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Judgment
N. Kumar, J.—These appeals are by the assessee challenging the order passed by the Tribunal holding that as per DTAA, the profit attributable to the liaison office held as a PE in India, is taxable.
The assessee is a South Korean enterprise originally engaged in the business of trading in semi-conductor components manufactured by various companies across the world, moved into the manufacture of PCB (printed circuit boards), LCD (liquid crystal displays) and SMPs (switch mode power supplies) in its factory in China from 2003. The assessee set up a liaison office at Bangalore in 1998 after obtaining the required approval from the RBI.
By the permission dt. 2-12-1999, the RBI accorded permission for continuing the liaison office for a further period of three years i.e. upto 4-8-2002. The RBI acceded to the request of the assessee for setting up an additional liaison office at New Delhi vide approval dt. 1-12-2001 on similar terms and conditions. The permission was extended by the RBI periodically upto 4-8-2008.
The case of the assessee is that, it is engaged solely in liaison activities as permitted by the RBI i.e., acting as a communication channel between the head office at Korea and the parties in India by communicating technical specifications, commercial terms and bridging the language barrier. Following the repeal of the Foreign Exchange Regulation Act, 1973 and the enactment of the Foreign Exchange Management Act, 1999, the regulations governing a liaison office are similar to those under the former.
The liaison office comprised five employees and their role was limited to finding out prospective buyers for the assessees products, obtaining enquiries in that regard and passing it on to the head office in Korea. After obtaining the quotations for the products from the head office, the liaison office would communicate the same to the intending buyers. At times, the head office would indicate a price band for each of the products to enable the liaison office to persuade the intending buyers to offer the best price within the permitted range, Eventually, the customers would place orders directly to the head office and not on the liaison office. Invoices would be raised by the head office while the liaison office would follow up and monitor the realization.
The assessee is a non-resident, carrying on no business in India and the role of the liaison office strictly and merely having been in the nature of a communication channel as permitted by the RBI, the assessee had no income liable for taxation in India. Therefore, it did not file any returns of income tax in India.
Following a survey conducted on the premises of the liaison office on 23-3-2007, the Addl. Director (International Taxation), Circle-I, Bangalore, issued a notice u/s 148 for the years 2001-02 to 2005-06 and a notice u/s 142 for the year 2006-07.
The statements of various employees of the liaison office were recorded, apart from collecting details with regard to sales and expenses from the employees. The assessee was called upon to file its returns for the four years. However, no return was filed. From the aforesaid material, the AO took note of the fact that the pay structure of the liaison office was such that the senior most employee, viz., the country manager was seen to be drawing a salary of Rs. 85,000 per month, while his deputy, viz., the general manager was seen to be drawing a salary of Rs. 35,000 per month. According to the AO, mere liaison functions would not lead to such payouts. Thus, he felt that there could be other non-liaison functions that the employees could be doing, for which such salaries were being paid. It is in this background the statements of Shri. V. Natarajan, country manager and Shri H.B. Raghumaran, senior engineer (marketing) were recorded.
On appreciation of the statements, the AO recorded a finding that the liaison office has a very clear-cut approach to the business to even the primary task of identifying customers. The primacy of the Indian liaison office in negotiations, procurement and step by step execution of the order is clearly visible. The liaison office is not at all into liaising, rather it is into full-fledged business activities. The final pricing is an issue decided at the Indian end without reference to the South Korean end. The margin of the liaison office is decided by the liaison office itself. This incidentally is the only variable element, while other components of the price viz., purchase price, freight, etc., are fixed and non-negotiable. The conclusion of the contract is done exclusively by the liaison office sales personnel. The South Korea office plays no role whatsoever in determining the actual price of the product. It simply obtains the purchase price from the supplier and leaves the actual price determination, negotiation and conclusion of the deal to the liaison office. There would have been no sales targets, unless actual sales were being done. Thus, the liaison office undertakes actual sales. The sales personnel of the liaison office are involved at all stages of procurement and supply. Though the South Korea office receives the payment, the entire process is constantly monitored and followed up by the liaison office. Therefore, from the aforesaid material, the assessing authority held that the Indian liaison office is seen to be virtually running its own ship, both on a day to day basis, as also for the purpose of finalizing orders. It leaves a limited role to the South Korea office. The liaison office does not need guidance from South Korea. Rather, the activities of the South Korea office are seen to be dependent on the Indian operations.
The liaison office performs the functions such as identifying new customers, pursuit and follow up of the customer, price negotiation and finalization, securing orders, processing of orders, payment for material and post-sale support. Thus, the liaison office is seen to perform about 57 per cent of the functions, leaving only the balance 43 per cent to the head office. Therefore, it was held that though the office established in Bangalore was treated as a liaison office, it has all the characteristics of a PE as defined under art. 5 of the DTAA. Therefore, the AO passed an assessment order directing it to pay the tax from the income earned by the assessee.
Aggrieved by the said order, the assessee preferred an appeal to the CIT(A)-IV, Bangalore. The appellate authority on reappreciation of the entire evidence on record came to the conclusion that the liaison office has only a limited flexibility in fixing its own margin subject to the condition within the minimum and maximum margins fixed by the head office, which in turn is dependent on the models, their unit price and set up charges. Therefore, the findings cannot be arrived at purely on the basis of the country managers, deposition wherein he has remarked that the head office has no role in deciding the sales margin unless it is suitably backed by incontrovertible evidence, which is not the case. Therefore, the appellate authority was of the view that the income cannot be deemed to accrue or arise in India through or from any business connection in India since it does not constitute a business activity carried out by the liaison office on behalf of the head office by habitually exercising an authority to conclude contracts on behalf of the non''-resident within the meaning of el. (a) of Expln. 2 to section 9(l)(i) of the IT Act. Therefore, the appeal was allowed. Hence the order passed by the AO was set aside. Aggrieved by the same, the revenue preferred an appeal to the Tribunal. The Tribunal reversing the judgment of the appellate authority years prior to asst. yr. 2004-05, there is a business connection in respect of source of income in India of the non-resident assessee and therefore, the income from such activity is deemed to accrue or arise and will therefore, be taxable in India. It also held that the business profit of the South Korea company can be taxed in India in case the South Korea company is having a PE. After referring to the terms of DTAA in particular art. 5 and the statements of Sri V. Natarajan held that the liaison office is engaged in promotion of import in India by procuring purchase orders after negotiating the deal and therefore the AO was justified in holding that the liaison office is a PE and therefore, the income attributable to the liaison office will be taxable as per art. 7 of the DTAA. Thus the appeal was allowed and the order of the appellate authority was set aside. The assessment orders were restored. Aggrieved by the said order of the Tribunal, the assessee is in appeal.
The learned senior counsel Sri K.P. Kumar, assailing the impugned order passed by the Tribunal contended that the liaison office was carrying on its activities strictly in conformity with the permission granted by RBI. The liaison office had no authority to conclude the contract between the assessee and the customers in India. The purchase orders were placed by the customers directly to the head office at Korea and supplies were made from Korea to the customers and the amount was paid directly to the head office at Korea and the only job of the liaison office was to make enquires, communicate with the head office the price quoted by the customers and after conclusion of the contract, to see that the material is supplied and also that the payment is made. It is purely a liaison work. They were not involved in any commercial activity and therefore, the liaison office at Bangalore could not be considered as a PE as per art. 5 of the DTAA. As such, the assessment order passed, which was upheld by the Tribunal, is erroneous and requires to be set aside.
Per contra, the learned counsel for the revenue submitted that though the assessee was granted permission from RBI to open the liaison office in Bangalore on terms and conditions, the nature of the activities carried out by the liaison office and its employees working therein makes it clear that they were actually selling the products of the assessee including entering into contract and promoting the business of the assessee. After conclusion of the contract, they sought to state that the transactions emanated from the head office directly to the customers in order to claim the exemption and therefore, he submits on the facts of this case, the finding recorded by the authorities that the liaison office at Bangalore was a PE as specified under art. 5 of the DTAA Rules is justified and the same is based on the legal evidence and no case for interference with the said question of fact is made out in these appeals.
In order to appreciate the rival contentions, it is necessary to refer to the relevant provisions in DTAA. Art. 5 of the DTAA explains the provision of a PE, which reads as under :
Article 5 : Permanent Establishment
For the purposes of this convention, the term PE means a fixed place of business through which the business of an enterprise is wholly or partly carried on.
The term PE shall include especially :
(a) a place of management;
(b) a branch;
(c) an office;
(d) a factory;
(e) a workshop; and
(f) a mine, an oil or gas well, a quarry or any other place of extraction of natural resources.
The term PE likewise encompasses a building site, a construction assembly or installation project or supervisory activities in connection therewith, but only where such site, project or activities continue for a period of more than nine months.
Notwithstanding the preceding provisions of this article, the term PE shall be deemed not to include;
(a) the use of facilities solely for the purpose of storage, display or delivery of goods or merchandise belonging to the enterprise;
(b) the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of storage, display or delivery;
(c) the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of processing by another enterprise;
(d) the maintenance of a fixed place of business solely for the purpose of purchasing goods or merchandise or for collecting information, for the enterprise;
(e) the maintenance of a fixed place of business for the purpose of advertising, the 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;
(f) The maintenance of a fixed place of business solely for any combination of activities mentioned in sub-paras (a) to (e) of this para, provided that the overall activity of the fixed place of business resulting from this combination is of a preparatory or auxiliary character.
Notwithstanding the provisions of paras 1 and 2, if a person--other than an agent of independent status to whom para 6 applies--is acting on behalf of an enterprise and has, and habitually exercises, in a Contracting State an authority to conclude contracts in the name of the enterprise, that enterprise shall be deemed to have a PE in that State in respect of any activities which that person undertakes for the enterprise unless the activities of such person are limited to those mentioned in para 4 which, if exercised through a fixed place of business, would not make this fixed place of business a PE by virtue of that para.
An enterprise shall not be deemed to have a PE in a Contracting State merely because it carries on business in that State through a broker, general commission agent or any other agent of an independent status, where such persons are acting in the ordinary course of their business.
The fact that a company which is a resident of a Contracting State controls or is controlled by a company which is a resident of the other Contracting State, or which carries on business in that other State (whether through a PE or otherwise) shall not, of itself, constitute either company or a PE of the other.
The assessee applied to the RBI for permission to set up a liaison office u/s 29(1)(a) of the FERA, 1973 and the same was acceded as per Annex. A on 5-8-1996. It was subject to the terms and conditions mentioned in the said permission. Clause 2 of the same reads as under :
We advise that we are agreeable to your establishing a liaison office at Mumbai and Bangalore initially for a period of three years for the purpose of undertaking solely liaison activities viz., to act as a communication channel between head office and parties in India. Please note that this permission has been granted subject to the following conditions :
(i) Except the proposed liaison work, the office in India will not undertake any other activity of a trading, commercial or industrial nature nor shall it enter into any business contracts in its own name without our prior permission.
(ii) No commission/fees will be charged or any other remuneration received/income earned by the office in India for the liaison activities/services rendered by it or otherwise in India.
(iii) The entire expenses of the office in India will be met exclusively out of the funds received from abroad through normal banking channels.
(iv) The liaison office in India shall not borrow or land any money from/to any person in India without our prior permission.
(v) The office in India shall not acquire, hold (otherwise than by way of lease for a period not exceeding five years) transfer or dispose of any immovable property in India without obtaining prior permission of the RBI u/s 31 of the Foreign Exchange Regulation Act, 1973.
(vi) The liaison office in India will furnish to our Mumbai Regional Office (on a yearly basis);
(a) a certificate from the auditors to the effect that during the year no income was earned by/or accrued to the office in India;
(b) details of remittances received from abroad duly supported by Inward Remittance Certification :
(c) certified copy of the audited final accounts of the office in India; and
(d) annual report of the work done by the office in India, stating therein the details of actual export or import, if any, effected during period in respect of which the office had rendered liaison services.
(e) The number of staff engaged/appointed and duties assigned to each staff.
(vii) The liaison office in India will not have signing/commitment powers except than those which are required for normal functioning of liaison office on behalf of the head office.
(viii) The liaison office will not render any consultancy or any other services directly/indirectly, with or without any consideration.
The said permission is being renewed year after year. As it is clear from the art. 7 of the DTAA 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. If the enterprise carries on business as aforesaid, the profits of the enterprise may be taxed in the other State but only so much of them as is attributable to that PE. Therefore, setting up of a PE by a Contracting State in India is a sine qua non for payment of income tax under the Act. What is a PE is defined under art. 5 of the DTAA. Sub-art. (4) of the art. (5) sets out what shall not be deemed to be a PE.
The permission granted by the RBI also makes it clear as to what the liaison office should not do. Relying on these provisions, it is contended by the assessee that the liaison office was opened to act as a communication channel between the head office at Korea and the parties in India. They have not undertaken any other activity of a trading or commercial or industrial nature nor have they entered into any business contract in their names. They have not charged any commission or any remuneration and they have not earned any such amount in India for liaison activities. The entire existence of the office in India is made exclusively out of the funds of the head office and they have not borrowed any money. They have not acquired any properties. They have no direct commitment with the customers and therefore, it was contended that the liaison office in Bangalore cannot be considered as a PE so as to attract the provisions of the Act. It is in this background, we have to see what was unearthed in the course of investigation by an investigating agency.
The liaison office of the assessee was opened in 1998. The operations of the assessee at Bangalore were carried out pursuant to the approval by the RBI. The liaison office has five employees in all. The South Korean based company is a trader in semi-conductor components manufactured by various companies across the world. In the course of the said survey and investigation, the authorities have recorded the statement of one Sri V. Natarajan, the country manager. He has stated on oath that out of the five employees who are working in the liaison office, three of them are directly related to sales (including him) and two administrative assistants. They also identify new customers by way of their past experiences in the field of sales and sometimes, the customers themselves will enquire with them regarding the products based on the market information. Once this is done, they will fix an appointment with the right person in the organization and try to identify the exact requirement and also to explain the availability of products. After this, the customer will give his requirement based on the products available with them. The customer expects their sales personnel to quote within a reasonable time. After this, the same enquiry is converted into a request for a quotation format to the head office staff responsible for purchase activities from their suppliers in Korea and China. As soon as they get the request for a quotation format fully filled up with price, delivery and specification in Bangalore through e-mail, the sales person who is responsible for generating the enquiry will reply to the customer with a quotation adding the sales margin. They have a thumb rule to calculate the sales margin depending upon the end-use of the product and the competition in the market and the volumes. They get only the buying price from the head office and the margins are decided by the sales team based in Bangalore on a case to case basis depending upon the merits of the case. After this, there will be a negotiation for each enquiry between the customers and the sales personnel of the office and in some cases, they are able to close the order to the satisfaction of the customer and the head office. In other cases, if the customer is not happy with the price and if he asks for more discount, the personnel at Korea will discuss the same with the suppliers to request for more discount in the price. If the supplier agrees for giving more discount, then accordingly, they quote a new discounted price to the customers and close the deal. After this, if the deal is through they have to process the order. They fill the details in the order processing chart and send the same to the head office through e-mail as an attachment. The purchase team at the head office will process and place the order to the supplier and then wait for the goods to be ready. Once the goods are ready, they will be inspected by the quality control team at the head quarters to ensure that the specifications are properly met. After that the goods are packed and shipped to the freight forwarder appointed by the customer. The same will be shipped directly to the customer by the first available flight or ship. The head office will send a copy of the commercial invoice, packing list and airway bill/bill of lading to the liaison office at Bangalore by e-mail/fax. They in turn send these three documents to the customer. Then the responsibility of getting the goods cleared lies with the customers. The payments will be made by the customer through telegraphic transfer through bank to the head office account at Korea. Their work also involves following up of payments from the customers and offer sales support, if necessary. He has also deposed that they have cent per cent freedom in deciding the margin or selling price provided they are not incurring any loss. It was stated that the marketing man is given the liberty to sell the goods on profit within a band margin of profit and in case any discount is asked then he has to revert back to the head office. Hence, only in those cases where the price quoted by the liaison office is not competitive then they have to revert back to the head office. Sri H.B. Raghumaran who was working as a Senior Engineer (Marketing) has stated that he enjoys full freedom in deciding the price of the material while negotiating with the customer. Once the selling price is arrived at with the customer, he does not need to discuss with the head office or the organization. He immediately requests the customer to release the purchase order. The annual sales target has also been fixed by the organization.
It is on the basis of the aforesaid material, the Tribunal held that the activities carried on by the liaison office are not confined only to the liaison work. They are actually carrying on the commercial activities of procuring purchase orders, identifying the buyers, negotiating with the buyers, agreeing to the price, thereafter, requesting them to place a purchase order and then the said purchase order is forwarded to the head office and then the material is dispatched to the customers and they follow up regarding the payments from the customers and also offer after-sales support. Therefore, it is clear 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 PE as defined in art. 5 of DTAA. In fact, the AO has clearly set out what was discovered during the investigation and the same has been properly appreciated by the Tribunal and it came to the conclusion that though the liaison office was set up in Bangalore with the permission of the RBI and in spite of the conditions being stipulated in the said permission preventing the liaison office from carrying on commercial activities, they have been carrying on commercial activities.
It was further contended that the RBI has not taken any action and therefore, such interference is not justified. Once the material on record clearly establishes that the 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. Now that the investigation has revealed the facts, we are sure that the same will be forwarded to the RBI for appropriate action in the matter in accordance with law. But merely because no action is initiated by RBI till today would not render the findings recorded by the authorities under the IT Act as erroneous or illegal.
We are satisfied from the material on record that the finding recorded by the Tribunal is based on legal evidence and that the finding that the liaison office is a PE as defined under art. 5 of DTAA and therefore, the business profits earned in India through this liaison office are liable for tax is established.
For the aforesaid reasons, we do not see any merit in these appeals. Accordingly, these appeals are dismissed.