The Supreme Court of India (Supreme Court) rules that a registered liaison office (LO) of a UAE company with the Indian Central Bank (RBI) engaged in fund remittance ancillary activities in India initiated from UAE, in conformity with the prescribed Indian exchange control guidelines (forex regulations), does not create a fixed place permanent establishment (PE) in India under Article 5, or is excluded within the meaning of Article 5(3)(e), of the India–UAE tax treaty (tax treaty).
Also, in the absence of PE in India, no profits of the UAE company is attributable to tax in India under Article 7 of the tax treaty.
The UAE Exchange Center (taxpayer) is a UAE-based company engaged in multiple business activities including fund remittance services from the UAE to India. The taxpayer established a registered LO in India to undertake permitted activities prescribed by the RBI of the UAE head office without engaging in commercial activities. The LO does not own immovable property in India except leased premises to operate the LO.
Under forex regulations, expenses of the LO are funded by the UAE head office through normal banking channels. Hence, no fee/commission is charged or received by the Indian LO for any prescribed services in India, in fact fund remittance services are provided by the taxpayer to nonresident Indians (NRIs) in the UAE, for which remittance contracts are executed between the taxpayer and the NRI remitter outside of India in the UAE.
The taxpayer filed return of income in India offering no taxable income claiming tax treaty exemption, even though its LO was engaged in activities of downloading particulars of remittances through electronic media and printing and delivery of checks/drafts drawn on the banks in India for the beneficiaries in India as per the instructions of the NRI remitter.
The taxpayer filed an application with the Authority for Advance Ruling (AAR) to determine if any income is accrued/deemed to be accrued of the taxpayer due to activities carried out by the LO in India.
The AAR, relying on the case of R.D. Aggarwal & Company, observed that the LO is continuously connected with the information available on the main server in the UAE of fund remittance to the beneficiaries in India by the NRI remitters.
The AAR ruled that all income accruing or arising, whether directly or indirectly, through or from any taxable presence (i.e. LO) of the taxpayer in India, or from any property in India, or through any assets or source of income in India, is deemed to accrue in India and profits to such extent attributable to the Indian LO operations are taxable in India both under Indian domestic tax laws and under Article 5 read with Article 7 of the tax treaty.
High Court Ruling
The taxpayer appealed before the High Court, where the High Court, relying on the Azadi Bachao Andolan case, opined that the approach of the AAR to first examine efficacy to determine income accrual in India under Indian domestic tax law, instead of applying the tax treaty principles, was inappropriate.
The High Court analyzed that the LO activity in India did not contribute directly or indirectly to the profits earned by the taxpayer in the UAE since the transaction was concluded in the UAE.
Further, the High Court observed that the nature of LO activities performed was merely supportive, preparatory and auxiliary in nature to the main transaction carried on in the UAE, expressly excluded under clause 5(3) of the tax treaty relying on a number of rulings. The High Court referred to similar exclusions of the tax treaty prevalent under the provisions of Indian domestic tax law which provides that business activity of a foreign enterprise through an LO in India is taxable only when such activities involved are more than supportive or subsidiary to the main function.
The High Court quashed the AAR ruling and notices issued by the revenue authorities (revenue) of income reassessment. The revenue decided to proceed against the High Court order and filed an appeal before the Supreme Court.
Supreme Court Ruling
The Supreme Court stated that the term “PE” under fixed place of PE Article 5(1) includes LO read with Article 5(2) of the tax treaty from where the activities are carried on by the taxpayer in India. However, Article 5(3) of the tax treaty is a non-obstante clause and a deeming provision to clauses 1 and 2 of Article 5 that excludes a PE, if any of the prescribed activities referred to in Article 5(3) are effective and only subject to the essential functional test of the activities.
The Supreme Court analyzed the expression “preparatory” not expressly defined under the Indian domestic tax law or the tax treaty but, relying on the dictionary meaning used in common parlance, as “preparatory work,” “travaux préparatoires” and auxiliary as “aiding” or “supporting,” “subsidiary,” “supplementary” explained in Black’s Law Dictionary and Oxford English Dictionary.
The key activities in the immediate case were (i) downloading particulars of remittances through electronic media; and (ii) printing and delivery of checks/drafts drawn on the banks in India, to the beneficiaries in India, in accordance with the instructions of the NRI remitter.
The Supreme Court also noted that limited function of the LO was permitted by the RBI that restricted the taxpayer to enter into any contract in India, but to only offer the following ancillary services of:
- quick response and economic inquiries from correspondent banks;
- reconciliation of bank accounts held in India;
- acting as a communication center of mail transfer, stop payments, payment details, etc., from taxpayer’s branches in the UAE and transmitting to Indian correspondent banks;
- printing Indian rupee drafts with facsimile signature from head office and countersignature by the authorized signatory of the LO; and
- following up with Indian correspondent banks.
The Supreme Court reaffirmed the High Court’s observation that the taxpayer did not perform any business activity in India, but was only engaged in dispensing with the remittances in India as per the instructions given by the NRI remitters in the UAE.
The transaction(s) were completed with NRI remitters in the UAE without any scope of collection of charges as fee/commission by the LO in India. The Indian LO was permitted to undertake only preparatory or auxiliary activities by the RBI and limited the taxpayer from engaging in any primary business activity of consultancy or other service, with or without any consideration in the form of commission/fee or income, and also prohibited the LO to borrow or lend any money in India without permission. Such supportive activities did not result in any income generated or earned by the LO in India.
Accordingly, the Supreme Court affirmed the High Court’s verdict which relied on the Morgan Stanley & Co. Inc. case, dealing with similar facts having an Indian office to support main office functions. The Supreme Court stated that the LO is not a PE under Article 5(1) of the tax treaty (as it is only carrying on preparatory or auxiliary activity), hence, no tax can be levied or collected from the LO of the taxpayer in India arising from the main business activities consummated by the taxpayer in UAE.
The Supreme Court concurred with the High Court’s opinion to rule that the stated activities of the LO of the taxpayer in India are of preparatory or auxiliary character—such activities of the taxpayer through the LO squarely falls within the excluded preparatory or auxiliary category of Article 5(3)(e) of the tax treaty.
The Supreme Court upheld the High Court’s order and ruled in favor of the taxpayer to conclude that the LO is deemed not to constitute PE of the taxpayer in India and it is not amenable to tax liability in terms of Article 7 of the tax treaty.
The issue of taxable presence of a nonresident and taxability of income from the PE activities like an LO with limited activities under a regulated environment is widely debated by the Indian courts.
The outcome of the Supreme Court ruling to exclude ancillary activities undertaken by such PE under Article 5(1) read with Article 5(3) under the OECD Model Tax Treaty (Model Tax Treaty), is an important statement and settles such similar issues, especially where the evaluation of supportive activities is a subject matter of functional test.
It is imperative to analyze the multilateral instruments (MLI) incorporating the OECD BEPS Action Plan 7 where the transactions are designed to be excluded within the exception provision of Article 5(3) of the Model Tax Treaty.
Importantly, under the MLI provision, India has adopted complete exemption of PE only where the overall activities of the fixed place of business are preparatory or auxiliary in nature. Thus, it becomes a subject matter of justification and evaluation if the complete activities in India are not preparatory or auxiliary in nature and such activities are not cohesive to the relevant business operations performed in the source country.
The commentaries also deal with the issue of profits attributable to each PE as derived from distinct activity of the cohesive business operation carried on by the PE. Therefore, careful implementation of activities in the contract would be essential, based on the Supreme High Court ruling, to prevent a taxable presence and attribution risk in India.
Shailendra Sharma is a Chartered Accountant associated with a multinational financial services firm, India.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.