A tax threat has cast its dark shadow over a section of the burgeoning business process outsourcing (BPO) industry. By taking on the tax department in the Supreme Court (SC), US-based investment bank Morgan Stanley will now bat for all captive BPOs in the country.
The investment bank is filing a cross-objection to SC admitting a tax department appeal, which challenges the ruling that its captive BPO in India does not constitute a permanent establishment (PE). If it were a PE, then Morgan Stanley would be liable to pay tax in India on a portion of its global income attributable to the activity of its PE. The ruling had been given by the Authority for Advance Ruling (AAR) a year ago.
The income-tax department has filed a special leave petition in the SC contesting some of the grounds of the AAR ruling. Morgan Stanley will file a cross-objection to the notice given by the SC on the SLP. Such a notice is the first step before the SC takes a call on whether or not to admit the petition. If the SC admits the case, it could have wide-ranging implications on the tax liability of several foreign companies outsourcing their back-office functions to Indian companies. The cross-objection will be filed within two weeks.
The SC has, under its powers under Article 136 of the Constitution, granted leave to appeal to the income-tax authorities. Keeping in mind the spirit of advance rulings to grant certainty to foreign investors as to their tax consequences, the SC would be hearing this matter on an expedited basis, said Nishith Desai, the counsel for Morgan Stanley. Harish Salve will represent Morgan Stanley in the SC.
The case is before admission stage, but not yet admitted. Notices have been issued. We are also filing a cross appeal against certain observations made in the AAR ruling. The court has said both the appeals will be listed after two weeks, said Jay Savla, advocate on record for Morgan Stanley in the SC.
The rulings of the AAR, which is a quasi judicial authority, are binding on both the tax payer and the income-tax department. Some tax experts reckon that the tax departments move to challenge AARs ruling will open up a new area of litigation.
For starters, Morgan Stanley set up a subsidiary, Morgan Stanley Advantage Services (MSAS), in India to provide support services. The AAR was approached to give a ruling, among other things, on whether Morgan Stanley would be regarded as having a PE in India on account of the services rendered by its subsidiary.
The AAR ruled that MSAS is not a fixed place business of Morgan Stanley. It also held that MSAS does not constitute an agency PE of Morgan Stanley one of the factors being that it does not have the authority to conclude contracts. Morgan Stanley will, therefore, not be liable to pay tax on a portion of its global profits if it pays the arms length price to its Indian subsidiary.
The tax department may be going by the latest OECD approach that says that is not necessary, in all circumstances, that the arms length compensation to the Indian enterprise will extinguish any further attribution of income to the foreign company, said Samir Gandhi, tax partner, Deloitte Haskins and Sells.
This means, depending on the facts of the case, a foreign company may have to pay tax in India on profits attributable to its operations here.
The department also wants to see whether the BPO unit is an extension of the foreign company. Simply put, it wants to examine whether the activities of the BPO are linked to those of the parent company. In such a case, there could be a rationale to tax a portion of the profits earned by the foreign company. India will thus get a share of the tax pie.