Captives BPOs of foreign firms operating in India will not be liable to be taxed in the country

In a judgment regarding case of Morgan Stanley Company (MSCo), the Supreme Court on 9th July held that if remuneration earned by a foreign company for a outsourced BPO services to its subsidiary Indian company, is fixed at arm's length basis, no further demand for tax could be raised.

MSCo has set up a captive BPO firm, Morgan Stanley Advantage Services (MSAS), in India. When the I-T department held that profit earned by parent company MSCo, due to its operation through captive unit MSAS in India should be taxed, MSCo went to the department's appellate authority.

The authority ruled that as the remuneration for the BPO services rendered by the Indian subsidiary was fixed on the arms' length price, the department cannot levy any tax on the profit made by MSCo because of its subsidiary's operation in India.

Supreme Court on 9th July, 2007 upheld the authority's ruling. It said: "As regards attribution of further profits to permanent establishment of MSCo, where transaction between the two are held to be at arm's length, we hold that the ruling is correct in principle, provided that an associated enterprise (that also constitute a PE) is remunerated on arm's length basis, taking into account all the risk taking functions of the multinational enterprises."

On determining tax liability, Supreme Court held "The Transactional Net Margin Method (net profit margin realized by the enterprise from a comparable uncontrolled transaction) was the appropriate method for determination of the arm's length price in respect of transaction between Morgan Stanley and MSAS."

“The ruling means that a tax would be levied on the net income of the Indian arm by valuing the services rendered to the US parent as if the same were provided to an outsider”