Taxation of Liaison Offices: Supreme Court Clarifies Double Taxation Avoidance Agreement

The Supreme Court of India recently delivered an important ruling in Union of India & Anr. vs. U.A.E. Exchange Centre, concerning the taxation of liaison offices under the Double Taxation Avoidance Agreement (DTAA) between India and the United Arab Emirates (UAE). The case revolved around whether the activities of the liaison office in India constituted a taxable permanent establishment (PE) under the Income Tax Act, 1961.

Background of the Case

The respondent, U.A.E. Exchange Centre, is a company incorporated in the UAE, engaged in providing remittance services for transferring funds from UAE to India. The company applied for permission under Section 29(1)(a) of the Foreign Exchange Regulation Act, 1973 (FERA), which was granted by the Reserve Bank of India (RBI) in 1996.

As per RBI’s approval, the liaison office in India was restricted to:

Responding to fraud-related queries from banks.
Reconciling accounts.
Receiving electronic messages from UAE and forwarding them to Indian banks.
Printing Indian Rupee drafts for remittance.

The respondent claimed that no income accrued in India as per Sections 5 and 9 of the Income Tax Act, 1961, since all transactions were executed in UAE and only supportive functions were carried out in India.

However, the Income Tax Department contended that the liaison office facilitated business in India, making it a taxable PE under the DTAA.

Key Legal Issues Raised

Whether the liaison office constituted a taxable PE under Article 5 of the India-UAE DTAA.
Whether any income was deemed to accrue in India under the Income Tax Act, 1961.
Whether activities of the liaison office were preparatory or auxiliary in nature.

Arguments by the Appellant (Union of India)

The government argued:

The liaison office was involved in downloading remittance details, printing cheques, and sending them to beneficiaries in India, which constituted business activities.
The RBI’s permission did not override tax laws, and the activities of the liaison office facilitated the company’s core operations.
By assisting in the execution of remittances, the office was beyond a preparatory or auxiliary role.
Under Article 5 of the DTAA, the liaison office should be treated as a permanent establishment, making its activities taxable in India.

Arguments by the Respondent (U.A.E. Exchange Centre)

The respondent countered:

The liaison office did not enter into contracts or earn any commission in India.
The primary business was conducted in the UAE, and Indian offices merely facilitated communication.
Under Article 5(3)(e) of the DTAA, preparatory and auxiliary activities do not constitute a permanent establishment.
All operations leading to profit occurred in UAE, and the role of the Indian office was strictly limited to processing instructions from UAE.

Supreme Court’s Observations and Ruling

The Supreme Court held:

The liaison office was only involved in preparatory and auxiliary activities, and thus, did not constitute a taxable PE.
The DTAA prevails over domestic tax laws, as reaffirmed in Azadi Bachao Andolan.
“Since the office was restricted from earning income in India as per RBI’s approval, no business connection could be established.”
Under Article 5(3)(e) of the DTAA, an enterprise is not considered a PE if it maintains a place of business solely for preparatory or auxiliary activities.
Consequently, the liaison office was not liable to pay tax in India.

Key Takeaways from the Judgment

Definition of Permanent Establishment: A PE must engage in business-generating activities; auxiliary operations alone do not suffice.
DTAA Overrides Domestic Law: The ruling reaffirms that tax treaties take precedence over local tax provisions.
RBI Approval and Taxation: If an entity operates strictly within RBI’s limitations, it may not be subject to Indian taxation.
Global Business Structuring: Multinational companies must carefully structure operations to avoid unintended tax liabilities.

Conclusion

This ruling provides clarity on taxation principles for foreign companies with liaison offices in India. It underscores the importance of DTAA provisions and affirms that merely facilitating transactions does not create a taxable presence. The judgment sets a precedent for similar cases involving multinational corporations operating in India.

Petitioner Name: Union of India & Anr..
Respondent Name: U.A.E. Exchange Centre.
Judgment By: Justice A.M. Khanwilkar, Justice Ajay Rastogi.
Place Of Incident: India.
Judgment Date: 24-04-2020.

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