TMI Blog2006 (2) TMI 77X X X X Extracts X X X X X X X X Extracts X X X X ..... of Delaware and it is a tax resident of USA. In attachment 2, applicant is described as "Morgan Stanley Co., U.S." and is shown as wholly owned subsidiary of Morgan Stanley, US. It is a leading investment Bank having a number of group companies in various parts of the world. The applicant, inter alia, provides financial advisory services, corporate lending and securities underwriting. The diverse activities of the applicant are undertaken by various divisions. One of the group companies is a Morgan Stanley Advantage Services Private Limited ("MSAS") which is incorporated in India and is set up by the Morgan Stanley Group to support the Group Member's front office and infrastructure unit functions in their global operations for providing support services. MSAS is a wholly owned subsidiary of Morgan Stanley International Holdings Inc., (U.S.) in which 80% shares are held by Morgan Stanley U.S. and 20% shares are held by Morgan Stanley International Corporated US which is a wholly owned subsidiary of Morgan Stanley, US. MSAS renders support services such as IT support, account reconciliation, research etc. Under an agreement dated 1.12.2003, the applicant has out-sourced support ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ongst the customers on a reasonable basis. For the financial year 2003-04, M/s Ernst Yong Private Limited has conducted a transfer pricing study for MSAS. The Transactional Net Margin Method (TNMM) was selected as the most appropriate method with operating profit margin being the profit level indicator in respect of services rendered by MSAS to the applicant. The average margin earned by the comparable companies providing similar services is worked out to 28.33% and under the existing arrangement MSAS charges the applicant a margin of 29% on the costs it incurs. 2. The Government of the United States of America and the Government of the Republic of India concluded a convention on avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income on 18th December, 1990 (hereinafter referred to as "Treaty"). 3. On the above mentioned facts, the applicant sought advance rulings of the Authority on the following questions:- Whether on the facts and in the circumstances of the case, Morgan Stanley Co. incorporated ("the Applicant") would be regarded as having a Permanent Establishment ("PE") in India under the provisions of Article 5 of the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... SAS, whether given the function which would be performed and risks that could be undertaken by such a PE, would a remuneration based on a margin on total operating cost of the PE be the appropriate profit attributable to such a PE? 4. On 11th July, 2005, the Authority passed order under section 245R(2) of the Act allowing question nos. 1, 4 and 5 for the purpose of pronouncing advance rulings under sub-section(4) thereof and calling upon the applicant to explain as to why question nos. 2 and 3 should not be rejected in view of proviso(ii) to Section 245R(2) of the Act. In response to the said order, the applicant has submitted that it has a right to seek advance rulings on question 2 and 3 and that proviso(ii) of section 245R(2) of the Act prohibits the Authority from allowing an application where the question raised involves determination of fair market value of any property and as the determination of either the arm's length price or the fair market value of services does not involve determination of fair market value of the property, the said proviso is not attracted. Question no. 2, submits the applicant, merely relates to the choice of the method adopted to determine t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... applicant, has submitted that consequent upon signing of the draft Service Agreement question no. 1(a) is recast as follows: - "a. Whether the Applicant would be regarded as having a PE in India under Article 5 of the Treaty on account of the services rendered by Morgan Stanley Advantage Services Private Limited ("MSAS") under the Services Agreement dated April 14, 2005 entered into by it with the Applicant ("Agreement")? " It may be pointed out at the outset that question nos. 1(e) and 3 are dropped; question no. 4 is consequential to the ruling on question no. 1 and the first part of question no. 5 is the premise for the second part which is in fact the real question and is nothing but an alternate formulation of question nos. 2 and 3 7. We shall enter upon the discussion on the first question. It contains 4 sub-questions which can conveniently be dealt with together. Mr. Desai, learned counsel for the applicant has made oral submissions and filed as many as 7 written submissions. He has argued that the applicant has no fixed place of business in India through which it can be said to carry on its business. The premises of MSAS in India is being used for carrying on t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he MSAS is principal to principal relationship as is evident from clause 21.5 of the agreement. It is also submitted that MSAS does not have any authority to conclude the contract on behalf of the applicant, it does not maintain stock of goods on behalf of the applicant nor does it secure orders in India wholly or almost wholly for the applicant. Much argument is also addressed to show that MSAS is independent of the applicant and it would not be correct to say that MSAS is a mere projection of the applicant. Mr. Chopra, learned counsel representing the Commissioner, contends that MSAS obtained registration with the Software Technology Park of India for its business units at Mumbai and Bangalore and claimed exemption on the ground of exporting software u/s. 10A of the Act. MSAS provides services- Research Support, Quantitative Modeling and Account Reconciliation- to the applicant and its associated enterprises. MSAS performs essential and significant activities of the Morgan Stanley, which are crucial and critical for the business being carried on by the applicant as well as the other group companies, the development of computer software including customized electronic data or pr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of the treaty. The service agreement between MSAS and the applicant and Morgan group, submits Mr. Chopra, clearly indicates that services are to be rendered by MSAS as economically and legally dependent agent to the Morgan Stanley customers exclusively, strictly following Morgan Stanley procedures, policies and practices. The applicant along with other Morgan Stanley entities would be in a position to exert a decisive influence on the business of the MSAS who would be working under direct control and supervision and subject to the instructions of Morgan Stanley group. The applicant and the other two Morgan Stanley entities provide customers material which include hardware, intellectual property rights, software or data licenses. There is, thus, no independent existence of business of MSAS except as dependent agent of the applicant. The applicant and the other Morgan Stanley entities would depute staff to MSAS which would work for more than 90 days in a year and thus exercise direct control and supervision over the activities of MSAS, which would constitute service PE in India under article 5(2)(l) of the Treaty. Though clause 21.5 says that the agreement does not make one party ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... authority but habitually maintains in the first-mentioned State a Stock of goods or merchandise from which he regularly delivers goods or merchandise on behalf of the enterprise, and some additional activities conducted in that State on behalf of the enterprise have contributed to the sale of the goods or merchandise; or he habitually secures orders in the first mentioned State, wholly or almost wholly for the enterprise. 5. An enterprise of a Contracting State shall not be deemed to have a permanent establishment in the other Contracting State merely because it carries on business in that other State through a broker, general commission agent, or any other agent of an independent status, provided that such persons are acting in the ordinary course of their business. However, when the activities of such an agent are devoted wholly or almost wholly on behalf of that enterprise and the transactions between the agent and the enterprise are not made under arm's length conditions, he shall not be considered an agent of independent status within the meaning of this paragraph. A careful reading of article 5 would show that para 1 thereof applies where an enterprise carries on busin ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... wholly for the enterprise. It is seen that para 5 contains an exclusionary clause which says that an enterprise of a contracting State shall not be deemed to have a permanent establishment in the other contracting State merely because it carries on business in that other State through a broker, general commission agent or any other agent of an independent status provided that such agents are acting in the ordinary course of business. Nonetheless when the activities of such an agent are devoted wholly or almost wholly on behalf of that enterprise and the transactions between the agent and the enterprise are not made under arm's length conditions, he shall not be considered as an agent of an independent status within the meaning of those paragraphs. It will be useful to refer to the rulings in the following cases:- In re (AAR/611/2003)2, the applicant, a UK company was carrying on business in derivatives in other countries. With a view to expand its business to invest in the Indian stock market it got registered with SEBI as a FII and obtained permission of RBI. It invested in derivative trading operations in India and availed the services of brokers, custodians and banks. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r merchandise for the enterprise; or (b) though he acts without authority, he habitually maintains a stock of goods or merchandise from which he regularly delivers them on behalf of the enterprise; or (c) he habitually secures orders for the enterprise itself or for the enterprise and other enterprises controlling, controlled by, or subject to the same control, as that enterprise". In re (AAR/542/2001)3, an American company and an Indian company formed a partnership. They jointly entered into a venture with another Indian company- the applicant. The American company was engaged in the business of international transportation services and its partner Indian company was a general sales agent for and on behalf of international and domestic airline companies of India. These companies and some other companies formed an international group of companies which were engaged in the business of international transportation services using common international logo. The applicant entered into an agreement of international transportation services with the American company for movement of parcels/packages within and outside India. The applicant and the American company worked on principal to p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nance and purchasing etc. Payment of annual fee to XYZ was agreed for that purpose. On the question, whether XYZ had a permanent establishment in India, it was held: "Even assuming that the inclusion clause should be interpreted "against the background" of the general definition contained in paragraph 1 and bears some analogy to it, all that could be said was that sporadic or isolated activities of the kind referred to in clause (1) would not be sufficient to constitute a permanent establishment and that there should be some degree of "continuity" or "durability" and a framework against which the services were rendered. That kind of framework and degree of stability and continuity was present here. It must be held, therefore, that XYZ had a permanent establishment in India within the meaning of clause (1) of article 5(2)". 9. On the facts stated above, MSAS entered into a service agreement on 14th April, 2005 with (i) M/s Morgan Stanley Co. International Ltd., UK, (ii) M/s Morgan Stanley Co. Incorporated USA and (iii) Morgan Stanley Fund Services Inc. USA (for short they are referred to as "Morgan Group"). Under the said agreement, MSAS has undertaken to provide Morg ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... EFSD of the Applicant provides values added services to Hedge Funds and earns revenue through securities lending and from acting as a 'Prime Broker'. These value added services include providing account and record reconciliation services. EFSD, within MSAS, mainly provides support to EFSDs of the Group Members in the form of portfolio accounting reconciliation services. FID: The FID of the Applicant is involved in fixed income broking and trading in fixed income instruments (e.g. commercial papers, government securities etc.). The research reports generated by the FID are not sold to clients but are made available free of cost to them as a part of a value added services to the clients. The FID within MSAS supports various FIDs of the Group Members in their research reports by gathering and organizing financial data, maintaining and managing databases, entering customer details into e-Trading web tool, updating changes in client details, trade reconciliation etc. Support to infrastructure business units ERD: The ERD of the Applicant is involved in research in the fields of economic, market and other data, and the publication of reports. The research reports generate ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e of employee trading transactions in Morgan Stanley Group accounts, assisting in the development of policies and procedures to assist the Applicant and its staff to observe the relevant regulations in regards to significant holdings, code of conduct and employee trading and developing IT functions to improve and better enable monitoring functions. MSAS assists Human Resources ("HR") by providing data entry services for HR applications, assistance in maintaining personnel files, providing data entry services for the firm-wide directory, performing daily, weekly and monthly data audits, data entry services in connection and temporary ID requests and status change requests, processing new hire paperwork, assisting in employee background check verifications, assisting in employee self service data entry, assisting in the handling of report requests and weekly temporary staff verifications. For the International Audit group, MSAS assists with general and application controls reviews and reviews of IT vendor management procedures. For the Company Strategy Planning Group, MSAS helps collect, maintain and organize competitor data within already established spreadsheets, assists ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d agreement in law. MSAS develops computer software including customized electronic data or product or computer programs which are of critical relevance for the various divisions of the applicant like equity research, fixed income division, equity financing service division and investment banking division, etc. It would be providing research report, data analysis and industry specific analysis, company specific analysis, earning models of companies as an on-going process so as to help various divisions of the applicant to formulate their business strategies and ensure inter alia that profits in the share portfolio and fixed income portfolio of the customers are enhanced and further that diverse business operations in the various divisions of the applicant embracing the entire gamut of financial services are carried out with optimum results. MSAS uses the logo brand name of Morgan Stanley. The agreement stipulates that MSAS would be provided with customer material including hardware, intellectual property rights, software or data licenses and procurement and connectivity etc. and that products developed by MSAS, described, as 'deliverables' would be the exclusive property of t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... es of the Morgan Stanley group so as to make activities of MSAS projection of Morgan Group. We have noticed above the requirements of article 5(1) of the treaty; namely, first, there should be a fixed place of business and secondly the business of the enterprise should be carried on wholly or partly through that place. The place of business of the MSAS is no doubt a fixed place but there is nothing to show that the business of the applicant, noted above, is carried on through the place of business of MSAS. We are not persuaded to accede to the contention that rendering of the aforementioned services by MSAS to the applicant and other group companies which may be usefully utilized by them in running their business amounts to carrying on business through the fixed place of business of MSAS. In a case where an Indian subsidiary of a foreign automobile manufacturing company, should design, undertake research work, prepare software and supply the same to the foreign company which may, after due study, utilize the same; can it be said in such a situation that the business of manufacturing automobiles is carried on through Indian subsidiary? We think 'not'. The germane condition of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rity in accordance with the lawful instructions given to him by his principal but he is also not subject in his exercise to the direct control or supervision of the principal. On the facts stated above, we are inclined to accept the contention of Mr. Chopra that the service agreement between the applicant and MSAS clearly proves that the latter is carrying on activities in India on behalf of the applicant and that the functions and the activities of MSAS are wholly and exclusively dependent on the applicant both legally and economically as is evident from the fact that for the year 2003-04, the entire revenue of Rs.19.23crore was received from Morgan Stanley Group only; there was no revenue from any independent party though it is stated that by virtue of the resolution of board of directors it can deal with third parties. However, the contentions of Mr. Chopra that the agreement between MSAS and the applicant gives unilateral advantage to the latter with no recompense to the former, if the latter suffers any loss or damage as a result of act of omission (clause 2.3 of the agreement); similarly right to rescind, amend, assign or enforce the agreement is given only to the recipient ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t may be that the benefit of services of the staff would enure to the applicant but it would not be the same as working for the applicant. In our day-to-day experience it is noticed that the benefits of labour of employees of companies manufacturing consumer products are enjoyed by the public, but it cannot be said that the employees are working for the public; they are employees of the companies and working for their employers. Once employees are sent by the applicant on deputation for stewardship activities they would be actively involved in the key managerial activities of MSAS as has been pointed out above. It follows that the ingredients of para 2(l) of article 5 are satisfied and therefore, MSAS would constitute the PE of the applicant/Morgan Group. Now, the moot question, whether question no. 2, is liable to be rejected in view of the first proviso to section 245R(2) read with Chapter X of the Act. Question no. 2 generated a lengthy debate. The Authority by its order dated 11th July, 2005, called upon the applicant to show as to why the said question should not be rejected in view of clause (i) of the first proviso to sub-section (2) of Section 245R of the Act. Howeve ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... that the notice to show cause was given to the applicant. The third proviso requires that the reasons for such rejection shall be given in the order. The second and the third proviso of sub-section (2) of Section 245N of the Act are not relevant for the present discussion. Clauses (i) and (ii) of the first proviso are relevant. Though the notice mentions only clause (ii) which prohibits the Authority from allowing an application where the question involves determination of fair market value of any property, the parties have referred to and argued both clauses (i) and (ii) of the first proviso. It is plain that clause (i) (of the first proviso to section 245R (2) of the Act ) speaks of a situation where the question raised in the application is already pending before any income tax authority or Appellate Authority or any Court. However, this proviso would apply to the case of a resident applicant falling in sub-clause (iii) of clause (b) of Section 245N of the Act only in regard to any Court. Mr. Desai has raised a two prong contention. The first is that the term 'question'. in the said proviso indicates a disagreement between the parties; he relies on the meaning of the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... pending between the applicant and the Income-tax Department and that the return had already been processed and the refund prayed for by the applicant had been granted. This does not advance the case of the applicant. Reliance is also placed on the following passages from the 'Hand book on Advance Rulings8" which reads as follows:- "….. unless there is any indication in the notice or some other material to show that the issue of this notice was in such circumstances as to show that the questions posed before the Authority had already been agitated by the assessee before, or had already arisen in the mind of, or discussed by, the assessing officer, it is difficult to say that the terms of clause (a) of the proviso to section 245R(2) are attracted. " (emphasis supplied) A careful reading of the passage, quoted above, shows that even if the question posed before the Authority had already arisen in the mind of the Assessing Officer in the proceeding before him, it would be sufficient to bring the case under clause (i) of the first proviso to sub-section (2) of Section 245R of the Act. This would obviously destroy the applicant's submission. The second limb of the contention ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... income from an international transaction is to be computed having regard to Arm's length price between the associated enterprises. Further, in terms of Section 92CA, a Transfer Pricing Officer, on a reference received from the Assessing Officer, is required to determine Arm's length price of an international transaction by an order and the Assessing Officer is required to compute the income having regard to the price so determined by the TPO. The notification regarding jurisdiction of TPO and their controlling officers have been issued by the CBDT and the copies thereof are enclosed for ready reference as Annexure-II. In order to maintain uniformity of procedure and to ensure that work in this important area proceeds smoothly and effectively, the following guidelines are hereby issued: Reference to Transfer of Pricing Officer (TPO) The Power to determine Arm's length price in an international transaction is contained in sub-section (3) of section 92C. However, section 92CA provides that where the Assessing Officer considers it necessary or expedient so to do, he may refer the computation of Arm's length price in relation to an international transaction to the TPO. Sub-se ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... action with an associated enterprises or there are transactions with more than one associated enterprises the aggregate value of which exceeds Rs.5 crores, the transactions should be referred to the TPO. Before making reference to the TPO, the AO has to seek approval of the Commissioner/Director as contemplated under the Act. Under the provisions of Section 92CA reference is in relation to the international transaction. Hence all transactions has to be explicitly mentioned in the letter of reference. Since the case will be selected for scrutiny before making reference to the TPO, the AO may proceed to examine other aspects of the case during pendency of assessment proceedings but await the report of the TPO on the value of international transaction before making final assessment. The threshold limit of Rs.5 crore will be reviewed depending upon the workload of the TPOs. The work relating to selection of cases for scrutiny and reference to TPO on the above basis in respect of pending returns filed for assessment year 2002-2003 should be completed by 30th June, 2003." From a perusal of the excerpt, quoted above, it is evident that under the heading 'Reference to Transfer Prici ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... far as it relates to question no. (2), has to be rejected. In view of the conclusion arrived at by us on clause (i) of the first proviso, it is inessential to dilate on clause (ii) of the said proviso. However as the learned counsel for the parties argued this aspect, we shall briefly refer to it. Now adverting to clause (ii) of the proviso, it is necessary to analyse question no. 2. This question requires the Authority to rule that Transactional Net Margin Method (TNMM) is the most appropriate method for the determination of arm's length price in respect of transactions between the applicant and MSAS in the light of the provisions of Section 92C of the Act read with Rules 10B and 10C of the Rules. Section 92C of the Act deals with "Computation of arm's length price" and reads as follows. Section 92 C Computation of arm's length price (1) The arm's length price in relation to an international transaction shall be determined by any of the following methods, being the most appropriate, having regard to the nature of transaction or class of transaction or class of associated persons or functions performed by such persons or such other relevant factors as the Board may ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... deliverables which include hardware, intellectual property, software etc. which are goods to the applicant and its associated enterprises. It follows that both tangible properties as well as services are required to be valued. Even assuming that the services are not within the mischief of first proviso to sub-section(2) of Section 245R of the Act, the hardware, intellectual property, software and other deliverables fall within meaning of property which has to be valued along with the services. Therefore the provision under clause (ii) of the first proviso to sub-section(2) of Section 245R of the Act will be attracted. In light of the above discussions, the application in so far as it relates to question no. 2 is liable to be rejected both under clauses (i) and (ii) of sub-section (2) of Section 245R of the Act. Question nos. 4 and 5 remain to be considered. So far as question no. 4 is concerned, Mr. Desai argues not much. However, in Annexure-III to the application, it is stated that as long as MSAS is remunerated for its services at arm's length price, there should be no additional profits attributable to the applicant or MSAS in India. Circular No. 23 of 1969 dat ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... h would be performed and risks that could be undertaken by such a PE" is the premise which is consequential to the ruling on question no. 1(c) (d); the second part of question which states "would a remuneration based on a margin on total operating cost of the PE be the appropriate profit attributable to such a PE", is nothing but an alternate formulation of question no. 2 and partly question no. 3. Since we have held above that question no. 2 is inadmissible and rejected the same and the applicant has dropped question no. 3, we do not propose to pronounce any ruling on question no. 5. In the light of above discussion we rule on question no :- 1. a. that MSAS is not the PE of the applicant in India under the provisions of article 5(1) of the Treaty; 1. b. that MSAS would not constitute an agency PE of the applicant under article 5(4) of the Treaty; 1.c. that MSAS would be regarded as the PE of the applicant in India under Article 5(2)(l) of the Treaty if it were to send some of its employees to India for undertaking stewardship activities as described in paragraph 3 in Annexure II for a period beyond ninety days; 1.d. that MSAS would be regarded as the PE of the a ..... X X X X Extracts X X X X X X X X Extracts X X X X
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