M/S. DIT (INTERNATIONAL TAXATION), MUMBAI vs. M/S. MORGAN STANLEY & CO.

CIVIL APPEAL No. 2914/2007Supreme Court[2007] 8 S.C.R. 5209 July 2007Bench: 2 JudgesAuthor: ARIJIT PASAYAT, S.H. KAPADIA34 pages
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What did the Supreme Court hold?

The Tribunal held that the Authority for Advance Ruling (AAR) was correct in ruling that MSAS would be a Service PE in India under Article 5(2)(1) of the DTAA, but solely on account of the services performed by deputationists deployed by MSCo, and not due to stewardship activities. The Tribunal found that stewardship activities, aimed at protecting MSCo's interests in terms of quality and confidentiality, do not constitute rendering services to MSAS, and thus MSCo's appeal on this aspect was partly allowed. Regarding deputationists, the Tribunal held that as long as they retain a lien with MSCo and MSCo retains control over their employment, and MSCo is responsible for their work, a Service PE can emerge. The Tribunal found that MSCo deputes its experienced staff to MSAS upon request, and these deputationists lend their expertise while retaining their lien with MSCo, thus constituting a Service PE. The Tribunal accepted the Transactional Net Margin Method (TNMM) as the appropriate method for determining the arm's length price for transactions between MSCo and MSAS, and upheld the remuneration fixed at a 29% mark-up on operating costs. The Tribunal further clarified that if an associated enterprise, which also constitutes a PE, is remunerated on an arm's length basis considering all risk-taking functions, no further profits need to be attributed to the PE. However, if the transfer pricing analysis does not adequately reflect functions and risks, profits may need to be attributed for those unconsidered aspects.

What were the facts?

Morgan Stanley & Co. (MSCo), a financial services company, established a captive Business Process Outsourcing (BPO) entity in India, Morgan Stanley Advantage Services (MSAS). MSCo sought an Advance Ruling from the Authority for Advance Ruling (AAR) to determine if it had a Permanent Establishment (PE) in India due to services rendered by MSAS, and if so, the income attributable to it. The AAR ruled that MSCo did not have a fixed place PE or an agency PE, but could have a PE if it sent employees to India as stewards or deputationists in MSAS's employment. The AAR's ruling was challenged by both MSCo and the Department of Income Tax (DIT). The Tribunal considered the nature of activities performed by stewards and deputationists deployed by MSCo to work in India for MSAS.

What were the issues?

1. Whether stewardship activities performed by employees of Morgan Stanley & Co. (MSCo) in India for Morgan Stanley Advantage Services Pvt. Ltd. (MSAS) constitute a Permanent Establishment (PE) under Article 5(2)(1) of the Double Taxation Avoidance Agreement (DTAA)? - Assessee (MSCo) argued that stewardship activities are merely to protect its interests and do not involve day-to-day management or specific services to MSAS, thus not constituting a PE. - Revenue (DIT) contended that these activities, aimed at ensuring output meets MSCo's requirements and monitoring outsourcing operations, fall under Article 5(2)(1). 2. Whether employees of MSCo deputed to work in India for MSAS constitute a Service PE under Article 5(2)(1) of the DTAA? - Assessee (MSCo) argued that deputationists retain their lien with MSCo and their activities are at MSAS's request, implying MSCo is not rendering services to MSAS. - Revenue (DIT) contended that where MSCo is responsible for the work of deputationists and they remain on MSCo's payroll, a Service PE can emerge, and MSCo is rendering services through its employees to MSAS. 3. Whether the remuneration fixed at a margin of 29% on operating costs based on the Cost Plus Method for services between MSCo and MSAS is appropriate for determining arm's length price and attributing profits to the PE?

Which sections of the Income-tax Act were involved?

Section 92

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1 -+- A MIS. DIT (INTERNATIONAL TAXATION), MUMBAI ,_..- v. MIS. MORGAN STANLEY & CO. JULY 9, 2007 B [DR. ARIJIT PASA YAT AND S.H. KAPADIA, JJ.] Income Tax Act, 1961: c Section 92-lnterniitional transaction-Computation of income from- Arm's length price-Relevance of-Methods to determine-Authority for Advanced Ruling (AAR)-Permanant Establishment (PE)-Projits attributable to-Morgan Stanley & Co. (MSC) has three main lines of business, namely, securities investments management, investment banking and credit services- MSCO had set up a captive Business Process Out sourcing (BPO) in India, D namely, Morgan Stanley Advantage Services (MSAS)-MSCo accordingly made an application seeking an Advance Ruling as to whether it was having \. a permanent Establishment (PE) in India and, if so, the amount of Income attributable to such PE-AAR held that MSCo could not be regarded as having a fixed place of business PE; that MSAS could not be regarded as E an agency PE; and that the applicant would be regarded, as having a PE in India only if it were to send some of its employees to India as stewards or as deputationists in the employment of MSAS-Validity of-Held: AAR was right

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