2025 (11) TMI 473 - AT - Income Tax

Liaison office not a Permanent Establishment under India-Netherlands DTAA; Article 5(4)/5(3)(e) exceptions applied, adhoc tax addition deleted

ITAT MUMBAI - AT held that the taxpayer's liaison office (LO) in India did not constitute a Permanent Establishment under the India-Netherlands DTAA, ... Income liable to tax in India or not - business connection in India and income as deemed to accrue to it on account of such business connection - India-Netherlands DTAA - Permanent Establishment (PE) in India - as per assessee assessee is employed highly qualified people in India and the services cannot be held as merely auxiliary and preparatory work HELD THAT:- In present case though the assessee is having a subsidiary in India, it is submitted that the company is dormant and no activity is carried on. Therefore unless the revenue is able to establish that the information collected by the LO is used by the subsidiary (which is a PE) and that the LO's activity is a complimentary function that are part of a cohesive business operation in India, the activities of the LO would fall within the exception as provided in Article 5(4) read with the MLI would apply to assessee's case. We also notice that the revenue has held the activities of the assessee as not preparatory or auxiliary on the ground that the LO has been carrying its activities for a long time and that LO is not merely gathering information. This contention in our considered view is not tenable, since neither the LO nor the subsidiary is concluding any business activity in India using the information collected. Employees of the LO are not authorised to conclude any business contracts nor have any signing authority. We also notice that the lower authorities have recorded a finding that the assessee failed to furnish details of parties with which business has been conducted in India without considering the submission that the assessee has not conducted any business in India. The requirement as demanded by the revenue would mean substantiating a negative fact which cannot be done and accordingly the conclusion drawn based on the said finding cannot be sustained. The Hon'ble Supreme Court in the case of UOI v. U.A.E. Exchange Center [2020 (4) TMI 794 - SUPREME COURT] as observed that the LO was permitted to undertake only those activities which were specified in the approval granted by the Reserve Bank of India (RBI). It was noted that the said permission contained a clear stipulation prohibiting the LO from rendering any consultancy or other services, either directly or indirectly, and whether for consideration or otherwise. The Court further observed that the activities carried out by the LO in India were confined strictly to the scope of the RBI permission and were of a preparatory or auxiliary nature. It was, therefore, held that such activities would fall within the ambit of Article 5(3)(e) of the DTAA. Consequently, the fixed place of business used by the assessee as its Liaison Office in India could not be regarded as constituting a Permanent Establishment within the meaning of Articles 5(1) and 5(2) of the DTAA, having regard to the non-obstante and deeming provisions contained in Article 5(3) thereof. It is also brought to our attention that the LO of the assessee has been carrying on activity in for a long time (as has been admitted by the revenue) and the returns have been accepted without any adjustment by the revenue till date. LO of the assessee cannot be treated as a PE within the meaning of Article 5 of India Netherlands DTAA and accordingly the adhoc addition made in this regard is liable to be deleted. ISSUES PRESENTED AND CONSIDERED 1. Whether the Liaison Office (LO) in India constitutes a 'business connection' or a Permanent Establishment (PE) of the non-resident enterprise under Article 5 of the India-Netherlands DTAA. 2. Whether activities carried on by the LO - specifically gathering and reporting market information/business analytics - are preparatory or auxiliary in character and thus excluded from PE under Article 5(4) (and related MLI/Article 13(2) provisions) or whether they form complementary functions of a cohesive business operation attracting PE status (including application of OECD Action 7 principles). 3. Whether an amount attributed to a PE (adhoc profit attribution of Rs. 37.63 lakhs reduced from an initial 50% attribution) could be sustained if the LO is held to constitute a PE (i.e., correctness and reasonableness of attribution methodology applied by the authorities). 4. Ancillary: Whether objections regarding assessment being time-barred or the AO applying provisions appropriate to a resident are rendered academic given the determination on PE. ISSUE-WISE DETAILED ANALYSIS Issue 1 - Whether the LO constitutes a PE/business connection under Article 5 of the DTAA Legal framework: Article 5(1) defines 'permanent establishment' as a fixed place of business through which the business of the enterprise is wholly or partly carried on; Article 5(4) (read with paragraph 2 of Article 13 of the MLI) contains exceptions excluding fixed places used solely for activities of a preparatory or auxiliary character (e.g., supply of information). FEMA/regulatory definition of 'Liaison Office' describes a place of business acting as a channel of communication that does not undertake commercial/trading/industrial activity and is maintained by inward remittance. Precedent treatment: The Court relied on the ratio in the apex-court decision holding that activities confined to the scope of RBI permission and of preparatory/auxiliary nature fall within Article 5(3)/(4) exceptions and do not amount to PE; that precedent was followed. Interpretation and reasoning: The Tribunal examined the LO's actual activities (collecting statistical/market information from refineries and user industries; preparing reports; no authority to conclude contracts; employees not involved in decision-making; no trading, no receipts from India; expenses met by inward remittances; audited accounts and statutory compliance). The revenue's contrary contention - that gathering information/business analytics employed qualified personnel and was integral rather than preparatory/auxiliary - was analysed against (a) whether the LO's functions formed part of a cohesive business operation in India (complementary functions to an existing PE or subsidiary), and (b) whether the LO enabled another in-country entity to carry on business such that the exceptions to PE would not apply (OECD/MLI concern about fragmentation). Key factual determinations: The in-country subsidiary was dormant; there was no evidence that information collected by the LO was used by any Indian PE/subsidiary to carry on business in India; LO employees lacked authority to sign contracts; no business was carried out in India; returns historically accepted by revenue without adjustment. Ratio vs. Obiter: The conclusion that the LO's activities are preparatory/auxiliary and within RBI permission - thereby not constituting a PE - is ratio (operative holding). Observations on the inapplicability of the revenue's evidentiary demands for proving negative facts and the inapplicability of the OECD anti-fragmentation example to the present facts are part of the Court's reasoning leading to the holding (ratio); broader commentary on the OECD BEPS Action 7 and MLI is explanatory (obiter to the extent it restates international policy but is applied to the facts). Conclusion: The LO does not constitute a business connection or PE under Article 5 read with Article 5(4) and relevant MLI provisions; the activities fall within the preparatory/auxiliary exceptions applicable to liaison offices operating under RBI permission. Issue 2 - Whether the LO's activities are preparatory/auxiliary or constitute complementary functions of a cohesive business operation (MLI/OECD Action 7 implications) Legal framework: Article 5(4) exceptions; MLI/paragraphs implementing OECD Action 7 to prevent artificial avoidance of PE by fragmenting cohesive operations; OECD commentary/examples addressing complementary functions and existing PEs. Precedent treatment: The Tribunal applied the apex-court precedent that where LO activities conform to RBI permission and are preparatory/auxiliary, they do not give rise to PE; the Tribunal also considered OECD examples to test the revenue's fragmentation/complementarity argument. Interpretation and reasoning: OECD Action 7 and MLI were acknowledged as clarifying that complementary functions forming part of a cohesive business operation can negate the preparatory/auxiliary exception where another PE exists. The Tribunal found no factual basis for such application: the alleged in-country subsidiary was dormant and not carrying on business; the revenue did not show that information collected by the LO was used by, or complementary to, activities of any in-country PE; thus the anti-fragmentation rule did not apply. Ratio vs. Obiter: The application of the OECD/MLI principles to test complementarity and fragmentation - and the finding that those principles did not negate the Article 5(4) exception on the facts - is part of the operative ratio. Exposition of OECD policy background is explanatory context (obiter to the extent not essential). Conclusion: OECD/MLI anti-avoidance principles do not apply on the facts; the LO's information-gathering and reporting are preparatory/auxiliary and excluded from PE under Article 5(4). Issue 3 - Validity of profit attribution to a PE (adhoc attribution reduced by DRP to 12.27% / AO's earlier 50%) Legal framework: Where a PE is found, profits attributable to the PE are to be determined in accordance with conventional norms; safe-harbour approaches/similar benchmarks (e.g., business analytics/market research margins under Rule 10) may be invoked for estimation when appropriate. Precedent treatment: The lower authorities applied an attribution percentage (first 50%, then 12.27%) by deeming LO activities to generate profits attributable to a PE; Tribunal's determination that there is no PE renders the attribution question moot. Interpretation and reasoning: Because the Tribunal held that the LO is not a PE, there is no legal basis to attribute profits to a PE. The Tribunal therefore deleted the adhoc addition made on account of PE attribution. The Tribunal observed that the revenue's finding that parties with whom business was conducted were not disclosed improperly demanded proof of a negative (i.e., that no business had occurred) and could not sustain the conclusion of PE or attribution. Ratio vs. Obiter: The deletion of the profit attribution/addition is ratio - it follows necessarily from the principal holding that no PE exists. Comments on estimation methodology by revenue and on safe-harbour approaches are obiter/contextual insofar as no PE was found to which such methods could apply. Conclusion: Profit attribution and the assessment addition based on an assumed PE are deleted; the adhoc addition is unsustainable in absence of a PE. Issue 4 - Ancillary grounds (limitation, AO applying resident provisions, selection for scrutiny) Legal framework and reasoning: These grounds were raised but the Tribunal's decision on the primary issue (no PE) rendered the limitation objection and other ancillary contentions academic. Conclusion: Ancillary legal grounds were left open/as academic in view of the Tribunal's decision on the merits that the LO is not a PE; appeal is partly allowed to the extent of deleting the PE-based addition.