Volume 4, Issue 1

3rd May, 2011

Tax Alert
Liaison Office- Permanent Establishment or Not ?

Recently, in the case of Jebon Corporation India1 for Assessment Year (A.Y.) 2006-07 on the issue of whether a liaison office (LO) opened with the permission of Reserve Bank of India (RBI) constitutes a Permanent Establishment (PE) and accordingly, liable to tax in India; the Karnataka High Court has held that the activities undertaken by the LO were commercial in nature and not limited to liaison activities. The fact that the RBI had not taken any action against the LO does not necessarily imply that the LO was not undertaking commercial activities. This Tax Alert analyses this ruling and its implications.

Facts of the Case

The Assessee is a South Korean enterprise engaged in the business of manufacturing Printed Circuit Boards (PCBs), Liquid Crystal Displays (LCDs) and Switch Mode Power Supplies (SMPs) in its factory in China.

It had set up a LO at Bangalore in India in 1998 after obtaining prior approval from the RBI and the same was renewed from time to time. The Assessee did not file any return of income in India on the premise that it was not carrying on any business in India.

A survey was conducted on the premises of the LO in FY 2006-07 by the tax department and statements of some of the employees were recorded. The Assessing Officer (AO) noted that the salaries paid to the employees of the LO were quite high and that these employees were not performing mere liaison functions but were also performing other non-liaison functions. The AO observed that the LO was found to be performing functions such as identifying new customers, pursuing and follow-up with customers, securing orders, processing of orders, negotiating the price, providing after sale services and follow-up for invoice realization. Consequently, the AO issued a notice for A.Y. 2001-02 to 2005-06 and required the LO to file return of income in India. The LO did not file the return of income on the ground that it was not carrying on any business in India.

The AO concluded the assessments and held that though the office established at Bangalore was treated as a liaison office, it had all the characteristics of a permanent establishment as defined under Article 5 of the Treaty.

Aggrieved by the said order, the assessee appealed to the first appellate authority - Commissioner of Income Tax (Appeals) (CIT(A)). The CIT(A) held that the LO had only limited flexibility in fixing its margins as it was subject to the minimum and maximum margins fixed by the Head Office (HO). It was further held by the CIT(A) that the findings of the AO cannot be based purely on the statements of the employees and hence, the order passed by the AO was set aside.

The matter went before the Tribunal and it was held that the LO is engaged in the promotion of import in India by procuring purchase orders after negotiating the deals and that the activities of the LO were not confined only to liaison work. The Tribunal held that the   LO  was  actually  carrying  on  commercial  activities  of  procuring orders, identifying
buyers, negotiating with buyers, agreeing to a price, negotiating with the buyers and securing orders. The LO would also follow up with customers for after sales support and realization of payments.

The Tribunal therefore concluded that there was a business connection in respect of the income of the assessee and hence, the LO constituted a PE in India.

Issue before the High Court

Whether the activities of LO constituted a PE in India and accordingly, was the assessee liable to tax in India?

Contentions of the Assessee before the High Court

The assessee contended that it was engaged solely in liaison activities as permitted by the RBI i.e., acting as a mere communication channel between the HO at Korea and the parties in India by communicating technical specifications, commercial terms and bridging the language barrier.

The LO comprised five employees whose role was limited to finding out prospective buyers for the assessee's products, obtaining enquiries in that regard and passing them on to the HO in Korea.

After obtaining the quotations for the products from the HO, the LO would communicate the same to the intending buyers.
Eventually, the customers would place purchase orders directly on the HO at Korea and supplies were made from Korea to the customers and the amount was paid directly to the HO at Korea and the only job of the LO was to make enquiries, communicate to the HO the price quoted by the customers and after conclusion of the contract, to see that the material is supplied and also that the payment is made by the customer.

Further, it was contended that since the RBI had not taken any action against the assessee for conducting the above activities, interference from the tax authorities was not justified.

Contentions of the tax authorities before the High Court

The High Court upheld the Tribunal’s order on the ground that the activities conducted by the LO amounted to commercial activities and not merely liaison activities.

The fact that the officials of the LO are not signing any contracts would not absolve them from any liability.

The Tribunal is the final fact finding authority and the finding recorded by the Tribunal is based on the legal evidence found during the course of investigation and the same has been clearly spelt out by the AO in his assessment order.

As regards the assessee’s contention that, since RBI had not taken any action for conducting commercial activities, the finding of the AO are illegal and unjustified, the High Court held that the tax authorities have discovered the facts during the course of investigation and merely because RBI has not taken any action will not render the findings recorded by the AO as illegal or unjustified.

Accordingly, it was held that activities conducted by the LO amounted to commercial activities and hence, the LO constituted a PE in India and consequently, the same would be liable to tax in India.

Our Comments

While setting up an LO, it is imperative to ensure that the activities of the LO are confined to liaison activities alone.

In this case, even though the employees of the LO have not signed any contract, the Court has nevertheless held that the LO constituted a PE. This sets a precedent for the tax authorities to tax Liaison Offices based on the facts.

The tax authorities can investigate and identify the actual activities undertaken by the LO even though the RBI has not initiated any action.

One needs to examine the activities of the existing LO on an annual basis, in the light of the above decision and find ways and means to mitigate the risks identified on such examination as the Finance Act, 2011 has made it mandatory for all LOs to file within 60 days from the end of the financial year, a statement showing activities of the LO in that financial year.

1 ITA No. 451 of 2009 and ITA Nos. 704-708 of 2009