In a case that will impact the taxability of BPO units of MNCs in India, the government in its counter-affidavit in the Supreme Court on Wednesday said the service linkages and economic relationship between a parent company and its outsourcing units should be considered to determine whether an agency has a ‘permanent establishment’ (PE) in India. The crucial aspect of determining whether the transactions were at an arm’s length should be left to the assessing officer, the government said.

The affidavit sums up the government’s position as it seeks to challenge a decision by the Authority for Advance Rulings (AAR), which said Morgan Stanley was not liable for taxation in India as its transactions with its outsourcing unit, Morgan Stanley Advantage Services (MSAS), were at an arm’s length.

“MSAS is a wholly-owned subsidiary of M/s Morgan Stanley International Holdings Inc, which is a part of the petitioner (Morgan Stanley) group of companies. It is engaged in the business of providing ‘back office support services’ to various companies in the petitioner’s group,” said the affidavit filed on behalf of director of I-T. The government has said the nature of services and their inter-connection between the parent companies and outsourcing units has to be taken into account for taxability purposes.

The agreement between the petitioner and MSAS has provided an “unilateral advantage” to the parent company with no recompense to the outsourcing unit. The right to rescind, amend, assign or enforce agreement rests with the customer, i.e.- the petitioner, and not with the supplier of services, i.e.- MSAS, said the affidavit.

MSAS was provided a logo and brand name of the parent company. The products developed by MSAS, described as ‘deliverables’, are the exclusive property of the petitioner group. Economically, MSAS is dependent on Morgan Stanley, which has to be taken into account, said the affidavit.

The government said AAR deciding the issue of arm’s length international transactions would nullify the effect of clause (ii) of proviso to Section 245-R (2) of I-T Act. Any AAR order on matters of valuation which would involve investigation would not be a feasible proposition and this is why it was kept outside competence of AAR by the legislature, added the affidavit.

The apex court is yet to decide on the maintainability of the I-T department’s plea. Morgan Stanley’s appeal challenging part of AAR findings is also yet to be admitted. AAR had said MSAS would be regarded as a PE of the parent company if it sent some of its employees for undertaking ‘stewardship’ activities. Again, it would be treated as PE if it sent some employees on deputation by way of employment in MSAS for over 90 days. “As regards the distinguishing of personnel ... it would be premature on part of AAR to decide on the issue which can be decided only by the assessing officer,” said the affidavit.