2011 (2) TMI 1233 - HC - Income Tax

Permanent establishment - as per Double Taxation Avoidance Agreement the profit attributable to the liaison office held as a permanent establishment in India Held that - merely because the buyers place orders directly with the Head Office and make payment directly to the Head Office and it is the Head Office which directly sends goods to the buyers would not be sufficient to hold that the work done by the liaison office is only liaison and it does not constitute a permanent establishment as defined in Article 5 of DTAA liaison office is undertaking an activity of trading and therefore entering into business contracts fixing price for sale of goods and merely because the officials of the liaison office are not signing any written contract would not absolve them from liability finding recorded by the tribunal is based on legal evidence and that the finding that the liaison office is a permanent establishment as defined under Article 5 of DTAA and therefore the business profits earned in India through this liaison office is liable for tax is established appeals are dismissed

Summary

Issues Involved:
1. Whether the liaison office constitutes a permanent establishment under Article 5 of the Double Taxation Avoidance Agreement (DTAA).
2. Whether the income attributable to the liaison office is taxable in India.
3. Compliance with RBI permissions and conditions for liaison offices.

Issue-wise Detailed Analysis:

1. Permanent Establishment under Article 5 of DTAA:

The primary issue revolves around whether the liaison office in Bangalore qualifies as a permanent establishment (PE) under Article 5 of the DTAA between India and South Korea. According to Article 5, a PE is defined as a "fixed place of business through which the business of an enterprise is wholly or partly carried on." The tribunal and the High Court scrutinized the activities of the liaison office, which included identifying customers, negotiating prices, securing orders, and providing post-sale support. The tribunal noted that the liaison office was not merely acting as a communication channel but was involved in full-fledged business activities. This conclusion was supported by the statements of the employees, who confirmed that they had significant autonomy in price negotiations and sales activities. Therefore, the tribunal held, and the High Court affirmed, that the liaison office had all the characteristics of a PE as defined under Article 5 of the DTAA.

2. Taxability of Income Attributable to the Liaison Office:

The second issue concerns whether the income attributable to the liaison office is taxable in India. Article 7 of the DTAA states that the profits of an enterprise of a Contracting State shall be taxable only in that State unless the enterprise carries on business in the other Contracting State through a PE situated therein. The High Court agreed with the tribunal's finding that the liaison office was engaged in activities that went beyond mere liaison work and constituted substantial business operations. Consequently, the profits attributable to these activities were deemed to accrue or arise in India and were therefore taxable under Indian law. The tribunal's reference to the Apex Court's judgment reinforced the principle that business profits can be taxed in India if there is a business connection or a PE in India.

3. Compliance with RBI Permissions and Conditions:

The third issue pertains to whether the liaison office was operating within the scope of permissions granted by the Reserve Bank of India (RBI). The RBI had granted permission for the liaison office to undertake solely liaison activities, explicitly prohibiting any trading, commercial, or industrial activities. Despite these conditions, the investigation revealed that the liaison office was involved in commercial activities, including negotiating prices and securing orders. The High Court noted that the RBI's lack of action against the liaison office did not absolve it from liability under the Income Tax Act. The tribunal and the High Court concluded that the liaison office's activities violated the terms of the RBI's permission and constituted a PE, thereby making the income attributable to these activities taxable in India.

Conclusion:

The High Court dismissed the appeals, affirming the tribunal's findings that the liaison office in Bangalore constituted a permanent establishment under Article 5 of the DTAA and that the income attributable to it was taxable in India. The court also emphasized that the liaison office's activities exceeded the scope of the RBI's permissions, further justifying the tax liability. The judgment underscores the importance of adhering to regulatory permissions and the broad interpretation of what constitutes a permanent establishment for tax purposes.