A foreign enterprise has to pay tax in India if it has an office, branch or any other entity, which carries on a business in India. However, if such entity undertakes auxiliary activities or it performs activities, which are not in the nature of well-defined business activities, the foreign enterprise will not be taxable in India.

This is because the foreign enterprise will not have a permanent establishment in India, under a Double Tax Avoidance Agreement (DTAA), which a foreign country has entered with India. Further, even under section 9(1)(i) of the Income-tax Act, 1961, the foreign enterprise would not be deemed to have a business connection in India where the Indian entity does not carry on a well-defined business.

The liability of a foreign enterprise to tax in India on its business income is governed by Article 7 of a Double Tax Avoidance Agreement (DTAA). Article 7.1 of a DTAA categorically provides that profits of an enterprise of a contracting state will be taxable only in that state, unless the enterprise carries on business, in the other state, through a permanent establishment situated therein. If the enterprise carries on business as aforesaid, the profits of the enterprise may be taxed in the other state, but only so much of that as is attributable to the permanent establishment.

Profits of an enterprise are liable to tax in India if an enterprise were to carry on business through permanent establishment, meaning thereby a fixed place of business through which business of an enterprise is wholly or partly carried on. Under Article 5.2, amongst others, permanent establishment includes an office. However, Article 5(3), which opens with a non-obstante clause, is illustrative of instances where, under the DTAA, various activities have been deemed as one, which would not fall within the ambit of the expression ‘permanent establishment’.

One such exclusionary clause is found in Article 5.3(e), which is maintenance of fixed place of business solely for the purpose of carrying on, for the enterprise, any activity of a preparatory or auxiliary character. The plain meaning of the word ‘auxiliary’ is found in Black’s Law dictionary, 7th Edition at page 130, which reads as “aiding or supporting, subsidiary”.

This point was considered by the Delhi High Court in UAE Exchange Centre Ltd v UOI (WP (C) No 14869 of 2004). The facts in this case were that the petitioner was providing remittance services for transferring monies from UAE to various places in India. In order to facilitate this purpose, the petitioner had opened liaison offices in India under a licence granted by the Reserve Bank of India (RBI).

As per the RBI order, the petitioner’s liaison offices, in India, are permitted to undertake only activities like, responding to enquires from correspondent banks with respect to drafts issued; undertaking reconciliation of bank accounts held in India with correspondent banks; acting as a communication centre for receiving computer advices of mail transfer from UAE and transmitting them to Indian correspondent banks; printing drafts and dispatching the same to the addressees.

RBI has specifically prohibited the petitioner’s liaison offices, in India, from charging any commission or fee or from receiving or earning any remittances from any activity undertaken by them. Furthermore, the expenses of the liaison offices in India are required to be met exclusively out of the funds received from abroad through normal banking channels.

The Authority for Advance Rulings (AAR) held that UAE Exchange Company had a permanent establishment in India because the liaison offices were undertaking business activities. The AAR also ruled that it had a business connection in India.

On a writ petition, the Delhi High Court held that the ruling of AAR was clearly erroneous. According to the court, the only activity of the liaison offices in India is simply to download information which is contained in the main servers located in UAE based on which cheques are drawn on banks in India whereupon the said cheques are couriered or dispatched to the beneficiaries in India, keeping in mind the instructions of the NRI remitter. The court held that the activities are in ‘aid’ or ‘support’ of the main activity undertaken in the UAE. The error into which the authority had fallen was in reading Article 5.3(e) as a clause, which permits making a value judgment as to whether the transaction would or would not have been complete till the role played by liaison offices in India was fulfilled.

Once an activity is subsidiary or in aid or support of the main activity it would 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-?-vis its customer. If looked at from that point of view, then, no activity could be construed as preparatory or of an ‘auxiliary’ character.

On this aspect of the matter, the Supreme Court in the case of DIT (International Taxation) v Morgan Stanley & Co (292 I.T.R. 416, 425-6, 427), amongst other issues, was called upon to decide as to whether back office operations carried on by Morgan Stanley in India for its foreign principal would qualify as a permanent establishment in India. The Supreme Court, while holding that back office operations fall within the exclusionary clause Article 5.3(e) of Indo-US Double Taxation DTAA, came to the conclusion that back office operations came within the purview of Article 5.3(e).

Relying on this decision of the apex Court, the Delhi High Court held that the AAR proceeded on a wrong premise, inasmuch as it ignored the plain meaning of the terms of exclusionary clause, Article 5.3(e), while examining as to whether by setting up a liaison office in India would result in setting up a permanent establishment within the meaning of DTAA. The decision of the authority in these circumstances, being contrary to, the well-established principles, as well as provisions of law, would amount to an error apparent on the face of the record and hence, amenable to a writ of certiorari.

The court further held that the AAR has misconstrued the ratio of the judgments of the Supreme Court in the case of Anglo French Textile Co Ltd v CIT (23 ITR 101) and CIT v RD Aggarwal & Co; (56 ITR 20). The ratio in both the judgments is that the non-resident entity could be taxed only if there was business connection between the business carried on by a non-resident which yields profits or gains and some activity in the taxable territory which contributes directly or indirectly to the earning of those profits or gains.

According to well-accepted business notions and usages, a particular activity must be a well-defined business operation. Activities which are not well defined would not fall within the ambit of this test. Hence, the Delhi High Court rightly concluded that the authority had clearly erred in applying the ratio of the judgment of Supreme Court in the cases of RD Agarwal and Anglo French Textile Co, which was not applicable in the present case. Consequently, the High Court quashed the ruling of the AAR and held that the UAE company was not taxable in India either on the ground that the petitioner had a permanent establishment under the Indo-UAE DTAA, or that there was a business connection in India, which could make the petitioner liable to tax.

The author is advocate, Supreme Court