Does a Liaison Company Attract Taxation Liability in India?


It is not unusual for foreign organizations who intend to do business in India, to establish a liaison office to carry out their promotional work. Starting a liaison office in India can serve as a precursor to commercial activities.

However, before starting a liaison office in India, approval from the Reserve Bank of India (RBI)) is mandatory. The liaison office is regulated by the Foreign Exchange Management Act (FEMA) 2000. There will be no difference in the eligibility of the foreign company to pay tax because liaison offices are not allowed to carry out any commercial activity in India.

The primary role of the liaison office is to promote exportation and importation of goods, to collect information in India for the foreign company and to facilitate collaboration between the foreign-based company and Indian companies they might want to do business with. They are restricted with the kind of activities they carry out. A liaison office is not allowed to carry out commercial activities, whether directly or indirectly. As their role is auxiliary in nature, they only support the foreign-based firm.

In a situation where after starting a liaison office in India, the liaison offices establish a ‘business connection' or a ‘permanent establishment’ for the foreign organization in India, the above legal condition might change. For example, looking at the case of UAE Exchange Center (268 ITR 9), the Authority for Advance Ruling interpreted the tax treaty between the UAE and India, maintaining that the liaison office created a business connection and permanent establishment.

In the case of Gutal Trading (278 ITR 643), however, the Authority for Advance Ruling interpreted the tax treaty and held that no business connection or permanent establishment was created by the liaison office, even though in these two cases, both liaison offices were acting as specified by the RBI.

The Authority for Advance Ruling held that as long as a liaison office doesn’t negotiate with Indian customers to buy or import goods from the company, it can be said that there is no business connection or permanent establishment between the foreign company and the liaison office. This means that the activities of the liaison office in India should not contribute either directly or indirectly to the income generated by the foreign organization or company.

If the liaison office creates a business connection or permanent establishment, the foreign company will have to pay taxes on their profits. However, if the liaison office does not establish a business connection or permanent establishment, the foreign company will not be liable to pay taxes in India.

In a recent case, (IKEA Trading (Hong Kong) Ltd. 308 ITR 422), it is important to note the ruling of the Authority for Advance Ruling. In this case, a liaison office was established by a foreign firm to carry out activities and buying goods from Indian exporters.

The liaison office made inquiries and considered supplies to buy from, checked the quality of the various products they wanted to buy, followed up with the Indian exporters, made social audits of the suppliers and also served as a communication channel between the Hong Kong-based firm and the exporters in India.

Few questions, however, were raised by the Authority for Advance Ruling:

    Will the foreign firm create a permanent establishment or business connection as a result of their activities?
    Will the income of the foreign-based firm accumulate or accrue as a result of the activities of the liaison office in India?

The Authority for Advance Ruling held that it is unimportant whether a business connection existed because the liaison office only purchased goods from India and there was no income accrued as a result of the activities of the liaison office.

Considering the various cases we’ve seen, the role of liaison offices in India can be a bit tricky and based on the Indian tax law, starting a liaison office in India can be challenging. However, if liaison offices carry out their activities properly, they can avoid paying taxes in India.

Therefore, before starting a liaison office in India, make sure you understand how to carry out activities without having to deal with tax issues. Also, familiarize yourself with the various court cases associated with liaison offices, so you can know how best to run your liaison office without crossing the boundaries set by the Indian authorities. This way, you can avoid a situation where the court deems your activities as creating permanent establishments or business connections.



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