Taxing BPO units in India has been a matter of controversy for quite some time. However, the legal position as clarified by CBDT vide its circular no.5/2004 dated 28.09.2004 is summarised here.
During the last decade or so, India has seen a steady growth in outsourcing of business processes by non-residents or foreign companies to IT-enabled entities in India.
Such entities are either branches or associated enterprises of the foreign enterprise or an independent Indian enterprise. Their activities range from mere procurement of orders for sale of goods or provision of services and answering sales related queries to the provision of services itself like software maintenance service, debt collection service, software development service, credit card / mobile phone related service, etc.
The non-resident entity or foreign company will be liable to tax in India only if the IT-enabled BPO unit in India constitutes its permanent establishment (PE). The extent to which the profits of the non-resident enterprise is to be attributed to the activities of such PE in India has been considered by the Board.
Paragraph 2 of Article 7 of tax treaties contain the central directive on which the allocation of the profits to a PE is intended to be based. The paragraph incorporates the view that the profits to be attributed to a PE are those which PE would have made if, instead of dealing with its head office, it had been dealing with an entirely separate enterprise under conditions and at prices prevailing in the ordinary market.
Hence, in determining the profits attributable to an IT-enabled BPO unit constituting a PE, it will be necessary to determine the price of the services rendered by the PE to the head office or by the head office to the PE on the basis of the arms length principle.
It is therefore clear that once the BPO unit constituting the PE is subjected to tax in India, the non-resident company will not be liable to pay any further tax in India. The above principle has also been approved by the Authority for Advance Rulings in a recent case of Morgan Stanley & Co., USA, 152 Taxman 1(AAR)
In this case Morgan Stanley & Co. is a non-resident in India and tax resident of USA. It is a leading investment bank having a number of group companies in various parts of the world. One of the group companies is Morgan Stanley Advantage Services Private Limited (MSAS), which is incorporated in India. MSAS renders support services such as IT support, account reconciliation, research etc.
In the question as to whether MSAS will constitute Morgans PE in India, AAR held that MSAS would be regarded as PE of the applicant in India because of its employees presence for more than 90 days in India.
Regarding the issue of taxable income in India, the question before the AAR was that as long as MSAS, being the PE of the applicant in India, is remunerated for its services at arms length by the applicant and as long as all its actual income is brought to tax, no further income can be attributed in the hands of the PE of the applicant.
The Authority held that as long as MSAS is remunerated for its services at arm's length price, there should be no additional profits attributable to the applicant or MSAS in India.
The above ruling will go a long way in allaying non-resident companies fears of paying tax beyond the profits made by their PE in India.