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Liaison offices of MNCs can't be taxed, rules ITAT
June, 17th 2008

Multinational companies sourcing their products from third-party manufacturers in India through a liaison office here have reasons to cheer. The Income Tax Appellate Tribunal (ITAT) has in a recent order favouring Nike, which has a similar arrangement in India, attempted to bring clarity on how to assess whether such liaison offices are actually carrying out their parents business operations that are taxable in India.

Income Tax law says that liaison offices, which merely assist the export of goods on behalf of the foreign parent, are exempt from tax liability. Tax authorities, however, apprehend that liaison offices of foreign companies create a taxable presence or permanent establishment in India a line of thinking that worries many foreign investors.
The Bangalore Bench of the Tribunal has ruled that services of such offshore units merely working towards export of goods for multinationals cannot be made to bear the tax burden, sources said.

Deciding on the taxability of liaison offices established in India by US-based global sportswear giant Nike, the Tribunal has held that purchase operations made by such offices in their process to cater to the companys export operations cannot be made liable to pay tax under domestic laws.

The intention of the law is to ensure that such liaison offices do not themselves make money out of their operations here. The Tribunals order is expected to be welcomed by global majors looking at tapping the low-cost labour in India for their manufacturing requirement.

The order, however, is always open to scrutiny by higher courts. The tribunals order has only a persuasive effect on authorities deciding on similar cases.

As per the current foreign exchange regulations, a foreign company can open a liaison office in India by seeking approval from the RBI. The law in this regard states that such offices would act as a representative office between the parent company and the vendors in India, and are not permitted to carry out any commercial activity. Tax authorities have of late argued that such offices of foreign companies carry out commercial activity in the country, resulting into business connection for the parent multi-national in India.

The broad interpretation given by the ITAT to the exclusion clause contained in the domestic tax law and the conclusion reached that such activities do not create a taxable presence is expected to be relied upon by other tax payers as well as who face challenges from tax authorities on similar issues, said Rajendra Nayak, tax partner, Ernst & Young.

The company maintained that its liaison office acted as an intermediary between its unrelated third party manufacturers in India and its US head quarters. Its activities were in the nature of a purchase function rather than being revenue-generative, the company argued.

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