2009 (4) TMI 505 - AT - Income Tax

DTAA between India and South Korea - No PEs or Liaison Office - Survey - Reopening - The case of the assessee would have been covered under art. 5(4)(e) if the LO is maintained solely for the purpose of advertising, supply of information, scientific research or any other activity if it has a preparatory or auxiliary character in the trade or business of the enterprise - In the instant case, the LO is having a freedom to fix the sale price and to conclude the contract provided the sale prices are within the band of profit margin communicated by the head office - Held that the AO was justified in holding that LO is a PE and therefore, income attributable to LO will be taxable as per art. 7 of the DTAA - The learned CIT(A) held that income of the non-resident assessee is not taxable under 9(1)(i) or under the DTAA and therefore has not decided the issue regarding validity of reopening of assessment and the quantum of profit attributable to the PE - as per DTAA, the profit attributable to the LO held as PE in India is taxable and therefore, the learned CIT(A) will have to adjudicate the issue on which he has not recorded his finding - Decided against the assessee

Issues Involved:
1. Existence of a Permanent Establishment (PE) in India.
2. Deemed accrual of income in India under Section 9 of the IT Act and Article 7 of the DTAA.
3. Nature of activities conducted by the Liaison Office (LO).
4. Validity of RBI approval in the context of IT Act.
5. Basis of conclusions drawn by the Assessing Officer (AO).
6. Finalization of contracts and pricing by the LO.

Analysis:

1. Existence of a Permanent Establishment (PE) in India:
The primary issue was whether the South Korean company's Liaison Office (LO) in India constituted a PE under Article 5 of the DTAA between India and South Korea. The Revenue argued that the LO was habitually exercising authority to conclude contracts in India, thus establishing a PE. The Tribunal examined the flowchart of the LO's business processes and statements from employees, concluding that the LO's activities went beyond mere liaison work and included significant business activities such as negotiating prices and securing orders. Therefore, the LO was deemed to be a PE under Article 5(2) and not excluded under Article 5(4)(e) as its activities were not merely preparatory or auxiliary.

2. Deemed Accrual of Income in India under Section 9 of the IT Act and Article 7 of the DTAA:
The Tribunal considered Section 9(1)(i) of the IT Act, which deems income to accrue in India if it arises through a business connection in India. The Tribunal found that the LO's activities created a business connection as defined under Explanation 2 to Section 9(1), particularly since the LO habitually secured orders for the non-resident company. Consequently, income attributable to these activities was deemed to accrue in India and was taxable under the IT Act. Furthermore, under Article 7 of the DTAA, profits attributable to the PE in India were taxable, reinforcing the conclusion that the LO's activities led to taxable income in India.

3. Nature of Activities Conducted by the Liaison Office (LO):
The Tribunal reviewed the activities of the LO, which included identifying customers, negotiating prices, and securing orders. Statements from the country manager and other employees indicated that the LO had significant freedom in price negotiations and concluding contracts, albeit within certain margins set by the head office. These activities were not merely preparatory or auxiliary but were integral to the business operations, contributing directly to the non-resident company's income. Thus, the LO's activities were deemed to constitute business activities rather than mere liaison work.

4. Validity of RBI Approval in the Context of IT Act:
The Tribunal noted that while the LO had RBI approval to operate, this approval was granted under the Foreign Exchange Management Act (FEMA) and was not determinative of the LO's activities under the IT Act. The RBI approval indicated that the LO was not engaged in trading, commercial, or industrial activities as per FEMA. However, for tax purposes, the nature of activities had to be independently examined under the IT Act. The Tribunal concluded that despite the RBI approval, the LO's activities constituted business operations under the IT Act.

5. Basis of Conclusions Drawn by the Assessing Officer (AO):
The AO's conclusions were based on a survey and statements recorded during the survey. The AO inferred that the LO was involved in full-fledged business activities, including price negotiations and securing orders. The Tribunal upheld these findings, noting that the AO's conclusions were supported by substantial evidence, including statements from employees and the nature of the LO's operations.

6. Finalization of Contracts and Pricing by the LO:
The Tribunal examined whether the LO had the authority to finalize contracts and pricing. Evidence showed that the LO had significant autonomy in negotiating prices within a specified margin and could finalize contracts without always reverting to the head office. This autonomy in concluding contracts and negotiating prices was a key factor in determining that the LO constituted a PE and was engaged in business activities, leading to taxable income in India.

Conclusion:
The Tribunal concluded that the LO of the South Korean company in India constituted a PE under Article 5 of the DTAA. The activities of the LO were not merely preparatory or auxiliary but were integral to the business operations, leading to taxable income in India under Section 9(1)(i) of the IT Act and Article 7 of the DTAA. The Tribunal directed the CIT(A) to adjudicate on the issues of reopening of assessment and the quantum of profit attributable to the PE, as these issues were not decided by the CIT(A) in the initial proceedings. The appeals by the Revenue were allowed, subject to the Tribunal's observations.

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