2014 (11) TMI 508 - HC - Income Tax

Liability to tax on business income - Article 5(3)(e) of India-USA DTAA LO constitutes PE or not - Whether the Liaison Office ('LO') was engaged in marketing/ promoting assessee's products in India Held that - The AO during the course of the assessment proceedings, had called upon the assessee to explain the nature of its activities - assessee also explained before the AO in pursuance of a notice to show cause dated 13 February 2006 that initially it had an agent in India for the purpose of contacting buyers but during the year relevant to the AY, the assessee had set up a liaison office - The assessee also explained before the AO that the activities of the liaison office also included various activities, for instance, coordinating the commercial activities like purchase orders, letters of credit and shipment - This was carried out through the office of the assessee at NOIDA by the Chief Representative Officer and other technical staff. The office also coordinated the technical service and sales visits of the company's representatives who visited India from the overseas office - The Tribunal rightly relied upon relevant documentary material in arriving at the conclusion that the activities of the liaison office established that it was promoting the sales of the assessee in India and the AO was justified in holding that the income attributable to the liaison office was taxable in India - the activity of the liaison office during the year relevant to the AY was not of a preliminary or preparatory nature so as to attract the exclusion under Article 5(3)(e) of the DTAA thus, no substantial question of law arises for consideration Decided against assessee. Article 7(1) of the DTAA provides that if an enterprise carries on business in the other contracting State through a permanent establishment situated therein, the profits of the enterprise may be taxed in the other State but only so much of them as is attributable to (a) that permanent establishment; (b) sales in the other State of goods or merchandise of the same or similar kind as those sold through that permanent establishment; or (c) other business activities carried on in the other State of the same or similar kind as those effected through that permanent establishment. The AO did not apply his mind to this crucial requirement which defines the extent of taxability - The AO followed a simplistic course of deducting the expenses of ₹ 38.86 lacs from the receipts of ₹ 63.72 lacs from the head office - Whether any part of the profits were attributable to the permanent establishment, has not been considered either in the order of the AO or, for that matter, by the Tribunal thus, the matter is remitted back to the AO for fresh determination of the taxable income having due regard to the provisions of Article 7 of the DTAA Decided partly in favour of assessee.

Issues Involved:
1. Tax liability of the appellant due to activities of the Liaison Office (LO) in India.
2. Applicability of Article 5(3)(e) of the India-USA DTAA regarding the LO's status as a Permanent Establishment (PE).
3. Taxation of surplus funds remitted by the appellant/Head Office.
4. Attribution of profits to the LO based on functions performed, assets employed, and risks assumed (FAR analysis).
5. Reasonableness of the Tribunal's decision.
6. Perversity of the Tribunal's findings.

Issue-wise Detailed Analysis:

1. Tax Liability of the Appellant Due to Activities of the LO in India:
The Tribunal upheld the findings of the Assessing Officer (AO) that the LO was engaged in marketing and promoting the appellant's products in India, thereby constituting business activities. The AO concluded that the LO's activities were not limited to being a communication channel but extended to searching for prospective buyers, providing information, and persuading them of the appellant's brand worth. Consequently, the income of the LO was computed as taxable in India.

2. Applicability of Article 5(3)(e) of the India-USA DTAA:
The appellant argued that the LO's activities fell within the exclusion of Article 5(3)(e) of the DTAA, which exempts activities of a preparatory or auxiliary character from constituting a PE. However, the AO and the Tribunal found that the LO's activities were beyond preparatory or auxiliary, involving actual marketing and promotion, thus constituting a PE. The Tribunal noted that the LO's performance was judged by the number of direct orders and market awareness generated, indicating substantial business activities.

3. Taxation of Surplus Funds Remitted by the Appellant/Head Office:
The AO taxed the amount received by the LO over and above the reimbursement of expenses, which the Tribunal affirmed. The LO had received funds exceeding the actual expenditure, and the excess was considered taxable income.

4. Attribution of Profits to the LO Based on FAR Analysis:
The appellant contended that only profits attributable to the LO's activities should be taxed, considering the functions performed, assets employed, and risks assumed. The Tribunal did not find merit in this argument, as the LO's activities were deemed substantial enough to warrant full taxation of the income attributed to it. However, the court noted that the AO did not adequately consider the extent of profits attributable to the PE, necessitating a fresh determination.

5. Reasonableness of the Tribunal's Decision:
The court found no perversity or misapplication of law in the Tribunal's decision. The Tribunal's findings were based on relevant documentary evidence and the nature of the LO's activities, which justified the conclusion that the LO was promoting sales and thus taxable in India.

6. Perversity of the Tribunal's Findings:
The court held that the Tribunal's findings were not perverse. The Tribunal correctly noted that the LO's activities were not merely preparatory or auxiliary but involved substantial business operations, justifying the taxation of income attributable to the LO.

Alternative Submission:
The court addressed the alternative submission regarding Article 7(1) of the DTAA, which limits taxability to the profits attributable to the PE. The AO did not consider this aspect, leading the court to restore the proceedings back to the AO for a fresh determination of the taxable income, considering the extent of profits attributable to the PE.

Conclusion:
The appeal was disposed of, with the proceedings restored to the AO for fresh determination of taxable income under Article 7 of the DTAA. No order as to costs was made.

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