Guidance to AOs-25
Taxability of Income Arising from Liaison Office (LO) of a Non-Resident
Guidance to AOs-25
(in respect of international transactions)
Taxability of Income Arising from Liaison Office (LO) of a Non-Resident
1. Ascertain the Legal Scope of Liaison Office Activities: A Liaison Office (LO) is permitted under RBI regulations only to carry out preparatory and auxiliary activities—such as market research, liaison between the head office and Indian customers, and promotional work. It is not allowed to engage in any trading, commercial, or business activity. During assessment, verify whether the LO’s claimed scope aligns with its RBI approval. Any deviation suggests unauthorized trading activity, attracting taxation.
2. Examine Whether Trading Activity Is Being Camouflaged: Assess whether the LO is indirectly participating in trading by facilitating contracts, identifying suppliers or customers, or being involved in pricing decisions. Even if sales are booked abroad, if the LO plays a key role in concluding the contracts, it may amount to a business connection or a Permanent Establishment (PE). Examine whether any trading profit is being diverted outside India despite business being conducted from within India.
3. Check Books of Accounts of the Foreign Head Office and LO: Liaison Offices are not supposed to maintain trading accounts. However, trading transactions may be routed through the head office, using the LO for execution support. Scrutinize if any part of the trading activity is reflected in the HO books but operationally carried out through the LO. If yes, attribution of profit under Section 9(1)(i) of the Income-tax Act may be warranted.
4. Investigate Emails, Invoices, and Communication Trails: Emails, invoices, or shipping instructions originating from the LO can demonstrate involvement in trading functions. If the LO instructs Indian clients regarding shipment, prices, or commercial terms—even while denying trading—it is acting beyond its permitted scope. This evidence supports recharacterization of the LO’s role into a revenue-generating PE.
5. Apply the Business Connection and PE Test: Even if the LO is legally not permitted to trade, its factual conduct can still create a business connection under Explanation 2 to Section 9(1)(i). Under treaties, if the LO constitutes a Fixed Place PE or Agency PE, the income attributable to such activities becomes taxable. Investigation of the trading account thus includes assessing whether LO’s activities create such a taxable presence in India.
6. Look for Hidden Procurement and Order Execution Functions: If the LO is engaged in locating suppliers, inspecting goods, coordinating orders, or facilitating imports/exports, it may be effectively running procurement and trading functions. The profit from such transactions, though recorded in the foreign entity’s books, may be attributable to India. Examine whether the LO’s role goes beyond communication into execution.
7. Compare LO’s Expenses with Its Declared Functions: Scrutinize whether the LO’s expenditure (employee costs, travel, communication, warehousing, etc.) is consistent with a non-trading role. If the LO incurs high logistics or handling expenses, it might be concealing trading operations. Disproportionate expenses for a passive liaison office hint at undisclosed commercial activities.
8. Investigate Whether Indian Entity Is a Conduit for Trading: Often, an Indian affiliate may be used as a conduit for routing transactions actually controlled by the LO. Examine trading account entries of the Indian affiliate for purchase and sales patterns that align with LO’s activities. If pricing, sourcing, or customer management decisions come from the LO, it undermines the legal separation.
9. Evaluate OECD and Treaty Provisions on LO-Related PEs: Most tax treaties (e.g., India–UAE, India–UK) provide that a LO does not constitute a PE unless it performs core trading or commercial functions. However, if evidence shows the LO is significantly involved in trading, the treaty benefit is lost. Apply Article 5 (PE) and Article 7 (Attribution of Profits) of the relevant DTAA to assess trading income attribution.
10.Benchmark Activities with Similar Entities Operating as Trading Arms: Compare the LO’s operations with those of similar entities functioning as trading liaison units or procurement support units. This can serve as circumstantial evidence to evaluate whether LO's actual conduct is indistinguishable from a back-office trading entity. If it behaves like a trading entity, despite its approval restrictions, tax liability arises under domestic and treaty rules.
11.Review RBI Approval Conditions and Correspondence: Scrutinize the original RBI approval letter and any subsequent correspondence or renewals granted to the LO. RBI grants approval with strict conditions that expressly prohibit revenue-generating or trading activities. If the LO's activities in India—reflected through documents or taxpayer behaviour—violate these terms, it strengthens the tax authority’s case to treat the LO as a PE and tax trading profits.
12.Investigate Involvement in Price Negotiation or Delivery Terms: If the LO is found to negotiate prices, approve commercial terms, or determine logistics like delivery schedules or incoterms, it is no longer functioning as a passive communication channel. These actions constitute core trading functions. Such evidence directly supports attribution of profits from the foreign entity’s trading account to the Indian LO.
13.Trace Sales Volume in India to LO-Supported Activities: Compare the increase in the foreign company's trading turnover with the intensity of LO activity in India. If significant revenue growth in India coincides with the LO’s operations—even without direct invoicing—it raises the presumption of value creation in India. This permits attribution of a share of profits under Section 9 read with the relevant DTAA.
14. Conduct Survey or Verification of LO Premises: Where documentary evidence is insufficient, a survey under Section 133A may uncover operational details—such as inventory samples, customer communications, local staff performing trading functions, or internal ERP systems. This may uncover commercial activities hidden behind the façade of liaison functions. Any such findings make attribution of trading profits to the LO legally tenable.
15. Look for Profit Attribution Methodology under OECD/UN Models:Use OECD’s and UN’s Model Convention commentaries on PE attribution to determine what proportion of global profits should be attributed to Indian activities. Even where sales are booked offshore, if demand creation, market development, or post-sale service are conducted by the LO, profit must be attributed to India on a reasonable basis. Functionally linked indirect profits should not escape assessment.
16. Examine Related Party Transactions in Indian AE’s Trading Account: In many cases, the Indian AE may maintain a trading account, while the LO is used for execution or support functions. Examine whether there’s an artificial split between income booked by the AE and services performed by the LO. Substance-over-form analysis may reveal that the LO is effectively engaged in part of the profit-making process.:
17.Assess Whether GAAR Provisions Apply: Where the structure involving an LO is designed primarily to avoid tax—by routing operations through a so-called non-profit-generating liaison office—General Anti-Avoidance Rules (GAAR) may be invoked. If it is found that the LO’s operations have economic substance inconsistent with its legal form, the transaction may be recharacterized under Chapter X-A, and trading profits may be taxed in India.:
18.Document All PE Indicators in Investigation Report: Prepare a detailed investigation report highlighting PE indicators—e.g., fixed place of business, authority to conclude contracts, commercial negotiation, revenue generation, and use of premises. This report must align with OECD’s and Indian judicial standards for PE determination. If the LO meets PE thresholds, the trading account of the foreign enterprise can be partially attributed and taxed in India.
19.Consider Past Judicial Precedents on LO Taxation: Refer to landmark rulings such as:
(i) UAE Exchange Centre v UOI [2009] 183 Taxman 495 (Delhi): Activities carried on by liaison offices in India did not in any manner contribute directly or indirectly to earning of profits or gains by petitioner in UAE as activities performed by them was only supportive of transaction carried on in UAE. Hence LO was held not to constitute PE.
(ii) Airlines Rotables v JDIT (IT) [2011] 44 SOT 368 (Mum.): Where the LO’s role in facilitating business led to profit attribution.
(iii) Use judicial tests—such as whether the LO has disposal of premises, habitually exercises authority, or facilitates revenue—to analyze its linkage with the trading account.
20.Recommend Appropriate Tax and Penal Consequences: If it is established that the LO is a disguised trading entity or constitutes a PE, raise demand for tax under Section 143(3), initiate penalty under Section 271(1)(c) for concealment, and consider prosecution where suppression is deliberate. Also, inform RBI and DGFT of breach of conditions under FEMA. Such cases also merit audit referral and high-risk profiling under the Income Tax Business Application (ITBA) system.