1. Branch office, Liaison offices and a Project office –Tax Issues 2 July 2010 Presenter: Prashant Khatore AICAS Workshop on Direct Taxes

2. Page 2 Contents Branch Office Project Office Liaison Office Business Presence 3 4 2 1 Comparative Analysis5

3. Page 3 Business Presence ► Liaison Office (Short Term) ► Channel of communication between HO and Indian entities ► No commercial / trading / industrial/ income generating activity ► Maintenance from foreign inward remittances ► Branch office (Medium term) ► Established for undertaking permitted commercial activities ► Project office (Specific purpose) ► Represents interests of foreign company executing specific project Each of the above 3 forms are discussed in detail in the ensuing slides

4. Liaison Office

5. Page 5 ► Permitted activities for a LO in India – Schedule II of the FEMA regulation ► Representing in India the parent company/ group companies ► Promoting export/ import from/ to India ► Promoting technical/ financial collaboration between parent/ group companies and companies in India ► Acting as a communication channel between the parent company and Indian companies ► Setting up of a Liaison Office ► Prior approval from RBI in Form ‘FNC’ ► Registered with ROC within 30 days of its establishment (i.e., date of opening of bank account, taking premises on lease etc) ► Annual compliance ► Auditor’s certificate confirming compliance with terms and conditions of RBI approval on or before April 30, 2010 (Annual Activity Certificate) ► Inflow of funds ► Inward remittances from the HO Liaison Office

6. Page 6 ► Section 5(2) Subject to the provisions of this Act, the total income of any previous year of a person who is a non-resident includes all income from whatever source derived which – (a) is received or is deemed to be received in India in such year by or on behalf of such person ; or (b) accrues or arises or is deemed to accrue or arise to him in India during such year. Explanation 1.—Income accruing or arising outside India shall not be deemed to be received in India within the meaning of this section by reason only of the fact that it is taken into account in a balance sheet prepared in India. Explanation 2.—For the removal of doubts, it is hereby declared that income which has been included in the total income of a person on the basis that it has accrued or arisen or is deemed to have accrued or arisen to him shall not again be so included on the basis that it is received or deemed to be received by him in India. Liaison Office –Taxability

7. Page 7 ► Section 9(1)(i) 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.—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 ; (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. Liaison Office –Taxability

8. Page 8 ► Section 9(1)(i) (contd.) 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 contracts on behalf of the non- resident, unless his activities are limited to purchase of goods or merchandise for the nonresident; 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 nonresident or for 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 principal 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. Explanation 3.—Where a business is carried on in India through a person referred to in clause (a) or clause (b) or clause (c) of Explanation 2, only so much of income as is attributable to the operations carried out in India shall be deemed to accrue or arise in India; Liaison Office –Taxability

9. Page 9 ► Foreign Company taxable on all income received or deemed to be received in India; or accrues or arises or is deemed to accrue or arise in India ► Income deemed to accrue or arise in India interalia includes income from any business connection in India ► Exception – Income from operations of non resident which are confined to purchase of goods in India for purpose of export ► Business connection to include any business activity carried out through a person who, acting on behalf of non – resident:- ► has and habitually exercises authority to conclude contracts ► habitually maintains stock from where regular delivery of goods is effected ► habitually secures orders mainly or wholly for non-resident and commonly controlled entities ► Exception – Agent of independent status [i.e. Agent not working mainly for non resident / non residents under common control] Liaison Office –Taxability- Business Connection

10. Page 10 ► Business connection to be constituted under certain scenarios*: ► Existence of a real and intimate relation between business activities carried by non resident in foreign country and India ► Contribution by such relation to earning of income by non-resident in his business ► Continuity of relationship and not a mere isolated /stray nexus between the business of non-resident outside India and the activity in India Liaison Office –Taxability- Business Connection (contd.) Even if business connection, income attributable to the operations carried out in India should be taxable in India * CIT Vs. R.D. Aggarwal & Co. [ 56 ITR 20 (SC) ] Barendra Prasad Roy v. ITO [129 ITR 295)(SC)]

11. Page 11 ► 1. For the purposes of this Agreement, the term "permanent establishment" means a fixed place of business through which the business of the 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; (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 warehouse in relation to a person providing storage facilities for others; (h) a farm, plantation or other place where agriculture, forestry, plantation or related activities are carried on; (i) premises used as a sales outlet or for soliciting and receiving orders; (j) an installation or structure used for the exploration or exploitation of natural resources but only if so used for a period of more than 120 days in any fiscal year. Liaison Office –Taxability - Article 5

12. Page 12 ► 3. A building site or construction, installation or assembly project constitutes a permanent establishment only if it continues for a period of more than 183 days in any fiscal year. ► 4. An enterprise shall be deemed to have a permanent establishment in a Contracting State and to carry on business through that permanent establishment if it carries on supervisory activities in that Contracting State for a period of more than 183 days in any fiscal year in connection with a building site or construction, installation or assembly project which is being undertaken in that Contracting State. ► 5. Notwithstanding the provisions of paragraphs 3 and 4, an enterprise shall be deemed to have a permanent establishment in a Contracting State and to carry on business through that permanent establishment if it provides services or facilities in that Contracting State for a period of more than 183 days in any fiscal year in connection with the exploration, exploitation or extraction of mineral oils in that Contracting State. ► 6. ……………….. Liaison Office –Taxability - Article 5 (contd.)

13. Page 13 ► 7. 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 occasional 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 occasional 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 advertising, for the supply of information, for scientific research, or for similar activities which have a preparatory or auxiliary character, for the enterprise. However, the provisions of sub-paragraph (a) to (e) shall not be applicable where the enterprise maintains any other fixed place of business in the other Contracting State through which the business of the enterprise is wholly or partly carried on. Liaison Office –Taxability - Article 5 (contd.)

14. Page 14 ► 8. Notwithstanding the provisions of paragraphs 1 and 2, where a person -- other than an agent of an independent status to whom paragraph 9 applies -- is acting in a Contracting State on behalf of an enterprise of the other Contracting State that enterprise shall be deemed to have a permanent establishment in the first-mentioned State, if (a) he has and habitually exercises in that State an authority to conclude contracts on behalf of the enterprise, unless his activities are limited to the purchase of goods or merchandise for the enterprise; (b) he has no such authority, but habitually maintains in the first-mentioned State a stock of goods or merchandise from which he regularly delivers goods or merchandise on behalf of the enterprise; or (c) he habitually secures orders in the first-mentioned State, wholly or almost wholly for the enterprise itself or for the enterprise and other enterprises controlling, controlled by, or subject to the same common control, as that enterprise. Liaison Office –Taxability - Article 5 (contd.)

15. Page 15 ► Business income of foreign company taxable if it has PE in India ► However, only income attributable to PE taxable in India ► Typically, PE defined in Article 5 to include: ► Fixed Place PE ► Place of management, branch, office, factory, workshop, warehouse ► Installation / Construction PE ► Service PE ► Agency PE (excluding agent of independent status) Liaison Office –Taxability - PE PE interalia excludes maintenance of fixed place of business solely for the purpose of purchasing goods, collecting information, carrying out activity of preparatory or auxiliary character

16. Page 16 ► LO may not constitute ‘business connection’ and clear exception office for purchase of goods for export ► LO not a PE if its activities are ‘solely’ of preparatory or auxiliary nature ► Preparatory / Auxiliary – Not defined under the Act / Treaty – Need to evaluate ► Preparatory and auxiliary activities in the case of LO of a trading company ► RBI approval - not conclusive* ► Recent actions by revenue authorities ► Appropriate documentation needed * Special Bench of Delhi in the case of Mitsui & Co may be relevant Liaison Office –Taxability - Key issues

17. Page 17 ► K.T. Corporation, In re 181 Taxman 94 (AAR) ► Held that collecting information is auxiliary unless collection of information is the primary purpose of the enterprise. Preparation of reports dealing with India’s market scenario in mobile as well broadband segments etc are in ‘aid’ or ‘support’ to the main activities ► DCIT vs Jebon Corporation India Liaison Office 127 TTJ 98 (Bangalore Tribunal) ► Held that the freedom to fix the price by LO and to conclude the contract even if, the sale price are within the band of profit margin communicated by Head Office, cannot be termed as preparatory or auxiliary in character. ► Each activity performed by LO formed part of and was in continuation of the trading activity of the HO and thus there was a business connection in India ► UAE Exchange Centre Ltd vs UOI 213 Taxation 628 (Delhi HC) ► Held that the activity of downloading information contained from servers in UAE and printing & dispatching of cheques – merely an aid to main activity ► If completion of transaction is necessary to determine preparatory/auxiliary nature of activities, then no activity could be construed as preparatory or auxiliary in nature. Every other activity which an enterprise undertakes is with the ultimate view of giving effect to the obligations undertaken by an enterprise vis a vis its customer Liaison Office – Recent Case Laws

18. Branch Office

19. Page 19 ► Permitted activities for a BO in India ► Export/ import of goods. ► Rendering professional/ consultancy services. ► Carrying out research work, in which the parent company is engaged. ► Promoting technical or financial collaborations between Indian companies and parent or overseas group company. ► Representing the parent company in India and acting as a buying/ selling agent in India. ► Rendering services in Information Technology and development of software in India. ► Rendering technical support to the products supplied by the parent/ group companies ► Foreign airline/ shipping company. ► Setting up of a Branch Office ► Prior approval from RBI in Form ‘FNC’ ► Registered with ROC within 30 days of its establishment ► Annual Compliances ► Auditor’s certificate confirming compliance with terms and conditions of RBI approval on or before April 30, 2010 (Annual Activity Certificate) Branch Office

20. Page 20 ► Inflow of funds ► Funds received from Head Office (HO) or ► Income generated by BO from undertaking permitted activities. ► Local Borrowings by BO (require prior approval from RBI) Branch Office (cont’d)

21. Page 21 Taxability ► Treated as a foreign company for tax purposes in India ► Income attributable to Indian operations subject to tax in India ► Business profits under the domestic tax laws taxed at the rate of 42.23/ 41.82 percent on a net income basis ► Mandatory to file a return of income with the Indian Revenue authorities ► Benefits of relevant tax treaty could be explored ► Parent company could avail of tax credits in its home country for taxes paid in India subject to domestic tax laws of the parent’s country ► Withholding rates as applicable to non-residents ► BO can claim deduction for expenses incurred by the HO abroad on behalf of the BO, without any additional tax liability on the HO, subject to prescribed guidelines Branch Office -Taxability

22. Page 22 ► CIT vs Emirates Commercial Bank Ltd. 262 ITR 55 (Bombay HC) ► Held that there can be no disallowance in respect of Head office expenses reimbursed by the Branch office, where such expenses were exclusively entered for the India branch office ► The ceiling imposed under the Act is in relation to the general Head office expenses and not the branch expenses Branch Office – Recent Case Laws

23. Project Office

24. Page 24 Project Office ► Permitted activities for a PO in India ► Limited to execution of a particular project in India ► PO permitted to undertake specific activities in relation and incidental to execution of project ► Pre-requisites to setting-up ► A Foreign company secures contract to execute a project in India ► Project to have a fixed duration ► Setting up of a Project Office ► Foreign companies granted general permission to set-up project offices in India without any approval in certain cases subject to certain conditions: ► it has secured from an Indian company, a contract to execute a project in India ► the project is funded directly by inward remittances from abroad/ bilateral or multilateral International financing agency ► the project has been cleared by an appropriate authority ► the company or entity in India awarding the contract has been granted term loan facility by a Public Financial Institution or bank in India ► Intimation to be filed within 30 days before RBI ► Register with ROC within 30 days of its establishment

25. Page 25 ► Inflow of funds ► Inward remittance from abroad ► Project revenues ► Taxability ► Similar to that of a BO Project Office (cont’d)

26. Page 26 Project Office – Issues ► Article 5(2) 2. The term "permanent establishment" includes especially: (a) ……..; (b) ……..; (c) an office; (d) ………. ► Article 5(3) 3. A building site or construction, installation or assembly project constitutes a permanent establishment only if it continues for a period of more than 183 days in any fiscal year. Whether an ‘office’ established specifically for the above activities would be considered to be a PE if it is established for less than 183 days?

27. Comparative Analysis

28. Page 28 Comparative Analysis Key ParametersLOBOPO Legal StatusRepresents the parent company Extension of parent company Approval requirements for establishment Prior approval from RBI required No prior approval required from RBI (Subject to applicable conditions) Flexibility of operationsOperations subject to activities permitted by RBI. Operations subject to activities permitted by RBI Operations restricted to specific activities in relation and incidental to execution of the project. Financing Indian operationsFinanced by means of inward remittances Financed by means of inward remittances or permitted sources Financed by means of inward remittances and project revenue

29. Page 29 Comparative Analysis (cont’d) Key ParametersLOBOPO Option to determine the income under tax treaty in respect of Indian operations Not applicable Available Treated as PE of the HO in India Available Treated as PE of the HO in India Taxation of business profits under domestic tax law Not applicable Taxed at 42.23% on a net income basis MAT, if applicable - 19.004% Taxed at 42.23% on a net income basis MAT, if applicable - 19.004% Manner of computation of net incomeNot applicable Profits attributable to BO (PE) taxable on a ‘net income basis’ in accordance with the provisions of the Indian tax laws or the relevant tax treaty. Deduction for executive and general administrative expenses may be claimed to the extent of 5% of total income as per the provisions of Indian tax laws Profits attributable to PO (PE) taxable on a ‘net income basis’ in accordance with the provisions of the Indian tax laws or the relevant tax treaty. Deduction for executive and general administrative expenses may be claimed to the extent of 5% of total income as per the provisions of Indian tax laws

30. Page 30 Comparative Analysis (cont’d) Key ParametersLOBOPO Residential status under Indian tax lawsNon-resident Scope of incomeNot applicableIncome attributable to operations carried out in India Income attributable to the Indian operations taxed in India Repatriation of profitsNot applicableSubject to procedural requirements Limitation of liabilityNot applicableLiability, if any, could extend to the foreign company Applicability of Indian transfer pricing regulations Not applicableYes

31. Thank you