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India: Creation of service PE by activities of employees deputed to India



Rajendra Nayak

Aastha Jain

The Mumbai Income Tax Appellate Tribunal (Tribunal) recently ruled on the taxability of payments received under a deputation arrangement in the case of Morgan Stanley International (taxpayer). Taxpayer, a resident company in the US, was engaged in the primary activity of providing support services to group companies located in various countries, including India. During the tax year under consideration, the taxpayer deputed five of its employees to its Indian subsidiaries (I Cos), who worked under the control and supervision of the board of directors of I Cos. Further, I Cos were responsible for the day-to-day activities of the deputed employees. The taxpayer paid salary to the deputees on behalf of I Cos after withholding taxes as per the provisions of the Indian Tax Laws (ITL). Subsequently, the taxpayer recovered the amount of salary paid (without any mark-up) from the I Cos. The issue was with regard to the taxability of the salary amounts recovered from I Cos.

Taxpayer contended that the amount received from I Cos was in the nature of pure reimbursement of salary costs and, since there is no income element embedded in it, it was not taxable in India. However, the Indian tax authority rejected the above claim with a view that the deputed employees were highly qualified and technical persons providing consultancy services to I Cos. Further, the technical knowledge, experience, skill, know-how and so on were "made available" to I Cos through these services. Hence, the payment is taxable as fees for technical services (FTS) or as fees for included services (FIS) under the ITL as well as under the India-US double taxation avoidance agreement (DTAA).

The Tribunal observed that the taxpayer was the "real employer" of the deputed employees. Drawing support from the Supreme Court decision of Morgan Stanley (292 ITR 416), it was held that the deputed employees created a service permanent establishment (PE) for the taxpayer in India, since they continued to be on the payroll of the taxpayer or continued to have lien of their jobs with the taxpayer and they rendered services on behalf of taxpayer in India. Further, it was held that once a service PE is created, the provisions of FIS article under the DTAA would not apply. This is clear from the express terms of the FIS provision of the DTAA, which excludes profits in connection with PE from its ambit. The Tribunal directed the tax authority to compute the income of the taxpayer as per the "business profits" provision of the DTAA, by treating the payment received from I Cos as a business income in the hands of the taxpayer and by allowing the salary costs of the deputed employees as deduction in the hands of I Co.

This ruling of the Tribunal clarifies the non-applicability of FIS article of India-US DTAA, where a PE is created and helps taxpayers to evaluate their taxability under similar arrangements.

Rajendra Nayak ( and Aastha Jain (


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