January 30, 2008
An update on the recent international tax rulings in
Supreme Court rejects the review petition of the revenue in
the case of Morgan Stanley
The Supreme Court of
India (“Supreme Court”) dismissed the review
petition filed by the Income-Tax Department (“Revenue
Authority”) in the case of Morgan Stanley & Co. U.S (“Morgan
Stanley”), relating to taxation of back
office operations of foreign companies in India. Thus, the
favourable ruling in the case of the outsourcing industry has become the
law of the land in India.
The Revenue Authority by means of a special leave
petition (“SLP”) had initially challenged the
ruling of the Authority for Advance Rulings (“AAR”), wherein the AAR had ruled that captive service
provider would not form a permanent establishment (“PE”)
of Morgan Stanley.
The SLP filed by the Revenue Authority was
disposed off by the Supreme Court.
While disposing the SLP, the Supreme Court held that services
rendered by personnel of the parent company on deputation to the
captive service provider would constitute a PE. However, if the
personnel of the parent company were engaged in stewardship
activities in the captive group company, then the same would not
constitute a PE in India. Further, the Supreme Court also held
that an arm’s length relationship between a non-resident
enterprise and its PE in India absolved the non-resident
enterprise from any further profit attribution.
The SC entertains
review petitions against its own rulings in very rare cases. The
dismissal of the Revenue Authority’s review petition brings with
it the much need certainty that was required in relation to
taxation of back office operations of foreign companies in India.
The Vodafone Saga!
The Writ Petition filed by Vodafone Essar Limited (“Company”)
before the Bombay High Court Division Bench (“High Court”)
against the show cause notice issued by the Revenue Authority
is currently sub-judice. The Revenue Authority via the show cause
notice had raised a tax demand of approximately US$ 2.1 billion
from the Company.
Hutchison had sold shares of its Cayman Islands holding company
to Vodafone International Holdings BV (“Vodafone
International”), a Dutch Company. The Revenue Authority
alleged that Vodafone International had indirectly acquired the
beneficial interest in the Company and it would get ownership
and control of assets in India. The Revenue Authority also
alleged that the Company had a Business Connection with the
seller i.e. Hutchison and hence gains earned by Hutchison would
be subject to capital gains tax in India. Since Vodafone
International had failed to withhold the tax at source, its
Indian subsidiary was held to be its ‘agent’ and an ‘assessee
(taxpayer) in default’.
The Revenue Authority raised a preliminary objection on the
ground of maintainability of the Writ Petition. Writ Petitions
are normally entertained inter alia only if all alternative
remedies are exhausted or there is prejudice in the minds of
revenue. Presently, the High Court has put a stay on the the tax
demand raised from the Company and fixed the matter for final
hearing on March 10, 2008. A similar case has also been
initiated by the Revenue Authority in the case of Genpact, which
was the captive outsourcing subsidiary of GE. GE sold a part of
its stake to private equity investors. Genpact has filed a Writ
Petition which is scheduled to be heard by the Delhi High Court
in early February.
This case will have a significant bearing on many inbound
investment structures where shares of overseas holding companies
 (2007) 7 SCC 1