It is quite common for multinational companies to depute their employees to work with their subsidiaries in India. Whether such employees create a permanent establishment (PE) in India or not, has been a subject matter of controversy.
This issue arose in case of Morgan Stanley & Co which is a non-resident in India and tax resident of the US. It is a leading an 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.
In the above case of Morgan Stanley & Co (284 ITR 260), employees were deputed to work in India with its subsidiary company. The employees were deputed in two different categories. One category of employees was primarily for quality control in the subsidiary, which was called the stewardship activities. The other category of employees were deputed to work in temporary employment of the subsidiary on request from the subsidiary. In both categories, the tax department considered that the deputation of employees will constitute Morgans PE in India. When the matter was taken to the Authority for Advance Rulings (AAR), it was held that the subsidiary would be regarded as the PE of the US company in India if the employees were deputed for a period beyond 90 days.
Regarding the issue of taxability of income in India, the Authority held that as long as Indian subsidiary is remunerated for its services at arms length price, there should be no additional profits attributable to the Morgans or its subsidiary. Therefore, there will be no tax on Morgans income in India beyond the income of the PE.The matter finally reached the Apex Court. The Honourable Supreme Court in its judgement dated July 9, 2007 has held as under:
it can not be said that the Morgan has been rendering the services to subsidiary. In our view Morgan is merely protecting its own interests in the competitive world by ensuring the quality and confidentiality of subsidiarys services. We do not agree with the ruling of the AAR that the stewardship activity would fall under Article 5(2)(l). Thus there will be no PE on this account.
However, affirming the view of the AAR that deputed employees in temporary employment of the Indian enterprise will constitute PE in India, the SC observed that Morgan is rendering services through its employees to subsidiary. Therefore, the Department is right in its contention that under the above situation there exists a service PE in India.
As far as allocation of taxable profits to Morgans through its Indian PE is concerned, the Honourable court affirmed the ruling of AAR by holding that : under the impugned ruling delivered by the AAR, remuneration to MSAS (subsidiary) was justified by a transfer pricing analysis and therefore, no further income could be attributed to the PE (MSAS). In other words, the said ruling equates an arms length analysis (ALA) with attribution of profits. It holds that once a transfer pricing analysis is undertaken; there is no further need to attribute profits to PE.
The Morgan Stanleys case also sets at rest the controversy created by Mumbai Tribunal in case of Deputy CIT vs Set Sattelite (Pte) Ltd, 106 ITD 175, wherein it was held that the tax liability of a foreign enterprise is not extinguished by making an arms length payment to an agency PE in India. This decision stands overruled by Morgans case.