Challenging a finding of the Authority for Advance Ruling (AAR), the department of income tax (DIT) has told the Supreme Court that it has a right to tax a slice of the global income of Morgan Stanley on the ground that Morgan Stanleys BPO operations in India, constituting a permanent establishment (PE), perform an integral role in its securities trading operations.

The affidavit comes in response to a counter petition moved by the US- based investment bank Morgan Stanley, opposing the petition of the DIT. Morgan Stanley had filed the counter appeal after DIT challenged a decision of the Authority for Advance Ruling, to the effect that Morgan Stanley was not liable for taxation in India as its transactions with the Indian BPO were at arms length.

The apex court is examining whether the petitions, the one filed by the department and the counter appeal by Morgan Stanley, are to be admitted or not.

Till the Supreme Court comes out with its decision, DITs stance would discourage American companies from setting up captive BPOs in India.

International taxation is still at a nebulous stage in India and the Supreme Courts decision in the matter will become a major precedent, said Salil Gupta, director, KPMG.

The AAR had conceded that Morgan Stanleys BPO, Morgan Stanley Advantage Services (MSAS), constitutes a service PE. However, since its transactions were at arms length, Morgan Stanleys global income did not come under the purview of Indian tax. DIT has challenged this attribution of income using the principle of force of attraction. Because the BPO acts as the back office without whose services Morgan Stanley would not be able to carry out its securities business, the department believes that the force of attraction principle applies. This, the AAR has overlooked, claims DIT.

Challenging the AAR ruling, the department said the Morgan Stanley was providing services to MSAS which amounted to a service PE in India. The department has also raised the issue of control over the place of working. If the BPO premises are under the control of the parent company which uses it for its own business, it shall be treated as PE.

However, the US-based investment company is yet to file its reply to the notice issued by the Supreme Court on the DIT petition.