The Hindu Business Line : Concept of Service PE under Indo-US Treaty

The concept of service PE exists only in the UN Model and certain Indian treaties. No such concept exists in the US model, although it was incorporated in the Indo-US treaty.

The Authority for Advance Ruling (AAR) in the Morgan Stanley & Co, US(Business Line, June 10) case held that MSAS, incorporated in India, formed the service Permanent Establishment (PE) for Morgan Stanley, under Article 5(2)(l) of the Indo-US Treaty, if it were to send some of its employees to India for taking up stewardship activities or on deputation in the employment of Morgan Stanley, since such employees would be actively involved in the key managerial activities of MSAS and would not be working for Morgan Stanley.

Service PE under US treaty

To understand the concept of a service PE, para (1) and sub-para (2)(l) of Article 5 of this Treaty are reproduced below:

For the purposes of this Convention, the term PE means a fixed place of business through which the business of an enterprise is wholly or partly carried on.

The term PE includes especially the furnishing of services... within a contracting state by an enterprise through employees or other personnel.

Furnishing of services need not be from a `fixed place' to form a PE. If the conditions prescribed in sub-para (l) are complied, the US enterprise would be deemed to have a `fixed place of business' in India.

The concept of service PE exists only in the UN Model and certain Indian treaties. No such concept exists in the US model, though it was incorporated in the Indo-US Treaty. In its absence, a PE can be formed only if service activities are provided from a fixed place of business or by a dependent agent.

Before the AAR, it was argued that the service PE does not exist.

The applicant sends staff to MSAS for certain stewardship functions, only to ensure that MSAS adheres to the stringent quality benchmarks and other requirements of the Morgan Stanley group so as to protect the interests of the shareholders of Morgan Stanley US. Therefore theemployees are not involved in the management of MSAS. Briefing and providing basic training to MSAS staff on the job for effective transitioning of projects is to ensure the best output of MSAS and to minimise the risk arising to the US arm from the outsourcing of services to MSAS.

Exception to service PE

Though the AAR did not agree with this view, it is to be seen whether the argument could have support from para 3 of the Treaty, which was not discussed, by the Authority.Sub-para (e) may raise doubts, whether only activities especially specified in sub-para (e), only, were not to be considered to constitute PE.

The OECD MC 77 made clear that the list of exceptions is not meant to be exhaustive, but is designed to include the whole variety of range of auxiliary activities. It also clarified that `where a fixed place of business serves a variety of favoured activities, rather than just a single one, if the activities establishing a PE are exercised alongside `lesser' auxiliary activities, they will create a PE'. However, this may not hold good in regard to the US Treaty, because of initial qualifying phrase `any one or more' in the beginning of para 3.

In the context of the US model, having exception to `combination of different excepted activities', Mr Klaus Vogel states (pp 324, item 121) that, "a combination of different excepted activities will in no event constitute a PE." This view should also apply to the Indo-US Treaty, having the phrase `any one or more', as long as the combined activities taken together retain their preparatory or auxiliary character.

Nature of stewardship activities

The Authority accepted the contention of the Department that MSAS was carrying out activities in India on behalf of Morgan Stanley US. What are these activities? MSAS has not only to provide Research Support, Quantitative Modelling and Account Reconciliation but also hand over deliverables, which include hardware, intellectual property, software, etc. These are `scientific research' activities, falling into excepted activities of sub-clause (e) of para 5(3). Service PE cannot be constituted by MSAS from these activities. Do stewardship and other similar activities fall within the phrase `other activities'?

The stewardship activities do not fall in the instances of negative list of preparatory and auxiliary activities. These would fall within the excepted activities in para 3 and should not form a service PE.

Can cumulative activities be regarded as a facility serving a preparatory or auxiliary purpose? Mr Klaus Vogel states (pp 322, item 117a) that, "a combination of preparatory or auxiliary activities cannot constitute a PE unless and until it leads to the emergence of a facility, which would be economically viable if separated from the enterprise to which it belongs."

The AAR considered the activities of MSAS, whereas for service PE we have to consider whether the stewardship activities of Morgan Stanley in India led to emergence of a facility which would be economically viable, if separated from the US arm.

The employees of Morgan Stanley US may look like furnishing services to MSAS, but, in fact, they furnish their services to Morgan Stanley US and are working for the same. In this process, the benefits may inure to MSAS. The Authority may not be correct in its conclusion that `it may be that the benefit of services of the staff would be inured to Morgan Stanley but it would not be the same thing as working for Morgan Stanley'.

(The author, a former Chief Commissioner of Income-Tax, can be reached at s_bhargava2005@rediffmail.com)