[The following update has been brought to you by Dibya Prakash Behera, Manager and Editor.]
Recently, the Delhi Income Tax Appellate Tribunal (ITAT/Tribunal) held that the liaison office of Hitachi Singapore (Assessee) in India would constitute its permanent establishment (PE) in India, thereby being subject to tax for the income arising within India. The ruling holds much significance as it draws a clear distinction between the activities of a liaison office and a branch office. The ITAT, while holding the same, has also clarified certain contours of the DTAA entered into between the countries by drawing a comparison with other similar agreements.
The assessee had established a liaison office (LO) in India (earlier known as Nissei Sangyo (Singapore) Pte Ltd) for rendering preparatory and auxiliary services, including market research and liaison activities. The Reserve Bank of India, while granting permission for the said activity, barred the entity from undertaking any other activity of trading, commercial or industrial nature and also from entering into any business contracts in its own name without prior permission. It was also mandated that the LO shall neither charge any commission/fee nor shall receive any remuneration or earn income for liaison activities rendered by representatives. Moreover, the entire expenses of the representative office was to be met exclusively out of the funds received from abroad through normal banking channels.
Deviating from such terms and conditions on which the permission was granted, the LO was engaged in ascertaining customer requirements, price negotiation, receipt of purchase orders, following up on delivery of material and payments. The assessee contended that such activities do not form the core business of the office but only auxiliary and ancillary activities of the LO.
The Revenue Department, in furtherance of the survey conducted in accordance with Section 133A, Income Tax Act 1962, perused the documents found, mostly email exchanges among the representatives at LO, tax consultants and employees of Hitachi High Technologies to finally proceed by treating the LO as a PE thereby resulting into attribution of profits. The assessee denied such determination on the grounds that such activities were auxiliary and ancillary to the main activity of the LO thereby being eligible for protection of Article 5 of the India-Singapore Double Taxation Avoidance Agreement (India-Singapore DTAA).
Notably, per Article 5(7)(e) of the India-Singapore DTAA, there would be no PE if the place of business is maintained:
"solely for the purpose of advertising, for the supply of information, for scientific research, or for similar activities which have a preparatory or auxiliary character..."
The Tribunal applied the rule of ejusdem generis to interpret the term ‘similar activities’ as appearing in the exclusion provision to hold that 'similar activities which have preparatory or auxiliary character' must be read as business solely used for the purpose of advertising, for the supply of information, for scientific research or for activities of similar nature. It drew a distinction with the corresponding term in the India-Canada DTAA wherein the exclusion provision uses the expression 'other activities'. The Tribunal held thereafter that the exclusion clause in the India-Singapore DTAA is restrictive in nature and cannot include under its ambit the activities which were carried out by the LO in the instant matter. Especially when the employees of the LO were engaged in marketing, sales promotion and market research activities which are sine qua non for a trading business, i.e. the appellant’s business, it became much more difficult for the Tribunal to grant it the protection of the exclusion provision of the India-Singapore DTAA.
However, the Tribunal provided some relaxation to the assessee in that it held the attribution made by the Revenue ranging from 163% to 2357% to be not only excessive but also absurd and abnormal. Relying on the decision rendered in the case of Morgan Stanley [162 Taxmann 165], the Tribunal observed that the LO was performing routine and limited functions and was operating in a risk immune environment and, therefore, the allocation of profit should be done by applying the transactional net margin method as the most appropriate method. The ruling was based on the law, also finding support in Article 7(2) of the India-Singapore DTAA, that when a PE is treated as if it were an independent enterprise, its profits should be determined on the basis that it was an independent enterprise.