Morgan Stanley and Co Vs Dit International Taxation Mumbai - Citation 1114724 - Court Judgment

Judgment:

Justice Syed Shah Mohammed Quadri

The applicant in this application, under section 245Q (1) of the Income-tax Act, 1961 (for short âthe Actâ), is a non-resident company; it was incorporated in the United States of America (USA) under the General Corporate Law of the State of Delaware and it is a tax resident of USA. In attachment 2, applicant is described as âMorgan Stanley and Co., U.S.â 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 (âMSASâ) which is incorporated in India and is set up by the Morgan Stanley Group to support the Group Members 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 services specified in Schedule-II thereto as amended from time to time. MSAS does not undertake the important revenue generating functions of the applicant nor does it bear any significant market risk with respect to its transactions with the applicant. The clients interaction is done entirely by the employees/personnel of the applicant. The applicant proposes to send its staff to India for stewardship activities and other similar activities to ensure that the high standards of quality are met as Morgan Stanley group entities are to be satisfied that the services received by them from other group companies meet the Morgan Stanley standards. Like any other customer, the applicant has to undertake certain stewardship and similar activities such as briefing MSAS on the standard of services expected, acquainting the staff on various aspects of the functions by conducting briefing sessions for effective transitioning of various functions and providing basic guidance so that services provided meet the overall global value benchmarks of the Morgan Stanley Group. The stewardship activities include monitoring the overall outsourcing operations at MSAS. Firm management and infrastructure personnel travel to India for a very short term to ensure that the establishment and operations of MSAS proceed without any material exposure from the investors perspectives but they are not involved in any day-to-day management or other specific services to or for MSAS. The applicants staff is also sent on deputation on the request of MSAS for periods ranging between several months to a couple of years to work under its control and supervision. From an employment contract perspective, the staff will continue to be employed or engaged and their salaries and fees will be directly paid by the applicant. MSAS is required to reimburse the compensation cost to the applicant with no profit element. The consideration paid to MSAS by the applicant for the services rendered will be the sum of the costs and a mark-up of a certain percentage of the costs as agreed upon between the parties. The term âcosts is defined in Schedule 3 of the agreement to include direct and indirect costs incurred by MSAS in providing the services, including all costs relating to under-utilization of capacity, such as idle time cost of employees, rent for vacant space, etc. MSAS shall allocate indirect costs amongst the customers on a reasonable basis. For the financial year 2003-04, M/s Ernst and 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 âTreatyâ).

3. On the above mentioned facts, the applicant sought advance rulings of the Authority on the following questions:-

1. Whether on the facts and in the circumstances of the case, Morgan Stanley and Co. incorporated (âthe Applicantâ) would be regarded as having a Permanent Establishment (âPEâ) in India under the provisions of Article 5 of the Agreement for Avoidance of Double Taxation and Prevention of Fiscal Evasion with Respect to taxes on Income and Capital Gains entered into between the Government of the Republic of India and the Government of the United States of America (hereinafter referred to as the âTreatyâ), and specifically:-

(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 (âMSASâ) under the Draft Services Agreement proposed to be entered into by it with the Applicant (âAgreementâ)?

(b) Whether MSAS would be regarded as constituting an agency PE of the Applicant under Article 5(4) of the Treaty?

(c) Whether the Applicant would be regarded as having a PE in India under Article 5(2)(l) of the Treaty if it were to send some of its employees to India for undertaking certain Stewardship Activities as described in paragraph 3 in Annexure II?

(d) Whether the Applicant would be regarded as having a PE in India under Article 5(2)(I) of the Treaty if it were to send some of its employees to India on deputation in the employment of MSAS?

(e) Whether the Applicant would have a PE in India for any other reason?

2. Whether, on the facts and in the circumstances of the case and in light of the provisions of Section 92C of the Income Tax Act, 1961 (âITAâ) read with Rules 10B and 10C of the Income-tax Rules, 1962 (âthe Rulesâ), the âTransactional Net Margin Method (âTNMMâ) is the most appropriate method for the determination of the arms length price in respect of transactions between the Applicant and MSAS?

3. Whether on the facts and in the circumstances of the case, a mark-up of 29% (using the TNMM for the benchmarking analysis) on the operating costs incurred by MSAS for providing services to the Applicant would meet the arms length test as prescribed under Chapter X of the ITA?

4. Based on the facts and in the circumstances of the case, even in the event MSAS constitutes a PE of the Applicant in India, as long as MSAS is remunerated for its services at arms length, whether any further income can be attributed in the hands of the PE of the Applicant?

5. Based on the facts and in the circumstances of the case, in the event the Applicant is deemed to have a PE in India as a result of sending employees to India or due to deputation of employees to MSAS, 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 arms 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 the arms length price and therefore a ruling on the most appropriate method to be used for determining arms length price based on the provisions of Section 92C of the Act read with Rules 10B and 10C of the Income-tax Rules, 1962 (for short âthe Rulesâ), does not amount to valuation of the property. It is, further, submitted that in the absence of an advance pricing mechanism under the Indian tax regime, the only recourse available to the applicant to guard against harsh penalty, is to seek an advance ruling. The courts world over have taken up and resolved issues arising from transfer pricing, therefore, it is requested that advance ruling be pronounced on question nos. 2 and 3 also.

5. The Director of Income-tax (International taxation), Mumbai (referred to in this ruling as âthe Commissionerâ) has submitted the following comments to the application:-

MSAS was incorporated as a wholly owned subsidiary of M/s Morgan Stanley International Holdings Incorporation (the ultimate holding company being M/s Morgan Stanley, USA). MSAS obtained registration with the Software Technology Park of India for the business units, namely: (i) Global Knowledge Centre (GKC) at Mumbai; (ii) Data Centre at Mumbai and (iii) Data Centre at Bangalore. The Global Knowledge Centre and Data Centres are engaged in the development of soft wares and providing information technology enabled services such as back office operation, data processing, support centre and technical services to Morgan Stanley Group. These activities fall within the extended definition of computer software under Explanation (2) to Section 10A read with Notification No. SO 890(E) dated 26.9.2000. MSAS has claimed exemption of income under section 10A of the Act. MSAS entered into a service agreement on 14th April, 2005 with (i) M/s Morgan Stanley and Co. International Ltd., UK (ii) M/s Morgan Stanley and Co. incorporated USA and (iii) Morgan Stanley Fund Services Inc. USA.

Under the said agreement, MSAS is to render as many as 17 services. The applicant has proposed to send staff to MSAS for stewardship activities and other similar activities. Staff shall also be sent by the applicant on request to MSAS on deputation. Comments of the Commissioner in regard to each question will be referred to while dealing with the respective question.

6. At the time of oral hearing, Mr. Desai, learned counsel for the applicant, has submitted that consequent upon signing of the draft Service Agreement question no. 1(a) is recast as follows: -

âa. 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 (âMSASâ) under the Services Agreement dated April 14, 2005 entered into by it with the Applicant (âAgreementâ)? â

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 the business of MSAS and not of the applicant. The applicant, it is submitted, has outsourced certain activities to MSAS under the agreement dated December 1, 2003 (amended agreement dated 14.4.2003) and that the applicant does not carry out its business either wholly or in part in India. It is next submitted by Mr. Desai that the services rendered by the MSAS do not constitute service PE within the meaning of article 5(2)(l) of the Treaty. The applicant has not deputed a single person to MSAS so far and though the applicant will send staff to MSAS for certain stewardship functions, it is only to ensure that MSAS adheres to the stringent quality benchmarks and other requirements of the Morgan Stanley Group with a view to protect the business interest of shareholders of the applicant, therefore the applicants employees are not involved in the management of MSAS. Briefing and providing basic training to MSAS staff on the job for effective transitioning of projects is to ensure the best output of MSAS and to minimize the risk arising to it from the outsourcing of services to MSAS. According to him, a service PE is constituted if services are furnished by an enterprise through employees or other personnel in the other contracting state to a third party on being solicited by the recipient; but where an entity sends staff without the services being solicited by the recipient, it can be only for the benefits of the entity and it cannot be said that services are rendered to the entity that hosts them. As the applicant sends staff for its own benefit, bears the economic burden of salary and other costs while they are in India, the staff in fact renders âquality and risk management servicesâ to the applicant and not to MSAS; they would work under the supervision of Board of Directors of MSAS and that the applicant does not exercise any control over the operations of MSAS other then the level of control a client would exercise over his service provider. Though initially the salary etc. would be borne by the applicant, the same is later on recovered from MSAS. In regard to agency PE under article 5(4) of the Treaty, it is submitted that MSAS is not an agent of the applicant and that MSAS does not act on behalf of the applicant. While rendering services to the applicant, MSAS is acting in furtherance of its own business and that the relation between the applicant and the 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 product or computer programme are also of critical relevance for the applicant and the group. It is on the basis of the material research support, data analysis etc. that the applicant formulates its business strategy and ensures, inter alia, that profits in the share portfolio and fixed income portfolio of customers are increased. MSAS would necessarily have business interface on an ongoing basis with vendors of information in the market and have regular contacts with various sources in India for getting the required data and information and other industry specifics for preparing its research reports, review etc. and thus develop in India a network of contacts and sources relating to relevant industry etc. Therefore, the functions performed by MSAS are essential core-functions for the enterprise and cannot be described preparatory and auxiliary in nature. By virtue of the agreement â clause (A) to (F) under the caption âintroductionâ â MSAS would render service wholly and exclusively to the applicant and its group. The agreement also provides that MSAS is subject to detailed instructions and control with respect to conduct of the business which shows that MSAS is a dependent agent. There is unlimited access of the customers to the premises of MSAS and other business premises to the employees of bank division, auditors and security division. On giving notice and even without notice, the representative of the applicant/Morgan group may undertake investigation as directed by the customers. Clauses 9.2 and 9.3 show that there is unrestricted access to the premises of MSAS and this shows that MSAS is working for and on behalf of the applicant and is a mere projection of the applicant and the group. By virtue of clause 12 if MSAS ceased to be a member of Morgan Stanley group it would result in termination of agreement which would amount to extinction of business of MSAS. Confidentiality clause â clause 19 â disables the supplier from disclosing the information contained in the software products, etc. to any party except Morgan group but it would be open to that group to share the information with others. MSAS is also kept free from the business risk. Clause 16.3 and clause 19 would also disclose that MSAS has no independent existence. In effect, MSAS is merely the projection of the applicant on the soil of India and therefore the PE under para 1 of article 5 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 the agent of the other party, what is material is the substance of the agreement which clearly shows that MSAS is merely a dependent agent. Further, the contention that MSAS does not have any authority to conclude any contract on behalf of the applicant as such the requirement of para (4) of article 5 is not fulfilled, ignores the commercial reality of the situation and all these facts show that MSAS is not an independent agent. Thus, MSAS is PE under 5(1), 5(2)(l) as well as 5(4) of the Treaty.

8. It is a common ground that the applicant is entitled to avail the benefit of the treaty. The theme of the first question is âpermanent establishment (PE)â which is defined in Article 5 of the treaty. We shall quote article 5 in so far as it is relevant for the present discussion: -

Article 5 â Permanent Establishment

1. For the purposes of this Convention, the term âpermanent establishmentâ means a fixed place of business through which the business of an enterprise is wholly or partly carried on.

2. The term âpermanent establishmentâ includes especially:

(a) to (k) xx xx xx xx xx xx xx xx

(I) the furnishing of services, other than included services as defined in Article 12 (Royalties and Fees for Included Services), within a Contracting State by an enterprise through employees or other personnel, but only if:

(i) activities of that nature continue within that State for a period or periods aggregating to more than 90 days within any twelve months period; or

(ii) the services are performed within that State for a related enterprise [within the meaning of paragraph 1 of article 9 (associated enterprises)]

3. x x x x x

4. Notwithstanding the provisions of paragraphs 1 and 2, where a person- other than an agent of an independent status to whom paragraph 5 applies â is acting in a Contracting State on behalf of an enterprise of the other Contracting State, that enterprise shall be deemed to have a permanent establishment in the first-mentioned state, if:-

(a) he has and habitually exercises in the first-mentioned State an authority to conclude contracts on behalf of the enterprise, unless his activities are limited to those mentioned in paragraph 3 which, if exercised through a fixed place of business, would not make that fixed place of business a permanent establishment under the provisions of that paragraph;

(b) he has no such 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

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 arms 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 business, whether wholly or partly, through a fixed place of business. The commentary of OECD on article 5 says that there must a fixed place of business which takes in not only a fixed premises but also machinery or equipment. The expression a fixed place indicates a certain degree of permanence. It is necessary that the business of the enterprise be carried on through a fixed place

(see C.I.T. v. Visakhapatnam Port Trust) (144 ITR 146). Para 2 is an inclusive provision which takes in various places and services enumerated in clauses (a) to (l ). A number of places are specified in clauses (a) to (k) whereas clause (l) postulates furnishing of services by an enterprise within a Contracting State through employees or other personnel. This clause is subject to the following alternative conditions. They are: (i) the activities of the nature of services continue within the state for a period or periods aggregating to more than 90 days within any twelve-months period; or (ii) the services are performed within that state for a related enterprise within the meaning of paragraph 1 of article 9 which deals with taxation of the profits of âAssociated Enterprisesâ. In the circumstances mentioned in the said para the enterprises are treated as related enterprises. Paras 4 and 5 are complementary. An agent of an independent status to whom para 5 applies, is excluded from para 4. Para 4 commences with a nonobstante clause and says that notwithstanding the definition of the expression P.E. outlined in paras 1 and 2, a person, other than an agent of independent status to whom para 5 applies, acting in a contracting state on behalf of an enterprise of the other contracting state shall be deemed to have a permanent establishment in the first mentioned state, if any one of clauses (a), (b) and (c) thereof applies. Clause (a) deals with a person who has and habitually exercises authority to conclude contracts on behalf of the enterprise in the first mentioned state unless (i) the activities are limited to those mentioned in para 3 (excluded activities) and (ii) if they are exercised through a fixed place of business, would not make that fixed place of business a permanent establishment under the provisions of that para. Clause (b) deals with a person who acts without authority. Clause (c) says that the person habitually secures orders in the first mentioned state wholly or almost 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 arms 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) (272 ITR 416), 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. The custodian and the banker were to keep custody of the contracts, clear the trades on exchanges, receive and disburse the cash and maintain adequate records. None of them was having any authority to conclude any transaction on behalf of the applicant. They were to render service to the applicant in the ordinary course of their business. The applicant was one of their clients. It was ruled by the Authority :

â(i) that paragraph 5 of article 5 of the Agreement for Avoidance of Double Taxation and Prevention of Fiscal Evasion between India and the U.K. provides that an enterprise of the Contracting State shall not be deemed to have a permanent establishment in the other Contracting State merely because it carries on business in that State through a broker, general commission agent or any other agent of an independent status provided such person is acting in the ordinary course of business. However, this is subject to an exception, namely, where activities of such an agent are wholly or almost wholly devoted for the enterprise or controlling enterprise. In such a situation such an agent shall not be considered an agent of independent status. Paragraph 4 of article 5 of the Agreement is couched in very wide language to take in its fold a person other than an agent covered by paragraph 5, which includes a dependent agent. But merely because an agent does not satisfy the test embodied in paragraph 5, he does not per se become a dependent agent so as to be called a deemed permanent establishment under paragraph 4. To bring a person within the meaning of permanent establishment under paragraph 4, the following conditions have to be satisfied: (i) the person must be acting in a Contracting State for and on behalf of an enterprise of the other Contracting State; (ii) such person must be other than an agent of an independent status to whom paragraph 5 of article 5 applies; (iii) in addition the activities of such person should fall under one of the three clauses, clauses (a) to (c), of paragraph 4. On the mere ground of an agent not being an independent agent falling under paragraph 5 he cannot be brought within the meaning of deemed permanent establishment under paragraph 4 as a dependent agent, unless (a) he has an habitually exercises authority to conclude contracts on behalf of the enterprise and the activities are not limited to the purchase of goods or 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 enterpriseâ.

In re (AAR/542/2001) (274 ITR 501), 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 principal basis. It was claimed that the American company did not own or otherwise operate through any business premises in India. The germane question was whether the applicant was a permanent establishment of the American Company. It was ruled by the Authority that the facts disclosed that the American company had vested interest in the business of the applicant which was not an independent contractor but was an agent of the American company which was carrying on business through the fixed place of business of the applicant, therefore, it had to be treated as permanent establishment of the American company for the purposes of article 5(1) of the treaty. In view of the findings that the applicant was an agent and was acting for and on behalf of the American company in the case of outbound consignments, booking orders collecting parcels etc. and also in the case of inbound consignments, the applicant was held to be permanent establishment under para 4 of article 5 of the treaty.

Mr. Chopra relied upon rulings of the Authority in re AAR P.No. 8 of 1995 (223 ITR 416) and in re AAR (P. No. 28 of 1999) (242 ITR 208). In the case first mentioned, the applicant was a Swiss Company. It proposed to set up a subsidiary in India to provide consultancy services from India for use outside India. In view of the terms of the proposed agreement the applicant sought an advance ruling, inter alia, on the question as to whether the applicant would have a permanent establishment in India. Having noted that the applicant had a controlled subsidiary company in India, which proposed to render services to the applicant as envisaged by the proposed agreements between them, it was ruled that there would be a permanent establishment of the applicant in India within the meaning of article 5.2(l) of the treaty.

In the second case, A, an Indian company and B of USA formed a joint venture AB for the production and sale of motor cars and automotive products. A and B each held 50% shares in the joint venture. The joint venture (AB) entered into an agreement with a German company to obtain a technology licence to produce certain motor vehicles. AB also entered into a management agreement with XYZ under which the managerial services were to be provided by it for development and operation of the business. Under the agreement, XYZ was to make available executive personnel for development of general management, finance 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:

âEven assuming that the inclusion clause should be interpreted âagainst the backgroundâ 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 âcontinuityâ or âdurabilityâ 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)â.

9. On the facts stated above, MSAS entered into a service agreement on 14th April, 2005 with (i) M/s Morgan Stanley and Co. International Ltd., UK, (ii) M/s Morgan Stanley and Co. Incorporated USA and (iii) Morgan Stanley Fund Services Inc. USA (for short they are referred to as âMorgan Groupâ). Under the said agreement, MSAS has undertaken to provide Morgan group support services. The business activities of the applicant and the support services provided by MSAS are noted in Annexure-II to the application thus:-

2.1 x x x x

2.2 â¦â¦â¦â¦â¦. The services can be broadly classified as follows:

(a) Support to front office business units â The activities classified here are those which provide back office support to various business units or front offices of the Applicant. The divisions under the category are:-

â¢ Investment Banking Division (âIBDâ)

â¢ Institutional Equities Division (âIEDâ)

â¢ Equity Financing Services Division (âEFSDâ) and

â¢ Fixed Income Division (âIFDâ)

(b) Support to infrastructure/support units â The activities classified here are those which provide support to various infrastructure/support units of the Applicant. These infrastructure/ support units do not generate any revenues for the Applicant. The divisions under the category are

â¢ Equity Research Division (âERDâ)

â¢ Business Information Services Division (âBISDâ)

â¢ Information Technology (âITDâ)

â¢ Institutional Securities Group â Marketing (âISGMDâ); and

â¢ Institutional Data Integrity (âIDIDâ); and

â¢ Other infrastructure as set out at Paragraph 2.3.2(f) below.

2.3 A brief description of the activities of the nature of work carried out by the divisions of the Applicant and by MSAS in India is discussed in the following paragraphs.

2.3.1 Support to front office business units.

(a) IBD: The IBD of the Applicant provides financial advisory services, corporate lending and securities underwriting. Globally, these services are further broken down into business development and execution of client work. The IBD of MSAS provides support to the business development activity of IBDs of the Group Members by preparing company and management profiles, maintaining industry database, assisting with statistical and financial analysis, monitoring industries, companies and deals etc.

(b) IED: The IED of the Applicant is engaged in broking/sale of cash and derivative equity financial products to institutional clients. IED primarily earns its revenues through brokerage services. IED within MSAS provides support to the IEDs of the Group Members by assisting in market data gathering for corporates, performing standard data collection and statistical analysis, supporting with power-point document products, reconciling swap/stock bookings etc.

(c) EFSD: The EFSD of the Applicant provides values added services to Hedge Funds and earns revenue through securities lending and from acting as a âPrime 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 and reconciliation services.

(d) 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.

2.3.2 Support to infrastructure business units

(a) 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 generated by the ERD are almost never sold to clients but are made available free of cost to them as a part of a value added service to the clients. They serve as a marketing tool. The ERD within MSAS supports the ERDs of the Group Members by compiling historical financial data, preparing spreadsheets, data mining, maintaining database etc.

(b) BISD: BISD of the Applicant addresses the information/data requirements of the various divisions of the Applicant by searching/downloading information available on the internet/publicly available databases. The BISD within MSAS supports the BISD of the Applicant as well as various divisions within MSAS by providing data/information as mentioned above.

(c) ITD: The ITD of the Applicant provides back office support in the form of providing IT assistance to various Group Members. Specially in India, the ITD within MSAS is involved in; gathering requirements for software enhancements, implementing software enhancements for new features, and fixing any software bugs and enhancements.

(d) ISGMD: The ISGMD of the Applicant supports various divisions on the applicant by providing information and analysis relating to various clients e.g. Client billing, no. of hours spent on a client, etc. The ISGMD within MSAS supports the ISGMDs of the Group Members by mining data from various internal databases, summarizing findings and results into PowerPoint presentations, designing metrics, ad hoc reporting etc.

(e) IDID: The IDID of the Applicant is engaged in the maintenance of client contact information for the Institutional Security Division of the Applicant, e.g. validating client addresses, updating client profits etc. The IDID of MSAS provides support to the operations of the IDIDs of the Group Members by validating client addresses, updating contact profiles etc.

(f) Other Infrastructure Groups

In addition to the infrastructure groups listed above, MSAS also provides services for the following infrastructure group: Compliance Support â Asia Pacific, Human Resources, Internal Audit and Company Strategy Planning.

â¢ For Compliance Support â Asia Pacific, MSAS assists in code of conduct implementation for new hires, assists in the monitoring of firm positions on securities across Asia, monitoring and surveillance of employee trading transactions in outside brokerage accounts that have been approved by the firm, monitoring and surveillance 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.

â¢ MSAS assists Human Resources (âHRâ) 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.

â¢ For the International Audit group, MSAS assists with general and application controls reviews and reviews of IT vendor management procedures.

â¢ For the Company Strategy Planning Group, MSAS helps collect, maintain and organize competitor data within already established spreadsheets, assists in organizing information in internal reports and coordinates with internal groups to collect data that is included in the internal quarterly competitor analysis presentation.

â¢ MSAS Corporate Action Validation (âCAVSâ) assists the Applicant by monitoring the flow of vendor data, researching and resolving conflicts, assisting in the adding of new announcements and updating terms, and researching and responding to inquiries from CAVS users.

â¢ MSAS also renders assistance to the Law Division (Netting Project Analyst) in reviewing financial contracts and completing fact sheets and reports, researching company documentation and information databases to retrieve contracts and information on counter parties, preparing simple spreadsheets populated with counter party information, researching and reviewing counter party websites for information and co-ordinating internally with divisions of the Applicant to obtain data for contract reports.

â¢ MSAS assists the Applicants Modelware group by assisting in the creation of internal client service responses and supporting the infrastructure related to Modelware. The MSAS Moderware group tracks and categorizes internal client queries, acts as an interface between internal clients and the Modelware group for new product roll outs, upgrades and other initiatives, works with the Modelware helpdesk to track requests, discern patterns and customize responses, generate ongoing assessments and improvement ideas in regards to the performance of Modelware, assist in gathering requirements for future product enhancements as well as certain liaison functionsâ.

2.4 x x x x x

3. x x x x x

4. x x x x x

To enable MSAS to provide these services, it is agreed between the parties that the applicant will send staff to MSAS (India) for stewardship activities and other similar activities and also on deputation in the employment of MSAS. The Morgan group agreed to pay to MSAS the actual sum of all costs together with an appropriate mark up mutually agreed between them.

We have carefully gone through the business activities of the applicant, the agreement and the support services provided by MSAS outlined above and considered the submissions of Mr. Desai and Mr. Chopra. We are of the view that it is not for this Authority to pronounce upon the validity of the agreement of service. We proceed on the footing that it is a valid 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 and 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 âdeliverables would be the exclusive property of the Morgan Stanley group. Clause 12, inter alia, postulates that if MSAS ceases to be member of Morgan group it would result in termination of the agreement; Clause 14 of the agreement lays down that MSAS will assign all rights, titles and interests including intellectual property rights and ownership rights in the deliverables to the Morgan Stanley group. MSAS will be using brand name, trade name as well as computer hardware of the Morgan Stanley and whatever is produced or developed by it, is passed on to Morgan Stanley group and it would have no right or interest in the said products. The staff deputed to the MSAS would be on the payroll of the applicant and the remuneration paid by it will be reimbursed by the MSAS. Out of total remuneration of Rs. 49,402,704/- paid to employees, reimbursement to associate company for deputed staff aggregates to Rs.24,220,631/-; performance appraisal, promotion and discipline etc. would be carried out in consultation with the applicant. Clause (4) of the agreement expressly stipulates that MSAS shall comply with all performance standards as specified by Morgan Group and that it shall comply with all reasonable directions or instructions of the group. Operation manual would be prepared and updated in conformity with the policy, procedures and practices of the Morgan group. Clause 7 enjoins upon MSAS to submit reports or other information concerning the services that the group may require. It further enjoins MSAS to attend all meetings convened for reviewing the services at the appointed time, place and agenda fixed by the group. By virtue of clause 8, MSAS is required to maintain complete record which would be subject to audit and investigation by the applicant. The persons authorized by the Morgan Group are provided unrestricted access to the business premises of the MSAS for audit and investigation. While clause 19 of the Agreement disables MSAS from disclosing the information contained in the software products to any party except the Morgan group which has the liberty to share the information with any member of the Morgan group. All this would show that the applicant would be in a position to exercise close control and supervision on the working of MSAS. Further these features in the agreement vividly bring out that the business of MSAS is inextricably linked with the business of the applicant and other two entities 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 ânot. The germane condition of carrying on business through fixed place of business of MSAS, not being fulfilled, article 5(1) of the treaty will not be attracted, therefore, in regard to question no. 1(a), MSAS can not be treated as the permanent establishment of the applicant and/or Morgan group.

So far as question 1(b) is concerned, we have already referred to the scope of para 4 of article 5 of the treaty. To constitute MSAS a PE of the applicant/Morgan group, it has to be shown that (1) MSAS is acting in India on behalf of the applicant/Morgan Group of US; (2) MSAS is a person other than an agent of independent status to whom para 5 applies; (3) MSAS (a) has and habitually exercises an authority to conclude contracts on behalf of the applicant ; (b) has no such authority but habitually maintains a stock of goods or merchandise from which it regularly delivers goods on behalf of the applicant; or (c) habitually secures orders in India wholly or almost wholly for the applicant/Morgan Group. Clause 21.5 of the Service Agreement is pressed into service by Mr. Desai to show that no provision of the agreement creates a partnership or agency between the parties and no party has any authority to bind, to contract in the name of other or to create liability for any other party, in any other way or for any other purpose, and it is submitted that MSAS renders services to the applicant in its independent capacity and cannot be regarded an agent of the applicant. It is necessary to observe that a stipulation in an agreement, such as clause 21.5 referred to above, is never determinative of the question as to whether one party to the contract is the agent of the other party. The question needs to be decided on a reading of the agreement as a whole.

In Dun and Bradstreet Espana, S.A. (272 ITR at page 110 31), after exhaustive consideration of the definitions of the term âagentâ, the Authority noted,

âA close reading of the above extract brings out the essence of the term agent. An âagentâ works for another in accordance with his authority while dealing with third partiesâ.

In a recent ruling In re AAR. 542 of 2001 (supra 3), the Authority has again considered the distinction between the âagent and the âcontractor and has held that though contractor is independent of any control or interference and is only bound to produce the specified result as per the contract, the agent has to exercise his authority 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 company and not to MSAS (clause 2.4 of the agreement); the obligation of a customer is only to MSAS whereas the customer has no obligation vis-Ã -vis another (clause 1.5 of the agreement); the service agreement entered into by the applicant and MSAS is a unilateral agreement with all disability and disqualification fastened to the supplier alone; thus, in short, it is unconscionable contract, are wholly irrelevant to this question.

In the light of the above principles, we have to examine whether the service agreement creates any agency PE between the applicant/Morgan group and MSAS for the purpose of para 4 of article 5 of the treaty. We would point out that for the purpose of para 4 it is not necessary that MSAS should be an agent of the applicant/Morgan group. It is enough if it satisfies the above mentioned three requirements which are cumulative. So far as requirement (1) is concerned, we have held above that MSAS is acting in India on behalf of the applicant/Morgan group. Regarding requirement (2), according to the applicant MSAS is not agent and according to the Commissioner, it is not an agent of independent status thus admittedly this requirement is also satisfied.

Having carefully gone through the facts and contentions of the parties both oral and written we cannot but hold that there is no material to record a finding that any of the three requisites of requirements (3) is also satisfied. It follows that paragraph 4 of article 5 will not be attracted for the purpose of sub-question (b) of question no.1 and therefore MSAS can not be held the agency PE of the applicant/Morgan group.

Taking up sub-questions (c) and (d) of question 1, the ingredients of para 2(l) of the treaty have to be fulfilled. We have noted them earlier. From the terms of agreement referred to in the discussion, it is understood that employees of the applicant are to be sent to MSAS whether for stewardship activity or on deputation basis for more than 90 days. Nowhere it is stated by the applicant that they would be working with MSAS for less than 90 days. What is sought to be clarified is that employees are not yet sent. It hardly makes any difference because advance ruling is given on the basis of the agreement, which postulates sending of employees on deputation. Mr. Desai has emphasized that the staff would be working for the applicant only. We are unable to accede. It 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. However, during the hearing both clauses (i) and (ii) of the first proviso are argued elaborately. It may not be out of place to mention that if any one of the clauses of the first proviso applies, the question has to be rejected.

It will be apt to refer to section 245R (2) of the Act which is in the following terms: -

Procedure on receipt of application

245R. (1) xx xx xx xx xx xx xx xx xx xx xx xx xx

(2) The authority may, after examining the application and the records called for, by order, either allow or reject the application.

Provided that the Authority shall not allow the application where the question in the application â

(i) is already pending before any income-tax authority or Appellate Tribunal [except in the case of a resident applicant falling in sub-clause (iii) of clause (b) of section 245N] or any court;

(ii) involves determination of fair market value of any property;

(iii) relates to a transaction or issue which is designed prima facie for the avoidance of income-tax [except in the case of a resident applicant falling in sub-clause (iii) of clause (b) of section 245N]:

Provided further that no application shall be rejected under this sub-section unless an opportunity has been given to the applicant of being heard:

Provided also that where the application is rejected, reasons for such rejection shall be given in the order.

Sub-section 2 of 245 of the Act empowers the Authority to either allow or reject the application after examining the same and the records called for by an order. The first proviso enjoins that the application shall not be allowed when the question raised in the application â

(i) is already pending before any income-tax authority or Appellate Tribunal [except in the case of a resident applicant falling in sub-clause (iii) of clause (b) of Section 245N] or any court;

(ii) involves determination of fair market value of any property;

We shall advert to the first proviso presently. The second proviso of sub-section (2) of Section 245N of the Act enjoins that before rejection of the application an opportunity of being heard shall be given to the applicant and it is in compliance with this proviso 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 âquestion. in the said proviso indicates a disagreement between the parties; he relies on the meaning of the term in Blacks law dictionary, observations in Jagtar Singh v/s Commissioner of Income-tax (213 ITR 512) and a passage from the âHand Book on Advance Rulings. We find no merit in the contention. In Blacks Law dictionary, the meaning of the term is given thus :

âQuestion. A subject or point of investigation, examination or debate; theme of inquiry; problem; matter to be inquired into, as subject matter or civil or criminal discovery. A point on which the parties are not agreed and which is submitted to the decision of a judge and jury. See also issue.

An interrogation put to a witness, for the purpose of having him declare the truth of certain facts as far as he knows them; e.g. direct or cross examination of witness at trial. See also Discovery; Interrogationâ.

It is obvious that the term has various meanings. It is a well-settled proposition that a word takes its meaning from the context in which it occurs. Out of diverse meanings, noted above, having regard to the context of clause (i) of the first proviso the term âquestion would mean âa point of investigationâ or âtheme of enquiry. It is in this sense, an applicant also uses the term when formulating a question to seek advance ruling of the Authority. Another meaning of the term is âexamination; it is in that sense the term is used popularly by people when referring to a âquestion paper. This shows that the meaning suggested by the learned counsel is not the only meaning of the term and the aforementioned examples would establish this position. .

The following passage in Jagtar Singh v/s Commissioner of Income-tax (supra 7) is relied upon by Mr. Desai:-.

â A question might arise as to whether the assessees act of filing the return including the amount of arrears in his return will preclude him from approaching the authority for a ruling. It is clear it does not. In the first place, there is no pending dispute between the applicant and the income-tax Department because the return has been processed under Section 143(1) and the refund as prayed for by the applicant has been grantedâ.

A perusal of the above passage shows that the Court was considering whether the assessees act of filing the return including the amount of arrears in his return would preclude him from approaching the authority for a ruling. Having recorded the reply in the negative, the Court pointed out that no dispute was 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 âHand book on Advance Rulings (page 24 of Tax Payers Information Series-20 published by Income Tax Department, New Delhi)â which reads as follows:-

ââ¦.. 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. â (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 applicants submission.

The second limb of the contention of Mr. Desai is that the question cannot be said to arise on filing of the return, it would arise only when the CIT grants approval under section 92CA to refer to computation of arms length price in relation to international transaction under section 92C to the Transfer Pricing Officer. Mr. Chopra relies on instruction No. 3 of 2003 vide F.No. 500/19/2003-FTD dated 20th May, 2003 issued by the Foreign tax Division of Ministry of Finance, Department of Revenue (which says that where the aggregate value of international transaction exceeds Rs. 5 crore, the Board has directed the Assessing Officer to refer all such cases to the Transfer Pricing Officer) and submits that as grant of approval by the Commissioner would be a mere formality, therefore after filing return the question of computation of arms length price would be deemed pending before the Assessing Officer.

It would be necessary to refer to the following dates which are relevant to the contentions of the parties:-

28.10.2004

For the assessment year 2004-05 the return was filed by the MSAS

13.04.2005

Notice under section 143(2) was issued

15.04.2005

16.04.2005

Letter of DIT Transfer Pricing for referring the cases was issued

Notice under section 143(2) was received by the applicant

16.5.2005

ITO (9-23) Mumbai sought approval for reference of the CIT

18.5.2005

The present application was filed by the applicant before the AAR.

20.5.2005

CIT(9), Mumbai granted approval for referring the case to TPO

25.5.2005

The reference is made to TPO.

It appears no report has been received from the TPO so far.

It would be useful to refer to the relevant portion of the said instructions which read as under:-

âInstruction No.3 of 2003

261 ITR (St.) 0051

F.No.500/19/2003-FTD

Government of India

Ministry of Finance

Department of Revenue

(Foreign Tax Division)

New Delhi, the 20th May, 2003

All Chief Commissioners of Income Tax

All Directors Generals of Income Tax

Sub: Computation of income from international transaction having regard to arms length price â Section 92 of the income-tax Act â Reference to Transfer Pricing Officer and his role âRegarding.

The provisions relating to transfer price contained in Sections 92 to 92F of the Income-tax Act having come into force w.e.f. assessment year 2002-03. In terms of provisions, income from an international transaction is to be computed having regard to Arms 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 Arms 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:

(1) Reference to Transfer of Pricing Officer (TPO)

The Power to determine Arms 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 Arms length price in relation to an international transaction to the TPO. Sub-section (3) of section 92CA provides that the TPO after taking into account the material available with him shall, by an order in writing, determine the arms length price in accordance with sub-section (3) of section 92C. Sub-section (4) of section 92CA provides that on receipt of the order of the TPO, the Assessing Officer shall proceed to compute the total income of the assessee having regard to the Arms length determine by the TPO. Thus, whereas the determination of the arms length price wherever reference is made to him, is required to be done by the TPO under sub-section (3) of section 92CA read with sub-section (3) of Section 92C, the computation of total income having regard to the arms length price so determined by the TPO is required to be done by the Assessing Officer under sub-section (4) of section 92C read with sub-section (4) of section 92CA.

In order to make reference to the TPO, the Assessing Officer has to satisfy himself that the taxpayer has entered into an international transaction with an associated enterprise. One of the source from which the factual information regarding international transaction can be gathered is Form No. 3CEB filed with the return which is in the nature of an accountants report containing details of an international transaction entered into by the tax payer during the year and the associated enterprise with which such transaction is entered into, the nature of document maintained and the method followed. Thus, the primary details regarding such international transactions would normally be available in the accountants report. The AO can arrive at prima facie belief on the basis of these details whether a reference is considered necessary. No detailed inquiries are needed at this stage and the assessing officer should not embark upon scrutinizing the correctness or otherwise of the price of the international transaction at this stage. In the initial years of implementation of these provisions and pending development of adequate database, it would be appropriate if a small number of cases are selected for scrutiny of transfer price and these are dealt with effectively. CBDT, therefore, have decided that wherever the aggregate value of international transaction exceeds Rs.5 crore, the case should be picked up for scrutiny and the reference under section 92CA be made to the TPO. If there are more than one transaction 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.â

From a perusal of the excerpt, quoted above, it is evident that under the heading âReference to Transfer Pricing Officer (TPO), the first paragraph has summarized the position under the Act. The second para thereunder notes and states that one of the sources from which the factual information regarding international transaction can be gathered is in Form No. 3CEB filed with the return which is in the nature of an accountants report containing basic details of an international transaction entered into by the tax payer during the year and the associated enterprise with which such transaction is entered into and thus the primary details regarding such international transaction would be normally available in the accountants report. On the basis of those details, the AAO can arrive at prima facie belief as to whether the reference is considered necessary. It records that the CBDT have decided that wherever the aggregate value of international transaction exceeds Rs. 5 crore, the case should be picked up for scrutiny and the reference under section 92CA be made to the TPO. It also notes that before making reference to TPO, the AO has to seek approval of the Commissioner/Director as contemplated under the Act. Since in the instant case the value of international transaction exceeds Rs. 5 crore, it will have to be selected for scrutiny and making reference to the TPO. In view of the directions of CBDT the picking up of the case by the AO and grant of approval by the Commissioner/Director in cases where the aggregate value of international transaction exceeds Rs. 5 crore are mandatory.

On the facts of the present case the value of international transaction is admittedly more than Rs. 5 crore; it cannot but be said that by virtue of above mentioned instruction of CBDT, particularly in view of letter of DIT Transfer Pricing dated 15.4.2005, the question of determination of arms length price by the TPO in terms of Section 92C of the Act had already arisen in the mind of and is pending before AO who has no option but to follow the instructions of CBDT and direction of DIT. We are, therefore, of the view that on the ground that CIT granted approval two days after filing of the application by the applicant in AAR, it cannot be validly contended that the question of determination of arms length price is not pending before the AO who is as much as income tax authority as TPO. If this be the position, clause (i) of the first proviso will apply and the application in so 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 arms 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 âComputation of arms length priceâ and reads as follows.

Section 92 C

Computation of arms length price

(1) The arms 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 prescribed.

It provides that arms length price in relation to an international transaction shall be determined by any of the following methods being the most appropriate method, having regard to the nature of the 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 prescribe :-

(a) comparable uncontrolled price method;

(b) resale price method;

(d) profit split method;

(e) transactional net margin method

(f) such other method as may be prescribed by the Board.

The most appropriate method referred to in sub-section(1) of Section 92C of the Act shall be applied for determination of arms length price in the manner as may be prescribed. Rule 10B of the Rules provides for determination of arms length price under section 92C of the Act and Rule 10C of the Rules says that for purposes of sub-section (1) of Section 92C of the Act, the most appropriate method shall be the method which is best suited to the facts and circumstances of each particular international transaction and further provides the most reliable measure of an arms length price in relation to the international transaction. Sub-rule (2) of Rule 10C enumerates six factors which have to be taken into consideration in selecting the most appropriate method. The expression âinternational taxation is defined in Section 92B of the Act. It is obvious, the meaning of the expression âinternational transaction as defined in Section 92B of the Act read with Rules 10B and C of the Rules is exhaustive. It takes in its fold a transaction between two or more associated enterprises either or both of whom are non-residents, not only in the nature of purchase, sale or lease of tangible or intangible property but also provision of services, or lending or borrowing money, or any other transaction having a bearing on the profits, income, losses or assets of such enterprises. The contention of Mr. Desai that the services cannot be treated as tangible and intangible property ignores the definition of the meaning of international transaction in section 92B of the Act which covers services that are subject matter of the agreement.

We have already discussed above that under the agreement MSAS has not only to provide Research Support, Quantitative Modeling and Account Reconciliation but also hand over 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 arms length price, there should be no additional profits attributable to the applicant or MSAS in India. Circular No. 23 of 1969 dated 23rd July, 1969 and Circular No. 5 of 2004 dated 25th September, 2004 are quoted to show that the amount taxable in India would be only that much as is attributable to operations of MSAS. This is too well settled to admit of any elaboration. Mr. Chopra contends, in his written submission that article 7 of the Treaty adopts the force of attraction rule as against attribution rule adopted in many countries. By attraction rule the scope of profits of the enterprise liable to be taxed in other contracting state would get expanded and if the applicant has any business activity in India which is in any manner connected with the permanent establishment, income therefrom would also be liable to be taxed in India. He elaborates stating that if the applicant carries on in India any activity connected with shares, derivatives, bonds, debentures etc. even if such transaction are carried out directly, income would be liable to be taxed in India in view of the force of attraction rule. We find it hard to accept such an expansive contention of Mr. Chopra, which in our view, runs counter to article 7(1) of the treaty. Section 92C of the Act requires that international transaction between associated enterprise should be at arms length price. It would satisfy the requirement of Section 92C of the Act if MSAS is remunerated for its services at arms length price. Further article 7 of the treaty makes it clear that where the enterprise carries on business in the other Contracting State through a permanent establishment situated therein so much of the profits of the enterprise as is attributable to that permanent establishment, may be taxed. The requirement of the profits being through permanent establishment, is also contained in clauses (b) and (c) of para 1 of article 7 of the Treaty. When transactions of shares, derivatives etc. are carried on in India by the applicant dehors MSAS, the same do not appear to be taxable under the Treaty. We hasten to add that our rejection of the contention of Mr. Chopra should not be understood as giving ruling on the aforesaid proposition since it is not the subject matter of the question.

Now, turning to question no. 5 the first part of question, â in the event the Applicant is deemed to have a PE in India as result of sending employees to India or due to deputation of employees to MSAS, whether given the function which would be performed and risks that could be undertaken by such a PEâ is the premise which is consequential to the ruling on question no. 1(c) and (d); the second part of question which states âwould a remuneration based on a margin on total operating cost of the PE be the appropriate profit attributable to such a PEâ, 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 applicant in India under Article 5(2)(l) of the Treaty if it were to send some of its employees to India on deputation in the employment of MSAS for a period beyond ninety days;

2. that the question is liable to be rejected in view of the first proviso to sub-section (2) of Section 245R of the Act;

3. that as this question is dropped, we decline to pronounce any ruling on it.

4. that based on the facts and circumstances of the case, as long as MSAS, being the PE of the applicant in India, is remunerated for its services at arms length by the applicant/Morgan group and as long as all its actual income is brought to tax, no further income can be attributed in the hands of the PE of the applicant.

5. that as the first part of the question which is consequential to question nos. 1(c) and (d) 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); in as much as question no. (2) is rejected and question no. (3) is dropped, no ruling need be given on this question.

Pronounced in the open Court of the Authority on this 13th day of February, 2006.

Court	Authority for Advance Rulings
Decided On	Feb-13-2006
Case Number	A.A.R. NO. 661 OF 2005
Judge	Honâble Mr. Justice Syed Shah Mohammed Quadri (Chairman)Mr. A.S. Narang (Member)
Appellant	Morgan Stanley and Co.
Respondent	Dit(international Taxation)mumbai
Advocates:	Present for the Department : Mr. T.N. Chopra, Advocate. Mr. Fuzail Ahmad Ayyubi Advocate Present for the Applicant : Mr. Nishith Desai and others.

Morgan Stanley and Co. Vs. Dit(international Taxation)mumbai - Court Judgment