The Supreme Court today held that the no portion of the global income of the US investment banking firm, Morgan Stanley is liable to be taxed under the Indian income tax law.

The Court gave this ruling on the contention of the income tax department that the companys outsourcing outfit, Morgan Stanley Advantage Services (MSAS) which is engaged in back office processing work constituted, within the framework of the Indian tax laws, a Permanent Establishment of the investment banking firm. Consequently, the department had gone on to argue, a portion of the global income accrued to the establishment in India (MSAS) and ought to be taxed as Indian income.

Upholding the Authority for Advance Ruling (AAR) order on the subject, the bench headed by Mr Justice S.H. Kapadia said MSAS was not a permanent establishment (PE) as it was performing only back office operations in India and cannot be taxed under PE rules.

The bench also held that the Indian outfit did not also carry out any agency function for the US principal to warrant the consideration of any portion of its global income as liable to tax under Indian laws.

There was no agency PE as the PE in India had no authority to enter into or conclude the contracts. The contracts would be entered in the US. The implementation of those contracts only to the extent of back office functions would be carried out in India, it said.

The ruling meant that a tax would be levied on the net income of the Indian arm by valuing the services rendered to the US parent as if the same were provided to an outsider.

On determining tax liability, it said: The Transactional Net Margin Method (net profit margin realised by the enterprise from a comparable uncontrolled transaction) was the appropriate method for determination of the arms length price in respect of transaction between Morgan Stanley and MSAS.

Agreeing with the computation by income tax department, it said: We accept as correct the computation of the remuneration based on cost plus mark-up worked out at 29 per cent on the operating costs of MSAS.

The apex court ruling is likely to benefit foreign companies like GE, HSBC, Standard Chartered Bank which outsource their back office functions to their Indian units.

Morgan Stanley counsel, Mr Jay Savla, said it was the victory for the US investment bank as the court had held the Indian subsidiarys income arising from global operations will not be taxed in the country.

Only that income will be taxed on the basis of transfer pricing principle which arises from Indian operations, he added.

According to industry experts, the judgment will also help the Government attract foreign investment in BPO sector from MNCs.

Reacting to the SC judgment, PricewaterhouseCoopers (PwC) head of taxation, Mr Dinesh Kanabar, said, It is delightful news for the BPO industry, because once it is established that an arms length pricing is maintained, no further profits are liable to be taxed in India. While the view that the captive unit in this case is a service PE because people were deputed on a long-term basis could be a matter of concern, so long that there is no further taxation, the issue of PE is irrelevant.

The SC judgment shows that foreign companies that have captives in India do not constitute a PE and do not have a taxable presence in India, according to Mr Rahul K. Mitra, Executive Director, PwC.