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Recent
Advance Ruling - A shot in the arm for the Indian outsourcing
industry
The
Authority for Advance Rulings ("AAR") has pronounced a
landmark judgement in the case of Morgan Stanley & Co, a US investment
bank ("Morgan Stanley") in the business of providing financial
advisory services, corporate lending and securities underwriting
services. Like many other multinationals, Morgan Stanley outsources
a wide range of high-end support services to its captive group
company, Morgan Stanley Advantage Services Private Limited ("MSAS").
The ruling is a shot in the arm for the outsourcing industry as
a whole and has tremendous implications especially for the emerging
KPOs, and for outsourced R&D and contract manufacturing.
One
of the daunting questions which the outsourcing industry has been
confronted with, is whether outsourcing to Indian companies, particularly
to captive service providers / manufacturers would cause a permanent
establishment ("PE") to come into existence. If Indian
tax authorities were to hold that such activities would tantamount
to a PE, the global profits attributable to the PE would be taxable
in India at the rate of approximately 41% in the hands of the
foreign entity. Further, the availability of tax credit for such
tax paid in the home jurisdiction may be uncertain, thus potentially
leading to double taxation and wiping out the economic advantage
of outsourcing to India. On the other hand, if there exists no
PE, no profits can be subjected to Indian corporate tax.
In
the instant case, Morgan Stanley raised certain questions before
the Authority with respect to its outsourcing arrangement, viz.;
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- Whether
the Applicant had a PE in India under the India US tax treaty
by virtue of MSAS being regarded as (i) its fixed place of business
or (ii) a dependent agent or (iii) constituting a service PE
on account of deputation of its employees in India?
- Whether
the method used for transfer pricing between the Applicant and
MSAS was the 'most appropriate' method, and whether the price
paid was at 'arm's length'?
- Whether,
in case it were to be held that there was indeed a PE in India,
there would be anything further attributable to the PE if the
PE was compensated at arm's length?
The
AAR in the case of Morgan Stanley has held that the captive service
provider i.e., MSAS is not a fixed place of business PE of Morgan
Stanley, as it is not the business of Morgan Stanley that is carried
out from there. The Authority has also held that MSAS would not
constitute an agency PE of Morgan Stanley, one of the factors
for this being that it does not have the authority to conclude
contracts on behalf of Morgan Stanley.
Importantly,
on an equally sensitive issue of whether if a PE was constituted,
a portion of global profits of Morgan Stanley would be brought
to tax in India where the Indian company was compensated at arm's
length, the Authority has held in the negative. Given that multinationals
doing business with an associated company in India are required
to comply with transfer pricing, and to compensate the Indian
entity at arm's length, this finding provides much needed certainty
regarding exposure to tax in India.
With
regard to the exposure to service PE upon the proposed deputation
of personnel, the Authority has held that the presence of employees
for over 90 days would constitute a service PE in India. The Authority
has rejected the contention that as the deputed personnel are
sent to MSAS to oversee the functioning of MSAS and to perform
quality control and risk management services, they cannot be said
to be the employees of the Applicant even though their salaries
were borne by the Applicant.
The
Authority did not admit the questions relating to transfer pricing
on the grounds that the Authority is precluded from giving a ruling
on a question which involves determination of fair market value
of property. As this question involved valuation of service as
well as property in the form of hardware on which the 'deliverables'
of service were transmitted, it was rejected. The Authority also
denied the ruling on the grounds that the question was already
pending, by taking a very stringent view that as in case of taxpayers
having international transactions above Indian Rupees 50 million,
the tax officers have been instructed to scrutinize the cases
without any discretion, it can be said that the question is already
pending before the tax authorities and hence, no ruling can be
granted on the same. This seems to open a window of opportunity
for the admission of questions on transfer pricing when they involve
services alone and in cases where a ruling is sought on proposed
transaction, where no tax returns are filed.
All
things considered, the outsourcing industry in India can rest
easy in the knowledge that outsourcing in itself does not expose
the business income of multinationals to corporate tax in India.
Though in India, an advance ruling is binding only on the Applicant
it has significant persuasive value and plays a critical role
in the evolution of international tax jurisprudence.
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can direct your queries or comments to the authors
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