January 30, 2008
An update on the recent international tax rulings in India
The Supreme Court of India (“Supreme Court”) dismissed the review petition filed by the Income-Tax Department (“Revenue Authority”) in the case of Morgan Stanley & Co. U.S (“Morgan Stanley”), relating to taxation of back office operations of foreign companies in India. Thus, the favourable ruling in the case of the outsourcing industry has become the law of the land in India.
The Revenue Authority by means of a special leave petition (“SLP”) had initially challenged the ruling of the Authority for Advance Rulings (“AAR”), wherein the AAR had ruled that captive service provider would not form a permanent establishment (“PE”) of Morgan Stanley.
The SLP filed by the Revenue Authority was disposed off by the Supreme Court. While disposing the SLP, the Supreme Court held that services rendered by personnel of the parent company on deputation to the captive service provider would constitute a PE. However, if the personnel of the parent company were engaged in stewardship activities in the captive group company, then the same would not constitute a PE in India. Further, the Supreme Court also held that an arm’s length relationship between a non-resident enterprise and its PE in India absolved the non-resident enterprise from any further profit attribution.
The SC entertains review petitions against its own rulings in very rare cases. The dismissal of the Revenue Authority’s review petition brings with it the much need certainty that was required in relation to taxation of back office operations of foreign companies in India.
The Writ Petition filed by Vodafone Essar Limited (“Company”) before the Bombay High Court Division Bench (“High Court”) against the show cause notice issued by the Revenue Authority is currently sub-judice. The Revenue Authority via the show cause notice had raised a tax demand of approximately US$ 2.1 billion from the Company.
This case will have a significant bearing on many inbound investment structures where shares of overseas holding companies are transferred.
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