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July 9, 2007
Supreme Court
rules on permanent establishment in the outsourcing industry
The Supreme Court
of India (“Supreme Court”) has earlier this morning,
pronounced in a landmark judgment that the performance of
back-office and other outsourced services, by a captive group
company to its parent company should not per se create a permanent
establishment (“PE”) of the parent company in
India
. The Supreme Court thus disposed of the special leave petition
(“SLP”) filed by the revenue authorities against the ruling
of the Authority for Advance Rulings (“AAR”) in matter
of Morgan Stanley & Co.
U.S.
(“Morgan Stanley”). However on account of services
rendered by personnel of the parent company on deputation to the
captive service provider, the Supreme Court held (in the context
of the India U.S. Tax Treaty) that it would constitute a PE.
Nevertheless the Supreme Court also held that personnel of the
parent company engaged in stewardship activities in the captive
group company, would not constitute a PE for the parent company in
India
. Thus multinationals enterprises would have to henceforth
structure inter-company assignments for their employees with
careful consideration.
Morgan Stanley is
in the business of providing financial advisory services,
corporate lending and securities underwriting services. As is the
case with 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").
Earlier last year the AAR had ruled upon an application by Morgan
Stanley that the activities of MSAS will not constitute a PE of
Morgan Stanley in
India
; the revenue authorities had filed an SLP against this ruling.
The Supreme Court has, in today’s judgment re-affirmed the
ruling of the
AAR
in this regard.
With
regard to attribution of profits to the PE, the Supreme Court
upheld that the Transactional Net Margin Method (“TNMM”)
would be the correct method to arrive at a suitable arm’s length
price which must be paid by the non-resident enterprise to its PE.
The Supreme Court found that the mark-up of 29% being charged by
MSAS (based on a transfer pricing study using the TNMM method) was
correct and also accepted by the revenue authorities.
The Supreme Court
also found that once an arm’s length price has been paid by a
non-resident enterprise to its PE in India, nothing further can be attributed. In this regard the Supreme
Court noted that the transfer pricing study to determine the
arm’s length price will have to properly include the risks taken. Only
the operative part of the judgment has been pronounced in open
court and the text of the judgment is to be made public shortly.
We will be sending a follow-up hotline after perusing the same.
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