In the context of BPO units, do the presence of stewards and secondees create a PE in India? The AAR ruling in the Morgan Stanley case throws light on this issue.
Though the concept of service PE is not there in the OECD model, some Indian tax treaties have it. The India-US treaty is one. The service PE clause provides that rendering of services (other than those giving rise to fees for technical services FTS) by employees or other personnel in India, for a particular period, would give rise to a service PE of the US company in India.
It is in this context that one should see whether the stewards and/or secondees would result in creating a service PE or any other PE. In the Morgan Stanley (MS) case, the Authority for Advance Ruling (AAR) ruled that both the stewards and the secondees would result in MS India creating a service PE of MS US in India.
Before going into any discussions, one thing would surely baffle everybody. Even if there is, for the sake of argument, a service PE of MS US in India, the same would be created only by the employees of MS US, that is, the stewards and secondees. Under no circumstances can MS India be said to create a service PE of MS US in India through the stewards and secondees. This is an absolutely incorrect conclusion or observation on the part of the AAR.
Stewards in service
Let's deal with the stewards first. Clearly, the stewards are not rendering any services whatsoever in favour of MS India. MS US has sent the stewards to monitor the workings of MS India with a view to ensure that the deliverables by MS India meet the quality requirements of MS US. Under this scenario, there is no question of any service PE being created by the stewards.
However, the point needs to be looked from another critical angle. In case the stewards are allotted a certain space in the business premises of the Indian subsidiary, where they work on the desired objective of monitoring the workings of the Indian subsidiary and ensuring the quality of the deliverables of the Indian subsidiary, for a considerably long period of time [general threshold under tax treaties is six months, as per the OECD model commentary], the space made available to the stewards could be treated as a fixed place of business PE of the US parent, unless of course the same can be excluded under the exemption list of PE [preparatory and auxillary, etc.]. This is also borne out by the OECD model commentary.
Therefore, the point to consider is whether the fixed place of business created through the stewards occupying the same in the premises of the Indian subsidiary, can fall under the exempted category. If not, the same could give rise to a fixed place of business PE.
To cut a long story short, in case the activities of the people in India can be regarded as incidental or routine in the gamut of the entire business operations of the foreign company, then a stance can be taken that the same would be covered by the exemption clause. While deciding on this point, it is important to consider the significance of the exemption clause.
There is a specific provision in the exemption clause that a place of business existing solely for the purposes of sourcing goods or merchandise for the foreign head-office, would not create a PE. The same principle also follows from Article 7(4) of the India-US treaty that "no profits shall be attributed to a permanent establishment by reason of the mere purchase by that permanent establishment of goods or merchandise for the enterprise." [Similar provision is contained in Article 7(5) of the OECD model treaty.]
The rationale of the said exclusion is that, in the event the sourcing activity per se [exemption covered by Article 7(5) of the OECD model], or the activities relating to sourcing [exemption covered by exclusion clause of Article 5] are routine in nature, then the said activities would not give rise to any significant business profits in the host country, thus negating the requirement to either (a) attribute any profits to a PE [case covered by Article 7(5), where an already existing PE, for example branch, carries out such sourcing activity]; or (b) creation of a PE by itself [case covered by exclusion clause of Article 5, where activities are carried out relating to sourcing].
By implication, one could extend the exclusion clause even in the case of sourcing of services. However, the point to note or consider is whether the functions or activities performed by the stewards could be treated to be routine enough, so as to enjoy the benefit of the exclusion clause. This will depend upon a functional analysis of the activities performed by the stewards. If it is a mere routine activity, then one could take the benefit of the exclusion clause.
However, in the event the quality control/monitoring activities carried out by the stewards are significant and core, in the context of the overall business operations of the foreign company, then there is a possibility of the foreign company creating a fixed place of business PE through the space occupied by the stewards in India and the next step would be the attribution of profits to the PE depending upon the functional analysis, which is again a transfer pricing issue. Thus, there are no straightjacket formulae in this regard and one would need to evaluate the position on a case-to-case basis while deciding upon whether or not such stewards would create a PE of the foreign company.
(To be concluded)
Rahul Krishna Mitra (The author is Executive Director, PricewaterhouseCoopers.)