BPOs date with SC on tax soon

The tax treatment of foreign companies setting up BPO units is in focus again. The Supreme Court will consider next week whether or not to admit a special leave petition (SLP) filed by the income-tax department challenging the decision of the Authority for Advance Ruling (AAR) in Morgan Stanley’s case.

AAR — which is a quasi-judicial body — had ruled that the business process outsourcing done by the Indian subsidiary of Morgan Stanley will not constitute a permanent establishment (PE) or a fixed place of business in India. If there is no PE, the parent company will not have to pay corporate tax in India on a portion of its profits.

Simply put, AAR’s ruling meant that a portion of Morgan Stanley’s global profits are not liable to be taxed in India as long as it pays an arm’s length price to the Indian subsidiary. “AAR’s ruling is in line with the Central Board of Direct Taxes’ circular which broadly states that the foreign parent will not have any extra tax liability in India if it compensates its Indian subsidiary on an arm’s length basis. The critical issue here will be the mapping of the BPO unit’s functions to see whether it is an extension of the foreign company,” according to Vispi T Patel, head-transfer pricing, RSM & Co.

The government probably wants to examine whether the activities of the BPO are linked to the parent company’s. In such a case, there could be a rationale to tax a portion of the profits earned by the foreign company. After all, the government also wants a share of the tax pie.

“We recommended filing an SLP in the Supreme Court challenging some grounds of AAR’s ruling. The petition has been filed after consulting the law ministry,” BM Singh, Director General, International Taxation, told ET.

AAR’s rulings are binding on the tax payer and the department. It also has a persuasive value. AAR’s ruling in the Morgan Stanley case came as a relief to foreign companies outsourcing their back office functions to Indian companies, specially to captive service providers.