SC's tax relief for MNCs' captive BPO units

In a major relief to foreign firms operating in India, the Supreme Court today held that their captive business process outsourcing (BPO) units are not liable to be taxed in the country if they are billing the subsidiaries on an "arm's length" basis or without giving any preference.

The judgement was delivered in a case between US investment bank Morgan Stanley and the income tax department.

The department had said that outsourcing activities of Morgan Stanley Advantage Services (MSAS), the firm's Indian arm, must be taxed.

A bench headed by Justice S H Kapadia said MSAS was not a permanent establishment (PE) as it was performing only back office operations in India and could not be taxed under PE rules, upholding an order of Authority for Advance Ruling (AAR).

"There was no agency PE as the PE in India had no authority to enter into or conclude contracts. The contracts would be entered in the US. The implementation of those contracts only to the extent of back office functions would be carried out in India," the bench said.

The apex court also held that MSAS would be a service PE in India under the India-US Tax Treaty on account of the services to be performed by executives deputed by Morgan Stanley and not on account of stewardship activities.

The ruling is likely to benefit foreign companies like GE, HSBC, and Standard Chartered Bank that outsource back office functions to their Indian units.

Foreign companies operating in India pay tax at a rate of about 42 per cent and the judgement establishes that the income of subsidiaries on work done for parent companies is not taxable.

Tax consultant Mukesh Butani, partner, BMR & Associates, said it was a big relief for captive BPOs as the apex court had ruled on two important principles.

"One, stewardship activity does not constitute a PE. Second, if the Indian BPO is remunerated on an arm's length basis, no further income of a multinational can be attributed to India," he said.

Morgan Stanley counsel Jay Savla said it was a victory for the US investment bank as the court had held that the Indian subsidiary's income arising from global operations will not be taxed in the country.

"Only that income will be taxed on the basis of the transfer pricing principle which arises from Indian operations," he added.

Industry experts said the judgement will also help the government attract foreign investment in the BPO sector from multinationals that are shifting their offshore operations to low-cost countries like India and China.