UNION OF INDIA & ANR. versus EXCHANGE CENTRE
[2020] 4 S.C.R. 719, Supreme Court of India, 2020
Outcome: Dismissed (Dismissed)
Segment: Ratio
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UNION OF INDIA & ANR.
v.
U.A.E. EXCHANGE CENTRE
(Civil Appeal No. 9775 of 2011)
APRIL 24, 2020
[A. M. KHANWILKAR AND AJAY RASTOGI, JJ.]
Income Tax Act, 1961: ss.2(24), 90 – Double Taxation
Avoidance Agreement (DTAA) – Respondent, a company
incorporated in the UAE was engaged in offering remittance services
for transferring amounts from UAE to various places in India – RBI
granted permission to respondent u/s.29(1)(a) of FERA for opening
liaison office in India – Pursuant thereto, respondent set up liason
offices in India – Crucial activities of the liaison offices were of
downloading particulars of remittances through electronic media
and then printing cheques/drafts drawn on the banks in India, and
then courier or dispatch to the beneficiaries in India, in accordance
with the instructions of the NRI remitter – While doing so, the liaison
office remained connected with its main server in UAE and the
information residing thereat accessed by the liaison office in India
for remitting funds to the beneficiaries in India – As per the Authority
for Advance Rulings, income from the activities carried out by the
liaison offices were deemed to be accrued in India – High Court
quashed the impugned ruling holding that the nature of activities
carried on by the respondent in the liaison offices being only of
preparatory and auxillary character were clearly excluded by virtue
of deeming provision – On appeal, held: Permission by the RBI to
respondent u/s.29(1)(a) of
the FERA clearly showed that it did not
allow respondent to enter into a contract with anyone in India, but
only allowed it to provide service of delivery of cheques/drafts drawn
on the banks in India – Even the permitted activities were subject to
conditions which included not to render any consultancy or any
other service, directly or indirectly, with or without any consideration
– The conditions made it amply clear that the office in India would
not undertake any other activity of trading, commercial or industrial,
nor enter into any business contracts in its own name without prior
permission of the RBI – The liaison office could not even charge
commission/fee or receive any remuneration or income in respect of
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the activities undertaken by it in India – Thus, the activities of liason
office(s) of the respondent in India were circumscribed by the
permission given by the RBI and were in the nature of preparatory
or auxiliary character and, therefore, covered by Art. 5(3)(e) of the
DTAA – As a result, the fixed place used by the respondent as liaison
office in India, would not qualify the definition of Permanent
Establishment (PE) in terms of Arts. 5(1) and 5(2) of the DTAA on
account of non-obstante and deeming clause in Article 5(3) of the
DTAA – It must follow that the respondent was not carrying on any
business activity in India as such, but only dispensing with the
remittances as per the instructions given by the NRI remitters in
UAE – The transaction(s) had completed with the remitters in UAE,
and no charges towards fee/commission could be collected by the
liaison office in India in that regard – Thus, no income as specified
in s.2(24) of the 1961 Act is earned by the liaison office in India
and moreso because, the liaison office is not a PE in terms of Article
5 of DTAA.
Dismissing the appeal, the Court
HELD: 1.1 Article 5(3) of the DTAA opens with a non-
obstante clause and also contains a deeming provision. It
predicates that notwithstanding the preceding provisions of the
concerned Article, which would mean clauses 1 and 2 of Article
5, it would still not be a PE, if any of the clauses in Article 5(3) are
applicable.
For that, the functional test regarding the activity in
question would be essential. [Para 8][743-G-H; 748-A-B]
1.2 The crucial activities in the instant case are of
downloading particulars of remittances through electronic media
and then printing cheques/drafts drawn on the banks in India,
which, in turn, are couriered or dispatched to the beneficiaries in
India, in accordance with the instructions of the NRI remitter.
While doing so, the liaison office of the respondent in India
remains connected with its main server of the respondent in UAE
and the information residing thereat is accessed by the liaison
offices in India for the purpose of remittance of funds to the
beneficiaries in India by the NRI remitters. [Para 8][745-B-C]
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2. The permission given by the RBI to the respondent
under Section 29(1)(a) of the 1973 Act, on 24.9.1996 show that
the RBI had agreed for establishing a liaison office of the
respondent at Cochin, initially for a period of three years to enable
the respondent to (i) respond quickly and economically to
enquiries from correspondent banks with regard to suspected
fraudulent drafts; (ii) undertake reconciliation of bank accounts
held in India; (iii) act as a communication centre receiving
computer (via modem) advices of mail transfer T.T. stop payments
messages, payment details etc., originating from respondent’s
several branches in UAE and transmitting to its Indian
correspondent banks; (iv) printing Indian Rupee drafts with
facsimile signature from the Head Office and counter signature
by the authorised signatory of the Head Office at Cochin; and (v)
following up with the Indian correspondent banks. These are the
limited activities which the respondent has been permitted to
carry on within India. This permission does not allow the
respondent-assessee to enter into a contract with anyone in India,
but only to provide service of delivery of cheques/drafts drawn
on the banks in India. Notably, even the permitted activities are
required to be carried out by the respondent subject to conditions
specified in clause 3 of the permission, which includes not to
render any consultancy or any other service, directly or indirectly,
with or without any consideration and
further that the liaison office
in India shall not borrow or lend any money from or to any person
in India without prior permission of RBI. The conditions make it
amply clear that the office in India will not undertake any other
activity of trading, commercial or industrial, nor shall it enter
into any business contracts in its his own name without prior
permission of the RBI. The liaison office of the respondent in
India cannot even charge commission/fee or receive any
remuneration or income in respect of the activities undertaken
by the liaison office in India. From the onerous stipulations
specified by the RBI, it could be safely concluded, as opined by
the High Court, that the activities of liason office(s) of the
respondent in India are circumscribed by the permission given
by the RBI and are in the nature of preparatory or auxiliary
character and, therefore, covered by Article 5(3)(e). As a result,
the fixed place used by the respondent as liaison office in India,
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would not qualify the definition of PE in terms of Articles 5(1) and
5(2) of the DTAA on account of non-obstante and deeming clause
in Article 5(3) of the DTAA. Having said thus, it must follow that
the respondent was not carrying on any business activity in India
as such, but only dispensing with the remittances by downloading
information from the main server of respondent in UAE and
printing cheques/drafts drawn on the banks in India as per the
instructions given by the NRI remitters in UAE. The
transaction(s) had completed with the remitters in UAE, and no
charges towards fee/commission could be collected by the liaison
office in India in that regard. To put it differently, no income as
specified in Section 2(24) of the 1961 Act is earned by the liaison
office in India and moreso because, the liaison office is not a PE
in terms of Article 5 of DTAA, (as it is only carrying on activity of
a preparatory or auxiliary character). The concomitant is - no tax
can be levied or collected from the liaison office of the respondent
in India in respect of the primary business activities completed
consummated by the respondent in UAE. The activities to be
carried on by the liaison office of the respondent in India as
permitted by the RBI, clearly demonstrated that the liaison office
of the respondent in India must steer away from engaging in any
primary business activity and in establishing business connection
as such. It can
carry on activities of preparatory or auxiliary nature
only.
In that case, the deeming provisions in Sections 5 and 9 of
the 1961 Act can have no bearing whatsoever. [Paras 9, 10,
11][745-D-H;746-A-C; 748-F-H; 749-A-C]
Union of India & Anr. v. Azadi Bachao Andolan & Anr.
(2004) 10 SCC 1 : [2003] 4 Suppl. SCR 222 – relied
on.
Commissioner of Income Tax, Punjab v. R.D. Aggarwal
& Company & Anr. AIR 1965 SC 1526 : [1965] 1 SCR
660 ; Anglo- French Textile Co. Ltd., by Agents,
M/s. Best & Company Ltd., Madras v. Commissioner of
Income Tax, Madras AIR 1953 SC 105 : [1953] SCR
454 ; Commissioner of Income Tax, AP-IIT v.
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Vishakhapatnam Port Trust (1983) 144 ITR 146 (AP) ;
Commissioner of Income Tax IT v. Davy Ashmore India
Ltd. (1991) 190 ITR 626 (Cal) ; Leonhardt Andra Und
Partner, GmbH v. Commissioner of Income Tax (2001)
249 ITR 418 (Cal) ; Commissioner of Income Tax v.
R.M. Muthaiah (1993) 202 ITR 508 (Karn). Arabian
Express Line Ltd. of United Kingdom & Ors. v. Union
of India (1995) 212 ITR 31 (Guj); DIT (International
Taxation), Mumbai v. Morgan Stanley & Co. Inc. (2007)
7 SCC 1: [2007] 8 SCR 52; Assistant Director of Income
Tax-1, New Delhi v. E-Funds IT Solution Inc. (2018) 13
SCC 294 : [2017] 1 SCR 157 – referred to.
Case Law Reference
[1965] 1 SCR 660
referred to
Para 3
[2003] 4 Suppl. SCR 222
relied on
Para 4
[1953] SCR 454
referred to
Para 4
[2007] 8 SCR 52
referred to
Para 10
[2017] 1 SCR 157
referred to
Para 12
CIVIL APPELLATE JURISDICTION: Civil Appeal No. 9775
of 2011.
From the Judgment and Order dated 13.02.2009 of the High Court
of  Delhi at New Delhi in W.P. (C) No. 14869 of 2004.
Arijit Prasad, Sr. Adv., Ms. Niranjana Singh, Ms. Purnima Bhat,
Ms. Anil Katiyar, B.V  Balaram Das, Advs. for the Appellants.
H.P. Ranina, Vishnu B. Saharya, Viresh B. Saharya, Vivek B.
Saharya, Akshat Agarwal, M/s. Saharya & Co., Advs. for the
Respondent.
The Judgment of the Court was delivered by
A. M. KHANWILKAR, J.
1. The respondent is a limited company incorporated in the United
Arab Emirates (UAE). It is engaged in offering, among others, remittance
services for
transferring amounts from UAE to various places in India.
It had applied for a permission under Section 29(1)(a) of the Foreign
Exchange Regulation Act, 1973 (for short, “the 1973 Act”), pursuant to
UNION OF INDIA & ANR. v. U.A.E. EXCHANGE CENTRE
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which approval was granted by the Reserve Bank of India (for short,
“the RBI”) vide letter dated 24.9.1996. The same reads thus: -
“Telegrams
RESERVE BANK OF INDIA
Post Box No. 1055
“RESERVE BANK”
EXCHANGE CONTROL DEPARTMENT
Fax No.: 022-2665330
BOMBAY
                   CENTRAL OFFICE
                 022-2654121
     CENTRAL OFFICE BUILDING
Please quote Ref. in Reply               BOMBAY – 400 023.
Ref. No. EC Co. FID(I)/137/10-I-05-02/3975 (Activity)/96-97
BY AIR MAIL/REGISTERED A.D.
U.A.E. Exchange Centre L.L.C.,
24 Sep 1996
Post Box 170,
Abu Dhabi,
UAE.
Dear Sirs,
Permission under Section 29(1)(a) of the Foreign Exchange
Regulation Act, 1973 for opening a liaison office in India
Please refer to your application dated Nil and the correspondence
resting with your letter Ref. UAEEC/HO/479/96 dated 9th August,
1996 on the captioned subject.
2. We advise that we are agreeable to your establishing a liaison
office at Cochin initially for a period of three years to enable you
to i) respond quickly and economically to enquiries from
correspondent banks with regard to suspected fraudulent drafts,
ii) to undertake reconciliation of bank accounts held in India, iii) to
act as a communication centre receiving computer (via Modem)
advices of mail transfer T.T. stop payments messages, payments
details etc., originating from your several branches in UAE and
transmitting to your Indian correspondent banks, iv) Printing Indian
Rupee drafts with facsimile signature from the Head Office and
counter signature by the authorised signatory of the Office at
Cochin, v) following up with the Indian correspondent banks.
3. Please note that this permission has been granted subject to the
following conditions:
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i)
Except the above mentioned work, the office in India will
not undertake any other activity of a trading, commercial
or industrial nature nor shall it enter into any business
contracts in its own name without our prior permission.
ii)
No commission/fees will be charged or any other
remuneration received/income earned by the office in India
for any activity undertaken by it as listed in para 2 of this
letter or otherwise in India.
iii)
The entire expenses of the office in India will be met
exclusively out of the funds received from abroad through
normal banking channels
iv)
The Liaison office in India shall not borrow or lend any
money from/to any person in India without our prior
permission.
v)
The office in India 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 prior permission of the Reserve Bank of
India under Section 31 of the Foreign Exchange Regulation
Act, 1973.
vi)
The Liaison office in India will furnish to our Cochin Regional
Office (on a yearly basis):
a) a certificate from the auditors to the effect that during
the year no income was earned by/or accrued to the
office in India;
b) details of remittances received from abroad duly
supported by Inward Remittance Certificates;
c) certified copy of the audited final accounts of the office
in India; and
d) annual report of the work done by the office in India,
stating therein the
details of actual remittances received
from NRI through your office during period in respect
of which the office had rendered liaison services.
e) The number of staff engaged/appointed and duties
assigned to each staff.
UNION OF INDIA & ANR. v. U.A.E. EXCHANGE CENTRE
[A. M. KHANWILKAR, J.]
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vii)
The incharge of the liaison office in India will not have
signing/commitment powers except than those which are
required for normal functioning of liaison office on behalf
of the Head Office.
viii)
The liaison office will not render any consultancy or any
other services directly/indirectly, with or without any
consideration.
4. In case you desire to open a head office account in the books
of your liaison office in India, we hereby grant you our approval
to maintain such an account subject to the conditions that the
credits to the account should represent the funds received from
head office through normal banking channels for meeting the
expenses of the office and no other amount should be credited
without prior permission of the Reserve Bank. Similarly debits to
this account could be raised only for meeting the local expenses
of the office. Audited transcript of the head office account may
be forwarded to our Cochin Regional Office alongwith the annual
accounts mentioned above.
5. It is further clarified that the permission granted hereby is limited
to and for the purpose of the provisions of Section 29 ibid only and
shall not be construed in any way as regularising, condoning or in
any manner validating any irregularities, contraventions or other
lapses if any under the provisions of any other law for the time
being in force.
6. Please note to furnish to us the postal address of your liaison
office in due course
for our record. You may also note to address
the correspondence in future to our Cochin Regional Office.
7. Please acknowledge receipt.
Yours faithfully,
Sd/-
(Prashant Saran)
Deputy General Manager”
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2. The respondent set up its first liaison office in Cochin, Kerala
(India) in January, 1997 and thereafter, in Chennai, New Delhi, Mumbai
and Jalandhar in India. The activities carried on by the respondent from
the said liaison offices are stated to be in conformity with the terms and
conditions prescribed by the RBI in its letter dated 24.9.1996. The entire
expenses of the liaison offices in India are met exclusively out of funds
received from UAE through normal banking channels. Indisputably, it is
asserted by the respondent that its liaison offices undertake no activity
of trading, commercial or industrial, as the case may be. The respondent
has no immovable property in India otherwise than by way of lease for
operating the liaison offices. No fee/commission is charged or received
in India by any of the liaison offices for services rendered in India. It is
claimed that no income accrues or arises or deemed to accrue or arise,
directly or indirectly, through or from any source in India from liaison
offices within the meaning of Section 5 or Section 9 of the Income Tax
Act, 1961 (for short, “the 1961 Act”). According to the respondent, the
remittance services are offered by the respondent to Non-Resident
Indians (for short, “NRIs”) in UAE. The contract pursuant to which the
funds are handed over by the NRI to the respondent in UAE, is entered
between the respondent and the NRI remitter in UAE. The funds are
collected from the NRI remitter by the
respondent in UAE by charging
one-time fee of Dirhams 15. After collecting the funds from the NRI
remitter, the respondent makes an electronic remittance of the funds on
behalf of its NRI customer in two ways:-
(i) by telegraphic transfer through bank channels; or
(ii) On the request of the NRI remitter, the respondent sends
instruments/cheques through its liaison offices to the beneficiaries in
India, designated by the NRI remitter.
The dispute arises in respect of the second mode of remittance
through the liaison offices in India. That is on account of the activity
undertaken in the liaison office in India of downloading the particulars of
remittances through electronic media and printing cheques/drafts drawn
on the banks in India, which, in turn, are couriered or dispatched to the
beneficiaries in India, in accordance with the instructions of the NRI
remitter. While doing this, the liaison office of the respondent remains
connected with its main server in UAE, as the information is contained
in the main server thereat, which could be accessed by the liaison office
UNION OF INDIA & ANR. v. U.A.E. EXCHANGE CENTRE
[A. M. KHANWILKAR, J.]
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in India for the purpose of remittance of funds to the beneficiaries in
India by the NRI remitters.
3. It is stated that, in compliance with Section 139 of the 1961
Act, the respondent had been filing its returns of income, since the
assessment year 1998-1999 until 2003-2004, showing NIL income, as
according to the respondent, no income had accrued or deemed to have
accrued to it in India, both under the 1961 Act, as well as, the agreement
entered into between the Government of the Republic of India and the
Government of the UAE, which is known as Double Taxation Avoidance
Agreement (for short, “DTAA”). This agreement (DTAA) has been
entered into between the two sovereign countries in exercise of powers
under Section 90 of the 1961 Act, for the purpose of avoidance of double
taxation and prevention of fiscal evasion, with respect to taxes and income
on capital. The DTAA has been notified vide notification No. GSR No.
710(E) dated 18.11.1993. As noted earlier, returns were filed on regular
basis by the respondent, which were accepted by the Department without
any demur. However, as some doubt was entertained, the respondent
filed an application under Section 245Q(1) of the 1961 Act before the
Authority for Advance Rulings (Income Tax), New Delhi (for short,
“the Authority”), which was numbered as AAR No. 608/2003 and sought
ruling of the Authority on the following question: -
“Whether any income is accrued/deemed to be
accrued in India
from the activities carried out by the Company in India?”
The Authority, vide its ruling dated 26.5.2004 answered the question
in the affirmative, namely, “Income shall be deemed to accrue in India
from the activity carried out by the liaison offices of the applicant in
India.” For so holding, the Authority opined that in view of the deeming
provision in Sections 2(24), 4 and 5 read with Section 9 of the 1961 Act,
the respondent-assessee would be liable to pay tax under the 1961 Act,
as it had carried on business in India through a “permanent establishment”
(for short, “PE”) situated in India and the profits of the enterprise needed
to be taxed in India, but only so much of that, as is attributable to the
liaison offices in India (PE). The Authority, amongst others, first examined
the facts of the case to ascertain as to whether any income accrues/
arises or is deemed to accrue/arise to the respondent in India under
Sections 2(24), 5(2) and 9(1)(i) of the 1961 Act. It noted that the business
of the respondent was being carried on in UAE; a contract for remitting
the amounts is entered into with NRIs and is executed outside India; and
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even the commission for remitting the amounts is also earned by the
respondent outside India, therefore, ostensibly no income accrues/arises,
or is deemed to accrue or arise in India. It then adverted to explanation
to Section 9(1)(i) and observed that all income accruing or arising, whether
directly or indirectly, through or from any business connection in India,
or from any property in India, or through any assets or source of income
in India or through transfer of capital assets situate in India, shall be
deemed to accrue in India. It went on to observe that in the present
case, it was evident that all the operations of the business of the respondent
were not carried out in India. In such a situation, to attract the provisions
referred to above, it must be shown that – (i) the applicant has ‘business
connections’ in India; and (ii) the income of the business can be deemed
to accrue or arise in India from such operations, as are carried out in
India. After analysing this aspect and explanation 2 to Section 9(1)(i)
inserted by the Finance Act, 2003, it noted the decision of this Court in
Commissioner of Income Tax, Punjab vs. R.D. Aggarwal &
Company  &  Anr.1 and  culled  out  the  essential  features  of expression
“business connection” as follows:-
“10. In the light of above discussion, the essential features of
“business connection” may be summed up as follows: -
(a) a real and intimate relation must exist between the trading
activities by a
non-resident carried on outside India and the
activities within India:
(b) the relation contributes directly or indirectly to the earning
of income by the non-resident in his business;
(c) a course of dealing or continuity of relationship and not a
mere isolated or stray nexus between the business of the non-
resident outside India and the activity in India, would furnish a
strong indication of business connection.”
It then observed in paragraph 11 of the ruling, as follows: -
“11. Admittedly, the applicant is having liaison offices in India.
They attend to the complaints of the clients in cases where
remittances are sent directly to banks in India UAE. In addition,
in cases where the applicant has to remit the amounts to the
beneficiaries in India, as per the directions of the NRIs, the liaison
1 AIR 1965 SC 1526
UNION OF INDIA & ANR. v. U.A.E. EXCHANGE CENTRE
[A. M. KHANWILKAR, J.]
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offices down load the information from the internet, print cheques/
drafts in the name of the beneficiaries in India send them through
couriers to various places in India. Without the latter activity, the
transaction of remittance of the amounts in terms of the contract
with the NRIs would not be complete. The commission which the
applicant receives for remitting the amount covers not only the
business activities carried on in UAE but also the activity of
remittance of the amount to the beneficiary in India by cheques/
drafts through courier which is being attend to by the liaison
offices. There is, therefore, a real relation between the business
carried on by the applicant for which it receives commission in
UAE and the activities of, the liaison offices, downloading of
information, printing and preparation of cheques/drafts and sending
the same to the beneficiaries in India, which contributes directly
or indirectly to the earning of the income by the applicant by way
of commission. There is also continuity between the business of
the applicant in UAE and the activities carried on by the liaison
offices. Therefore, it follows that income shall be deemed to
accrue/arise to the applicant in UAE from ‘business connection’
in India. However, the deemed accrual of income to the applicant
from the business connection in India in view the Explanation (I)
would be only such part of the income as is reasonably attributable
to
the operations which are carried out in India…….”
The Authority also took note of Articles 5 and 7 of DTAA and
then noted in paragraph 14 as follows: -
“……The moot question is whether the exclusionary clause (e)
of para 3 is attracted; if so, whether the liaison offices would
stand excluded from the meaning of the expression ‘permanent
establishment’. Clause (e) of para 3 says that the expression
‘permanent establishment’ shall be deemed not to include the
maintaining of a fixed place of business solely for the purpose of
carrying on for an enterprise any other activity of a preparatory
or auxiliary character, Mr. Ranina placed before us extracts from
various dictionaries to show the meaning of the word ‘auxiliary’.
It is unnecessary to refer to them here. Suffice it to say that the
word ‘auxiliary’ in common English usage means helping, assisting
or supporting the main activity. We have, therefore, to ascertain
whether the activities carried on in the liaison offices in India, are
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only supportive of the main business or form one of the main
functions of the business. The applicant enters into a contract
with a NRI to remit to the nominated banks or the nominated
beneficiaries in India the amount which is the Indian rupee
equivalent of foreign currency handed over to it. It is true that the
contract is entered into in UAE and the amount to be remitted as
well as the commission is also received in UAE. The contract is,
therefore executed in UAE. To fulfill its obligation under the
contract the applicant remits the amount in either of the following
two modes:
By establishment in UAE –
(i) by telegraphic instructions from Abu Dhabi through banking
channels or by liaison offices in India-
(ii) by dispatching through courier the instruments of cheques/
drafts prepared by liaison offices to the beneficiaries at various
places in India.
In so far as the first mode is concerned, the amount is remitted
telegraphically by transferring directly from UAE through bank
channel to various places in India and in such remittances the
liaison offices have no role to play except attending to the
complaints, if any, in India regarding the remittances in cases of
fraud etc. This is undoubtedly a work of auxiliary character.
However, where is undoubtedly a work of auxiliary character.
However, where the applicant adopts the second mode for remitting
the amounts in India -an activity approved by the RBI – the liaison
offices of the applicant play an
important role. They down load
the data from internet with regard to the amount to be remitted,
the names and addresses of the beneficiaries and then print cheques/
drafts and dispatch them to the addresses of the beneficiaries in
India through courier. The role of liaison offices in remitting the
amounts by adopting the second mode, is nothing short of
performing the contract of remitting the amounts at least in part.
This case presents a good example of an auxiliary activity to the
main activities and an essential activity in performance of
contractual obligation. Whereas in the first mode, the activity
undertaken by the liaison offices in India may be said to be auxiliary
in character, the same cannot be said of the second mode. Down
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loading the data, preparing cheques for remitting the amount,
dispatching the same through courier by the liaison offices is an
important part of the main work itself because without remitting
the amount to the beneficiaries as desired by the NRIs,
performance of the contract will not be complete. So the activities
of the liaison offices in the second mode remittance, cannot be
said to be work of auxiliary character. It is indeed a significant
part of the main work of UAE establishment. It follows that the
liaison offices of the applicant in India for the purposes of the
second mode of remittance of amount would be a ‘permanent
establishment’ within the meaning of the expression in DTAA.”
The Authority accordingly concluded that so much of the profits
as shall be deemed to accrue or arise to the respondent in India, which
were attributable to the PE, namely, the liaison offices in India, would be
taxable in India even under the DTAA, and answered the question
affirmatively against the respondent-assessee.
4. Following the impugned ruling of the Authority, dated 26.5.2004,
the Department issued four notices of even date i.e. 19.7.2004 under
Section 148 of the 1961 Act addressed to the respondent pertaining to
assessment years 2000-2001, 2001-2002, 2002-2003 and 2003-2004
respectively. The respondent, therefore, carried the matter before the
High Court of Delhi at New Delhi (for short, “the High Court”) by way
of Writ
Petition No. 14869/2004, inter alia, for quashing of the ruling of
the Authority dated 26.5.2004, quashing of stated notices and for a
direction to the appellants not to tax the respondent in India because no
income had accrued to it or is deemed to have accrued to it in India from
its activities of liaison offices in India. The High Court, after adverting to
indisputable facts, noted that the Authority committed manifest error in
appreciating the relevant facts and materials on record and more
particularly, misread the purport of Section 90 of the 1961 Act and the
settled legal position that the DTAA ought to override the provisions of
the Act (the 1961 Act). In other words, the tax liability of the respondent
was required to be assessed on the basis of the provisions in the stated
treaty, namely, DTAA. The High Court adverted to the exposition in
Union of India & Anr. vs. Azadi Bachao Andolan & Anr.2 in
paragraphs 28 and 29 and then observed as follows: -
2 (2004) 10 SCC 1
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“11.2 In the present case, the liability to tax under the DTAA is
governed by Article 7. Sub-section (1) of Article 7 of the DTAA
categorically provides that profits of an enterprise of a contracting
State shall be taxable only in that State, unless the enterprise carries
on business, in the other State, through a permanent establishment
situated thereof. 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. Therefore, the liability on account of tax, of an
enterprise of either of the contracting State, in India, would arise
if the enterprise in issue, i.e., the petitioner, had a permanent
establishment in India. The provisions of Section 5(2) (b) and
Section 9(1)(1) of the Act would have, in our view, no applicability.
Discussion with respect to the ‘business connection’ in the
impugned ruling was, in our view, unnecessary. The Authority
had to determine only whether the petitioner carried on business
in India through a permanent establishment. For this purpose it
was required to examine the definition of permanent establishment
as contained in Article 5 of DTAA read with Article 5(3)(e). There
is no dispute raised by the petitioner that it maintains liaison offices
in India and hence, would fall within the definition of permanent
establishment in accordance with the provisions of Article 5(2)(c).
The petitioner,
however, has contended both before the Authority
and before us that it falls within the exclusionary clause contained
in Article 5(3)(e) in as much as the activity carried on by the
liaison offices in India, has an ‘auxiliary’ character. On this aspect
of the matter the discussion and reasoning by the Authority is
contained in paragraphs 12 to 15 of the impugned ruling. The
Authority came to the conclusion that the activity carried on by
the liaison offices in India did not have an ‘auxiliary’ character in
terms of Article 5(3)(e) of the Act as the option of remitting of
funds through the liaison offices in India was exercised by the
NRI remitter which was “nothing short of, as in the words of
the parties, performing contract of remitting the amounts”.
The Authority, thus, held that while, in respect of all remittances
of funds by telegraphic transfer through banking channels, the
role of the liaison offices in India of an ‘auxiliary’ character, the
same was not true in respect of remittance of funds through liaison
offices in India. This was based on the reasoning that without
UNION OF INDIA & ANR. v. U.A.E. EXCHANGE CENTRE
[A. M. KHANWILKAR, J.]
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remittances of funds to the beneficiaries in India performance
under the contract would not have been complete and thus, the
downloading of data, preparation of cheques for remitting the
amount, dispatching the same through courier by the liaison offices,
constituted an important part of the main work, which was,
remitting the amount to the beneficiaries as desired by the NRIs.
Based on this reasoning, the Authority came to the conclusion
that the work of the liaison offices in India, being a significant part
of the main work of UAE establishment, the liaison office of the
petitioner, in India, would constitute a ‘permanent establishment’
within the provisions of the DTAA.”
And again, whilst analysing the scope of Articles 5 and 7 of the
DTAA in paragraph 12 of the impugned judgment, the High Court noted
thus: -
“12.…...In the case of DTAA under consideration in the present
case under Article 5 read with Article 7, profits of an enterprise
are liable to tax in India if an enterprise were to carry on business
through permanent establishment, meaning thereby fixed place of
business through which business of an enterprise is wholly or partly
carried on. Under Article 5(2)(c), 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 ones
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 other 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”. 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. Can
such an activity be anything but auxiliary in character. Plainly to
our minds, the instant activity is in ‘aid’ or ‘support’ of the main
activity. The error into which, according to us, the Authority has
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fallen is 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 as represented by the petitioner to their NRI
remitter. According to us, what has been lost sight of, is that, by
invoking the clause with regard to permanent establishment, we
would, by a deeming fiction tax an income which otherwise neither
arose nor accrued in India – when looked at from this point of
view, the exclusionary clause contained in Article 5(3) and in this
case in particular, sub-clause (e) have to be given a wider and
liberal play. Once an activity is construed as being subsidiary or in
aid or support of the main activity it would, according to us, 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-a-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) vs. Morgan Stanley & Co; 2007(7)
SCC 1 amongst other issues was called upon to decide as to
whether back office operations carried on by
Morgan Stanley
Company for one of its Morgan Stanley Advantages Services
Pvt. Ltd would qualify as having 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, which is, identical to DTAA under
consideration in the present case, came to the conclusion that
back office operations came within the purview of Article 5(3)(e).
It is laid down by the Supreme Court in the case of Morgan Stanley
(supra) that in ascertaining what would constitute a ‘permanent
establishment’ within the meaning of Article 5(1) of the Indo-US
DTAA, one had to undertake what is called a functional and factual
analysis of each of the activities undertaken by an establishment.
In that case the Supreme Court came to the conclusion that the
entity located in India which was engaged in only supporting the
front office functions of Morgan Stanley & Co., a non-resident, in
fixed income and equity research and information technology
enabled services such as data processing support centre, technical
UNION OF INDIA & ANR. v. U.A.E. EXCHANGE CENTRE
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services and reconciliation of accounts being back office operators
would not fall with Article 5(1) of the Indo-US DTAA.”
Accordingly, the High Court was of the opinion that the Authority
proceeded on a wrong premise by first examining the efficacy of Section
5(2)(b) and Section 9(1)(i) of the 1961 Act instead of applying the
provisions in Articles 5 and 7 of the DTAA for ascertaining the
respondent’s liability to tax. Further, the nature of activities carried on by
the respondent-assessee in the liaison offices being only of preparatory
and auxiliary character, were clearly excluded by virtue of deeming
provision. The High Court distinguished the decisions relied upon by the
Authority in Anglo-French Textile Co. Ltd., by Agents, M/s. Best &
Company Ltd., Madras vs. Commissioner of Income Tax, Madras3
and R.D. Aggarwal & Company (supra). Inasmuch as, the ratio in
these decisions, according to the High Court, was 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. The High Court then concluded
that the activity carried on by the liaison offices of the respondent in
India did not in any manner contribute directly or indirectly to the earning
of profits or gains by the respondent in UAE
and more so, every aspect
of the transaction was concluded in UAE, whereas, the activity
performed by the liaison offices in India was only supportive of the
transaction carried on in UAE. The High Court also took note of
explanation 2 to Section 9(1)(i) and observed that the same reinforces
the fact that in order to have a business connection, in respect of a
business activity carried on by non-resident through a person situated in
India, it should involve more than what is supportive or subsidiary to the
main function referred to in clauses (a) to (c). The High Court eventually
quashed the impugned ruling of the Authority and also the notices issued
by the Department under Section 148 of the 1961 Act, since the notices
were based on the ruling which was being set aside. The High Court,
however, gave liberty to the appellants to proceed against the respondent
on any other ground, as may be permissible in law.
5. Feeling aggrieved, the Department has assailed the decision of
the High Court by way of the present appeal arising from SLP(C) No.
31276/2011.
3 AIR 1953 SC 105
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6. We have heard Mr. Arijit Prasad, learned senior counsel for
the appellants and Mr. H.P. Ranina, learned counsel for the respondent.
7. Both sides have more or less reiterated the stand taken before
the Authority and the High Court. After cogitating over the rival
submissions and the opinion recorded by the Authority and the High
Court, the core issue that needs to be answered in this appeal is: whether
the stated activities of the respondent-assessee would qualify the
expression “of preparatory or auxiliary character”? Having regard to
the nature of activities carried on by the respondent-assessee, as held
by the Authority, it would appear that the respondent was engaged in
“business” and had “business connections”, for which, by virtue of
deeming provision and the sweep of Sections 2(24), 4 and 5 read with
Section 9 of the 1961 Act including the exposition in Anglo-French
Textile Co. Ltd. (supra) and R.D. Aggarwal & Company (supra), it
would be a case of income deemed to accrue or arise in India to the
respondent.
8. However, in the present case, the matter in issue will have to
be answered on the basis of the stipulations in DTAA notified in exercise
of powers conferred under Section 90 of the 1961 Act. This position is
no more res integra in view of the dictum in Azadi Bachao Andolan
(supra). The efficacy of Section 90 of the 1961 Act has been delineated
by this Court after adverting to the decisions in Commissioner of Income
Tax, AP-I vs.
Vishakhapatnam Port Trust4, Commissioner of Income
Tax vs. Davy Ashmore India Ltd.5, Leonhardt Andra And Partner,
GmbH vs. Commissioner of Income Tax6, Commissioner of Income
Tax vs. R.M. Muthaiah7 and Arabian Express Line Ltd. of United
Kingdom & Ors. vs. Union of India8, whereafter the Court went on to
observe in paragraph 28, as follows: -
“28. A survey of the aforesaid cases makes it clear that the judicial
consensus in India has been that Section 90 is specifically intended
to enable and empower the Central Government to issue a
notification for implementation of the terms of a Double Taxation
Avoidance Agreement. When that happens, the provisions of
4 (1983) 144 ITR 146 (AP)
5 (1991) 190 ITR 626 (Cal)
6 (2001) 249 ITR 418 (Cal)
7 (1993) 202 ITR 508 (Kant)
8 (1995) 212 ITR 31 (Guj)
UNION OF INDIA & ANR. v. U.A.E. EXCHANGE CENTRE
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such an agreement, with respect to cases to which they
apply, would operate even if inconsistent with the provisions
of the Income Tax Act. We approve of the reasoning in the
decisions which we have noticed. If it was not the intention of the
legislature to make a departure from the general principle of
chargeability to tax under Section 4 and the general principle of
ascertainment of total income under Section 5 of the Act, then
there was no purpose of making those sections “subject to the
provisions of the Act”. The very object of grafting the said two
sections with the said clause is to enable the Central Government
to issue a notification under Section 90 towards implementation
of the terms of DTACs which would automatically override the
provisions of the Income Tax Act in the matter of ascertainment
of chargeability to income tax and ascertainment of total income,
to the extent of inconsistency with the terms of DTAC.”
(emphasis supplied)
In view of this exposition, which squarely applies to the fact
situation of the present case, we must answer the question under
consideration in light of the purport of provisions in DTAA, which has
been executed by the Government of India and the Government of UAE,
and has come into force consequent to publication vide notification dated
18.11.1993. The recitals of the said notification read thus: -
“Income-tax Act, 1961:Notification under section 90:
Agreement Between the
Government of the Republic of
India and the Government of the United Arab Emirates
for the avoidance of double taxation and the prevention
of fiscal evasion with respect to taxes on income and on
capital
Notification G.S.R. No. 710(E), dated 18th November, 1993
Whereas the annexed agreement between the Government of
the United Arab Emirates and the Government of the Republic of
India for the avoidance of double taxation and prevention of fiscal
evasion with respect to taxes on income and on capital has entered
into force on the 22nd September, 1993, after the notification by
both the Contracting States to each other of the completion of the
proceedings required by laws for bringing into force of the said
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agreement in accordance with paragraph 1 of Article 30 of the
said Agreement:
Now, therefore, in exercise of the powers conferred by section
90 of the Income-tax Act, 1961 (43 of 1961), section 24A of the
Companies (Profits) Surtax Act, 1964 (7 of 1964), and section
44A of the Wealth-tax Act, 1957 (27 of 1957), the Central
Government hereby directs that all the provisions of the said
agreement shall be given effect to in the Union of India.
ANNEXURE
AN  AGREEMENT  BETWEEN  THE  GOVERNMENT  OF
THE REPUBLIC OF INDIA AND THE GOVERNMENT OF
THE UNITED ARAB EMIRATES FOR THE AVOIDANCE
OF DOUBLE TAXATION AND THE PREVENTION OF
FISCAL EVASION WITH RESPECT TO TAXES ON
INCOME AND ON CAPITAL.
The Government of the Republic of India and the Government of
the United Arab Emirates
Desiring to promote mutual economic relations by concluding an
Agreement for the avoidance of double taxation and the prevention
of fiscal evasion with respect to taxes on income and on capital.
Have agreed as follows:”
Article 1 of the DTAA bears title “Personal Scope” predicating
that the agreement shall apply to persons who are residents of one or
both of the contracting States. Article 2 deals with “Taxes Covered”, to
which the agreement would apply. Article 2 reads thus: -
“Article 2
TAXES COVERED
1. There shall be regarded as taxes on income and on capital all
taxes imposed on total income, on total capital, or on elements of
income of capital including taxes on gains from alienation of
movable or immovable property as well as on capital appreciation.
2. The existing taxes to which the Agreement shall apply are:
(a) In United Arab Emirates:
UNION OF INDIA & ANR. v. U.A.E. EXCHANGE CENTRE
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(i) Income-tax;
(ii) Corporation tax;
(iii) Wealth-tax
(hereinafter referred to as “U.A.E. tax”);
(b) In India:
(i) the income-tax including any surcharge thereon;
(ii) the surtax; and
(iii) the wealth-tax
(hereinafter referred to as “Indian tax”).
3. This Agreement shall also apply to any identical or substantially
similar taxes on income or capital which are imposed at Federal
or State level by either Contracting State in addition to, or in place
of, the taxes referred to in paragraph 2 of this Article. The
competent authorities of the Contracting States shall notify each
other of any substantial changes which are made in their respective
taxation laws.”
Article 3 refers to General Definitions and the meaning of the
concerned expression contained in the agreement, unless the context
otherwise requires. Article 4 pertains to “Resident of the Contracting
State”. The other Articles which may have bearing on the question posed
before us are Articles 5 and 7, dealing with “Permanent Establishment
(PE)” and “Business Profits” respectively, which read thus: -
“Article 5
PEMANENT ESTABLISHMENT
1. For the purposes of this Agreement, the term “permanent
establishment” means a fixed place of business through which
the business of an enterprise is wholly or partly carried on.
2. The term “permanent establishment” includes especially:
a. a place of management;
b. a branch;
c. an office;
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d. a factory;
e. a workshop;
f. a mine, an oil or gas well, a quarry or any other place of
extraction of natural resources;
g. a farm or plantation;
h. a building site or construction or assembly project or
supervisory activities in connection therewith, but only where
such site, project or activity continues for a period of more
than 9 months;
i. the furnishing of services including consultancy services by
an enterprise of a Contracting State through employees or other
personnel in the other Contracting State, provided that such
activities continue for the same project or connected project
for a period or periods aggregating to more than 9 months within
any twelve-month period.
3. Notwithstanding the preceding provisions of this Article, the
term “permanent establishment” shall be deemed not to include:
a. the use of facilities solely for the purpose of storage, 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.
4. Notwithstanding the provisions of paragraphs 1 and 2, where a
person - other than an agent of independent status to whom
paragraph 5 applies - is acting on behalf of an enterprise and has,
UNION OF INDIA & ANR. v. U.A.E. EXCHANGE CENTRE
[A. M. KHANWILKAR, J.]
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and habitually exercises in a Contracting State an authority to
conclude contracts on behalf of the enterprise, that enterprise
shall be deemed to have a permanent establishment in that State
in respect of any activities which that person undertakes for the
enterprise, unless the activities of such persons are limited to the
purchase of goods or merchandise for the enterprise.
5. An enterprise of a Contracting State shall not be deemed to
have a permanent establishment in the other Contracting State
merely because it carries on business in that other State through a
broker, general commission agent or any other agent of an
independent status, provided that such persons are acting in the
ordinary course of their business. However, when the activities
of such an agent are devoted wholly or almost wholly on behalf of
that enterprise, he will not be considered an agent of an independent
status within the meaning of this paragraph.
Article 7
BUSINESS PROFITS
1. The profits of an enterprise of a Contracting State shall be
taxable only in that State unless the enterprise carries on business
in the other Contracting 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 them as is attributable to that permanent
establishment.
2. Subject to the provisions of paragraph 3, where an enterprise
of a Contracting State carries on business in the other Contracting
State through a permanent establishment situated therein, there
shall in each Contracting State be attributed to that permanent
establishment the profits which it might be expected to make if it
were a distinct and separate enterprise engaged in the same or
similar activities under the same or similar conditions and dealing
wholly independently with the enterprise of which it is a permanent
establishment.
3. In determining the profits of a permanent establishment, there
shall be allowed as deductions expenses which are incurred for
the purposes of the business of the permanent establishment,
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including executive and general administrative expenses so
incurred, whether in the State in which the permanent establishment
is situated or elsewhere.
4. In so far as it has been customary in a Contracting State to
determine the profits to be attributed to a permanent establishment
on the basis of an apportionment of the total profits of the enterprise
to its various parts, nothing in paragraph 2 shall preclude that
Contracting State from determining the profits to be taxed by such
an apportionment as may be customary; the methods of
apportionment adopted shall, however, be such that, the result
shall be in accordance with the principles contained in this Article.
5. No profits shall be attributed to a permanent establishment by
reason of the mere purchase by the permanent establishment of
goods or merchandise for the enterprise.
6. For the purposes of the preceding paragraphs, the profits to be
attributed to the permanent establishment shall be determined by
the same method year by year unless there is good and sufficient
reason to the contrary.
7. Where profits include items of income which are dealt with
separately in other Articles of this Agreement, then the provisions
of those Articles shall not be affected by the provisions of this
Article.”
Keeping in view the finding recorded by the High Court, we may
proceed on the basis that the respondent-assessee had a fixed place of
business through which the business of the respondent was being wholly
or
partly carried on. That, however, would not be conclusive until a further
finding is recorded that the respondent had a PE situated in India, so as
to attract Article 7 dealing with business profits to become taxable in
India, to the extent attributable to the PE of the respondent in India. For
that, we may have to revert back to Article 5, which deals with and
defines the “Permanent Establishment (PE)”. A fixed place of business
through which the business of an enterprise is wholly or partly carried
on is regarded as a PE. The term “Permanent Establishment (PE)”
would include the specified places referred to in clause 2 of Article 5. It
is not in dispute that the place from where the activities are carried on
by the respondent in India is a liaison office and would, therefore, be
covered by the term PE in Article 5(2). However, Article 5(3) of the
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DTAA opens with a non-obstante clause and also contains a deeming
provision. It predicates that notwithstanding the preceding provisions of
the concerned Article, which would mean clauses 1 and 2 of Article 5, it
would still not be a PE, if any of the clauses in Article 5(3) are applicable.
For that, the functional test regarding the activity in question would be
essential. The High Court has opined that the respondent was carrying
on stated activities in the fixed place of business in India of a preparatory
or auxiliary character. Indeed, the expression “business” has been defined
in the 1961 Act, as follows: -
“2. Definitions.- In this Act, unless the context otherwise requires,-
xxx xxx xxx
(13) “business” includes any trade, commerce or manufacture or
any adventure or concern in the nature of trade, commerce or
manufacture;”
The expression “business connection” can be discerned from
Section 9(1), as also, the meaning of expression “business activity”. We
will advert to those provisions a little later and for the time being, assume
that the stated activities of the respondent are business activities. However,
since the stated activities of the liaison offices of the respondent in India
are of preparatory or auxiliary character, the same would fall within the
excepted category under Article 5(3)(e) of the DTAA. Resultantly, it
cannot be regarded as a PE within the sweep of Article 7 of DTAA.
The expression
“preparatory” is not defined in the 1961 Act or the DTAA.
The dictionary meaning of that expression can be traced to term
“preparatory work” and “travaux préparatoires”, which in the Black’s
Law Dictionary (Eleventh Edition), read thus:-
“preparatory work.  See TRAVAUX PRÉPARATOIRES.
travaux préparatoires. Materials used in preparing the ultimate
form of an agreement or statute, and esp. of an international treaty;
the draft or legislative history of a treaty.”
The expression “auxiliary” is also not defined in the 1961 Act or
the DTAA. In common parlance, the meaning of that expression is
predicated in Concise Oxford English Dictionary (Twelfth Edition), which
reads thus: -
“Auxiliary- adj. providing additional help or support. n. an
auxiliary person or thing. N. Amer. A group of volunteers who
assist a church, hospital, etc. with charitable activities.”
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In Black’s Law Dictionary (Eleventh Edition), the term “auxiliary”
is defined as follows: -
“Auxiliary adj. 1. Aiding or supporting. 2. Subsidiary.
3. Supplementary.”
The crucial activities in the present case are of downloading
particulars of remittances through electronic media and then printing
cheques/drafts drawn on the banks in India, which, in turn, are couriered
or dispatched to the beneficiaries in India, in accordance with the
instructions of the NRI remitter. While doing so, the liaison office of the
respondent in India remains connected with its main server in UAE and
the information residing thereat is accessed by the liaison office in India
for the purpose of remittance of funds to the beneficiaries in India by the
NRI remitters. These are combination of virtual and physical activities
unlike the virtual activity of funds being remitted by telegraphic transfer
through banking channels. As regards the latter, it is not the case of the
Department that the same would be covered and amenable to tax liability
by virtue of deeming provision in the 1961 Act.
9. While answering the question as to whether the activity in
question can be termed as other than that “of preparatory or auxiliary
character”, we need to keep in mind the limited permission given by the
RBI to the respondent under Section 29(1)(a) of the 1973 Act, on
24.9.1996. From paragraph 2 of the stated permission, it is evident that
the RBI had agreed for establishing a liaison office
of the respondent at
Cochin, initially for a period of three years to enable the respondent to (i)
respond quickly and economically to enquiries from correspondent banks
with regard to suspected fraudulent drafts; (ii) undertake reconciliation
of bank accounts held in India; (iii) act as a communication centre
receiving computer (via modem) advices of mail transfer T.T. stop
payments messages, payment details etc., originating from respondent’s
several branches in UAE and transmitting to its Indian correspondent
banks; (iv) printing Indian Rupee drafts with facsimile signature from
the Head Office and counter signature by the authorised signatory of
the Office at Cochin; and (v) following up with the Indian correspondent
banks. These are the limited activities which the respondent has been
permitted to carry on within India. This permission does not allow the
respondent-assessee to enter into a contract with anyone in India, but
only to provide service of delivery of cheques/drafts drawn on the banks
in India. Notably, the permitted activities are required to be carried out
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by the respondent subject to conditions specified in clause 3 of the
permission, which includes not to render any consultancy or any other
service, directly or indirectly, with or without any consideration and further
that the liaison office in India shall not borrow or lend any money from
or to any person in India without prior permission of RBI. The conditions
make it amply clear that the office in India will not undertake any other
activity of trading, commercial or industrial, nor shall it enter into any
business contracts in its own name without prior permission of the RBI.
The liaison office of the respondent in India cannot even charge
commission/fee or receive any remuneration or income in respect of the
activities undertaken by the liaison office in India. From the onerous
stipulations specified by the RBI, it could be safely concluded, as opined
by the High Court, that the activities in question of the liaison office(s) of
the respondent in India are circumscribed by the permission given by the
RBI and are in the nature of preparatory or auxiliary character. That
finding reached by the High Court is unexceptionable.
10. The High Court had justly adverted to the exposition of this
Court in DIT (International Taxation), Mumbai vs. Morgan Stanley
& Co. Inc.9, which dealt with the case of an assessee having set up
office in India to support the main office functions in fixed income and
equity research and in
providing IT enabled services such as back office
operations, data processing and support centres to the entity in United
States. This Court, in paragraphs 10 to 14, observed thus: -
“10. In our view, the second requirement of Article 5(1) of DTAA
is not satisfied as regards back office functions. We have examined
the terms of the Agreement along with the advance ruling
application made by MSCo inviting AAR to give its ruling. It is
clear from reading of the above Agreement/application that MSAS
in India would be engaged in supporting the front office functions
of MSCo in fixed income and equity research and in providing IT
enabled services such as data processing support centre and
technical services as also reconciliation of accounts. In order to
decide whether a PE stood constituted one has to undertake
what is called as a functional and factual analysis of each of
the activities to be undertaken by an establishment. It is
from that point of view, we are in agreement with the ruling of
AAR that in the present case Article 5(1) is not applicable as the
9 (2007) 7 SCC 1
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said MSAS would be performing in India only back office
operations. Therefore to the extent of the above back office
functions the second part of Article 5(1) is not attracted.
11. Lastly, as rightly held by AAR there is no agency PE as
the PE in India had no authority to enter into or conclude
the contracts. The contracts would be entered into in the
United States. They would be concluded in US. The
implementation of those contracts only to the extent of back
office functions would be carried out in India, and therefore,
MSAS would not constitute an agency PE as contended on
behalf of the Department.
12. In DTAA, the term PE means a fixed place of business through
which the business of an MNE is wholly or partly carried out.
The definition of the word PE in Section 92-F(iii) is inclusive,
however, it is not under Article 5(1) of the Treaty. It is for this
reason that Article 5(2) of DTAA herein refers to places included
as PE of the MNE. One such place is mentioned in Article 5(2)(l)
which deals with furnishing of services.
13. The concept of PE was introduced in the 1961 Act as part of
the statutory provisions of transfer pricing by the Finance Act of
2001. In Section 92-F(iii) the word “enterprise” is defined to mean
“a person (including a permanent establishment of such person)
who is, or has been, or is proposed to be, engaged in any activity,
relating to the production, …”
Under CBDT Circular No. 14 of 2001 it has been clarified that
the term PE has
not been defined in the Act but its meaning may
be understood with reference to DTAA entered into by India.
Thus the intention was to rely on the concept and definition of PE
in DTAA. However, vide the Finance Act, 2002 the definition of
PE was inserted in the Income Tax Act, 1961 (for short “the IT
Act”) vide Section 92-F(iii-a) which states that the PE shall
include a fixed place of business through which the business of
MNE is wholly or partly carried on. This is where the difference
lies between the definition of the word PE in the inclusive
sense under the IT Act as against the definition of the word
PE in the exhaustive sense under DTAA. This analysis is
important because it indicates the intention of Parliament
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in adopting an inclusive definition of PE so as to cover
service PE, agency PE, software PE, construction PE, etc.
14. There is one more aspect which needs to be discussed,
namely, exclusion of PE under Article 5(3). Under Article
5(3)(e) activities which are preparatory or auxiliary in
character which are carried out at a fixed place of business
will not constitute a PE. Article 5(3) commences with a non
obstante clause. It states that notwithstanding what is stated
in Article 5(1) or under Article 5(2) the term PE shall not
include maintenance of a fixed place of business solely for
advertisement, scientific research or for activities which
are preparatory or auxiliary in character. In the present case
we are of the view that the abovementioned back office functions
proposed to be performed by MSAS in India falls under Article
5(3)(e) of DTAA. Therefore, in our view in the present case MSAS
would not constitute a fixed place PE under Article 5(1) of DTAA
as regards its back office operations.”
(emphasis supplied)
Learned counsel for the appellant, however, attempted to distinguish
this judgment on the argument that this case dealt with the issue of
service PE. According to him, the Court must examine the full transactions
of the respondent to determine whether the work done by the respondent-
assessee was one of a backup office work or auxiliary work. Insofar as
the nature of activities carried on by the respondent
through the liaison
office in India, as permitted by the RBI, we have upheld the conclusion
of the High Court that the same were in the nature of “preparatory or
auxiliary character” and, therefore, covered by Article 5(3)(e). As a
result, the fixed place used by the respondent as liaison office in India,
would not qualify the definition of PE in terms of Articles 5(1) and 5(2)
of the DTAA on account of non-obstante and deeming clause in Article
5(3) of the DTAA.
11. Having said thus, it must follow that the respondent was not
carrying on any business activity in India as such, but only dispensing
with the remittances by downloading information from the main server
of respondent in UAE and printing cheques/drafts drawn on the banks
in India as per the instructions given by the NRI remitters in UAE. The
transaction(s) had completed with the remitters in UAE, and no charges
towards fee/commission could be collected by the liaison office in India
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in that regard. To put it differently, no income as specified in Section
2(24) of the 1961 Act is earned by the liaison office in India and moreso
because, the liaison office is not a PE in terms of Article 5 of DTAA (as
it is only carrying on activity of a preparatory or auxiliary character).
The concomitant is - no tax can be levied or collected from the liaison
office of the respondent in India in respect of the primary business
activities consummated by the respondent in UAE. The activities carried
on by the liaison office of the respondent in India as permitted by the
RBI, clearly demonstrate that the respondent must steer away from
engaging in any primary business activity and in establishing business
connection as such. It can carry on activities of preparatory or auxiliary
nature only. In that case, the deeming provisions in Sections 5 and 9 of
the 1961 Act can have no bearing whatsoever.
12. Our  attention  was  invited  to  the  dictum  in  Assistant
Director of Income Tax-1, New Delhi vs. E-Funds IT Solution Inc.10.
Paragraph 2 of the said decision would clearly indicate the background
in which the issue was answered by this Court. The same reads thus: -
“2. The assessing authority decided that the assessees had a
permanent establishment (hereinafter referred to as “PE”) as they
had a fixed place where they carried on their own business in
Delhi, and that, consequently, Article 5 of the India US Double
Taxation Avoidance Agreement of 1990
(hereinafter referred to
as “DTAA”) was attracted. Consequently, the assessees were
liable to pay tax in respect of what they earned from the aforesaid
fixed place PE in India. The CIT (Appeals) dismissed the appeals
of the assessees holding that Article 5 was attracted, not only
because there was a fixed place where the assessees carried on
their business, but also because they were “service PEs” and
“agency PEs” under Article 5. In an appeal to the ITAT, the ITAT
held that the CIT (Appeals) was right in holding that a “fixed
place PE” and “service PE” had been made out under Article 5,
but said nothing about the “agency PE” as that was not argued by
the Revenue before the ITAT. However, the ITAT, on a calculation
formula different from that of the CIT (Appeals), arrived at a nil
figure of income for all the relevant assessment years. The appeal
of the assessees to the High Court proved successful and the
High Court, by an elaborate judgment, has set aside the findings
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of all the authorities referred to above, and further dismissed the
cross-appeals of the Revenue. Consequently, the Revenue is before
us in these appeals.”
The Court, after analysing the decisions and the concerned report
produced before it, observed in paragraph 22 as follows: -
“22. This report would show that no part of the main business
and revenue earning activity of the two American companies
is carried on through a fixed business place in India which
has been put at their disposal. It is clear from the above
that the Indian company only renders support services which
enable the assessees in turn to render services to their
clients abroad. This outsourcing of work to India would not
give rise to a fixed place PE and the High Court judgment
is, therefore, correct on this score.”
(emphasis supplied)
We may usefully refer to paragraphs 24 and 26 of the reported
decision, which read thus: -
“24. It has already been seen that none of the customers of
the assessees are located in India or have received any
services in India. This being the case, it is clear that the
very first ingredient contained in Article 5(2)(l) is not
satisfied. However, the learned Attorney General, relying upon
Para 42.31 of the OECD Commentary, has argued that services
have to be furnished within India, which does not mean that they
have to be furnished to customers in India. Para 42.31 of the
OECD Commentary reads as under:
“42.31. … Whether
or not the relevant services are furnished
to a resident of a State does not matter; what matters is that
the services are performed in the State through an individual
present in that State.”
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26. We entirely agree with the approach of the High Court in this
regard. Para 42.31 of the OECD Commentary does not mean
that services need not be rendered by the foreign assessees in
India. If any customer is rendered a service in India, whether
resident in India or outside India, a “service PE” would be
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established in India. As has been noticed by us hereinabove, no
customer, resident or otherwise, receives any service in India from
the assessees. All its customers receive services only in locations
outside India. Only auxiliary operations that facilitate such services
are carried out in India. This being so, it is not necessary to advert
to the other ground, namely, that “other personnel” would cover
personnel employed by the Indian company as well, and that the
US companies through such personnel are furnishing services in
India. This being the case, it is clear that as the very first part of
Article 5(2)(l) is not attracted, the question of going to any other
part of the said article does not arise. It is perhaps for this reason
that the assessing officer did not give any finding on this score.”
(emphasis supplied)
As aforesaid, we agree with the finding recorded by the High
Court about the nature and character of stated activities carried on by
the liaison offices of the respondent and in our view, the High Court
justly reckoned the same as being of preparatory or auxiliary character,
falling under Article 5(3)(e).
13. The High Court has also examined the matter in the context
of explanation to Section 9(1)(i) of the 1961 Act. Prior to enactment of
Finance Act, 2003 (32 of 2003), Section 9(1)(i) read thus: -
“Income deemed to accrue or arise in India.
9. (1) The following incomes shall be deemed to accrue or arise
in India: -
(i) all income accruing
or arising, whether directly or indirectly,
through or from any business connection in India, or through
or from any property in India, or through or from any asset or
source of income in India, or through the transfer of a capital
asset situate in India.
Explanation.— For the purposes of this clause— (a) in the
case of a business of which all the operations are not carried
out in India, the income of the business deemed under this
clause to accrue or arise in India shall be only such part of the
income as is reasonably attributable to the operations carried
out in India;
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(b) in the case of a non-resident, no income shall be deemed to
accrue or arise in India to him through or from operations which
are confined to the purchase of goods in India for the purpose of
export;
(c) in the case of a non-resident, being a person engaged in the
business of running a news agency or of publishing newspapers,
magazines or journals, no income shall be deemed to accrue or
arise in India to him through or from activities which are confined
to the collection of news and views in India for transmission out
of India;
(d) in the case of a non-resident, being—
(1) an individual who is not a citizen of India; or
(2) a firm which does not have any partner who is a citizen of
India or who is resident in India; or
(3) a company which does not have any shareholder who is a
citizen of India or who is resident in India, no income shall be
deemed to accrue or arise in India to such individual, firm or
company through or from operations which are confined to
the shooting of any cinematograph film in India.
…………………..”
After the enactment of Finance Act, 2003, explanation 2 came to
be inserted after the renumbered explanation 1 to clause (i) of
sub-Section (1) of Section 9 with effect from 1.4.2004. The same
reads thus: -
“Income deemed to accrue or arise in India.
9. (1) The following incomes shall be deemed to accrue or arise
in India: -
(i) all income accruing or arising, whether directly or indirectly,
through or
from any business connection in India, or through
or from any property in India, or through or from any asset or
source of income in India, or through the transfer of a capital
asset situate in India.
Explanation 1.-
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Explanation 2.– For the removal of doubts, it is hereby declared
that “business connection” shall include any business activity
carried out through a person who, acting on behalf of the non-
resident,-
(a) has and habitually exercises in India, an authority to
conclude contact on behalf of the non-resident, unless his
activities are limited to the purchase of goods or merchandise
for the non-resident; or
(b) has no such authority, but habitually maintains in India a
stock of goods or merchandise from which he regularly delivers
goods or merchandise on behalf of the non-resident; or
(c) habitually secures orders in India, mainly or wholly for the
non-resident or that non-resident and other non-residents
controlling, controlled by, or subject to the same common
control, as that non-resident:
Provided that such business connection shall not include any
business activity carried out through a broker, general
commission agent or any other agent having an independent
status, if such broker, general commission agent or any other
agent having an independent status is acting in the ordinary
course of his business:
Provided further that where such broker, general commission
agent or any other agent works mainly or wholly on behalf of
a non-resident (hereafter in this proviso referred to as the
principal non-resident) or on behalf of such non-resident and
other non-residents which are controlled by the principal non-
resident or have a controlling interest in the
principle non-
resident or are subject to the same common control as the
principal non-resident, he shall not be deemed to be a broker,
general commission agent or an agent of an independent
status.”
The meaning of expressions “business connection” and “business
activity” has been articulated. However, even if the stated activity(ies)
of the liaison office of the respondent in India is regarded as business
activity, as noted earlier, the same being “of preparatory or auxiliary
character”; by virtue of Article 5(3)(e) of the DTAA, the fixed place of
business (liaison office) of the respondent in India otherwise a PE, is
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deemed to be expressly excluded from being so. And since by a legal
fiction it is deemed not to be a PE of the respondent in India, it is not
amenable to tax liability in terms of Article 7 of the DTAA.
14. Taking any view of the matter, therefore, we find no substance
in this appeal. We uphold the conclusions reached by the High Court for
the reasons stated hitherto.
15. Accordingly, the appeal is dismissed with no order as to costs.
Pending interlocutory applications, if any, shall stand disposed of.
Devika Gujral
Appeal dismissed.