On 10 July 2007, the Supreme Court pronounced its judgement in the case of DIT (Mumbai) v. Morgan Stanley & Co., making history in the field of international taxation. Morgan Stanley, a US-based multinational investment bank outsources certain support services to a group company in Mumbai. The key question that arose for the court’s consideration was whether Morgan Stanley had a ‘permanent establishment’ (PE) in India on account of such outsourcing activities and, if yes, to what extent the US company was taxable in India.
The existence of a non-resident’s PE in India establishes an economic nexus between the non-resident and India, which renders the non-resident taxable in India. Whether or not a PE exists is determined by the provisions of India’s tax treaties with other countries. A fixed place of business in India, for example a branch, will generally be seen as the non-resident’s PE in India making the non-resident taxable in India.
Understandably, multinationals generally tread carefully to avoid the existence of a PE in India since that could open up a Pandora’s box of tax uncertainties.
In Morgan Stanley’s case, the Supreme Court concluded that the US company did not have a PE in India on most accounts, except that if personnel are deputed to India, then the deputees are likely to constitute a ‘service PE’ in India. Under the India-US tax treaty, if a US company renders services within India through its personnel for a specified period, the US company will have a ‘service PE’ in India.
In this case, the court examined the consequences of Morgan Stanley sending personnel to India (i.e., the Mumbai company) on stewardship and deputation and concluded that as regards stewardship, no ‘service PE’ will exist, whereas deputation will result in a ‘service PE’.
In arriving at this conclusion, the Supreme Court has for the first time distinguished between ‘stewardship’ and ‘deputation’.
The court ruled that stewardship activities, which essentially involved supervision of the operations of the Mumbai company and similar activities, were for purposes of risk mitigation and quality control for Morgan Stanley’s benefit. These activities are not the same as ‘rendering services’ to the Mumbai company and therefore does not result in a PE of Morgan Stanley in India. This is obviously a welcome development for India’s BPO industry, a substantial part of which comprises captive outsourcing by multinationals. Typically, the multinationals send personnel to India to oversee the transitioning of processes, functioning of Indian operations and similar activities.
The Supreme Court has held that if it can be demonstrated that the activities of these personnel are in the interest of the non-resident and not the resident, these activities will not be treated as ‘services’ rendered to the resident and hence the non-resident will not be taxable in India.
The Supreme Court, on the other hand, held that ‘deputation’ of personnel by Morgan Stanley to the Mumbai company will expose Morgan Stanley to a service PE in India. Assuming the existence of Morgan Stanley’s PE in India, the Supreme Court then went on to evaluate Indian tax consequences in the hands of Morgan Stanley.
Tax treaties generally provide that such part of the non-resident’s income that is ‘attributable’ to the PE will be subject to tax in the PE country. The question of how much income is attributable to the PE has always been contentious. One of the proposed methods for determining income attributable to a PE has been the “arm’s length” basis of attribution. Take a ‘branch’ as an example. If the branch is treated as a separate company, accounting for its functions, assets (like employees or capital) and risks, and assuming a profit comparable with other similar companies, then based on “arm’s length” attribution, this comparable profit will be offered for taxation in India.
Under Indian transfer pricing laws, international transactions with associated enterprises are required to be at an arm’s length price. This is independent of whether the non-resident party has a PE in India or not. Hence multinationals will anyway be transacting with their related parties on an arm’s length basis, wherethere are any Indian tax consequences.
Before the Supreme Court’s decision in the Morgan Stanley case, despite the fact that transactions were concluded on an arm’s length basis, the income attributable to the Indian PE was still uncertain since the tax authorities could go beyond the arm’s length consideration attributable to an Indian PE. The Supreme Court has put this to rest.
Given that an arm’s length payment now subsumes income attributable to a non-resident’s Indian PE, the existence or absence of an Indian PE becomes academic since transactions between a non-resident and its Indian PE would anyway comply with prescribed transfer pricing guidelines.
This column is contributed by AZB & Partners, Advocates & Solicitors.
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