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January 2019

Liaison Office as PE under India-US DTAA


By Tanmay Bhatnagar

A liaison office is defined under the Foreign Exchange Regulations as a place of business, which is meant to merely act as a channel of communication between the Head Office and other entities in India. Such liaison office is not supposed to undertake any commercial /trading/ industrial activity and does not have any independent source of revenue other than inward remittances received from Head Office.

The failure to comply with the said restriction by a liaison office would not only impact the permission granted by the RBI under the Foreign Exchange Management Act, 1999, but can also lead to tax implications under Income-tax law, since carrying out commercial activities can result in the constitution of a permanent establishment (‘PE’) as has been envisaged in the various Double Taxation Avoidance Agreements (‘DTAAs’) entered into by India.     

GE Energy Parts Ltd. v. CIT

Questions regarding the activities of a liaison office and whether the same would result in the constitution of a PE under the India -US DTAA arose before the Delhi High Court in the recent case of GE Energy Parts Ltd. v. CIT: [2019] 101 taxmann.com 142 (Delhi). The appellants in this group of appeals were the General Electric group of companies (‘GE Overseas’). The ITAT had previously held that GE Overseas had a fixed place PE as well as a dependent agent PE (‘DAPE’) in India. The findings of the ITAT have been upheld by the High Court on both counts.

Fixed Place PE

On the question of whether the liaison office set-up by GEIOC, a member of GE Overseas, constituted a fixed place PE, the High Court firstly held that GE Overseas had a ‘place of business in India since as per Article 5(1) of the India-US DTAA and OECD Model Tax Convention, a ‘place of business’ means any premises, facilities or installations used for carrying on the business of the enterprise. The Court placed reliance on the decision of the Apex Court in Formula One World Championship v. Commissioner of Income Tax: [2017] 390 ITR 199 to hold that having certain premises at its disposal for continuous usage, even without any legal right over the same, would also satisfy the ‘place of business’ requirement.

In this case, the space leased out for the liaison office by GEIOC, though was also being used by the Indian entity, viz. GE India, was at the constant disposal of the GE staff for their work. As such, the liaison office was held to a ‘place of business’ of GE Overseas in India.

Further, the High Court rejected the appellant’s contentions that the presence of GE India employees could not lead to the conclusion that sales were being made from the aforesaid premises. It instead held that the core of the sales activity was done from the leased location and that if the premises were not where the relevant business activities occurred, then the location where they did would likely form the fixed place PE.

The contentions of the appellants were twofold:
  1. The activities being carried out were preparatory or auxiliary in nature and thus excluded under Article 5 (3) of the DTAA;
  2. Only the authority to conclude contracts would result in business activities.
However, the Court rejected both the contentions and held that it if an activity is responsible for the realization of profits it is not preparatory or auxiliary and that there was no mention in Article 5(3) of the DTAA regarding the authority to conclude contracts and it was not a necessary condition for the constitution of a fixed place PE.

The Court concluded that the process of sales and marketing of the appellants’ products involved complex processes involving technical specifications, commercial terms, financial terms and other policies of GE, which could only be addressed by highly qualified employees and officials. The said employees were involved in not only information gathering and analysis but also participated in intensive negotiations with respect to change of technical parameters of specific goods and products, which had to be made to suit the customers.

Upon perusal of e-mails, self-appraisals of employees and other evidence collected during survey proceedings, the Court noted that these showed important roles were played by GE India employees in the negotiating process. Even though the Indian office could not take a final decision to conclude contracts, important responsibilities relating to finalization of commercial terms were being carried out by employees of GE India from the premises of the liaison office. Consequently, the liaison office was held to constitute a fixed place PE.

Dependent Agent PE

The second question before the Court was whether the activities carried out by the employees of GE India constituted a DAPE under the India-US DTAA.
The contention of the appellant regarding the same was that the OECD Commentary on Model Tax Convention states that mere participation in negotiation would not lead to the implication that there exists an authority to conclude contracts. However, the same was rejected by the Court since other parts of the commentary took a contrary view in that lack of active involvement by an enterprise/principal in transactions may be indicative of a grant of authority to an agent.

Furthermore, reliance was placed by the Court on the decision of an Italian Court in Ministry of Finance (Tax Office) v. Philip Morris (GmBH): Corte Suprema di Cassazione No. 7682/02 wherein it was held that participation of employees of a resident company “in a phase of the conclusion of a contract between a foreign company and another resident entity may fall within the concept of authority to conclude contracts in the name of the foreign company.”

The Court came to the conclusion that the term ‘authority to conclude’ did not mean all elements and details, since that would make other portion of the clause redundant and therefore, only meant that the activity needed to be core in nature.

The Court subsequently observed that the activities of GE Overseas were such that the employees of GE India had to involve themselves in contract negotiation, which included core or “key” areas, modification of technical specifications and the negotiations for it, to fulfill local needs and regulatory requirements, complex price negotiation, etc. The Court thus held, that such activities were core activities of the business and not merely auxiliary in character.

Interpreting Articles 5(1) and 5(3) of the DTAA, the Court held that considering the nature of activities carried out by employees of GE India, it was clear that there existed authority to conclude contracts on behalf of GE Overseas.

Therefore, by focusing on the nature of activities carried out of the liaison office and by the employees of GE India, the Court held that both a fixed place PE and DAPE were constituted on behalf of GE Overseas in India.

[The author is an Associate, Direct Tax Team, Lakshmikumaran & Sridharan, Delhi]

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