article 5.1 of the DTAA with USA - income attributable to Liaison office is taxable in India Issues Involved:1. Accrual of income in India.2. Business connection in India.3. Scope of activities confined to purchase for export.4. Attribution of profits to operations in India.5. Permanent establishment under DTAA.6. Taxation of income attributable to the Liaison Office.Detailed Analysis:1. Accrual of Income in India:- The applicant, a US-based company, operates a liaison office in India primarily for coordinating purchases. The applicant argued that since no revenue-generating activities occur in India, no income accrues or arises in India under Section 5(2) of the Income-tax Act.- The Authority ruled that the activities of the liaison office, which include vendor identification, quality control, and compliance monitoring, are integral to the business of the applicant. These activities are not merely preparatory or auxiliary but are essential to the business operations. Therefore, a portion of the income from the business of designing, manufacturing, and selling products imported from India accrues to the applicant in India.2. Business Connection in India:- The applicant contended that the liaison office acts only as a communication link and does not conclude contracts or generate revenue in India, thus not establishing a business connection under Section 9(1)(i) of the Act.- The Authority found that the liaison office's activities, including quality control and vendor management, establish a business connection in India. The liaison office performs substantial business functions that contribute to the overall business operations of the applicant, thereby creating a business connection in India.3. Scope of Activities Confined to Purchase for Export:- The applicant claimed that the activities of the liaison office are confined to the purchase of goods for export, which should be excluded from taxation under Explanation 1(b) to Section 9(1)(i) of the Act.- The Authority determined that the activities of the liaison office go beyond mere purchase functions. The office is involved in quality control, compliance monitoring, and other business activities that are integral to the applicant's operations. Therefore, the activities are not confined to the purchase of goods for export, and the exclusion under Explanation 1(b) does not apply.4. Attribution of Profits to Operations in India:- The applicant argued that no income is attributable to the liaison office as it only incurs expenditure and does not generate revenue.- The Authority ruled that the income attributable to the operations carried out in India must be determined. The profits attributable to the liaison office's activities, which are integral to the business operations, are taxable in India. The exact computation of the taxable income is a matter of further determination.5. Permanent Establishment under DTAA:- The applicant contended that the liaison office does not constitute a permanent establishment under Article 5 of the DTAA between India and the USA.- The Authority found that the liaison office constitutes a permanent establishment under Article 5.1 of the DTAA. The office has a fixed place of business and performs significant business functions, including quality control and compliance monitoring, which are integral to the applicant's operations.6. Taxation of Income Attributable to the Liaison Office:- The applicant argued that even if the liaison office is considered a permanent establishment, the activities should be exempt under Article 5(3)(d) of the DTAA, which excludes activities of a preparatory or auxiliary character.- The Authority ruled that the liaison office's activities are not merely preparatory or auxiliary but are substantial business functions. Therefore, the income attributable to the liaison office is taxable in India under Article 7 of the DTAA. Only the income attributable to the operations carried out by the liaison office in India is subject to taxation.Ruling Pronounced:1. A portion of the income from the business of designing, manufacturing, and selling products imported from India accrues to the applicant in India.2. The applicant has a business connection in India through its liaison office.3. The activities of the liaison office are not confined to the purchase of goods for export.4. The income taxable in India will be that part of the income attributable to the operations carried out in India.5. The liaison office constitutes a permanent establishment under Article 5.1 of the DTAA.6. Under Article 7 of the DTAA, only the income attributable to the liaison office is taxable in India.