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India's Outsourcing Sector Boosted By Tax Ruling

by Lorys Charalambous,, Cyprus

11 July 2007

India's Supreme Court has said that outsourcing activities carried out by a unit of Morgan Stanley in India are not liable for Indian taxes, in a case that was being keenly watched by other major multinationals with operations in India.

The Supreme Court bench, headed by Justice S. H. Kapadia, was of the opinion that Morgan Stanley Advantage Services (MSAS) was not liable for tax in India since it was a back office processing unit, and did not constitute a permanent establishment in the country.

"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 judgment stated.

However, the court also said that the parent company would have to pay an appropriate "arms length" price to the Indian subsidiary, otherwise tax could be imposed.

The ruling is likely to be viewed with some relief by the numerous other multinational companies such as HSBC and Standard Chartered which have outsourced their back office and administrative functions to India.

The outsourcing industry has been a boom sector for the Indian economy in recent years, but the tax authorities have been unsure on the tax status of such companies, known as ‘BPOs’ (Business Process Outsourcing firms). Tax uncertainty was heightened when the Indian government notified firms in 2003 that a BPO would be liable for income tax on earnings which related to their parent company’s core business. The BPOs opposed the move, arguing that the services being provided were sold to foreign customers, and that therefore foreign firms should be liable for tax.

A Morgan Stanley official speaking after the verdict said that "significant certainty" on the taxation of BPOs had been restored by the Supreme Court.

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