2007 Supreme(SC) 933

Supreme Court Of India
DIT (International Taxation), Mumbai - Appellant
Versus
Morgan Stanley & Co.INC - Respondent
Decided On : 07/09/2007

The concept of P.E. was introduced in 1961 Act as part of the statutory provisions of transfer pricing by the Finance Act of 2001.

Headnote:

DOUBLE TAX AVOIDANCE AGREEMENT - TRANSFER PRICING - PERMANENT ESTABLISHMENT - SERVICE PE - ARMS LENGTH PRINCIPLE - TRANSACTIONAL NET MARGIN METHOD - INCOME ATTRIBUTABLE TO PE - ECONOMIC NEXUS.

Fact of the Case:

Morgan Stanley Group (MS Group) is one of the worlds largest diversifying financial services companies. It is a world wide leader in investment banking and it is ranked amongst the top institutions in merger and acquisitions, underwriting of equity and equity and related transactions. It has a major presence in major securities market, with traders in numerous countries around the world offering a unique distribution of products. It has three main lines of business, namely securities investment management and investment banking and credit services. Morgan Stanley and Company (for short, MSCo) is an investment bank engaged in the business of providing financial advisory services, corporate lending and securities underwriting. One of the group companies of Morgan Stanley, Morgan Stanley Advantages Services Pvt. Ltd. (for short, MSAS) entered into an agreement for providing certain support services to MSCo. MSCo outsourced some of its activities to MSAS. The said MSAS was set up to support the main office functions in equity and fixed income research, account reconciliation and providing IT enabled services such as back office operation, data processing and support centre to MSCo.

Finding of the Court:

The AAR was right in ruling that MSAS would be a Service PE in India under Article 5(2)(l), though only on account of the services to be performed by the deputationists deployed by MSCo and not on account of stewardship activities. As regards income attributable to the PE (MSAS) we hold that the Transactional Net Margin Method was the appropriate method for determination of the arms length price in respect of transaction between MSCo and MSAS. We accept as correct the computation of the remuneration based on cost plus mark-up worked out at 29% on the operating costs of MSAS. This position is also accepted by the Assessing Officer in his order dated 29.12.06 (after the impugned ruling) and also by the transfer pricing officer vide order dated 22.9.06. As regards attribution of further profits to the PE of MSCo where the transaction between the two are held to be at arms length, we hold that the ruling is correct in principle provided that an associated enterprise (that also constitutes a PE) is remunerated on arms length basis taking into account all the risk-taking functions of the multinational enterprise. In such a case nothing further would be left to attribute to the PE. The situation would be different if the transfer pricing analysis does not adequately reflect the functions performed and the risks assumed by the enterprise. In such a case, there would be need to attribute profits to the PE for those functions/risks that have not been considered. The entire exercise ultimately is to ascertain whether the service charges payable or paid to the service provider (MSAS in this case) fully represents the value of the profit attributable to his service.

Issues: Whether the activities to be undertaken by MSAS consists of back office operations of the MSCo and if so whether such operations would fall within the ambit of the expression "the place through which the business of an enterprise is wholly or partly carried out" in Article 5(1).

Ratio Decidendi: The second requirement of Article 5(1) of DTAA is not satisfied as regards back office functions. The concept of P.E. was introduced in 1961 Act as part of the statutory provisions of transfer pricing by the Finance Act of 2001. In Section 92-F (iii) the word "enterprise" is defined to mean "a person including a P.E. of such person who is proposed to be engaged in any activity relating to the production". Under the CBDT circular No.14 of 2001 it has been clarified that the term P.E. has not been defined in the Act but its meaning may be understood with reference to the DTAA entered into by India. Thus the intention was to rely on the concept and definition of P.E. in the DTAA. However, vide Finance Act, 2002 the definition of P.E. was inserted in the Income Tax Act, 1961 (for short, I.T. Act) vide Section 92-F (iiia) which states that the P.E. shall include a fixed place of business through which the business of the MNE is wholly or partly carried on. This is where the difference lies between the definition of the word P.E. in the inclusive sense under the I.T. Act as against the definition of the word P.E. in the exhaustive sense under the DTAA. This analysis is important because it indicates the intention of the Parliament in adopting an inclusive definition of P.E. so as to cover service P.E., agency P.E., software P.E., Construction PE etc.

Final Decision: Both the civil appeals filed by the applicant (MSCo) and by the Department are partly allowed with no order as to costs.