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Karnataka HC Rules On Taxability Of Liaison Office

Published on Mon, Jun 24,2013 | 17:29, Updated at Mon, Jun 24 at 17:30Source : 

By Nikhil Rohera, Executive Director -Direct Tax , PwC

In a much awaited judgement, the Karnataka High Court has held that the Indian Liaison Office (LO) of a US sports major does not trigger its taxable presence in India. The High Court thus held that no part of the assessee company’s income could be brought to tax by virtue of the procurement activities of the LO in India.

The issue of taxability of LO of foreign MNCs in India has been gaining controversy with some conflicting rulings being pronounced by Courts in recent times.  It will be recalled that not so long ago, the same Court in Jebon Corporation V. CIT 19 119 had held that LO of the South Korean assessee which was soliciting sales in India resulted in its permanent establishment and hence, taxability in India. However, the key difference in assessee’s case seemed to be that it’s LO was procuring ‘purchases’ from Indian suppliers as distinct from Jebon’s LO which was soliciting ‘sales’ orders to prospective Indian buyers.

The assessee had its Head Office (HO) in USA from where it arranged the procurement of goods to its various subsidiaries spread all over the world.  It set up a LO in India in the year 1997 after seeking necessary approval from the Reserve Bank of India (RBI).   In its application for approval, the assessee had categorically stated that the LO will not undertake any activity of trading, commercial or any industrial nature or enter into any business contracts in its own name.  Further, it will not charge any commission or remuneration for any of the services rendered by it in India.  As such, the expenses of the LO were to be met only by inward remittances from the US HO.  The main activity of the LO was to facilitate procurement of apparels from Indian manufacturers on behalf of various overseas affiliates.  Of course, with a view to ensure quality of various products sourced from India, the LO employed expert staff like quality engineer, product analyst, etc.

As a result of the survey conducted on the LO under section 133A of the Income-tax Act, 1961 (‘the Act’), the activities carried on were verified in detail by the tax authorities.  As the LO had not filed any tax returns, reopening notices were issued under section 148.   The assessee contended that the activities of the LO were well within the limited framework of RBI guidelines and are only ancillary and auxiliary to the activities of the HO.  It contended that no income can be deemed to accrue or arise in India to any non-resident from operations that are confined to the purchase of goods in India for the purposes of export in terms of Explanation 1(b) to section 9(1) (i) of the Act.  The Assessing Officer (AO) however did not accept the claim of the assessee and held that a part of the assessee’s income is chargeable to tax in India.  Thus, he proceeded to estimate 5% of the export value as taxable income from the activities of the LO.  While the Commissioner (Appeals) confirmed the action of the AO, the Bangalore Income Tax Appellate Tribunal reversed these orders on second appeal and granted relief to the assessee.

The Revenue appealed the matter before the Karnataka High Court and contended that the LO operated beyond its scope and contravened the terms of approval granted by RBI.  Further, it argued that the purchase of goods by the overseas affiliates cannot be equated with purchase of goods by the assessee and therefore the benefit of Explanation (1)(b) could not be granted to the assessee.  On the other hand, the assessee countered by stating that the transaction in question is clearly limited to purchase of goods for the purposes of export which cannot result in any taxable income in India.

The High Court, after analysing the relevant provisions of the Act, held that the assessee does not have any ‘business connection’ in India as so defined.  In doing so, the Court relied upon the landmark decisions of Apex Court in Anglo-French Textile Company and R.D. Agarwal where it was held that a relation to be a business connection must be real and intimate and from which income must accrue or arise whether directly or indirectly to the non-resident.  It was observed that even the definition of business connection excluded activities which were limited to purchase of goods for the non-resident. It was also heartening to see the Court go behind the object of such provisions and opine that the purpose was also to encourage exports so that the Country could benefit by earning foreign exchange (surely, this observation will resonate with many given that our Rupee has depreciated to its all-time low!).

As per the Court, the assessee was not earning any income in India and it was not even certain whether the overseas affiliates were paying any consideration to the assessee outside India.  If at all, this contract between the assessee and the overseas affiliates was entered outside India and for that reason too, even if any income accrued to the assessee, it would be outside India.

In times like these, where various MNCs have been put under the scanner in India for alleged tax defaults, this judgement comes as a welcome relief and should reinforce faith in the Indian judiciary. Having said that, it will be interesting to see if the Revenue now decides to knock on the doors of the Apex Court.


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