Stability and consistency on PE adds up to the image of India. Ensuring certainty can avoid controversies and litigations   

The ruling of Supreme Court in the Morgan Stanley case is a big relief for captive BPOs of foreign firms operating in India. The bench said Morgan Stanley Advantage Services (MSAS) was not a permanent establishment (PE) as it was performing only back office operations in India and cannot be taxed under PE rules. 

Indian companies and partnership firms are liable to tax on business profits at the normal rate viz. 33.99%, and 42.3% in case of branches of foreign companies. However, most of the units are eligible for tax sops under the provisions offered to STPs (Software Technology Park) and SEZs (Special Economic Zone).  

Most of the units do not pay corporate tax except MAT (Minimum alternative tax) introduced in the last budget for STP units. 

Stewardship and Deputation 

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.  

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 MSAS and for the purposes of risk mitigation and quality control for Morgan Stanley’s benefit. 

It noted that the activities of MSAS did not constitute a permanent establishment. However, due to the deputation of employees from Morgan Stanley to MSAS, the latter could be considered a service PE.  

Arm’s length pricing 

A foreign company can avoid paying tax in India, if it is compensating the outsourcing unit on arm’s length basis. 

‘Arm’s length pricing’ connotes a price that an independent person would charge for the same service.  

Transfer pricing regulations of our tax regime provide several methods for determination of the arm’s length price. The Supreme Court stated that the transactional net margin (TNM) method is the most appropriate in the Morgan Stanley case.  

The arm’s length price accepted for MSAS was at cost plus 29 percent. The benchmarking of particular transaction should be based on functions, asset and risk analysis and margins earned by comparables. So, arm’s length price in each case should be examined at its won merit.  

Tax practitioners believe that 29 percent claimed by Morgan Stanley appears to be on the higher side as most units have an operating margin of 12 to 15 percent.  

Stability and consistency  

The Supreme Court ruling has brought in a stability and consistency, in relation to the question of PE (permanent establishment). 

Industry experts says that this Supreme Court ruling will help the government to attract foreign investments in the BPO sector from MNC companies like HSBC, Standard Chartered, American Express, ABN Amro, Dell and HP. This ruling will have a great impact on their investment decisions in India.

As outsourcing represents a great opportunity for India and generate lot of employment, tax issues and concerns should be addressed promptly to facilitate smooth flow of business. India can consider a ‘safe harbor rule’ provisions as in Australia and Mexico – where cost plus mark-up can be set out to follow by players in the relevant industry. This will ensure certainty and avoid controversies and litigations.

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