In a relief to captive BPOs of foreign firms operating in India, the Supreme Court today held that outsourcing activities by Morgan Stanley Advantage Services (MSAS), the Indian arm of the US investment banker, was not liable to be taxed in the country.

Upholding the Authority for Advance Ruling (AAR) order, a bench headed by Justice S H Kapadia said MSAS was not a permanent establishment (PE) as it was performing only back office operations in India and cannot be taxed under PE rules.

The bench also partly allowed the appeals of both income tax department and investment banking firm Morgan Stanley.

“There was no agency PE as the PE in India had no authority to enter into or conclude the contracts. The contracts would be entered in the US. The implementation of those contracts only to the extent of back office functions would be carried out in India,” the apex court ruling said.

However, the court held that Morgan Stanley Advantage Services would be a service PE in India under Article 5(2)(1) of the India-US Tax Treaty on account of the services to be performed by officials deputed by Morgan Stanley and not on account of stewardship activities.

On determining tax liability, it said: “The Transactional Net Margin Method (net profit margin realised 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.” Agreeing with the computation by the income tax department, it said: “We accept as correct the computation of the remuneration based on cost plus mark-up worked out at 29 per cent on the operating costs of MSAS.”