Facts

The Assessee was a limited company incorporated in the United Arab Emirates (UAE). It was engaged in offering, among others, remittance services for transferring amounts from UAE to various places in India. It had applied for a permission under section 29(1)(a) of the Foreign Exchange Regulation Act, 1973, (‘FERA’) pursuant to which approval was granted by the Reserve Bank of India (‘RBI’) with certain conditions.

Assessee set up its first liaison office in Cochin, Kerala (India) and thereafter, in Chennai, New Delhi, Mumbai and Jalandhar in India. The activities carried on      by the Assessee from the said liaison offices were in conformity with the terms   and conditions prescribed by the RBI. The entire expenses of the are met liaison offices in India exclusively out of funds received from UAE through normalbanking channels. Indisputably, the liaison offices did not undertake any trading, commercial or industrial activity. Further,  Assessee had no immovable property   in India otherwise than by way of lease for operating the liaison offices. No fee/ commission was charged orreceived in India by any of the liaison offices for services rendered in India. The remittance services were offered by the Assessee    to Non-Resident Indians (‘NRIs’) in UAE. The contract pursuant to which the funds were handed over by the NRI to the Assessee in UAE, was entered with      the NRI remitter in UAE.  The funds are collected from the NRI remitter in UAE   by charging one-time fee in Dirhams. After collecting the funds from the NRI remitter, Assessee made an electronic remittance of the funds on behalf of its NRI customer in two ways: —

• By telegraphic transfer through bank channels; or
• On the request of the NRI remitter, Assessee sends instruments/cheques through its liaison offices to the beneficiaries in India, designated by the NRI

Assessee had filed its returns of income showing NIL income, on the ground that  no income had accrued or deemed to have accrued to it in India, both under

 

 

the 1961 Act, as well as, the agreement entered into between the Government      of the Republic of India and the Government of the UAE, which is known as Double Taxation Avoidance Agreement (‘DTAA’). Returns filed on regular basis were accepted by the Department. However certain doubt arose in respect of the second mode of remittance through the liaison offices in India more particularly   on account of the activity undertaken in the liaison office in India  of downloading the particulars of remittances through electronic media and printing cheques/ drafts drawn on the banks in India, which, in turn, are couriered or dispatched      to the beneficiaries in India, in accordance with the instructions of the NRI remitter. While doing this, the liaison office of the Assessee remains connected with its main server in UAE, as the information is contained in the main server there, which could be accessed by the liaison office in India for the purpose of remittance of funds to the beneficiaries in India by the NRI remitters. Hence Assessee filed an application u/s 245Q(1) of the Act before the Authority for Advance Rulings (‘AAR’), and sought ruling on the question as to whether any income is accrued/deemed to be accrued in India from the activities carried out    by the Company in India.

The Authority, vide its ruling answered the question in the affirmative, namely, “Income shall be deemed to accrue in India from the activity carried out by the liaison offices of the applicant in India.” For holding so, the AAR opined that in view of the deeming provision in Sections 2(24), 4 and 5 read with Section 9 of    the 1961 Act, the  Assessee would  be  liable to  pay  tax  under the  1961 Act,  as it had carried on business in India through a “permanent establishment” (‘PE’) situated in India and the profits of the enterprise needed to be taxed in India, but only so much of that, as is attributable to the liaison offices in India (PE). The Authority observed that it was evident that all the operations of the business of    the respondent were not carried out in India. In such a situation, to attract the provisions, it must be shown that – (i) the Assessee has ‘business connections’ in India; and (ii) the income of the business can be deemed to accrue or arise in    India from such operations, as are carried out in India. After analyzing this aspect and Explanation 2 to Section 9(1)(i) inserted by the Finance Act, 2003, it noted    the decision of this Court in CIT v.  R. D. Aggarwal & Company [1965] 56 ITR     20 (SC) that culled out the essential features of expression “business connection”. AAR observed that in  cases where the applicant has to remit the amounts to  the beneficiaries in India, as per the directions of the NRIs, the liaison offices download the information from the internet, print cheques/drafts in the name of  the beneficiaries in India send them through couriers to various places in India. Without the latter activity,  the transaction of remittance of the amounts in terms   of the contract with the NRIs would not be  complete. The  commission which the applicant receives for remitting the amount covers not only the business activities carried on in UAE  but also the activity of remittance of the amount to   the beneficiary in India by cheques/drafts through courier which is being attend    to by the liaison offices. There was a real relation between the business carried

 

 

on by the Assessee for which it receives commission in UAE  and the activities     of, the  liaison offices, which contributes directly or  indirectly to  the  earning  of the income by the Assessee by way of commission. There is also continuity between the business of the applicant in UAE and the activities carried on by the liaison offices. However, the deemed accrual of income to the applicant from the business connection in India in view the Explanation (I) would be only such part   of the income as is reasonably attributable to the operations which are carried     out in India. AAR also took note of Articles 5 and 7 of DTAA and observed that clause (e) of para 3 says that the expression ‘permanent establishment’ shall be deemed not to include the maintaining of a fixed place of business solely for the purpose of carrying on for an enterprise any other activity of a preparatory or auxiliary character. It held that as far as first mode is concerned, the amount is remitted telegraphically by transferring directly from UAE  through bank channel  to various places in India and in such remittances the liaison offices have  no  role to play except attending to the complaints, if any, in India regarding the remittances in cases of fraud etc. This was undoubtedly a work of auxiliary character. However, where the applicant adopts the second mode for remitting  the amounts in India -an activity approved by the RBI  –  the  liaison offices of the applicant play an important role. The role of liaison offices in remitting the amounts by adopting the second mode, is nothing short of performing the contract   of remitting the amounts at least in part. So, the activities of the liaison offices       in the second mode remittance, cannot be said to be work of auxiliary character.    It was a significant part of the main work of UAE establishment. The AAR accordingly concluded that so much of the profits as shall be deemed to accrue     or arise to the respondent in India, which were attributable to the PE, namely,     the liaison offices in India, would be taxable in India even under the DTAA, and answered the question affirmativelyagainst the Assessee.

Following the ruling of AAR, the Department issued notices under Section 148.  The Assessee, therefore, carried the matter before the High Court for quashing of the AAR ruling and quashing of reopening notices.

The High Court noted that the Authority committed manifest error in appreciating the relevant facts and materials on record. The High Court adverted to the exposition in UOI v. Azadi Bachao Andolan [2003] 263 ITR 706 (SC) and observed that the liability to tax under the DTAA  is governed by article 7.   The provisions of Section 5(2)(b) and Section 9(1)(i) of the Act would have no applicability. Discussion with respect to the ‘business connection’ in the AAR ruling was unnecessary. The Court observed that AAR came to the conclusion  that the activity carried on by the liaison offices in India did have an ‘auxiliary’ character in terms of Article 5(3)(e) of the Act as the option of remitting of funds through the liaison offices in India was exercised by the NRI remitter which was nothing short of, as in the words of the parties, performing contract of remitting  the amounts, and without remittances of funds to the beneficiaries in India performance under the contract would not have been complete.

 

 

High Court held that the activity of the liaison offices in India was simply auxiliary in character. The activity was in ‘aid’ or ‘support’ of the main activity.  The error into which, AAR had fallen was in reading article 5(3)(e) as a clause which permits making a value judgment as  to  whether the  transaction would or would not have been complete till the role played by liaison offices in India    was fulfilled as  represented by  the  Assessee to  their NRI  remitter.  To  say that  a particular activity was necessary for completion of the contract is, in a sense saying the obvious as every other activity which an enterprise undertakes in earning profits is with the ultimate view of giving effect to the obligations undertaken by an enterprise vis-a-vis its customer. If looked at from that point       of view, then, no activity could be construed as preparatory or of an ‘auxiliary’ character. Accordingly, the High Court held that the nature of activities carried     on by the respondent-assessee in the liaison offices being only of preparatory and auxiliary character, were clearlyexcluded by virtue of deeming provision.

Feeling aggrieved, the Department filed an appeal before the Supreme Court.

 

Issue

Whether the activities of the Assessee as discussed in the facts above, would qualify the expression “of preparatory or auxiliary character”?

 

Views

In view of the exposition, that provisions of DTAA override the provision of Income Tax  Act, in the matter of ascertainment of chargeability to income tax   and ascertainment of total income, to the extent of inconsistency with the terms    of DTAA, the Court proceeded to answer the question in light of the purport of provisions in DTAA,  which has been executed by the Government of India and   the Government of UAE. Based on the findings recorded by the High Court, the Court proceeded on the basis that the Assessee had a fixed place of business through which the business of the Assessee was being wholly or partly carried     on. That, however, would not be conclusive until a further finding is recorded    that the Assessee had a PE, in terms of Article 5, situated in India, so as toattract Article 7 dealing with business profits to become taxable in India, to the extent attributable to the PE of the Assessee in India. The Court observed that Article 5(3) of the DTAA opens with a non- obstante clause and also contains a deeming provision. It predicates that notwithstanding the preceding provisions of the concerned article, which would mean clauses 1 and 2 of article 5, it would    still not be a PE, if any of the clauses in article 5(3) are applicable. For that, the functional test regarding the activity in question would be essential. The Court observed that since Assessee argued that the activities of  the  liaison offices of are of preparatory or auxiliary character, the same would fall within the excepted category under Article 5(3)(e) of the DTAA.  Resultantly, it cannot be regarded as     a PE within thesweep of Article 7 of DTAA. The expression “preparatory” is not

 

 

defined in the 1961 Act or the DTAA. The dictionary meaning of that expression can be traced to term “preparatory work” and “travaux preparatoires”, which in   the Black’s Law Dictionary (Eleventh Edition), read thus: —

“preparatory work. See TRAVAUX   PREPARATOIRES.

travaux preparatoires. Materials used in preparing the  ultimate form of an agreement or statute, and esp. of an international treaty; the draft or legislative history of a treaty.”

The expression “auxiliary” is also not defined in the 1961 Act or the DTAA. In common parlance, the meaning of that expression is predicated in Concise Oxford English Dictionary (Twelfth Edition), which reads thus: —

“Auxiliary-  adj. providing additional help or support. n. an auxiliary person  or thing. N. Amer. A group of volunteers who assist a church, hospital,    etc. with charitable activities.”

In Black’s Law Dictionary (Eleventh Edition), the term “auxiliary” is defined as follows: —

“Auxiliary adj. 1. Aiding or supporting. 2. Subsidiary. 3. Supplementary.”

The Court referred to the limited permission given by the RBI to the Assessee under section 29(1)(a) of FERA. From  the stated permission, it was evident that   the RBI had agreed for establishing a liaison office of the Assessee at Cochin, initially for a period ofthree years to enable the Assessee to

• respond quickly and economically to enquiries from correspondent banks with regard to suspected fraudulent drafts;
• undertake reconciliation of bank accounts held in India;
• act as a communication centre receiving computer (via modem) advices of mail transfer T. stop payments messages, payment details etc., originating from Assessee’s several branches in UAE and transmitting to its Indian correspondent banks;
• printing Indian Rupee drafts with facsimile signature from the Head Office and counter signature by the authorized signatory of the Office at Cochin; and
• following up with the Indian correspondent

These were limited activities which the Assessee has  been permitted to carry  on within India. This permission does not allow the Assessee to enter into a contract with anyone in India, but only to provide service of delivery of cheques/ drafts drawn on the banks in India. Notably, the permitted  activities are required  to be carried out by the Assessee subject to conditions specified in clause 3

 

 

of the permission, which includes not to render any consultancy or any other service, directly or indirectly, with or without any consideration and further that the liaison office in India shall not borrow or lend any money from or to any person in India without prior permission of RBI. The conditions make it amply clear that the office in India will not undertake any other activity of trading, commercial or industrial, nor shall it enter into any business contracts in its own name without prior permission of the RBI. The liaison office of the Assessee in India cannot even charge commission/fee or receive any remuneration or income  in respect of the activities undertaken by the liaison office in India. From the onerous stipulations specified by the RBI, the Court opined that the activities in question of the liaison office(s) of the Assessee in India are circumscribed by the permission given by the RBI and are in the nature of preparatory or auxiliary character.

The Court was of the view that no income as specified in section 2(24) of  the  1961 Act was 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 Assessee in India in respect      of the primary business activities consummated by the Assessee in UAE. The activities carried on by the liaison office of the Assessee in India as permitted by the RBI, clearly demonstrate that the Assessee 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.

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 Assessee 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 Assessee 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 Assessee in India, it is not amenable to tax liability in terms of article 7 of the DTAA.

 

Held

Dismissing the appeal of the  revenue the  Court held that the  activities carried on by the liaison office of the non-resident in India as permitted by the RBI, demonstrate that the liaison office 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. A liaison officewhich is

 

 

only carrying on  such activity of  a  “preparatory or  auxiliary” character is  not  a PE in terms of Article 5 of the  DTAA.  The deeming provisions in  Sections 5 and 9 of the 1961 Act can have no bearing whatsoever. (CA No. 9775 of 2011      dt. 24.04.2020)

Editorial: Functional and factual analysis of the activities of the MNCs is the prime factor to decide that whether it is involved in the core activities or the preparatory and auxiliary activities. PE analysis is a mixed question of facts and law. These ruling once again highlights the extent to which tax authorities examine facts; they do not limit their review only to the intra-group contractual arrangements but go far beyond it to understand the factual matrix. One will also have to analyse the effect of Treaties which India has signed with the respective countries in each case (including the protocol and MFN clause, if any).

“Each night, when I go to sleep, I die. And the next morning, when I wake up, I am reborn.”

– Mahatma Gandhi