Sunday, March 06, 2011

Law Street - Economic Times (March 2011) - Post budget column on LO

Dear Readers,
Zenobia Aunty is a bit perturbed about the duplication in work load that business entities are subjected to. Take for example, Liaison offices in India. They are currently filing activity statements with India's apex bank - The Reserve Bank of India (RBI) .

The Finance Bill, 2011-12 has announced the intent to introduce a new form that will be filed with the tax authorities. It is true that India should not lose its slice of the tax pie, as while legally Liaison offices are not permitted to carry out business activities in India, it is vital to examine whether this is really so. If business activities are carried out in India, the profits attributed to the Permanent Establishment (PE) in India (in this case the Liaison Office) can be subject to tax in India.

But, some better co-ordination with the RBI would have helped matters. Further, it is vital to avoid a spate of litigation in this arena. All Liaison Office's should not be subjected to the same brush stroke and treating as a PE of their foreign enterprise.

Interesting times lie ahead and we need to wait for the developments.

For reading this column on the epaper of The Economic Times, click here. Or you may scroll below as the column is also pasted below.
You may also look up the budget booklet of Ernst & Young, on its website, by clicking here.
Disclosure: This blogger is an employee at Ernst & Young, India. The above booklet is available on the internet for public use.
Hope everyone is having a nice weekend.
Best regards,

LO and behold!
• Liaison Offices currently file annual activity certificates with authorized banks
• Finance Bill’s proposal of filing of annual information is yet another procedure
• Such additional procedure must not lead to additional hassles

This columnist was seated in her favourite restaurant enjoying every little delectable morsel of lemon cheesecake. Everyone seemed to be in a cheerful mood, even the otherwise surly man at the cash counter was smiling. But, peace and quiet was soon shattered! In stomped Zenobia Aunty, note-book in hand and pounced on her once-favourite niece, for having neglected to take dictation last month, which resulted in a column missed.

Let us say: Hell, hath no fury, like an Aunty scorned. The lemon cheese cake suddenly seemed unappetizing. Perhaps this columnist redeemed herself a bit by letting Spot gobble the uneaten slice. “Right ho, then,” remarked Zenobia Aunty, thrusting note pad and pen at her niece and commencing her dictation post haste.

“So Pranab-da (as India's Finance Minister) wants to eat his slice of the cheese cake and perhaps much more,” began Zenobia Aunty. “It is one thing to put down things on paper, another thing to ensure that these are implemented in the right spirit,” she went on. Zenobia Aunt was referring to the information disclosure required from Liaison Offices in India.

The recently tabled Finance Bill has made it mandatory for filing of annual information within sixty days from the end of the financial year. This proposal will take effect a few months down the line from June 1, this year.

In the initial stages, where India is being explored as a potential market, foreign enterprises prefer to set up a LO. Later, once they know for certain they want to carry on business operations in India, they may set up a subsidiary in India. As LO’s cannot carry out an income generating business activity in India and fund their expenses through remittances from overseas, they typically do not file a tax return.
A debate that often arises is whether a LO can constitute a permanent establishment (PE) of its foreign parent company in India. Only if the answer is positive, can profits be attributed to the PE and consequently, the foreign enterprise can be subject to tax in India.

Under most of India’s tax treaties, a fixed place through which a business of a foreign enterprise is wholly or partly carried would result in a PE of that enterprise in India. This could typically be the case where a foreign enterprise sets up a branch office for carrying on commercial or core business activities. However, having regard to the limited operational profile which a LO is subject under the exchange control regulations and also on account of the fact that most tax treaties exclude from the definition of PE a fixed place whose purpose restricted to that of purely preparatory of auxiliary for the enterprise, a question often arises as to whether a LO can create a PE for the foreign enterprise and if so, under what circumstances.

Over the last few years, the above question has come up on several occasions before the judiciary. As acknowledged by the OECD Commentary, it is often difficult to distinguish between the activities which have a “preparatory or auxiliary” character and those which do not. Thus each case needs to be examined on its own merits.
At present, as prescribed by the Reserve Bank of India (RBI), LO’s have to file an Annual Activity Certificate (AACs) obtained from the Auditors, as at end of March 31, along with the audited Balance Sheet on or before September 30 of that year, stating that the LO has undertaken only those activities permitted by the RBI. This has to be filed with an authorized bank, which in turn intimates the RBI in case of any impermissible activities have been carried out. In case the annual accounts of the LO are finalized with reference to a date other than March 31, the AAC along with the audited Balance Sheet may be submitted within six months from the due date of the Balance Sheet.

Thus, the annual filing of information, albeit in a form prescribed by the MoF appears to be just another procedural addition for the LO’s. Perhaps, this new form (not yet prescribed) will better enable the tax authorities to understand the nature of activities carried out by a foreign enterprise in India through its LO and also whether or not any revenue has been generated in India, the source of funding of Indian expenses and what have you. This may perhaps equip the tax department to decipher whether such activities in India are business activities that can be subjected to Indian taxes.

It is vital that India does not lose its justified share of tax revenues, however, LO’s must not be subjected to any additional uncalled for hassles. Else, like many unresolved issues chocking up our tribunals and courts, litigation on this front will be a never ending dilemma, forcing many a foreign enterprise to turn away from its India dreams, in turn denting a largely FDI friendly image of the Indian economy. After all, an LO set up is the ‘first taste of India’, sums up Zenobia Aunty, biting into a chocolate mud pie.

Photograph: This photograph is of the Gateway of India, shot several months ago.

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