Tribunal rules that the offices cannot be termed permanent establishments.

The revenue department has decided to challenge an Income Tax Appellate Tribunal (ITAT) order that liaison offices of foreign firms operating in India cannot be termed as permanent establishments (PEs).

The tribunals December 24 ruling concerned Tokyo-based Mitsui and Company, which has investments in various sectors in India, including machinery, chemicals, energy, lifestyle, iron and steel, information technology and food products.

The Income Tax Department had attributed 50 per cent of the income Mitsui earned from its Indian operations to the liaison office, which it termed a PE, for assessment year 2002-03. Tax officials said that if a company had a PE in India, the income would be taxed as business income. If a foreign company operating in India is taxed on its business income and the country does not have a specific double taxation avoidance treaty with India, the tax rate on income and gains is 55 per cent.

However, the department is in the process of filing a petition challenging the order in the high court since the ruling has revenue implications running into hundreds of crores. This is because almost all international tax cases hinge on whether or not the company has a PE in India.

The Organisation for Economic Co-operation and Development tax guidelines say a foreign firm is deemed to have a PE in a country if it employs an agent, other than an independent agent, to regularly act for it and conclude contracts on its behalf.

Although the order did not clearly specify the reason clearly, tax experts said the liaison office might not be termed as PE if it did not employ any agent to carry out the business or conclude contracts on its behalf. If a companys income is not taxed as business income, it is taxed as royalty or technical fees.

On PEs, the Supreme Court had in July 2007 ruled out any tax liability in India of US-based investment bank Morgan Stanley on income from its India-based outsourcing outfit, Morgan Stanley Advantage Services (MSAS). The Supreme Court quashed the Income Tax Departments contention that MSAS was not a PE.

Tax department officials do not agree with the tribunals ruling. When the economy was opened up in 1991, many foreign companies opened liaison offices to explore investment and other opportunities. In 1995, the ITAT had given a ruling that a liaison office was not a PE. However, these liaison offices are no longer mere offices as major investments are being made through these offices, said an official.