The appeal before the Income Tax Appellate Tribunal concerned the determination of whether the activities carried out by the Liaison Office (LO) of the assessee, a foreign company incorporated in the Netherlands, constituted a Permanent Establishment (PE) in India within the meaning of Article 5 of the India–Netherlands Double Taxation Avoidance Agreement (DTAA) and whether any profit attribution could consequently be made to such alleged PE.

The assessee had established a Liaison Office in India with due approval from the Reserve Bank of India (RBI). The LO was operating strictly in accordance with the permissions granted under FEMA regulations. For the relevant Assessment Year 2021-22, the assessee filed its return of income declaring NIL income, asserting that the LO was not engaged in any business activity in India and that its functions were limited to liaison and communication activities between Indian parties and the head office / group companies abroad.

The assessee submitted before the Assessing Officer that the LO incurred expenses only towards salaries, office rent, travel, and normal office running expenses. All expenses of the LO were met exclusively out of inward remittances received from the head office through a single bank account maintained in India. The LO operated from a rented premises and employed two personnel and one secretarial staff, all of whom were resident Indian citizens. The LO did not undertake any commercial, trading, or industrial activity in India, did not earn any income, did not maintain any stock or inventory, did not provide services to customers, and did not have any authority to negotiate or conclude contracts or sign agreements. The LO personnel had no role in decision-making of the assessee or the Oxbow Group. The LO maintained duly audited accounts, filed income-tax returns regularly, and was fully compliant with local regulatory requirements. Neither the LO nor the assessee had any agents in India.

The Assessing Officer rejected the assessee’s contention that no PE existed in India. The Assessing Officer held that since the assessee had employed highly qualified personnel in India, the services rendered by the LO could not be considered merely preparatory or auxiliary in nature. The Assessing Officer further observed that the assessee had not furnished adequate details of trade carried out with Indian parties or details regarding engagement of the LO with the Indian subsidiary. On this basis, the Assessing Officer concluded that the assessee had a PE in India and proceeded to attribute 50% of the income/profits to the alleged PE, making an addition of Rs. 1,53,22,235.

Aggrieved, the assessee raised objections before the Dispute Resolution Panel (DRP). The DRP rejected the assessee’s objections regarding non-existence of PE but granted partial relief by reducing the profit attribution percentage to 12.27%, thereby restricting the addition to Rs. 37,63,057. The assessee carried the matter in appeal before the Tribunal against the final assessment order passed pursuant to the DRP’s directions.

Before the Tribunal, the assessee reiterated that the LO was only acting as a channel of communication and that its activities were squarely covered within the definition of a Liaison Office under FEMA regulations, which expressly prohibit undertaking of any commercial or trading activity. The assessee emphasised that mere employment of qualified personnel does not alter the character of activities if such activities remain preparatory or auxiliary in nature. It was contended that in the absence of a PE, no profit attribution could be made.

The Departmental Representative argued that the assessee had a business connection in India in the form of a fixed place provided by the LO, particularly since the LO had been operating in India for a prolonged period. It was further contended that the LO’s activities of gathering information and reporting to the parent company amounted to “Business Analytics and Market Research”, and therefore, safe harbour rules applicable to such activities could be invoked to estimate profits attributable to the PE using Rule 10.

The Tribunal examined the definition of a Liaison Office under FEMA regulations, which provides that a LO is a place of business established to act as a channel of communication between the head office and entities in India, without undertaking any commercial, trading, or industrial activity, and which sustains itself out of inward remittances from abroad.

The Tribunal analysed Article 5(1) and Article 5(4) of the India–Netherlands DTAA, which exclude activities of a preparatory or auxiliary character from the definition of PE. In this context, the Tribunal referred to OECD BEPS Action 7, which clarifies that PE status cannot be avoided by fragmenting a cohesive operating business into several small operations to claim that each activity is preparatory or auxiliary. Applying this principle, the Tribunal noted that although the assessee had an Indian subsidiary, the subsidiary was dormant and not carrying out any business activity.

On examination of the factual record, including reports and documentation submitted by the assessee, the Tribunal found that neither the LO nor the Indian subsidiary was concluding any business activity in India using the information collected. The LO employees were not authorised to negotiate or conclude contracts, had no signing authority, and the information gathered was not used in India for carrying out business operations.

The Tribunal rejected the Revenue’s contention that the activities were not preparatory or auxiliary and held that the mere existence of qualified personnel or long duration of presence does not transform liaison activities into core business operations. The Tribunal further rejected the application of safe harbour rules and Rule 10 for profit attribution in the absence of a PE.

Placing reliance on the Supreme Court judgment in UOI v. UAE Exchange Centre, the Tribunal observed that activities carried out strictly within the scope permitted by RBI to a Liaison Office fall within preparatory and auxiliary activities and do not give rise to a PE.

Accordingly, the Tribunal held that the Liaison Office of the assessee cannot be treated as a Permanent Establishment in India within the meaning of Article 5 of the India–Netherlands DTAA. In the absence of a PE, the Tribunal held that no profit attribution could be made, and consequently, the ad-hoc additions made by the Assessing Officer and sustained partly by the DRP were deleted in full.

The appeal of the assessee was thus allowed, and the issue was decided in favour of the assessee for Assessment Year 2021-22.