Taxing Liaison Offices under GST regime

By Simran Jalan (simran@vinodkothari.com)

Introduction

A company resident outside India may initiate business in India by setting up a subsidiary or branch office or liaison office or project office or any other place of business by whatever name called after taking prior approval of the Reserve Bank of India (RBI). Setting up any of the aforementioned place of business has different tax implications. The present discussion focuses on the tax implication on Liaison office under the Goods and Services Tax (GST) regime.
The Foreign Exchange Management (Establishment in India of a branch office or a liaison office or a project office or any other place of business) Regulations, 2016 (FEMA Regulations) defines Liaison office as:
‘Liaison Office’ means a place of business to act as a channel of communication between the principal place of business or Head Office or by whatever name called and entities in India but which does not undertake any commercial /trading/ industrial activity, directly or indirectly, and maintains itself out of inward remittances received from abroad through normal banking channel.
Therefore, RBI permits the Liaison offices to undertake the following activities:

  • Representing the parent company/group companies in India.
  •  Promoting export/import from/to India.
  • Promoting technical /financial collaborations between parent/group companies and companies in India.
  • Acting as a communication channel between the parent and Indian companies.

However, Liaison offices are not permitted to undertake the following activities:

  • Export/import of goods
  • Domestic sale and purchase of goods
  • Rendering any professional or consultancy services
  • Payment of dividend
  • Borrowing/ Lending money
  • Any other activity which generates income

The FEMA Regulations provides an eligibility requirement for opening a liaison office in India. It states that a person resident outside India can establish a liaison office in India provided it has a profit-making track record during the immediately preceding three financial years in the home country and net worth of not less than USD 50,000.

Therefore, the role of liaison office is limited to acting as a communication channel between the head office and the Indian customers. It is prohibited to undertake any income generating activities. It receives reimbursements from the head office for the expenses incurred. The question that now arises is that whether the activities undertaken by the liaison office and expenses reimbursed by the head office to the liaison office is liable to GST or not. To answer this, we must first understand the following concepts.

Certain important concepts

Persons liable for registration under the GST Act

As per section 22 of the CGST Act, every supplier, having aggregate turnover of more than twenty lakh rupees in a financial year is liable to get themselves registered under the GST framework in the state from where he makes a taxable supply of goods or services or both.

Meaning of supply

Section 7 of the Central Goods and Services Act, 2017 (CGST Act) has defined supply which reads as under:

7. (1) For the purposes of this Act, the expression “supply” includes––
(a) all forms of supply of goods or services or both such as sale, transfer, barter, exchange, licence, rental, lease or disposal made or agreed to be made for a consideration by a person in the course or furtherance of business;
(b) import of services for a consideration whether or not in the course or furtherance of business;
(c) the activities specified in Schedule I, made or agreed to be made without a consideration; and
(d) the activities to be treated as supply of goods or supply of services as referred to in Schedule II.

Further, Schedule I lists down the activities which are to be treated as supply even if it is made without consideration. It includes the supply of goods/services/both between related parties or between distinct persons as specified in Section 25 of the CGST Act, when made in the course of furtherance of business.

Explaining the concept of “distinct persons”

Section 25 of the CGST Act defines distinct persons as “A person who has obtained or is required to obtain more than one registration, whether in one State or Union territory or more than one State or Union territory shall, in respect of each such registration, be treated as distinct persons for the purposes of this Act”.

The intention of this provision is to distinguish between two entities or two components of a single entity for the purpose of indirect taxation, which would otherwise, in natural course, not be treated as a separate entity. For example, two branches of the same entity located in two different states would be treated as distinct persons, even though, practically, they are part of the same entity.

This logic of distinct person cannot be applied in case of Liaison office because, a liaison office does not operate independent of its head office or principal and the former is just an extension of the latter one. A liaison office is not allowed to carry out any activities at all, it is just the face of a foreign entity in India, while the operations are carried out from outside in India.

This acts as a precursor to a couple of Advance Authority Rulings passed by the GST Council on taxability of liaison offices in India under GST, the same have been discussed at length below.

Rulings by Advance Authorities

I. M/s Takko Holding GmbH

Facts of the case:

Takko Holding is a company incorporated in Germany. They are permitted by RBI to have liaison office of the Company (hereinafter referred to as ‘Takko’ or the ‘Applicant’). The Applicant is not registered under GST. The Applicant is acting as a communication channel between the parent company located outside India and Indian companies. The applicant does not charge any fees /commission or does not earn any remuneration or income for the liaison services rendered by it.

Sought advance ruling on the following matters:

  • Whether Liaison office is liable to pay GST?
  • Whether Liaison office is required to be registered under GST Act?
  • Whether the Activities of a Liaison office amount to supply of services?

Discussion

It was stated that no consideration is being charged for the activities undertaken by the Liaison office and the liaison office does not have any business activities of its own. Further, the Liaison office and the head office are not related person as there is only one legal entity and no relationship can be established. They are not distinct person as per Section 25 of the CGST Act as distinct person has establishments in more than one state or Union territory. Therefore, the services provided by the Liaison office does not amount to supply.
As there is no supply of services, the Applicant would not be a supplier and hence, is not required to obtain registration under the CGST/SGST Act.

Ruling

  • The liaison activities are in line with the conditions specified by the RBI and it do not amount to supply under CGST and SGST Act.
  • Therefore, the applicant is not liable to pay CGST, SGST or IGST.
  • The applicant is not required to get itself registered under GST for the liaison activities.

II. Habufa Meubelen B.V.

Facts of the case

Habufa Meubelen B.V. (Head Office) is a company incorporated in Netherlands. They are permitted by the RBI to have a Liaison office in India (hereinafter referred as ‘Applicant’). The liaison office has been established for the purpose of liaising with the suppliers with the quality control of goods. Since, Liaison office do not have any source of income, it is dependent on the Head Office and all expenses incurred by such office are reimbursed by the Head Office.

Sought advance ruling on the following matters:

  • Whether the reimbursement of expenses and salary paid by the HO to the Liaison office established in India is liable to GST as supply of service, especially when no consideration for any services is charged / paid.
  • Whether the applicant is required to get registered under GST?
  • If it is assumed that the reimbursement of expenses and salary claimed by liaison office is a consideration towards a service, then what will be the place of supply?

Discussion

A perusal of definition of ‘service’ as per Section 2(102) of the CGST Act shows that for any activity to be considered as service under GST law there has to be charging of a separate consideration. If there is no separate consideration charged then it would not qualify as a service under the GST law.

Further, on reading the definition of ‘service’ and ‘supply’ in harmony, a conclusion can be drawn that a supply of service can be liable to GST only if a separate consideration is charged. Therefore, the activities undertaken by the liaison office neither amounts to supply nor to service. Further, the reimbursements claimed by them from their Head Office is also falling out of the purview of supply of service. Since there are no taxable supplies made by the Liaison office there is no requirement of getting registered under the GST Act.

Ruling

If the Liaison office in India does not render any consultancy or other services directly/indirectly, with or without consideration and the liaison office does not have significant commitment powers, except those which are required for the normal functioning of the office, on behalf of the Head Office, then the reimbursement of expenses or salary paid by the Head office to the Liaison office is not liable to GST and the Applicant is therefore, not required to get itself registered under GST.

Conclusion

Liaison office is only a communication channel between the Head office and the Indian customers and does not undertake any income generating activities of its own. It does not charge any separate consideration for the services provided to the Head Office. Therefore, it is difficult to distinguish a liaison office from the principal office. Therefore, the services provided by the Liaison Office does not fall under the purview of the term ‘supply’ under GST and hence, Liaison office is neither required to pay GST nor get themselves registered under the GST regime.

FAQs on Borrowing by Large Corporates: Unveiling the Perplexity!

By Pammy Jaiswal (pammy@vinodkothari.com) (corplaw@vinodkothari.com)

Background

The untiring efforts of SEBI as well as the Government in uplifting the bond market is quite commendable. SEBI has started taking long footsteps towards the accomplishment of the budget announcement by the Government for the year 2018-19. The steps include introduction of electronic bidding platform for privately placed debt securities, consolidation of ISIN of debt instruments and introduction of a secondary market for debt instruments.  Accordingly, our country’s bond market is almost at par with the banking loans to stand at Rs. 422 billion dollars as compared to Rs. 561 billion dollars[1] as on 31st March, 2018. However, majority of bonds issued in the country are on private placement basis. Despite gaining prominence, bond issued in India currently lacks an active secondary market

SEBI in its continued effort for deepening the bond market, issued a “circular” dated November 26, 2018[2] where it has mandated certain listed entities to mandatorily borrow a certain percentage of its borrowings through the issuance of debt securities.

While it is true that SEBI does not want to leave any stone unturned for strengthening the Indian bond market, however, there certain grey areas in the framework, which needs further clarification. In this paper, we intend to highlight these grey areas and potential answers to the problems.

Further, we have also prepared a summarised write-up on the said framework which can be viewed here.

FAQ Section

  1. When will the framework under the circular be applicable?

The framework under the circular is applicable w.e.f. FY 2019-20 (where the FY is from April to March) or FY 2020 (where FY is from January to December).

  1. What is the meaning of the term ‘Large Corporate’?

The entities which fulfil all the three conditions given below based on the financials of the previous year are termed as Large Corporate or LC:

  • Listed companies (specified securities, debt securities, non- convertible redeemable preference shares);
  • Having long term (maturity of more than 1 year) outstanding borrowings excluding ECBs and borrowings between parent and subsidiary of Rs. 100 cr and above; and
  • Carries a credit rating of AA and above of unsupported bank borrowings or plain vanilla bonds (highest rating to be considered in case of multiple ratings).
  1. Whether the applicability of the said circular has to be examined every year?

LCs are required to check the applicability of the aforesaid circular every year and accordingly be termed as Large Corporates.

  1. What is the meaning of unsupported borrowings?

The circular talks about the credit rating of unsupported borrowings or plain vanilla bonds. Clause (iii) of para 2.2 states:

“have a credit rating of “AA and above”, where credit rating shall be of the unsupported  bank  borrowing  or  plain  vanilla  bonds of an  entity,  which have  no  structuring/  support  built  in;  and  in  case,  where  an  issuer  has multiple ratings from multiple rating agencies, highest of such rating shall be considered for the purpose of applicability of this framework”

A supported borrowing may referred to as a borrowing backed by a collateral or some sort of a guarantee for ensuring its repayment. Therefore, an unsupported borrowing is nothing but an unsecured loan.  The reason behind keeping the requirement of credit rating of AA and above for unsupported borrowing is to mandate entities having good credit ability for not only secured but also unsecured borrowings to issue specified percentage of their debt securities in accordance with this circular.

Further, only such highly rated entities shall encourage an investor to invest.

  1. What are the various stipulations with respect to bond issuances imposed by this circular?

There are basically two stipulations imposed under this circular:

      1.Initial requirement:

For the first two years in which the framework becomes applicable (i.e. FY 2020 and 2021), the LC is required to raise a minimum of 25% of the long term borrowings (maturity of more than 1 year) in each of the FY (for which the entity becomes an LC) excluding ECBs and borrowings between parent and subsidiary (incremental borrowings) by way of issuance of debt securities

   2.Continual requirement:

From the third year of the applicability (i.e. FY 2022 onwards), the LC is required to mandatorily required to raise a minimum of 25% of its increased borrowing in such year from the issuance of debt securities over a period of one block of two years.

Further, in case of any shortfall of borrowing in any year, such shortfall is required to be carried forward to the next year in the block.

  1. What is the manner of adjusting the shortfall in any FY?

As we go through the illustration given in Annexure C of the circular, it becomes clear that for the first year of implementation there is no concept of carrying forward the shortfall to the second year, since the LC is required to explain the reason for not being able to comply with the borrowing requirements.

Further, as regards the shortfall for the second year and onwards is required to be carried forward to the next year. Now let us try and understand the manner of adjustment from the below mentioned illustration:

X Ltd is an LC as on the last day of the previous year being 31st March, 2019.

[Rs. in cr]

  2020 2021 2022 2023 2024

 

2025

[Not an LC]

Increased Borrowing [IB] 200 500 700 600 650 100
Mandatory borrowing from debt securities of 25% of the IB[MB] 50 125 175 150 162.5 NIL
Actual Borrowing from debt securities [AB] 40 100 75 200 100 5
Adjustment of the shortfall of the previous year NIL NIL NIL 100 50 112.5
Shortfall to carry forward NIL NIL 100 50 112.5 107.5
Penalty NIL NIL NIL NIL NIL 107.5* 0.2%

= 0.215

 

Basically, the LC shall first adjust the AB towards the shortfall of the previous year of the current block and then check whether it has complied with the MB requirements. Further, the penalty shall be levied if there is the shortfall of the previous year in the current block could not adjusted with the AB of the second year of the current block.

  1. What are the penal consequence for non- compliance?
  • For FY 19-20 & 20- 21, no penalty but explanation will be required;
  • From FY 21-22 onwards, the minimum funding requirement has to be met over a block of 2 years.
  • In case of any shortfall of the first year of the block is not met as on the last day of the next FY of the block, a monetary penalty of 0.2% of the shortfall amount shall be levied and paid to SE.
  • The manner of payment of the penalty has not been provided in the circular but SEs are expected to bring the same.
  1.     What are the disclosure requirements?
  • The fact that the entity has fulfilled the criteria of being an LC based on the financials of previous year has to be disclosed to SE within 30 days of the beginning of the FY. Format as per Annexure A to the Circular.
  • The details of incremental borrowings done in the FY has to be disclosed to SE within 45 days of the end of the FY.  Formats as per Annexure B1 [(applicable for FY 19-20 & 20-21) and B2 (applicable for FY 21-22 onwards)] to the Circular.
  • The aforesaid disclosures shall be certified both by the CS and CFO.
  • The aforesaid disclosures shall also form part of the annual audited financial results.
  1.     Any other specific requirements?
  1. The entity will need to choose any one of the Stock Exchanges (where the securities are listed) for payment of the penalty.
  2. The entity being an LC for the previous year and carrying a shortfall for that year in the current year for which the entity is not an LC shall also be required to make the requisite disclosures within 45 days of the end of the current year.

 

  1. Whether the requirements of the circular are relevant for all the LCs?

While the ambit of the circular is broad enough to cover both Non-Banking Financial Companies (‘NBFCs’) and Non-Banking Non-Financial Companies (‘NBNFCs’), the circular is more relevant for NBNFCs.

NBFCs are financial institutions and are engaged in lending and investing activities in their day to day operations and therefore, the major chunk of the working capital and long term funding requirements anyways come from issuance of debt securities considering the leverage issues.

Therefore, one may construe that the circular is more relevant for NBNFCs since they are not mandated to borrow from the issue of debt securities as the funding requirements of these entities can also be fulfilled by banks. Further, the circular should have laid down a specified threshold on the increased borrowing which if met should be required to constitute of debt securities also to the tune of 25%

  1. Whether relaxation is for any first two year of implementation or the year mentioned in the circular?

This circular was lead by a consultation paper issued by SEBI [3]on July 20, 2018 which clearly stated that “A “comply or explain” approach would be applicable for the initial two years of implementation.  Thus, in case of non-fulfilment of the requirement of market borrowing, reasons for the same shall be disclosed as part of the “continuous disclosure requirements”

However, the circular is clear on the initiation point of the said framework i.e. April, 2019, accordingly, one may take a view that the FY 2020 and 2021 shall mandatorily be the first two years in which the relaxation of comply or explain can be taken. Any entity which gets covered by the aforesaid circular at a later date shall have to mandatorily comply with the borrowing requirements and be liable to penalty in case of non-compliance.

  1. Whether the term ‘increased borrowings’ shall also cover Pass Through Certificates (‘PTCs’)?

As per the circular, “incremental borrowings” have been defined to include borrowings during a particular financial year with original maturity of more than 1 year, excluding ECBs and ICDs between a parent and its subsidiaries.

Further, IND AS 109, treats PTCs as collateralized borrowings only. Here it is pertinent to note that the question of showing the investor’s share in PTC as financial liability arises only because the securitised pool of assets fails the de-recognition test.

Originator has no obligation towards the investors of the PTC. The investors are exposed to the securitised pool of assets and not to the originator. Therefore, merely because the investor’s share appears on the balance sheet of the originator as financial liability, as per Ind AS 109, does not mean they are debt obligations of the originator.

Accordingly, incremental borrowings shall not include PTCs.

  1. In cases where an entity ceases to be an LC in one year and again gets covered by the circular in subsequent years, whether the initial disclosure to the stock exchange shall be required to be given again?

In our view, such entity should provide the exchange with the initial disclosure for the purpose and to enable the stock exchange to continuously monitor the compliance of the framework.

  1. How will the stock exchange be apprised that an entity is no more an LC

Ideally there should be an intimation to the exchange stating that the entity is no more an LC and accordingly the mandatory borrowing requirements should not be made applicable on for such FYs in which it is not an LC.

Further, this intimation may also indicate that the entity shall inform the exchange in terms of para 4.1 once it qualifies to be an LC.

  1. What is the role of the stock exchange in terms of para 5 of the circular?
  • The exchange shall collate the information about the LC and submit the same to the Board within 14 days of the last day of the annual financial results;
  • The exchange shall collect the fine as mentioned under para 3.2(ii); and
  • The said fine shall be remitted by the exchange to the SEBI IPEF within 10 days of the end of the month in which the fine was collected

 

Conclusion

SEBI has laid down penal provisions for not complying with the circular. However, if the issue size of mandatory borrowing is too small, then there may be a possibility that LCs may think of doing their cost benefit analysis between the issue cost and the penalty amount. Therefore, SEBI should set a minimum threshold for increased borrowings and cover only those LCs to raise funds through bond market who exceed such threshold.


[1] CRISIL’s yearbook on Indian bond market

[2] https://www.sebi.gov.in/legal/circulars/nov-2018/fund-raising-by-issuance-of-debt-securities-by-large-entities_41071.html

[3] https://www.sebi.gov.in/reports/reports/jul-2018/consultation-paper-for-designing-a-framework-for-enhanced-market-borrowings-by-large-corporates_39641.html

RBI temporarily relaxes the Guidelines on Securitisation for NBFCs

By Financial Services Division, finserv@vinodkothari.com

 

In the wake of the recent hues and cries of the entire country in anticipation of a liquidity crisis in the NBFC sector, the Reserve Bank of India, on 29th November, 2018, issued a notification[1] to modify the Securitisation Guidelines.The amendment aims to relax the minimum holding period requirements of the guidelines, subject to conditions, temporarily. Therefore, the changes vide this notification come with an expiry date. The key takeaways of the notification have been discussed below:

a. Relaxation in the MHP requirements: As per the notification, NBFCs will now be allowed to securitise/ assign loans originated by them, with original maturity of more than 5 years, after showing record of recovery of repayments of six monthly instalments or two quarterly instalments (as applicable). Currently, for loans with original maturity more than 5 years, the MHP requirements are repayment of at least twelve monthly instalments or four quarterly instalments (as applicable).

b. Change in MRR requirements for the loans securitised under this notification: The benefit mentioned above will be available only if the NBFC retains at least 20% of the assets securitised/ assigned. Currently, the MRR requirements ranges between 5%-10% depending on the tenure of the loans.

c. Timeline for availing this benefit: As already stated above, this is a temporary measure adopted by the RBI to ease out the tension relating to liquidity issues of the NBFCs; therefore, this comes with an expiry date, which in the present case is six months from the date of issuance of the notification. Therefore, this benefit will be available for only those loans which are securitised/ assigned during a period of six months from the date of issuance of this notification.

The requirements under the guidelines remains intact.

To summarise, the MHP requirements and the MRR requirements on securitisation/ assignment of loans looks as such –

Loans assigned between 29th November, 2018 – 28th May, 2019 Loans assigned after 29th May, 2019
MHP requirements for loans with original maturity less than 5 years Loans upto 2 years maturity – 3 months

 

Loans between 2 – 5 years – 6 months

Loans upto 2 years maturity – 3 months

 

Loans between 2 – 5 years – 6 months

MHP requirements for loans with original maturity less than 5 years If revised MRR requirements fulfilled – 6 months

 

If revised MRR requirements not fulfilled – 12 months

Loans upto 2 years maturity – 3 months

 

Loans between 2 – 5 years – 6 months

MRR requirements for loans with original maturity of less than 5 years Loans with original maturity upto 2 years – 5%

 

Loans with original maturity more than 2 years – 10%

Loans with original maturity upto 2 years – 5%

 

Loans with original maturity more than 2 years – 10%

MRR requirements for loans with original maturity of more than 5 years If benefit of MHP requirements availed – 20%

 

If benefit of MHP requirements not availed – 10%

Loans with original maturity upto 2 years – 5%

 

Loans with original maturity more than 2 years – 10%

 

Vinod Kothari comments: 

  •  Loans with original maturity of more than 5 years are essentially home loans and LAP loans. Home loans are housed mostly with HFCs. These guidelines ought to have come from NHB rather than RBI, but given the tradition that RBI guidelines are followed in case of HFCs as well, this “relaxation” will be more applicable to HFCs rather than NBFCs.
  • In case of LAP loans, given the current credit scenario prevailing in the country, taking exposure on LAP loans itself is subject to question. Issue is – will the relaxation prompt NBFCs to write LAP loans, or will it simply allow them to package and sell existing pools of lap loans sitting on their books waiting for the MHP of 12 months to get over? It is more likely to be latter than the former.
  • However, the so-called relaxation comes with a give-and-take – the MRR is 20%. The NBFC has, therefore, 2 options – wait for 12 months to be over and just do a transaction with 10% MRR, or avail the so-called relaxation and put in on-balance funding of 20%. Therefore, it is only for those who are desperate for refinancing that the so-called relaxation will seem appealing.
  • Our interaction with leading NBFCs reveals that there are immediate liquidity concerns . Banks are not willing to take on-balance sheet exposure on NBFCs; rather they are willing to take exposure on pools. Therefore, for more than 6 months and less than 12 months seasoned LAP pools, this might provide a temporary packaging opportunity.
  • This is indeed the best time to think of covered bonds. The proposition has been lying unresolved for last few years. If banks are willing to take exposure on pools, why not dual recourse by way of covered bonds? That indeed provides ideal solution, with ring fenced pools providing double layers of protection.

[1] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11422&Mode=0

For more articles on Securitisation and Covered Bonds, refer our page here.

Also refer our article: The name is Bond. Covered Bonds.

 

Filing of return for delayed payment to MSMEs- Effective or frittering?

By Simran Jalan (simran@vinodkothari.com)

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Anticipated boost in liquidity position of NBFCs and HFCs

By Vineet Ojha (vineet@vinodkothari.com)

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RBI’s Interoperability guidelines for PPIs- A move to promote Digitalization

By Simran Jalan (simran@vinodkothari.com)

Introduction

Interoperability is the ability of customers to use a set of payment instruments seamlessly with other users within the segment. It enables a payment system to be used in conjunction with other payment systems. It allows Prepaid Payment Instruments (PPI) issuers and other service providers to undertake, clear and settle payment transactions across systems, without participating in multiple systems. All the service providers adopt common standards so as to make the PPIs interoperable. This interoperability shall facilitate payments among different wallets inter se and with banks. Paytm, Freecharge, Oxygen wallet, Airtel money, etc. are some of the digital wallets operating in India currently.

Last year, RBI issued Master Directions on Issuance and Operation of Prepaid Payment Instruments[1] (“Master Directions”) to regulate the prepaid payment instruments and to monitor the working of the PPI issuers. This was the much required legislative framework to supervise the prepaid payment industry. The Master Directions also provided for interoperability of the PPIs. It stated that the interoperability shall be enabled in the following phases for the PPIs:

The Master Directions mandated the first phase for all KYC compliant PPIs (bank and non-bank) issued in the form of wallets to have interoperability amongst themselves through UPI within 6 months from the issue of the Master Directions. This ensured fair competition between the different PPI providers as some providers used to spend exorbitantly to get merchants on-board and this would in turn eliminate competition.

Read more