The tax treatment of foreign companies setting up BPO units in India is in focus once again. The Supreme Court will consider on Monday whether or not to admit a Special Leave Petition (SLP) filed by the income tax department challenging the decision of the Authority for Advance Ruling in Morgan Stanleys case.
The AAR which is a quasi judicial body had ruled that the business process outsourcing activities done by the Indian subsidiary of investment banker Morgan Stanley will not constitute a permanent establishment (PE) or a fixed place of business in India. If there is no PE, the parent company will not have to pay corporate tax in India on a portion of its profits.
Simply put, the AARs ruling meant that a portion of Morgan Stanleys global profits are not liable to be taxed in India as long as it pays an arms length price to the Indian subsidiary.
The AARs ruling is in line with the Central Board of Direct Taxes circular which broadly states that the foreign parent will not have any extra tax liability in India if it compensates its Indian subsidiary on an arms length basis. The critical issue here will be the mapping of the functions of the BPO unit to see whether it is an extension of the foreign company, according to Vispi T Patel, Head Transfer Pricing RSM.
The government probably 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. After all the government also wants a share of the tax pie.
We recommended filing an SLP in the Supreme Court challenging some of the grounds of the AARs ruling. The petition has been filed after consulting the law ministry, BM Singh, Director General International Taxation told ET.
The AARs rulings are binding on the tax payer and the department. It also has a persuasive value. The AARs ruling in the Morgan Stanley case came as a relief to several foreign companies outsourcing their back office functions to Indian companies, particularly to captive service providers.
The issue at stake was whether outsouring to captive service providers would result in a permanent establishment (PE) coming into existence. If Indian tax authorities were to hold that such activities would tantamount to a PE, then the global profits attributable to the PE would be taxed in India (at around 41%) in the hands of foreign entity, said a tax expert.
For starters, Morgan Stanley Advantage Services Private Limited (MSAS) is one of the group companies of Morgan Stanley which is incorporated in India to provide support services. The AAR reportedly held that MSAS is not a fixed of place business of Morgan Stanley.
It also held that MSAS does not constitute an agency PE of Morgan Stanley one of the factors for this being that it does not have the authority to conclude contracts.