Supreme Court DecisionsWhether Liaison Office is a Permanent Establishment?

SUPREME COURT OF INDIA

Union of India v. U.A.E. Exchange Center

CIVIL APPEAL NO. 9775 OF 2011 | 24th April, 2020

BACKGROUND

In the present case, the Respondent is the private limited company having its permanent residence in the United Arab Emirates (UAE). The Respondent company was engaged in the business of offering remittance services for transferring amounts from UAE to various places in India, wherein the funds were collected by the Respondent from the NRI remitter by charging him 15 Dirhams as a one-time fee.

The Respondent sends the electronic remittance of the funds after collection of the funds on the request of the NRI remitters on the behalf of NRI customers and dispatches the instrument/cheque through its liaison office to the beneficiaries in India which have been designated by the NRI remitters.

The Respondent has filed the application under Section 245Q (1) of the Income Tax Act, 1961 (the Act) before the AAR for Advance Rulings (Income Tax), New Delhi (“AAR”), The AAR held that income shall be deemed to accrue in India from the activity carried out by the liaison offices of the Respondent in India and answered the question affirmatively against the Respondent.

The Income Tax Authorities by relying on the ruling of the AAR has issued the notices to the Respondent. This led the matter reach before the Hon’ble High Court of Delhi at New Delhi (“the High Court”) by way of UAB Exchange Centre Ltd. v. Union India 313 ITR 94 inter alia, for quashing of the ruling of the AAR dated 26.5.2004, wherein the High Court ruled in the favour of the Respondent and held that activities carried out the liaison offices of the Respondent shall not be constituted as a Permanent Establishments (PE). It held that the liaison office does not contribute directly or indirectly to the income of the Respondent in UAE and liaison office was only a supportive or subsidiary of the transactions of the UAE.

Department being aggrieved has assailed the decision of the High Court by way of the present appeal arising from SLP(C) No. 31276/2011.

ISSUE BEFORE THE SUPREME COURT

Whether the activities carried by the Respondent would qualify the expression “of preparatory or auxiliary character” or would amount to the Permanent Establishment (PE)?

ANALYSIS OF THE JUDGMENT

The Apex Court (the Court) regarding the substantial issue noted that Respondent preliminarily applied to the Reserve Bank of India (RBI) vide letter dated 24.9.1996 for the approval of opening its liaison office in India under Section 29 (1)( a) of the Foreign Exchange Regulation Act, 1973 wherein RBI  had accorded for establishing a liaison office of the Respondent at Cochin, initially for three years for the limited activities which cover the activities carried by the liaison office of the Respondent in India.

The Court on the factual terms noted that activities carried on by the Respondent from the said liaison offices are stated to confirm with the terms and conditions prescribed by the RBI in its letter dated 24.9.1996 wherein as per the contract of the NRI remitters and Respondent, Respondent makes an electronic remittance of the funds on behalf of its NRI customers by the way of sending instruments/cheques through its liaison offices to the beneficiaries in India, designated by the NRI remitter after collecting it from the NRI remitters.

The real issue arises from the mode of remittance of the fund i.e. from remittance through liaison office.  Court further noted that Respondent is in line with the required compliance provided under Section 139 of the Act since in assessment years 1998-1999 till 2003-04 Respondent had shown the Nil income of its liaison office as no income was accrued in India in light of the Act and Double Taxation Avoidance Agreements (DTAA) between India and UAE for which Income Tax Authorities of India has also never objected. 

The Court highlighted the ruling of the High Court wherein Respondent aggrieved with the order of the AAR has challenged the order of the AAR dated 26.05.2004 wherein the High Court observed that the AAR committed manifest error in appreciating the relevant facts and materials on record and more particularly, misread the purport of Section 90 of the Act and the settled legal position that the DTAA ought to override the provisions of the Act.

The High Court replied on the decision of Union of India & Anr. v. Azadi Bachao Andolan ITR 706 SC 10 SCC 1 and observed that while considering the Article 5 read with Article 7 of the DTAA, profits of the company is liable to tax in India if it has its PE in India. Under Article 5(2)(c), amongst others, permanent establishment includes an office, However, Article 5(3) provides for the exception with the non-obstacle clauses wherein where-under the DTAA various activities have been deemed as ones which would not fall within the ambit of the expression ‘permanent establishment’. Article 5(3)(e) specifically states that;

“maintenance of fixed place of business solely for the purpose of carrying on, for the enterprise, any other activity of a preparatory or auxiliary character.”

High Court stated that the activity carried by the liaison office in India was merely to download information possessed in the main servers located in UAE based on which cheques are drawn on banks in India, thereafter the said cheques are couriered or dispatched to the beneficiaries in India, after considering the instructions of the NRI remitter. Such activities clearly shows the nature of service provided by the liaison office which is supportive in a character and nothing but auxiliary in nature, thus the activities carried by the Respondent falls under the ambit of Article 5(3)(e) of the DTAA. The High Court concluded that;

“the activity carried on by the liaison offices of the respondent in India did not in any manner contribute directly or indirectly to the earning of profits or gains by the respondent in UAE and more so, every aspect of the transaction was concluded in UAE, whereas, the activity performed by the liaison offices in India was only supportive of the transaction carried on in UAE”

The Court after observing the ruling of the High Court stated that; having the fixed place of business in India does not result into the deemed taxability of the liaison office in India, though the Respondent has the fixed place of business through which the business of the respondent was being wholly or partly carried on. However, the same would not be conclusive until PE situated in India attracts Article 7 of DTAA of India-UAE which deals with the business profits to become taxable in India, to the extent attributable to the PE of the respondent in India.

The Court again retreated the position held by High Court in the decision of DIT (International Taxation) v. Morgan Stanley & Co. Inc. [2007] 162 Taxman 165/292 ITR 416,wherein it was held that ;

“In our view, the second requirement of Article 5(1) of DTAA is not satisfied as regards back office functions. We have examined the terms of the Agreement along with the advance ruling application made by MSCo inviting AAR to give its ruling. It is clear from reading of the above Agreement/application that MSAS in India would be engaged in supporting the front office functions of MSCo in fixed income and equity research and in providing IT enabled services such as data processing support centre and technical services as also reconciliation of accounts. In order to decide whether a PE stood constituted one has to undertake what is called as a functional and factual analysis of each of the activities to be undertaken by an establishment. It is from that point of view, we are in agreement with the ruling of AAR that in the present case Article 5(1) is not applicable as the said MSAS would be performing in India only back office operations. Therefore to the extent of the above back office functions the second part of Article 5(1) is not attracted.”

“Lastly, as rightly held by AAR there is no agency PE as the PE in India had no authority to enter into or conclude the contracts. The contracts would be entered into in the United States. They would be concluded in US. The implementation of those contracts only to the extent of back office functions would be carried out in India, and therefore, MSAS would not constitute an agency PE as contended on behalf of the Department.”

“In DTAA, the term PE means a fixed place of business through which the business of an MNE is wholly or partly carried out. The definition of the word PE in Section 92-F(iii) is inclusive, however, it is not under Article 5(1) of the Treaty. It is for this reason that Article 5(2) of DTAA herein refers to places included as PE of the MNE. One such place is mentioned in Article 5(2)(l) which deals with furnishing of services.”

“The concept of PE was introduced in the 1961 Act as part of the statutory provisions of transfer pricing by the Finance Act of 2001. In Section 92-F(iii) the word “enterprise” is defined to mean

“a person (including a permanent establishment of such person) who is, or has been, or is proposed to be, engaged in any activity, relating to the production, …”

“Under CBDT Circular No. 14 of 2001 it has been clarified that the term PE has not been defined in the Act but its meaning may be understood with reference to DTAA entered into by India. Thus the intention was to rely on the concept and definition of PE in DTAA. However, vide the Finance Act, 2002 the definition of PE was inserted in the Income Tax Act, 1961 (for short “the IT Act”) vide Section 92-F(iiia) which states that the PE shall include a fixed place of business through which the business of MNE is wholly or partly carried on. This is where the difference lies between the definitions of the word PE in the inclusive sense under the IT Act as against the definition of the word PE in the exhaustive sense under DTAA. This analysis is important because it indicates the intention of Parliament in adopting an inclusive definition of PE so as to cover service PE, agency PE, software PE, construction PE, etc.”

“There is one more aspect which needs to be discussed, namely, exclusion of PE under Article 5(3). Under Article 5(3)(e) activities which are preparatory or auxiliary in character which are carried out at a fixed place of business will not constitute a PE. Article 5(3) commences with a non obstante clause. It states that notwithstanding what is stated in Article 5(1) or under Article 5(2) the term PE shall not include maintenance of a fixed place of business solely for advertisement, scientific research or for activities which are preparatory or auxiliary in character. In the present case we are of the view that the abovementioned back office functions proposed to be performed by MSAS in India falls under Article 5(3)(e) of DTAA. Therefore, in our view in the present case MSAS would not constitute a fixed place PE under Article 5(1) of DTAA as regards its back office operations.”

The Court followed the aforesaid ruling in the case of Morgan Stanley & Co. Inc (Supra) and stated that the Respondent has not varied any business activities in India but was only carrying the activities which were supportive in nature of remittances by downloading information from the main server of the respondent in UAE and printing cheques/drafts drawn on the banks in India as per the instructions given by the NRI remitters in UAE for which not no charges or fees were collected by the liaison office in India related to it. The Court further stated that no income is earned by the liaison office in terms of Section 2(24) of the Act as a liaison office in the present case is not the PE as it was only involved in carrying the activities which were of preparatory and auxiliary character. The Court finally upholds the conclusion reached by the High Court and held that; ;

“no tax can be levied or collected from the liaison office of the respondent in India in respect of the primary business activities consummated by the respondent in UAE. The activities carried on by the liaison office of the respondent in India as permitted by the RBI, clearly demonstrate that the respondent must steer away from engaging in any primary business activity and in establishing business connection as such. It can carry on activities of preparatory or auxiliary nature only. In that case, the deeming provisions in Sections 5 and 9 of the 1961 Act can have no bearing whatsoever.”

CONCLUSION

The present judgement has reiterated the positions of the law wherein it elucidated on Article 5(2) wherein a fixed place of business through which the business of an enterprise is wholly or partly carried on is regarded as a PE, however reading the Article 5(2) on a standalone basis would amount to absurdity.

Article 5(3) opens with a non-obstante clause wherein clause (e) of Article 5(3) specifically creates an exception to Article 5(2) wherein activities which are preparatory or auxiliary in character which are carried out at a fixed place of business will not constitute a PE. Article 5(3) commences with a non-obstante clause. It states that;

“notwithstanding what is stated in Article. The present case is a best example to cover under the roof of this exception.”

The High Court observed that the meaning of the activities covered under preparatory or auxiliary character wherein it explains that any subsidiary acting as a supportive or an aid to the main activity of the company would not result in the PE of the particular subsidiary.

While determining the existence of a PE in India of any company, sub-clause (e) of Article 5(3) has to be taken in a wider and liberal way. Once any activity has being construed being subsidiary or support of the main activity, then it would fall under the ambit of exclusionary clause i.e. sub-clause (e) of the Article 5 (3) of DTAA.

The High Court has also discussed on the facet of Section 90 of the Act by relying on the various decisions wherein it has become a trite law that the provisions of the DTAA will have an overriding effect on the provisions of the Act and shall apply even if it inconsistent with the provisions of the Act.

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