Liaison Office – A Tax Efficient Structure
By Shariq Contractor
In recent years, many businesses have expanded and set up cross border offices. This article,
which was published in the newsletter of the International Network of Accountants and
Auditors, outlines how a liaison office is a logical and tax efficient first step to establishing a
business presence in a foreign jurisdiction.
Preamble:
Cross border business transactions have increased exponentially in the last decade and
business perspective has changed from being local to global.
In such an environment it is increasingly common for businesses to expand their horizon and
set up their presence outside their home country through:
1. Branch Office
2. Fully owned Subsidiary
3. Joint Venture entity
In all the above cases, the business presence established in the offshore jurisdiction would be
liable to tax in that jurisdiction.
Liaison Office:
However, there is another alternative structure that is often overlooked - establishing a Liaison
or Representative Office, hereafter referred to as LO. LO is a structure whereby an entity
establishes its presence in another country for a very limited purpose and does not undertake
any direct business activity. It is like testing the local waters before deciding whether a full
fledged business presence should be established.
This article intends to deal with the concept of a Liaison Office (LO) and the taxability of such an
entity in the offshore jurisdiction. Though the article is based on Indian law and judicial
decisions, the principles discussed are universal and would apply to similar LOs established in
other countries, subject of course to the local laws and regulations.
Under the Indian Exchange Control Regulations, a Liaison Office is defined as under:
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.
The critical question is whether a LO would constitute a Permanent Establishment (PE), because
if it does, then the profits attributable to the LO would be taxable in the offshore jurisdiction
where the LO has been established.
Concept of Permanent Establishment:
The concept of PE is well understood under International juridical double taxation and is clearly
defined in the double tax avoidance agreements (DTAA) signed between any two sovereign
States to arrive at an acceptable basis of sharing tax revenue between them.
PE means a fixed place of business through which the business of an enterprise is wholly or
partly carried on. In a landmark decision, the Andhra Pradesh High Court in India in the case of
Vishakapatnam Port Trust, 144 ITR 146 observed that the words PE postulate the existence of a
substantial element of an enduring, permanent nature of a foreign enterprise in another, which
can be attributed to a fixed place of business in that country. It should be of such a nature that
it would amount to a virtual projection of the foreign enterprise of one country into the soil of
another country.
The term PE under most DTAAs does not include:
(a)
the use of facilities solely for the purpose of storage or 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 of collecting information, for the enterprise;
(e)
the maintenance of a fixed place of business solely for the purpose of carrying on,
for the enterprise, any other activity of a preparatory or auxiliary character;
(f)
the maintenance of a fixed place of business solely for any combination of activities
mentioned in sub-paragraphs (a) to (e), provided that the overall activity of the
fixed place of business resulting from this combination is of a preparatory or
auxiliary character. [Emphasis supplied]
Therefore, in order to decide whether a PE is constituted, one has to undertake a functional
and factual analysis of each of the activities undertaken by an establishment. The crux of
the analysis lies in whether the LO has been performing only such functions which are of a
preparatory or auxiliary character or whether it is actually carrying out full-fledged
activities, as carried on by a branch/subsidiary/JV Company.
Concept of the term preparatory and auxiliary services:
The terms preparatory and auxiliary have not been defined in either the UN or the OECD
Model double tax Convention and it is often difficult to distinguish between the activities
which are preparatory or auxiliary in character and those which are not. The facts of each
case have to be individually examined before coming to a final conclusion.
Generally, in the following situation a PE would deem to have been established:
a.
b.
c.
d.
e.
the activity of the fixed place of business in the offshore jurisdiction forms an
essential, indispensable and significant part (as opposed to only a small part) of the
activity of the whole enterprise;
the general purpose of the fixed place is identical to the general purpose of the
whole enterprise;
the fixed place engages in core functions;
the performance of the activity in the offshore jurisdiction is necessary for successful
performance of the contract executed by the principle entity;
the activity of the fixed place of business in the offshore jurisdiction is an income
producing nature.
Some Case Laws:
In the case of K.T.Corproation 181 TAXMAN 94 (2009), a Korean Company had established an
LO, which was carrying out the following activities in India:
Holding of seminars, conferences;
Receiving trade inquires from the customers;
Advertising the technology being used by the applicant in providing the
wired/wireless services and to answer the queries of the customers;
Collecting feedback from the prospective customer/consumers, trade
organization etc.;
On the above facts the Authority for Advance Rulings concluded that the liaison office did
not constitute a PE as it had not performed any ‘core business activity’ and had confined
itself to preparatory and auxiliary activities. The AAR held that the instant activities were
merely an ‘aid’ or ‘support’ to the main activities of the Company.
In the following cases the Delhi Tribunal held that though the LO had staff who were paid salary
and perquisites, there was no evidence to show that they were transacting any business in India
on behalf of the foreign company. The LO only carried out advertising activity and acted as a
channel of communication between the foreign entity and the Indian (potential) customers. It
also provided training to the agents about the standards of service and security, accounting
procedures, telecommunication systems and configuration, merchandising standards, etc. The
Tribunal held that such activity did not constitute a PE in India.
Motorola Inc & Others 95 ITD 269 (Del) (2005),
Western Union Financial Services Inc, 101 TTJ 56 (Del) (2006).
In the case of Jebon Corporation India, 127 TTJ (Bang) 98 (2009), it was held that the
activities like identifying customers and supply of information regarding customer
requirement and specifications could be construed as preparatory activities. However in this
case the LO was also engaged in securing orders in India for the South Korean Company,
which was engaged in the sale of electronic products. The LO had full freedom to decide the
margin or selling price and was required to revert back to the head office only in case the
customer asked for a discount. Therefore, the LO had the right to conclude contracts and
procure purchase orders. The Tribunal held that the freedom to fix the sale price and to
conclude a contract even where the sales price was within the band of profit margin
communicated by the head office could not be termed as a preparatory or auxiliary activity.
Hence the LO was treated as a PE of the Korean Company and the income attributable to
the LO was held to be taxable in India.
In Rolls Royce PLC 113 TTJ (Delhi) 446 (2008), A UK based company had set up a subsidiary
in India. The subsidiary was performing certain functions which were similar to the
functions of an LO.
However, the Tribunal also found evidence to the effect that:
1. the employees of the subsidiary were directly responsible to the UK Company
and were entrusted with functions of liaising with identified officials of its
customers;
2. the UK Company did not receive all orders from customers in India but only
such orders which were scrutinized and approved by its subsidiary in India;
3. there were certain letters written by the employees of the subsidiary to the HO
which were in the nature of advice to the HO for concluding contracts with the
Indian customers;
4. the employees of the subsidiary were authorized to solicit requests for
quotation / purchase order;
5. The managing director of the subsidiary had issued certificates which showed
that the subsidiary had the authority to sign documents and take decisions
which were binding on the UK Company;
6. Records were maintained by the subsidiary in respect of the sales activities of
the UK Company in India.
The Tribunal held that the above activities could not be said to be of a preparatory
or auxiliary character but were rather in the form of marketing product
manufactured by the UK Company. The Subsidiary was accordingly held to be liable
to tax in India.
Analysis of Judicial Decisions:
Analyses of various judicial decisions reveal that the following activities are
considered as preparatory or auxiliary activity:
i)
Services like data processing, account reconciliation etc performed by a back
office unit.
ii) Basic operations carried out by a foreign enterprise before its business actually
commences, like:
•
Industry analysis;
•
Market survey;
•
Furnishing of product information;
•
Ensuring technical presentations to potential users;
•
Development of market opportunities;
•
Ensuring distributorship & their warranty obligation;
•
Accounting and financing.
iii) Scientific research activities.
iv) Providing a communications link between suppliers and customers.
v) Relaying information through a mirror computer server for security purposes.
vi) Pre-designing or pre-engineering survey in respect of contracts, which on their
own, were not capable of generating any income;
vii) Advertising;
viii) Holding of seminars, conferences;
ix) Receiving trade inquires from the customers;
x)
Collecting feedback from the prospective customer / consumers;
xi) Identifying Customers;
xii) Supply of information regarding customer requirements and specifications;
Each of the above activities, by itself may be of preparatory or auxiliary in nature,
yet a combination of them may result in the emergence of a PE. An item by itself
may not be of significance and yet combined with another may become significant
enough to be more than just preparatory or auxiliary in nature. The test is whether
the activities jointly result in the emergence of a facility which would be
economically viable if separated from the enterprise to which it belongs. If it does
than PE is established. It is essential that LO should carry out only non core activities
that are not economically viable on a standalone basis.
The following activities have not been considered as preparatory or auxiliary
character, thereby attracting tax liability in the foreign jurisdiction.
i)
ii)
iii)
iv)
v)
vi)
Managing an enterprise or its part.
A research establishment which engages in manufacture.
An ISP which operates computer servers, for hosting websites of customers.
Supervision or control over performance of a contract between a resident and
the foreign company.
After sales services to customers.
A fixed place of business for the delivery of spare parts to customers.
Conclusion:
In conclusion, a LO would generally not constitute a PE and hence would not be
liable to tax in the foreign jurisdiction, if it is only engaged in preparatory or auxiliary
activities. It is recognised that a place of business may well contribute to the
productivity of an enterprise, but the services it performs may be so remote from
the actual realisation of profits that it would be difficult to allocate any profit to the
fixed place of business. Examples are fixed place 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 know-how contract, etc.
It is often difficult to distinguish between activities that are preparatory or auxiliary
in character and those which are 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. In any case, a fixed place of business whose general
purpose is identical to the general purpose of the whole enterprise cannot be
treated as a preparatory or auxiliary activity. Where an international concern has
delegated all management functions to its regional management offices, so that the
functions of the head office are restricted to general supervision (so-called polycyclic
enterprises), the regional management offices would have to be regarded as a place
of management. The function of managing an enterprise, even if it only covers a
certain area of the operations of the concern, constitutes an essential part of the
business operations of enterprise and therefore can in no way be regarded as an
activity which is only of a preparatory or auxiliary character.
LO is an interesting structure to look at if one is looking at merely testing the
offshore waters. It is ideally suited for getting a feel of the local conditions, doing
market research, acting as channel of communication between the local
customers/agents and the Head Office, carrying out advertising and other similar
activities. It is a structure which attracts no tax liability in the offshore jurisdiction. It
is the first logical step and a bridge between the exploratory stage and establishing a
full commercial presence in a foreign jurisdiction.