The High Court of Delhi in its recent judgement of DIT Vs. Mitsui & Co. Ltd (ITA 13/2005) expounded the criteria of classification of taxpayers as being a Permanent Establishment in India and the income directly or indirectly attributable to them being taxable. The Hon’ble Court through this judgement, established that the Liaison and Project Offices did not constitute Permanent Establishment (PE) and the income from the business turnover or imports in India was exempted from the purview of Double Taxation Avoidance Agreement (DTAA). It was held that where the taxpayer is not carrying on any activity of business, it cannot be regarded as PE.
Brief Facts
The taxpayer is a non-resident company headquartered in Japan and had two projects in India. Income Tax Return was filed by the taxpayer which was subsequently revised. The Assessing officer (AO) scrutinized and made addition to the taxable income concluding the taxpayer to be a Permanent Establishment (PE) in India with respect to the Indo-Japanese (‘DTAA’). As per the view of AO, the LO of the taxpayer helped it in finding new purchasers and sellers of goods and merchandise.
The taxpayer contended that it complied to the RBI guidelines to have an LO in India and that the said LOs merely provided information to the overseas offices and, thus the taxpayer had declared Nil income in respect of its liaison activity in India.
Considering the details of telephone expenses of the Project Office (PO), the AO concluded that some part thereof pertained to the LO and it was difficult to say that LO was separated from the project operations.
The AO contemplated the income from the project as taxable under Section 44BBB of the Act by taking the profit at 10 per cent of the total turnover and thus added some amount to the taxpayer’s income disallowing the loss claimed.
The Commissioner of Income Tax (Appeals) and eventually the Income Tax Appellate Tribunal arrived at the conclusion that the taxpayer as not a PE and income directly or indirectly attributable to these branches/offices is not taxable in India.
Decision
The Hon’ble Court upheld the correctness of the decision of the ITAT that:
1. Indian branches/offices of the taxpayer and their activities cannot be regarded as permanent establishment in India and income directly or indirectly attributable to these branches/offices is not taxable in India
2. The taxpayer does not have any permanent establishment in India and its income from business turnover/imports in India was exempt in view of Agreement for Avoidance for Double Taxation between Indian and Japan
Ratio
The Court gave detailed reasoning for their judgment which was based on the following points:
- In order to establish that the taxpayer is a PE, it is essential that such place was “a fixed place of business through which the business of an enterprise is wholly or partly carried out” and does not merely have an office, factory or workshop. (Articles 5(1) & (2) of DTAA).
- The use of facility solely for the purpose of search or display or for the maintenance of place for business solely for the purchases of goods or collecting information or for any other activity “preparatory or auxiliary in character” would take the outside the ambit of a PE.
- Merely because some portion of the telephone expenses were attributable to the LO or that the Chief Representative was managing both the LO as well as the PO was insufficient to conclude the LO was being used to carry on the business of the enterprises.
- After having treated the POs as separate taxable units and having offered the profits therefrom to tax under Section 44 BBB of the Income tax Act, the said POs cannot also be treated as PEs for the purpose of the DTAA.
- With respect to the issue of activity of ‘preparatory or auxiliary character’ the court considered the decision in National Petroleum Company Construction v. DIT as per which
- Liaison office can act as a channel of communication between the principal place of business and the entities in India and cannot undertake any commercial trading or industrial activity;
- Project office can play a much wider role but shall not undertake or carry on any other activity other than the “activity relating and incidental to execution of the project”.
- The taxpayer complied with the RBI regulations for running LO and the same had been accepted the RBI.
Opinion
In order to establish their business in India, the foreign companies enter the country through Liaison offices and Project Offices.
Being an extension of the Company headquartered abroad, Liaison offices primarily function to act as a media to connect the Parent Company with the Indian counterparts, aiding in development of prospective business ventures by collecting market information, providing technical and financial assistances and promoting imports and exports. For a Liaison Office to be established in India, mandatory compliances to RBI regulations should be made. The Liaison offices are strictly prohibited from carrying out any commercial activities in India directly or indirectly.
Project Offices manage large-scale, single, independent projects which are established only for the duration of the projects. These offices can undertake all activities that relate to the execution of project and its function and its function is not limited only to act as a channel of communication. RBI regulations permitting the setting up of project offices in India imposes restrictions on them preventing them thereby to undertake any activity other than execution of project.
The present judgement has endorsed the fact that, the taxpaying foreign offices are not involved in business transactions with Indian customers, no income accrues or arises in India. Accordingly, they should not be construed as a Permanent Establishment to enable them tax exemption in the view of DTAA. This will be beneficial in the longer run to promote investments in India.