income tax
Jebon Corporation, a South Korean entity, specializes in manufacturing Printed Circuit Boards, Liquid Crystal Displays, and Switch Mode Power Supplies at its facility in China. It established a Liaison Office (LO) in Bangalore with approval from the Reserve Bank of India (RBI), which periodically renewed this approval.
The LO operated with five employees whose primary role was to identify potential buyers for the corporation’s products, gather inquiries, and relay this information to the Head Office (HO) in Korea. After receiving product quotations from the HO, the LO would communicate these to prospective buyers. At times, the HO provided a price range for products, allowing the LO to negotiate effectively within specified limits. Ultimately, orders were directed to the HO rather than the LO, which monitored order payments and realizations.
The assessee claimed that it did not conduct any business in India, asserting that the LO merely served as a communication conduit, thereby resulting in no taxable income in India. As such, no tax returns were filed by the company.
However, tax authorities conducted a survey at the LO's premises, collecting information on sales and expenses while recording employee statements. The Additional Director (International Taxation), Circle-1, Bangalore, subsequently issued a notice under Section 148 of the Income-tax Act, 1961 (“the Act”) covering the assessment years 2001-02 to 2005-06, followed by a notice under Section 142 of the Act for the year 2006-07 requesting the LO to submit a return of income. The LO did not comply.
The Assessing Officer (AO) determined that the LO's activities extended beyond mere liaison functions, characterizing them as full-fledged business operations. Findings indicated that the final pricing decisions and profit margins were determined within India, with contract conclusions executed by LO personnel. The LO engaged in identifying customers, negotiating deals, processing orders, and providing post-sale support. Although orders were placed with the HO, the LO consistently monitored and managed the entire process. As a result, the LO was deemed a permanent establishment (PE) of Jebon Corporation in India under the India-Korea tax treaty and was mandated to pay tax on the income generated through its PE.
On appeal, the Commissioner (Appeals) held that the LO had limited authority in setting sales margins subject to HO guidelines and that the AO's findings lacked sufficient support from incontrovertible evidence. Consequently, the Commissioner ruled that income could not be deemed to arise in India, as the LO did not habitually exercise authority to conclude contracts on behalf of the non-resident, as defined in clause (a) of Explanation 2 to Section 9(1)(i) of the Act. Thus, the AO's order was overturned.
Dissatisfied with the Commissioner's conclusion, the Revenue appealed to the Tribunal, which reversed the decision. The Tribunal determined that the LO was involved in promoting imports by securing purchases after negotiations, thereby justifying the AO's classification of the LO as a PE. It concluded that income attributable to the LO was taxable under Article 7 of the India-Korea tax treaty. The assessee subsequently appealed to the High Court.
The assessee argued that the LO operated strictly within the scope of RBI permissions and lacked authority to finalize contracts between the company and Indian customers. Customers placed orders directly with the HO, and payment was directed to the HO after shipment. The LO's role was confined to making inquiries, communicating quoted prices from customers, and ensuring materials and payments were handled, which constituted purely liaison activities. Thus, the LO did not qualify as a PE under Article 5 of the India-Korea tax treaty.
Additionally, since the RBI had not acted against the LO for purportedly violating established permissions, the conclusion that the LO engaged in commercial activities was unwarranted.
The Revenue maintained that the activities performed by the LO and its employees indicated they were effectively selling products and promoting the business within India. The fact that the HO received orders directly did not exempt the LO from liability for tax, as the AO's findings supported treating the LO as a PE under Article 5 of the India-Korea tax treaty.
The Tribunal determined that the LO's operations extended beyond liaison work. The evidence presented established that the LO was engaged in commercial functions such as acquiring purchase orders, identifying buyers, negotiating prices, coordinating shipments, and providing after-sales support. The nature of these activities warranted the conclusion that the LO was conducting business rather than solely liaising.
Moreover, the lack of formal contract signatures by LO officials did not negate their responsibilities. The absence of RBI action concerning the LO did not invalidate the findings under the Act.
Upholding the Tribunal's ruling, the High Court affirmed that the LO constituted a PE under Article 5 of the India-Korea tax treaty. Consequently, the profits generated from business activities conducted via the LO in India were subject to taxation.
The High Court established that the LO qualifies as a PE according to the India-Korea tax treaty when it engages in trading activities, conducts business contracts, and sets sales prices. The absence of written contracts signed by LO officials does not exempt such activities from liability for taxation.