Liaison Office Applications Facing Stricter Application Rules

June 24, 2014 Posted by India Briefing Reading Time: 3 minutes

DELHI – Foreign companies seeking to register liaison offices (LOs) in India have begun encountering difficulties in having LO applications approved.

Establishing a liaison office in India is often an attractive option for foreign companies seeking to establish a local business presence at low financial and legal risk. LOs are permitted to facilitate and promote a parent company’s business activities, and act as a communications channel between the foreign parent company and Indian companies. Unable to engage in commercial, trading, or industrial activities, liaison offices must be sustained by private, inward remittances received from their foreign parent company and are not subject to profits tax rates.

Recently, however, authorities have begun applying a stricter interpretation of the LO application rules which specifically prohibit LOs from engaging in any ‘commercial activities’ and possessing a ‘direct trading connection between the LO and the parent.’

Subject to interpretation, hundreds of LO applications have been turned down in recent months and a number of existing LOs have been determined to have a ‘direct trading connection with the parent.’ Drawing this connection has enabled tax authorities to treat some existing LOs as ‘Permanent Establishments,’ and levy a tax in excess of 40 percent on ‘income’ – initially meant to cover LO operating costs.

LOs, like representative offices in China, have historically been used as low cost entities via which foreign companies can explore and research the Indian market, and facilitate trade with India without incurring tax penalties.

Because India’s tax rates are still higher than in many Asian countries, LOs are financially strategic options for businesses seeking to establish a local presence that enables them to search for suitable suppliers, build business relationships, work with Indian manufacturers and assess the potential for selling products on the local market. In this situation, products sold to India are invoiced by the foreign parent company rather than the LO.

“In China, the process of allowing foreign investors to use the equivalent of an LO [a representative office] worked well over many years, with thousands of LOs over time converting to capitalized wholly foreign owned enterprises committed to paying profits tax.” comments Chris Devonshire-Ellis of Dezan Shira & Associates.

“India is cutting off a route through which foreign investors can evaluate the Indian market at low risk. Without a looser interpretation of LO regulations, India is simply encouraging foreign investors to set up sourcing operations in alternative countries such as China, Vietnam and Indonesia. In time, it will be these countries that will see an upgrading of existing LOs to capitalized, tax-paying foreign investments, meaning India will miss out. You have to give foreign investors the opportunity to adequately assess the capabilities of the Indian market. LOs should be used as a market entry vehicle – especially for sourcing India products – and not face such strict regulatory barriers. It only hurts Indian manufacturers,” he continued.

Gunjan Sinha of Dezan Shira & Associates’ Delhi Office says, “The alternative to LOs for foreign investors is the Branch Office structure. However, this carries with it a higher tax burden. Not all foreign investors are willing to incur that upfront, although we are seeing a number who are instructing us to change their applications from LOs to Branch Offices. The Indian market for suppliers and supply chain sourcing remains strong, and companies who have previously identified India as a key sourcing or consumer market are advised to set up Branch Offices from the outset.”

Asia Briefing Ltd. is a subsidiary of Dezan Shira & Associates. Dezan Shira is a specialist foreign direct investment practice, providing corporate establishment, business advisory, tax advisory and compliance, accounting, payroll, due diligence and financial review services to multinationals investing in China, Hong Kong, India, Vietnam, Singapore and the rest of ASEAN. For further information, please email india@dezshira.com or visit www.dezshira.com.

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