IN what could be termed as a shocker, the Karnataka Authority for Advance Rulings (‘AAR’) has, in its ruling dated October 8, 2020, in respect of M/s FRAUNHOFER GESSELLSCHAFT ZUR FORDERUNG DER ANGEWWANDTEN FORSCHUNG E V, reported in- 2020-TIOL-267-AAR-GST, has held that the Indian liaison office of a foreign company is liable to registered as a taxable person under the GST law and accordingly discharge its tax liability.
Before we get into a discussion on some of the manifold ramifications that would arise from this latest ruling, it would do us good to get an understanding of what exactly a ‘liaison office’ means, especially considering the fact that this term has not been defined under the GST law. As is commonly understood, liaison offices are not allowed to engage in any trade or commerce and are only allowed to engage themselves in activities that are largely representative in nature. A Liaison office is a temporary office of a foreign company in India that is set up for carrying out liaising activities for its business in India without any exchange of commercial value. Since a liaison office does not earn any income from India, all the expenses of carrying on a Liaison office in India is borne from the foreign remittance received from its overseas head office. Further, Liaison offices are instrumental in promoting technical/ financial collaborations between its parent group companies and Indian companies by acting as a communication channel between the two. Usually, certain eligibility criterion should be met by a foreign company aspiring to set up a liaison office in India, namely a profitable track record of minimum 3 years in its home country and meeting the prescribed criteria of threshold net worth duly certified by a registered accounting practitioner.
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In terms of Master Circular No. 7/2015-16 dated July 1, 2015, RBI has stipulated that only the following activities are permitted to be undertaken by liaison offices, viz.
b.1 Permissible Activities for a Liaison Office
A Liaison Office (also known as Representative Office) can undertake only liaison activities, i.e. it can act as a channel of communication between Head Office abroad and parties in India. It is not allowed to undertake any business activity in India and cannot earn any income in India. Expenses of such offices are to be met entirely through inward remittances of foreign exchange from the Head Office outside India. The role of such offices is, therefore, limited to collecting information about possible market opportunities and providing information about the company and its products to the prospective Indian customers. Permission to set up such offices is initially granted for a period of 3 years and this may be extended from time to time by an AD Category I bank.
A Liaison Office can undertake the following activities in India:
i. Representing in India the parent company / group companies.
ii. Promoting export / import from / to India.
iii. Promoting technical/financial collaborations between parent/group companies and companies in India.
iv. Acting as a communication channel between the parent company and Indian companies.
The applicant in the instant case had submitted to the AAR that RBI had laid down the following stipulations while approving the setting up of the liaison office….
(i) The liaison office shall be established within six months from the date of the permission letter.
(ii) The liaison office will not generate income in India and will not engage in any trade / commercial activity and undertake only permissible activities as mentioned in Schedule II of FEMA Notification No. 22/2000-RB dated May 3, 2000, as amended from time to time.
(iii) It should restrict its activities to those given in Para 4 (iii) (a) of Form FNC submitted by the Applicant.
(iv) It will function as per the conditions mentioned in the Annexure-1 of RBI approval letter.
(v) It will represent only the applicant company and approach RBI for prior approval if it wants to represent any group company.
Further Annexure-I of the RBI permission letter provides the terms and conditions according to which the liaison office in India will perform the following functions.-
a. Representing in India the parent company.
b. Promoting export/import from/to India.
c. Promoting technical/Financial collaborations between parent/group companies and companies in India.
d. Acting as a communication channel between the parent Company and Indian Companies.
In addition, certain other conditions were also stipulated such as:-
(i) It shall work only for liaison activities and not for any indirect entry into service.
(ii) Shifting the liaison office to any other city shall be made only with the prior approval from RBI.
(iii) Except the proposed liaison work, the office will not undertake any other activity of trading, commercial or industrial nature nor shall it enter into ami business contracts in its name without RBI permission.
(iv) 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.
(v) The entire expenses of the office in India will be met exclusively out of the funds received from abroad through normal banking channels.
(vi) The liaison office shall not borrow or lend money from/to any person in India without prior permission of Reserve Bank of India.
(vii) It 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 permission by Reserve Bank of India. Under the Foreign Exchange Management Act (Acquisition and transfer) of immovable property in India.
(ix) It shall furnish and submit the Annual Activity Certificate of the activities of the Liaison office from the Auditors at the end of 31st March and same needs to be submitted on or before September 30 of that year. In case the annual accounts of the Liaison Office are finalized with reference to a date other than March 31, the AAC along with the audited Balance Sheet may be submitted -within six months from the due date of the Balance Sheet.
(x) It shall also submit a copy of Annual Report to the Directorate General of Income Tax (International Taxation), New Delhi.
(xi) It will not render any consultancy or any other services directly/ indirectly with or without consideration.
(xii) It 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.
(xiii) The activities/affairs of the offices may be verified/examined by RBI by carrying out a scrutiny as and when found necessary.
Given the above list of permissible transactions that can be entered into by the applicant, the question that arose was whether, any of these activities could be considered as ‘business’ within the meaning of Section 2(17) to attract tax. The relevant extracts Section 2(17) are reproduced below –
“business” includes,-
(a) any trade, commerce, manufacture, profession, vocation, adventure, wager or any other similar activity, whether or not it is for a pecuniary benefit;
(b) any activity or transaction in connection with or incidental or ancillary to sub-clause (a);
(c) any activity or transaction in the nature of sub-clause (a), whether or not there is volume, frequency, continuity or regularity of such transaction;
……………..
The AAR, while agreeing with the applicant that their activities would not fall under clause (a) of Section 2(17), has ruled that the applicant would be covered by clause (b) of the above referred definition of ‘business’. The relevant portion of the ruling dealing with this specific part, is reproduced below –
“In the instant case the applicant contends that they are not covered under Section 2(17) of the CGST Act 2017, by mainly focusing on clause (a) of the said Section. We observe that the impugned liaison activity of the applicant actually falls under clause (b) of Section 2 (17) of CGST Act, 2017 as it is ancillary to the activities mentioned in clause (a) of Section 2 (17) of CGST Act, 2017. Further, it is to be noted that the definition of business for the purpose of GST is derived from its definition in the Act and RBI’s injunction on business for the applicant can’t decide the scope of business for the purpose of GST. In view of the above, we find that the applicant is involved in the business.”
One completely fails to appreciate the rationale behind this view that, clause (b) of Section 2(17) can be read independent of clause (a) of the said Section. Thus, if a person in engaged in carrying out transactions in the nature of trade or business or commerce within the meaning of clause (a), any other transaction which is ancillary or incidental to the main activity (which is in the nature of trade, commerce, etc) would also be treated as ‘business’ notwithstanding that such incidental or ancillary transactions, do not by themselves, constitute ‘business’. Very unfortunately, this principle has not been appreciated by the AAR, which has held that even an incidental activity could by itself, be treated as business (even if the main activity is not one of trade or commerce or business).
If this view that clause (b) of Section 2(17) can be independently applied is accepted, the Tirumala Tirupati Devasthanam could also be treated as being engaged in ‘business’ in respect of the laddus sold by it (I am addicted to Tirupati laddus) notwithstanding the fact that TTD cannot be treated as being engaged in trade or commerce within the meaning of clause (a) of Section 2(17).
As can be seen from the para reproduced above, the AAR makes a further comment that they are not bound by the RBI’s injunctions imposed on the Applicant. One finds this to be rather amusing, as, in the absence of a clear definition of ‘liaison office’ under the GST law, the GST law has to follow the foreign exchange law under which these offices are established. Once RBI has stipulated that the liaison office cannot engage itself in trade or commerce or business, the matter should have ended there. Can one agency of the Central Government, viz. the CGST Department take a view that would contradict the view taken by RBI, another important agency?
Be that as it may…in the instant case, the applicant had quoted two earlier advance rulings that have held that liaison offices are not liable to be registered under the GST law and pay tax, on the basis that such liaison offices are not engaged in the carrying out any trade or business, etc.
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Very surprisingly, there is no discussion in the present ruling, on these earlier rulings and on how these rulings are not relevant to the present issue. The least that one would have expected is for the AAR to write para on these two earlier rulings, especially when the applicant had relied on these rulings.
We are aware of the legal position that an advance ruling is relevant only to the particular applicant and cannot be treated as a binding precedent. However, given the legal position that, the AAR is constituted by the representatives of both the Central Government as well as, the State Government, is it open to the Central Government to take a stand that is totally opposed to the stand that it had taken in the earlier two rulings on identical facts, especially considering the fact that the Central Government had not gone on appeal against the two earlier rulings? Will taking a different view in the case of the present applicant as contrasted to the view taken in the earlier two rulings, on the same set of facts and circumstances, not violate the landmark judgment of the Larger Bench of the Apex Court in CCE, Navi Mumbai v Amar Bitumen & Allied Products Pvt Ltd 2006-TIOL-96-SC-CX-LB, in which it has been held that, the Revenue cannot, while accepting an order in respect of an assessee, question its correctness in the case of another assessee, on the same issue?
Needless to say, though the earlier rulings are not binding on the AAR delivering the subsequent ruling, the earlier rulings do have a persuasive effect and the least the AAR could do, is to explain clearly as to why it is not following the earlier rulings.
Lastly, the question that would also arise in the case of liaison offices is whether, the provisions of Explanation 2 to Section 8(1) of the IGST Act, read with Section 25 of the CGST Act, along with Sl No 2 to Schedule I to the CGST Act would be applicable. The said explanation and the entry in Schedule I are reproduced below –
Explanation 2.– A person carrying on a business through a branch or an agency or a representational office in any territory shall be treated as having an establishment in that territory .
2. Supply of goods or services or both between related persons or between distinct persons as specified in section 25, when made in the course or furtherance of business:
A plain reading of this Explanation makes it clear that, only a person carrying on business through representational office shall be treated as having an establishment in that territory. Thus, merely having a representational office (a liaison office is largely similar to a representational office) would not attract Section 8(1). Such a representational office should also be engaged in business, to attract the provisions of the CGST Act.
Even assuming for the sake of an argument that the liaison office set up in India of a foreign entity is engaged in providing services to its Head Office, will these services be not exempt under Section 13(1) of the IGST Act, 2017? Yes, in my view. In my further view, the services rendered by an Indian liaison office to its head office cannot be treated as intermediary services within the meaning of Section 13(8)(b) of the IGST Act.
Lastly… the question as to whether liaison offices are to be treated as permanent establishments under the Income tax law, is gaining a lot of interest, of late. There have been contradicting decisions from the judicial fora, on this highly contentious issue. Broadly speaking, the juridical fora have held that when the liaison office is engaged in identifying new customers, entering into price negotiations, procuring orders, etc., it is to be treated as being engaged in commercial activities and is consequently, to be treated as a permanent establishment of the foreign company engaged in commercial activities and is consequently liable to pay income tax on the part of the income attributable to its Indian activities [Jebon Corporation India v CIT – 2011-TII-15-HC-KAR-INTL.
In its euphoric support for the BEPS initiative, India has yet again introduced a unilateral statutory insertion through the Finance Act 2018, thereby enhancing the discretionary power in the hands of tax authorities and unsettling judicial precedents around business connection and formation of a permanent establishment in India.
Following clause (a) has be substituted for the existing clause (a) of Explanation 2 to clause (i) of sub-section (1) of section 9 by the Finance Act, 2018, w.e.f. 1-4-2019 :
……’business connection’ shall include any business activity carried out through a person who, acting on behalf of the non-resident…
We need to see how this new development affects taxation of liaison offices in India, under the income tax law. But, for understanding the GST implications on liaison offices, I am of the view that we need not go into the income tax law.
Before parting..
By and large, the broad view is that, liaison offices are exempt from both income tax and indirect taxes. In most cases, foreign companies set up liaison offices as the first step, to understand the Indian market, before setting up their subsidiaries or branch offices. From the point of view of attracting foreign investment, it would be best to exempt liaison offices from the levy of GST as this kind of a confusion could lead to foreign companies to think twice about setting up these offices.
A clarification in this regard by the CBIC would do a whole lot good.
[The views expressed are strictly personal.]
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