M/S. K.T. Corporation Vs. Director of Income-tax(international Taxation-i), New Delhi - Court Judgment

Mr. Rao Ranvijay Singh

M/s. K.T. Corporation, Korea, has filed this application under Section 245Q(1) of the Income-tax Act (in short the Act) in the prescribed form No.34-C. The applicant is a foreign company registered in Korea.

2. The applicant states that it has opened a liaison office (in short L.O.) situated at Suite No.#311, Ashoka Hotel, Chanakyapuri, New Delhi, India, with the permission of the Reserve Bank of India (RBI) vide letter No.FE.CO.FID-10.1.05.02/6034 (Activity7)/2003-2004 dated 10^th June, 2004. The L.O. has been, as stated, opened for the sole purpose of liaisoning activities i.e. to act as a communication channel, between the Head Office of the applicant and the concerned parties i.e. Indian companies, within the parameters listed out by the RBI. The application has been signed by the General Manager of the L.O., namely Mr. Siung-Yong Shin, who has, reportedly, been directed by the Head Office to obtain the ruling on behalf of the applicant.

3. Details filed along with the application further reveal that pursuant to the opening of the L.O. in 2004, the applicant entered into a Reciprocal Carrier Service Agreement (in short RCSA), dated 13.8.2007, with Vodafone Essar South Ltd. (in short VESL) which is an Indian company registered in India with the address at C-48, Okhla Industrial Area, Phase-II, New Delhi. The applicant and VESL are telecommunication carriers/resellers and have agreed to enter into the agreement to provide certain services to each other. Under this agreement, they have agreed to interconnect with each other and to purchase and provide the services by a date confirmed between them. As per the agreement, the applicant shall bear the investment cost, the connection and maintenance of the connecting facilities between its Network and VESLs Foreign POP on locations (city and country) as may be mutually discussed and agreed. Similarly, VESL shall bear the investment cost, the provisioning and maintenance of connecting facilities in India and of its Foreign POP as well as for the connection between them. Further, in respect of the above services each party will send the other party an invoice of all traffic terminated on its side during each calendar month and as per clause 2(b) of the agreement, the Invoiced party will make payments to the Invoicing party.

4. In the above backdrop, the applicant has sought ruling of this Authority on the following question:-

1. Whether the Liaison Office of K.T. Corporation in New Delhi constitute a Permanent Establishment in respect of Clause 2(b) of Annexure A of the Draft Reciprocal Carrier Services Agreement between K.T. Corporation, Korea and Vodafone Essar South Limited?

5. In the comments furnished on merits, the Revenue has, at the very outset, submitted that the applicant has not sought advance ruling on question whether the payments made by the Invoiced party (VESL) to the Invoicing party (the applicant) is taxable in India or not as per the provisions of the Act and the Double Taxation Avoidance Agreement (in short the Treaty) between India and Korea. On the other hand, the applicant has, as contended by the Revenue, sought ruling only in respect of whether the Liaison Office in India constitutes a Permanent Establishment (PE) in terms of clause 2(b) of the aforesaid agreement as referred to above. It has been stated by the Revenue that the applicant has to furnish reply/details in respect of certain queries such as (i) What was the role of the L.O. in Pre-bid survey carried out before entering into the Agreement? (ii) How was the feasibility report prepared, did the L.O. play any role in it? (iii) Were the employees of the L.O. involved in the technical analysis of the project? And (iv) is the L.O. involved either in the technical analysis of the project or the execution of any part of the contract? The Revenue has, accordingly, emphasized the fact that answer to these and similar other queries are essential to find out whether the L.O. constitutes a Permanent Establishment of the applicant in terms of clause 2(b) of Annexure ‘A of the said agreement vis-à-vis the provisions of the Treaty. In the absence of these details the Revenue contends that it is not possible to conclude whether L.O. constitutes a PE of the applicant. Independent of the question whether L.O. will constitute a PE or not as sought by the applicant, the payments received by the applicant from VESL under the above agreement may be taxable in terms of section 5(2) read with section 9(1)(vi), 9(1)(vii) of the Act and Article 13 of the DTAA, avers the Revenue.

6. In the supplementary statement of facts filed on 24.2.09, the applicant has given the details of activities undertaken by the L.O. in India. It has been stated that the L.O. was set up in India to act only as a communication channel and it became functional within the restrictions imposed by the R.B.I. The applicants counsel has further submitted that the L.O. is, no doubt, a fixed place of business (i.e. an office) maintained exclusively for the purpose of collecting information for the applicant which is in the nature of preparatory and auxiliary character for the enterprise. Facts being so, it has been contended that the L.O. is deemed not to be Permanent Establishment especially in terms of Article 5(4)(d), 5(4)(e) and 5(4)(f) of the Treaty. Further, the LO. in India, as submitted, only carries out preparatory or auxiliary activities such as (i) holding of Seminars, Conferences (ii) receiving trade enquiries from the customers (iii) advertising about the technology being used by the applicant in providing the wired/wireless services and to answer the queries of the customers (iv) collecting feed back from the prospective customers/consumers, trade organizations etc. and has neither played any role in the pre-bid survey etc. before entering into the agreement with VESL nor has involved itself in the technical analysis of any project.

7. The applicant has subsequently filed some more factual details indicating that the L.O. has not undertaken any activity of trading, commercial or industrial nature. In this regard, an affidavit from Mr. S.Y.Shin, General Manager of the L.O., has also been filed. The activities undertaken by other four employees of the Liaison Office has also been furnished. As stated, the applicant does not, at this stage, want to seek ruling in respect of taxability of the receipts from VESL and has, as such, confined itself to seek ruling in respect of the following recast question:-

1. “Whether the Liaison Office of K.T. Corporation in New Delhi constitutes a Permanent Establishment (P.E.)?”

8. Arguing further, the counsel for the applicant has emphasized that the Liaison Office is only a representative office of the applicant in India and the RBI has permitted it to act only as a communication channel between the applicant and the parties with the RBIs restrictions as under:-

(i) Except the proposed liaison work, the office in India will not undertake any other activity of a trading, commercial or industrial nature nor shall it enter into any business contracts in its own name without our prior permission.

(ii) No commission/fees will be charged or any other remuneration received/income earned by the office in India for the liaison activities/services rendered by it or otherwise in India.

(iii) The entire expenses of the office in India will be met exclusively out of the funds received from abroad through normal banking channels.

(iv) The office in India shall not borrow or lend any money from/to any person in India without our prior permission.

(v) The office in India shall not acquire, hold, (otherwise than by way of lease for a period not exceeding five years) transfer or dispose of any immovable property in India without obtaining prior permission of the Reserve Bank of India under the Foreign Exchange Management (Acquisition and transfer of immovable property in India) Regulations, 2000.

(vi) The office in India will furnish to our Regional Office (on an yearly basis) a certificate from the auditor that the office has complied with the terms and conditions stipulated in the letter of approval issued by the Reserve Bank of India and that all the expenses are met by way of inward remittances. In the case of winding up of the office, you may approach Regional Office with the documents as required in terms of Regulations 6(1)(iii) of Notification No. FEMA.13/RB-2000 dated 3^rd May 2000.

(vii) The office in India will not render any consultancy or any other services directly/indirectly, with or without any consideration.

(viii) The office in India will not have any signing/commitment powers, except than those which are required for normal functioning of the office, on behalf of the Head Office.

(ix) In case you desire to open a Head Office account in the books of your liaison office in India, we hereby grant you our approval to maintain such an account subject to the conditions that the credits to the account should represent the funds received from Head Office through normal banking channels for meeting the expenses of the office. Debits to this account could be raised only for meeting the local expenses of the office.

(x) The activities/affairs of these offices may be verified / examined by RBI by carrying out a scrutiny as and when found necessary.

(xi) Please note that you shall have to obey the law of the land and there shall be no compromise or excuse for the ignorance of the Indian legal system in any manner.

9. Summing up the arguments the counsel for the applicant emphasized that the L.O. has neither undertaken any trading activity nor has entered into any business contracts on behalf of the applicant. It has also been contended that the L.O. has also not rendered any consultancy or any other services directly/indirectly with or without any consideration. Strictly speaking, the L.O. is as submitted, not a fixed place of business through which the business of the enterprise i.e. Head Office has either wholly or partly been carried on. On the contrary, it is a fixed place (an office) which has undertaken only preparatory or auxiliary work. It has thus been argued that the impugned Liaison Office cannot be regarded as Permanent Establishment as per the provisions of Article 5(1), 5(2) read with the specific clauses (d), (e) and (f) to Article 5(4) of the Treaty.

10. In the affidavit dated 4.4.2005 filed by the General Manager of the L.O., it has categorically been stated that the L.O. has neither entered into nor has been given the permission / authority to conclude any trade contract. The L.O., as stated, did not procure any orders for any potential customers and did not conclude any negotiations as well. It has also been stated therein that the L.O. has not transgressed the conditions imposed by RBI in the approval letter as referred to above. The General Manager has also solemnly affirmed that the L.O. was, in no way, involved in the Pre-Bid Survey, preparation of feasibility report or any technical analysis of the project.

11. In the given set of facts as stated above by the applicant, the question to be decided is whether the impugned Liaison Office can be regarded as a Permanent Establishment in light of the activities performed vis-à-vis the provisions of the Treaty. It is also important here to note that the actual activities carried out by the Liaison Office in India need to be examined in each case to determine whether the activities would fall within the ambit of preparatory or auxiliary activities.

12. To appreciate the point at issue, it would be quite apposite to advert, first, to paras 1,2,and 4, which are relevant for our purpose, of Article 5 of the Treaty between India and Korea (165 ITR (St) 191) which is as under:-

Article 5: Permanent Establishment

1. For the purposes of this Convention, the term “permanent establishment” means a fixed place of business through which the business of an enterprise is wholly or partly carried on.

2. The term “permanent establishment” shall include especially :

(a) a place of management;

(b) a branch;

(c) an office; …….

3. xxx xxx xxx

4. Notwithstanding the preceding provisions of this Article, the term “permanent establishment” shall be deemed not to include:

(a) the use of facilities solely for the purpose of storage, display or delivery of goods or merchandise belonging to the enterprise;

(b) the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of storage, display or delivery;

(c) the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of processing by another enterprise;

(d) the maintenance of a fixed place of business solely for the purpose of purchasing goods or merchandise or for collecting information, for the enterprise (Emphasis supplied.);

(e) the maintenance of a fixed place of business solely for the purpose of advertising, the supply of information, scientific research, or any other activity, if it has a preparatory or auxiliary character in the trade or business of the enterprise (Emphasis supplied.);

(f) the maintenance of a fixed place of business solely for any combination of activities mentioned in sub-paragraphs (a) to (e) of this paragraph, provided that the overall activity of the fixed place of business resulting from this combination is of a preparatory or auxiliary character (Emphasis supplied.).

13. To summarize, the expression ‘Permanent Establishment means a ‘fixed place of business through which the business of an enterprise (foreign entity) is wholly or partly carried on and includes within its ambit places enumerated in clauses (a) to (c) of para 2 above but excludes places specified in clauses (a) to (f) of para 4 referred to above in Article 5 of the Treaty. The activities listed above from clauses (a) to (f) of para 4 to Article 5 are exceptions to the basic concept of P.E. as enshrined in Para 1 of Article 5 and are considered to be incidental or preparatory / auxiliary vis-à-vis the main business activity of the foreign entity.

14. At this juncture, it would be quite appropriate to refer to the connotations of the phraseology ‘Liaison Office. Regulation 2(e) of Foreign Exchange Management Act (in short FEMA) 2000 defines it as follows:-

“(e) Liaison office means a place of business to act as a channel of communication between the principal place of business or Head Office by whatever name called and entities in India but which does not undertake any commercial/trading/industrial activity, directly or indirectly and maintains itself out of inward remittances received from abroad through normal banking channel”

Further, schedule II to the FEMA read with Regulation 6(1) gives the following list of activities, which can be carried on, through a Liaison Office:-

(i) “Representing the parent company/ group companies in India.

(ii) Promoting export/ import from/ to India.

(iii) Promoting technical /financial collaboration between parent/ group companies and Indian companies.

(iv) Acting as communication channel between parent and Indian companies.”

Also, the RBI generally lays down restrictive conditions, as referred to in preceding para, at the time of granting permission for the opening of a Liaison Office.

15. From the above, it is evident that even as per statutory provisions, the activities of a Liaison Office are much restricted and it cannot legally venture into securing orders from the customers in any manner either directly or indirectly.

No doubt, the Liaison Office is a fixed place and the activities conducted by it are seemingly business activities but these activities are restricted to preparatory or auxiliary activities only. Besides, the plain meaning of the word ‘auxiliary is found in Blacks Law Dictionary 7^th Edition at page 130 as ‘aiding or supporting, ancillary and subsidiary. Such ‘aiding, ‘assisting or ‘supporting are in relation to the main activities of the enterprise.

16. It has been urged by the applicant that maintenance of liaison office mainly for the purpose of communication channel between the Head Office of the applicant and the parties concerned is covered particularly by exclusionary clause (d), (e) and (f) as referred to above in Article 5(4) of the Treaty. It is emphasized that no business is entertained in the liaison office in pursuance of the parameters laid down by the RBI. Now, the main question remains whether the exclusionary clauses (d), (e) and (f) of para 4 are attracted: if so whether the liaison office would stand excluded from the meaning of the expression ‘Permanent Establishment.

17. As per the provisions of Article 5(4)(d), collecting information for an enterprise by a liaison office located abroad is, in our opinion, considered an auxiliary activity, unless the collecting of information is the primary purpose of the enterprise. In the instant case, the L.O., as the applicant submits, performs auxiliary activities, by collecting a host of information concerning various Indian companies and transmits them to the Head Office of the enterprise. It is nobodys case that collecting information is the primary purpose of the enterprise (the applicant). The applicants specific case is that the L.O. has nothing to do with the telecommunication services and network and the contracts connected therewith. Thus, the L.O. cannot be considered to be a PE in terms of clause (d) of Para 4 of Article 5 of the Treaty. Clause (e) of para 4 provides that a fixed place of business through which the enterprise exercises solely an activity which has, for the enterprise, a preparatory or auxiliary character, is deemed not to be a Permanent Establishment. The following extracts (para 21, 23, 24) from the OECD Model Commentary on Article 5 of the Treaty (July 2008 Edition) is quite eloquent:-

Paragraph 4

“21. This paragraph lists a number of business activities which are treated as exceptions to the general definition laid down in paragraph 1 and which are not permanent establishments, even if the activity is carried on through a fixed place of business. The common feature of these activities is that they are, in general, preparatory or auxiliary activities. This is laid down explicitly in the case of the exception mentioned in subparagraph e), which actually amounts to a general restriction of the scope of the definition contained in paragraph 1. Moreover sub paragraph f) provides that combinations of activities mentioned in subparagraphs a) to e) in the same fixed place of business shall be deemed not to be a permanent establishment, provided that the overall activity of the fixed place of business resulting from this combination is of a preparatory or auxiliary character. Thus the provisions of paragraph 4 are designed to prevent an enterprise of one State from being taxed in the other State, if it carries on in that other State, activities of a purely preparatory or auxiliary character.

23. …. To a considerable degree it limits that definition and excludes from its rather wide scope a number of forms of business organizations which, although they are carried on through a fixed place of business, should not be treated as permanent establishments. It is recognized that such a place of business may well contribute to the productivity of the enterprise, but the services it performs are so remote from the actual realization of profits that it is difficult to allocate any profit to the fixed place of business in question. Examples are fixed places of business solely for the purpose of advertising or for the supply of information or for scientific research or for the servicing of a patent or a know-how contract, if such activities have a preparatory or auxiliary character.”

24. It is often difficult to distinguish between activities which have a preparatory or auxiliary character and those which have not. The decisive criterion is whether or not the activity of the fixed place of business in itself forms an essential and significant part of the activity of the enterprise as a whole. Each individual case will have to be examined on its own merits.”

18. We have therefore, to ascertain whether the activities carried on in the liaison office in the instant case, are only supporting the main business or they are undertaking the main functions of the business. As stated by the applicant, the RBI, as per its letter dated 10.6.2004 had granted the permission to the applicant under the Foreign Exchange Management Act for establishing a liaison office initially for a period of three years for the purpose of liaisoning activities viz to act as a communication channel between the head office and parties in India. Since the liaison office had not transgressed the parameters and the terms prescribed, the RBI granted further extension for three years as per letter No.FED.F.O. No./4062/07.01.2085/2007-08 dated 28^th September, 2007 with the following additional conditions:-

“1. The office must submit the number of staff engaged/appointed and duties assigned to them, along with Auditors Certificate that the Liaison Office has complied with terms and conditions stipulated in the letter of approval issued by Reserve Bank of India. You may also furnish a declaration that all expenses are met by way of inward remittances only in case you are not in a position to submit Audited Annual Accounts in future.

2. The office will not render any consultancy or any other services directly/indirectly with or without any consideration.

3. Please note that no specific permission is required for crediting security refunds, income tax refunds, insurance claims and Govt. refunds to the bank account of the Liaison Office. However, for remittance of these amounts, specific permission of Reserve Bank of India will be necessary. Further in case of sale of assets at a profit, the Liaison Office has to take prior permission for the sale.”

19. From the facts made available, it has emerged that the liaison office, in this case, has not performed any ‘core business activity and has confined itself to preparatory and auxiliary activities only. In fact, all that seems to have been done by the L.O. fall within the parameters of supplying information which is preparatory to and auxiliary to the formation of the final contracts entered into by the applicant with VESL. Plainly to our minds, the instant activities viz. preparation of reports dealing with Indias market scenario in Mobile as well as broadband segments etc. are in ‘aid or ‘support of the main activities and accordingly rest in the realm of preparatory and auxiliary activities. The liaison office is very much covered within the exclusionary clause (e) and (f) of Article 5(4) of the Treaty and consequently cant be regarded as a Permanent Establishment in the sets of facts presented. It will be quite befitting to recall the following observation of the Supreme Court in the case of D.I.T.(International Taxation) vs. Morgan Stanley 292 ITR 416, 427:-

“There is one more aspect which needs to be discussed namely, exclusion of P.E. under Article 5(3). Under Article 5(3)(e) activities which are preparatory or auxiliary in character which are carried out at a fixed place of business will not constitute a P.E. Article 5(3) commences with a non obstante clause. It states that notwithstanding what is stated in Article 5(1) or under article 5(2) the term P.E shall not include maintenance of a fixed place of business solely for advertisement, scientific research or for activities which are preparatory or auxiliary in character. In the present case we are of the view that the above mentioned back office functions proposed to be performed by MSAS in India fall under Article 5(3)(e) of the DTAA. Therefore, in our view in the present case MSAS would not constitute a fixed place P.E. under Article 5(1) of the DTAA as regards its back office operations.”

Further, relying on the above, the Delhi High Court in the case of UAE Exchange Centre Ltd. vs. U.O.I. reported in (2009) 223 CTR 250, also observed thus at P.267:-

“Once an activity is construed as being subsidiary or in aid or support of the main activity it would, according to us, fall within the exclusionary clause. 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-à-vis its customer if looked at from that point of view, then no activity could be construed as preparatory or an “auxiliary” character.”

20. In the light of the above discussion and the facts stated by the applicant, we are of the view that the applicants liaison office in India cannot be regarded as a Permanent Establishment of the applicant as per the exclusionary provision, as referred to above, of Article 5(4) of the Treaty. However, we may add here that if the activities of the liaison office are enlarged beyond the parameters fixed by RBI or if the Department lays its hands on any concrete materials which substantially impact on the veracity of the applicants version of facts, it is open to the department to take appropriate steps under law. But, at this stage, we proceed to give ruling on the basis of facts stated by the applicant which cannot be treated as ex-facie untrue.

21. Having regard to the above discussion and also the facts presented before us, we are of the view that the L.O. in this case, does not constitute a P.E.

22. Accordingly, the ruling is given answering the question in negative, as contended by the applicant.

Pronounced by the Authority on this 29^th day of May 2009.