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Liaison Office in India engaged in Preparatory & Auxiliary Business Activities is not a Permanent Establishment (PE) : Supreme Court pronounces Landmark Judgement  dated 24.4.2020, in "Union of India vs UAE Exchange Centre", in Civil Appeal No. 9775 of 2011

In its recent landmark judgement in the case of "Union of India vs UAE Exchange Centre (Civil Appeal No. 9775 of 2011)", the Hon'ble Supreme Court have laid down that Liaison Office of a Non Resident Entity in India, engaged in Preparatory & Auxiliary Business Activities, in accordance with RBI approval, is not to be considered as a Permanent Establishment (PE) of that Non Resident Entity in India, so as to attract taxability in India.

For ready reference of the worthy Readers, the operating paras of the said SC judgement are being reproduced as under:

"13. The concept of PE was introduced in the 1961 Act as part of the statutory provisions of transfer pricing by the Finance Act of 2001. In Section 92-F(iii) the word “enterprise” is defined to mean “a person (including a permanent establishment of such person) who is, or has been, or is proposed to be, engaged in any activity, relating to the production, …” Under CBDT Circular No. 14 of 2001 it has been clarified that the term PE has not been defined in the Act but its meaning may be understood with reference to DTAA entered into by India. Thus the intention was to rely on the concept and definition of PE in DTAA. However, vide the Finance Act, 2002 the definition of PE was inserted in the Income Tax Act, 1961 (for short “the IT Act”) vide Section 92-F(iii-a) which states that the PE shall include a fixed place of business through which the business of MNE is wholly or partly carried on. This is where the difference lies between the definition of the word PE in the inclusive sense under the IT Act as against the definition of the word PE in the exhaustive sense under DTAA. This analysis is important because it indicates the intention of Parliament in adopting an inclusive definition of PE so as to cover service PE, agency PE, software PE, construction PE, etc.

14. There is one more aspect which needs to be discussed, namely, exclusion of PE under Article 5(3). Under Article 5(3)(e) activities which are preparatory or auxiliary in character which are carried out at a fixed place of business will not constitute a PE. Article 5(3) commences with a non obstante clause. It states that notwithstanding what is stated in Article 5(1) or under Article 5(2) the term PE shall not include maintenance of a fixed place of business solely for advertisement, scientific research or for activities which are preparatory or auxiliary in character. In the present case we are of the view that the abovementioned back office functions proposed to be performed by MSAS in India falls under Article 5(3)(e) of DTAA. Therefore, in our view in the present case MSAS would not constitute a fixed place PE under Article 5(1) of DTAA as regards its back office operations.” (emphasis supplied) Learned counsel for the appellant, however, attempted to distinguish this judgment on the argument that this case dealt with the issue of service PE. According to him, the Court must examine the full transactions of the respondent to determine whether the work done by the respondent-assessee was one of a backup office work or auxiliary work. Insofar as the nature of activities carried on by the respondent through the liaison office in India, as permitted by the RBI, we have upheld the conclusion of the High Court that the same were in the nature of “preparatory or auxiliary character” and, therefore, covered by Article 5(3)(e). As a result, the fixed place used by the respondent as liaison office in India, would not qualify the definition of PE in terms of Articles 5(1) and 5(2) of the DTAA on account of non-obstante and deeming clause in Article 5(3) of the DTAA.

15. Having said thus, it must follow that the respondent was not carrying on any business activity in India as such, but only dispensing with the remittances by downloading information from the main server of respondent in UAE and printing cheques/drafts drawn on the banks in India as per the instructions given by the NRI remitters in UAE. The transaction(s) had completed with the remitters in UAE, and no charges towards fee/commission could be collected by the liaison office in India in that regard. To put it differently, no income as specified in Section 2(24) of the 1961 Act is earned by the liaison office in India and moreso because, the liaison office is not a PE in terms of Article 5 of DTAA (as it is only carrying on activity of a preparatory or auxiliary character). The concomitant is - no tax can be levied or collected from the liaison office of the respondent in India in respect of the primary business activities consummated by the respondent in UAE. The activities carried on by the liaison office of the respondent in India as permitted by the RBI, clearly demonstrate that the respondent must steer away from engaging in any primary business activity and in establishing business connection as such. It can carry on activities of preparatory or auxiliary nature only. In that case, the deeming provisions in Sections 5 and 9 of the 1961 Act can have no bearing whatsoever.

16. Our attention was invited to the dictum in Assistant Director of Income Tax-1, New Delhi vs. E-Funds IT Solution Inc.10. Paragraph 2 of the said decision would clearly indicate the background in which the issue was answered by this Court. The same reads thus: -

(2018) 13 SCC 294 “2. The assessing authority decided that the assessees had a permanent establishment (hereinafter referred to as “PE”) as they had a fixed place where they carried on their own business in Delhi, and that, consequently, Article 5 of the India US Double Taxation Avoidance Agreement of 1990 (hereinafter referred to as “DTAA”) was attracted.

Consequently, the assessees were liable to pay tax in respect of what they earned from the aforesaid fixed place PE in India. The CIT (Appeals) dismissed the appeals of the assessees holding that Article 5 was attracted, not only because there was a fixed place where the assessees carried on their business, but also because they were “service PEs” and “agency PEs” under Article 5. In an appeal to the ITAT, the ITAT held that the CIT (Appeals) was right in holding that a “fixed place PE” and “service PE” had been made out under Article 5, but said nothing about the “agency PE” as that was not argued by the Revenue before the ITAT. However, the ITAT, on a calculation formula different from that of the CIT (Appeals), arrived at a nil figure of income for all the relevant assessment years. The appeal of the assessees to the High Court proved successful and the High Court, by an elaborate judgment, has set aside the findings of all the authorities referred to above, and further dismissed the cross-appeals of the Revenue. Consequently, the Revenue is before us in these appeals.” The Court, after analysing the decisions and the concerned report produced before it, observed in paragraph 22 as follows: -

“22. This report would show that no part of the main business and revenue earning activity of the two American companies is carried on through a fixed business place in India which has been put at their disposal. It is clear from the above that the Indian company only renders support services which enable the assessees in turn to render services to their clients abroad. This outsourcing of work to India would not give rise to a fixed place PE and the High Court judgment is, therefore, correct on this score.” (emphasis supplied) We may usefully refer to paragraphs 24 and 26 of the reported decision, which read thus: -

“24. It has already been seen that none of the customers of the assessees are located in India or have received any services in India. This being the case, it is clear that the very first ingredient contained in Article 5(2)(l) is not satisfied. However, the learned Attorney General, relying upon Para 42.31 of the OECD Commentary, has argued that services have to be furnished within India, which does not mean that they have to be furnished to customers in India. Para 42.31 of the OECD Commentary reads as under:

“42.31. … Whether or not the relevant services are furnished to a resident of a State does not matter;

what matters is that the services are performed in the State through an individual present in that State.” xxx xxx xxx

26. We entirely agree with the approach of the High Court in this regard. Para 42.31 of the OECD Commentary does not mean that services need not be rendered by the foreign assessees in India. If any customer is rendered a service in India, whether resident in India or outside India, a “service PE” would be established in India. As has been noticed by us hereinabove, no customer, resident or otherwise, receives any service in India from the assessees. All its customers receive services only in locations outside India. Only auxiliary operations that facilitate such services are carried out in India. This being so, it is not necessary to advert to the other ground, namely, that “other personnel” would cover personnel employed by the Indian company as well, and that the US companies through such personnel are furnishing services in India. This being the case, it is clear that as the very first part of Article 5(2)(l) is not attracted, the question of going to any other part of the said article does not arise. It is perhaps for this reason that the assessing officer did not give any finding on this score.” (emphasis supplied) As aforesaid, we agree with the finding recorded by the High Court about the nature and character of stated activities carried on by the liaison offices of the respondent and in our view, the High Court justly reckoned the same as being of preparatory or auxiliary character, falling under Article 5(3)(e).

17. The High Court has also examined the matter in the context of explanation to Section 9(1)(i) of the 1961 Act. Prior to enactment of Finance Act, 2003 (32 of 2003), Section 9(1)(i) read thus: -

“Income deemed to accrue or arise in India.

9. (1) The following incomes shall be deemed to accrue or arise in India: -

(i) all income accruing or arising, whether directly or indirectly, through or from any business connection in India, or through or from any property in India, or through or from any asset or source of income in India, or through the transfer of a capital asset situate in India.

Explanation.— For the purposes of this clause—

(a) in the case of a business of which all the operations are not carried out in India, the income of the business deemed under this clause to accrue or arise in India shall be only such part of the income as is reasonably attributable to the operations carried out in India;

(b) in the case of a non-resident, no income shall be deemed to accrue or arise in India to him through or from operations which are confined to the purchase of goods in India for the purpose of export;

(c) in the case of a non-resident, being a person engaged in the business of running a news agency or of publishing newspapers, magazines or journals, no income shall be deemed to accrue or arise in India to him through or from activities which are confined to the collection of news and views in India for transmission out of India;

                 (d)   in the case of a non-resident, being—
                       (1)    an individual who is not a citizen of
                       India; or
                       (2)    a firm which does not have any
                      partner who is a citizen of India or who is
                      resident in India; or
                      (3)    a company which does not have any
                      shareholder who is a citizen of India or
                      who is resident in India,
                      no income shall be deemed to accrue or

arise in India to such individual, firm or company through or from operations which are confined to the shooting of any cinematograph film in India.

…………………..” After the enactment of Finance Act, 2003, explanation 2 came to be inserted after the renumbered explanation 1 to clause (i) of sub-

Section (1) of Section 9 with effect from 1.4.2004. The same reads thus: -

“Income deemed to accrue or arise in India.

9. (1) The following incomes shall be deemed to accrue or arise in India: -

(i) all income accruing or arising, whether directly or indirectly, through or from any business connection in India, or through or from any property in India, or through or from any asset or source of income in India, or through the transfer of a capital asset situate in India.

Explanation 1.- xxx xxx xxx Explanation 2.– For the removal of doubts, it is hereby declared that “business connection” shall include any business activity carried out through a person who, acting on behalf of the non-resident,-

(a) has and habitually exercises in India, an authority to conclude contact on behalf of the non- resident, unless his activities are limited to the purchase of goods or merchandise for the non- resident; or

(b) has no such authority, but habitually maintains in India a stock of goods or merchandise from which he regularly delivers goods or merchandise on behalf of the non-resident; or

(c) habitually secures orders in India, mainly or wholly for the non-resident or that non-resident and other non-residents controlling, controlled by, or subject to the same common control, as that non- resident:

Provided that such business connection shall not include any business activity carried out through a broker, general commission agent or any other agent having an independent status, if such broker, general commission agent or any other agent having an independent status is acting in the ordinary course of his business:

Provided further that where such broker, general commission agent or any other agent works mainly or wholly on behalf of a non-resident (hereafter in this proviso referred to as the principal non- resident) or on behalf of such non-resident and other non-residents which are controlled by the principal non-resident or have a controlling interest in the principle non-resident or are subject to the same common control as the principal non-

resident, he shall not be deemed to be a broker, general commission agent or an agent of an independent status.” The meaning of expressions “business connection” and “business activity” has been articulated. However, even if the stated activity(ies) of the liaison office of the respondent in India is regarded as business activity, as noted earlier, the same being “of preparatory or auxiliary character”; by virtue of Article 5(3)(e) of the DTAA, the fixed place of business (liaison office) of the respondent in India otherwise a PE, is deemed to be expressly excluded from being so. And since by a legal fiction it is deemed not to be a PE of the respondent in India, it is not amenable to tax liability in terms of Article 7 of the DTAA.

18. Taking any view of the matter, therefore, we find no substance in this appeal. We uphold the conclusions reached by the High Court for the reasons stated hitherto.

19. Accordingly, the appeal is dismissed with no order as to costs.

Pending interlocutory applications, if any, shall stand disposed of.

..................................J. (A.M. Khanwilkar) ..................................J. (Ajay Rastogi) New Delhi;

April 24, 2020.