Preparatory or auxiliary liaison office functions do not create a permanent establishment or Indian tax liability under treaty rules.

Treaty protection prevails where liaison offices in India perform only preparatory or auxiliary support functions within the limits of regulatory permission. Under Article 5 of the applicable Double Taxation Avoidance Agreement, a fixed place of business becomes a permanent establishment only if it carries on core business activity, while a place maintained solely for preparatory or auxiliary work is excluded. The liaison offices were confined to support tasks for remittance operations and had no authority to undertake trading or earn commission in India, so they did not constitute a permanent establishment. As the activities were merely ancillary to contracts concluded abroad, the deeming rules on accrual and business connection under the Income-tax Act did not by themselves create Indian tax liability.

---

---

Issues: (i) whether the liaison offices in India constituted a permanent establishment under the Double Taxation Avoidance Agreement and were excluded by the preparatory or auxiliary character exception; (ii) whether the activities of the liaison offices gave rise to income deemed to accrue or arise in India under the Income-tax Act, 1961.

Issue (i): whether the liaison offices in India constituted a permanent establishment under the Double Taxation Avoidance Agreement and were excluded by the preparatory or auxiliary character exception.

Analysis: The treaty, notified under Section 90 of the Income-tax Act, 1961, governs taxability where its terms are more beneficial or otherwise inconsistent with the Act. Under Article 5, a fixed place of business is a permanent establishment, but Article 5(3)(e) excludes a fixed place maintained solely for preparatory or auxiliary activities. The liaison offices were confined by the RBI permission to limited support functions, including downloading remittance data, printing cheques or drafts, dispatching them, and follow-up work, with no authority to undertake trading or commercial business or earn commission in India. Those functions were held to be supportive of the main remittance business and not part of the core income-generating activity in India.

Conclusion: The liaison offices were not a permanent establishment for the relevant remittance activity and were covered by the preparatory or auxiliary character exception.

Issue (ii): whether the activities of the liaison offices gave rise to income deemed to accrue or arise in India under the Income-tax Act, 1961.

Analysis: Even though Section 9(1)(i) deems certain income to accrue in India through a business connection, that provision had to yield to the applicable treaty framework once Article 5 and Article 7 of the Double Taxation Avoidance Agreement were applied. The activities in India were only auxiliary to the remittance contracts concluded in the United Arab Emirates, and no income was earned in India by the liaison offices themselves. In these circumstances, the deeming provisions in Sections 5 and 9 could not fasten Indian tax liability on the respondent for the remittance business carried on abroad.

Conclusion: No income was held taxable in India on the basis of deemed accrual or business connection for the liaison office activities.

Final Conclusion: The treaty provisions prevailed, the Indian liaison activities were only supportive of the foreign business, and the tax notices based on deemed accrual were unsustainable.

Ratio Decidendi: Where a liaison office in India performs only preparatory or auxiliary support functions under the constraints of a treaty and regulatory permission, it does not constitute a permanent establishment and no income is taxable in India merely by applying the deeming rules on business connection.

---