Facts

Assessee, a US company, was an investment bank and was a part of the Morgan Stanley group. Assessee entered into an agreement with a group company Morgan Stanley Advantages Services Pvt. Ltd. (MSAS) for obtaining certain support services. Assessee filed an application with the Authority for Advance Rulings (AAR) seeking a decision as to whether the assessee had a permanent establishment (PE) in India and if so the income attributable to such PE. AAR  held that the assessee did not have a fixed place PE or agency PE in India. AAR, however, held that the assessee would be regarded as having a service PE under Article 5(2)(l) of the India US DTAA if it sends its employees as stewards or on deputation in the employment of MSAS. In respect of income determination, AAR held that the Transactional Net Margin Method was the most appropriate method for determining the arm’s length price for the services rendered. The ruling of the AAR was challenged by the assessee as well as by the department directly before the Supreme Court.

Issue

When does an assessee constitute a fixed place PE/agency PE/service PE in India? Does stewardship activity result in a service PE? Can a non-resident be taxed in India if it remunerates its associated enterprise which constitutes its permanent establishment in India on an arm’s length basis?

Views

Article 5(1) of the India US DTAA states that the term “permanent establishment” means a  fixed place of  business through which the business of  an  enterprise  is wholly or partly carried on. Article 5(2)(l) states that the term permanent establishment would specifically include furnishing of services within a Contracting State by an enterprise through its employees or other personnel  if  the other conditions stated therein are satisfied. As per Article 5(4) of the India USA DTAA, an assessee shall be deemed to have a permanent establishment if, inter alia, a person other an agent of an independent status habitually exercises    an authority to concludecontracts on behalf of the assessee.

Held: Supreme Court held that the assessee did not have a fixed place PE in India. Supreme Court noted that the group company MSAS would only be performing back office operations in India for the assessee and that it could  not be said that the assessee has a fixed place of business through which the assessee carries on its business. Supreme Court also held that no agency PE was constituted in India as MSAS had no authority to enter into or conclude contracts on behalf of the assessee. Supreme Court noted that the contracts would    be entered into and concluded in USA. Supreme Court also held that the term ‘permanent establishment’ was defined in an inclusive manner in section 92F(iiia) and would even include service PE, agency PE, construction PE, etc. Whiledetermining whether the assessee had a service PE in India, the Supreme Court bifurcated the activities into two – stewardship activities and work performed by employees on deputation. With respect to stewardship activities, Supreme Court observed that the assessee who has world-wide operations is entitled to insist on quality control and confidentiality from the service provider. In the present case, stewardship activities included briefing the staff of MSAS (i.e. service provider)     to ensure that the output meets the requirements of the assessee (i.e. service recipient) and to also monitor the operations at MSAS. Supreme Court held that  the object of stewardship activities is to protect the interests of the assessee customer and it could not be said that the assessee was rendering services to MSAS. Supreme Court, therefore, held that to the extent of stewardship activities, the assessee did not have a service PE in India. To the extent  of services rendered  by the employees on deputation, Supreme Court upheld the decision of the AAR that the deputed employees constitute a service PE of the assessee. Supreme Court observed that service PE is created in such instances as the assessee is responsible   for the work of employees on deputation and the employees continue to remain    on its payroll or they continue to have their lien on their jobs with the assessee. Supreme Court held that the income of the non-resident assessee is taxable in India to the extent of income attributable to the activities carried on by the non- resident through its permanent establishment in India. Supreme Court observed that the Transactional Net Margin Method is the appropriate method in the case    of service PE as it apportions the total operating profit arising  from  the transaction on the basis of sales, costs, assets, etc. Supreme Court further held that where an associated enterprise that also constitutes a PE is remunerated on an arm’s length basis taking into account all the risk-taking functions nothing further needs to be attributed to the PE. (CA No. 2914 of 2017 dt. 9-1-2007)

Editorial: Supreme Court in Formula One World Championship Limited v. CIT (2017) 394 ITR 80/150 DTR 305/247 Taxman 153/295 CTR 12 (SC) and ADIT v.  E-Funds IT Solution Inc. (2017) 399 ITR 34 (SC)/(2017) 298 CTR (SC)505/(2017)

251 Taxman 280 (SC) held that to constitute a fixed place PE in India there must

exist a fixed place of business in India which is ‘at the disposal’ of the assessee

i.e. the assessee should have the right to use the place and should have control thereupon through which it carries on its own business. To constitute service PE, Supreme Court in E-funds observed that it is essential that an enterprise furnishes services “within India” through employees or other personnel.

“Each one has to find his peace from within. And peace to be real must be unaffected by outside circumstances.”

– Mahatma Gandhi