The concept of software PE appears to be novel. The OECD Commentary says that, in certain circumstances, a server could constitute a PE.
Mr Dinesh Kanabar, ED and tax leader, PwC
When deciding the Morgan Stanley case, the Supreme Court proceeded on the basis that MSCo (Morgan Stanley and Co) does not have a fixed place PE (permanent establishment) since the back-office functions of MSCo were carried out in India.
This leads us to a question as to what could be the consequences if the operations carried out in India were front office operations. Could it lead to a PE exposure for the foreign enterprise in India? asks Mr Dinesh Kanabar, executive director and tax leader, PricewaterhouseCoopers.
Generally, the business carried on by a service provider would be its own business and not that of the enterprise to which it renders services. Thus, the operations carried on in the premises of MSAS (Morgan Stanley Advantage Services, India) would constitute business of MSAS and not that of MSCo, and so MSCo can be said to have a fixed place PE only if the office premises of MSAS are at the disposal of MSCo, through which its business is carried on. However, this was not the reasoning adopted in the case on hand.
Interestingly, the Supreme Court, after taking note of the fact that MSAS would be engaged in supporting front office functions of MSCo, treated these functions as back office operations and held that there is no fixed place PE in India, points out Mr Kanabar. Thus, in terms of the judgment, supporting of front office functions in India should also not lead to a PE exposure, he concludes.
The court referred to the concept of PE under Section 92F(iiia) of the Income-Tax (I-T) Act, 1961 vis--vis the tax treaties. The court observed that PE is defined in an inclusive sense under the I-T Act as against an exhaustiv e definition under the treaties. It said that the inclusive definition under the I-T Act covers service PE, agency PE, software PE, construction PE, etc.
The concept of software PE appears to be novel, says Mr Kanabar. The OECD Commentary indicates that in certain circumstances, a server could constitute a PE, but there is no reference to a software PE. This could have some adverse consequences vis--vis foreign enterprises having software lying in India.
However, a welcome step, according to him, is that the court noted MSCo would not have an agency PE in India as MSAS had no authority to conclude contracts on behalf of MSCo in India.
The ruling comes as a big relief to foreign enterprises which have outsourced back office operations to various Indian enterprises, from a PE exposure perspective. It is also beneficial to taxpayers insofar as it accepts that stewardship activities do not result in a creation of PE.
The broad acceptance of the principle that once transfer pricing adequately takes into account functions and risks, no further profits are attributable is a great positive step, says Mr Kanabar. Clearly, transfer pricing will need to be supported on a year to year basis.