Recently in Morgan Stanley International Incorporated vs. Deputy Director of Income-tax, it was held that the NR rendering support services to Indian subsidiary through seconded employees constitute its service PE in India and thus, are not taxable in India in the hands of NR.   

Facts of the case:
The Morgan Stanley International Incorporated (assessee) was a tax resident of USA. It provided support services to various Indian subsidiary companies. The assessee-company after deducting TDS under section 192 paid the salary of the employees who were seconded to Indian subsidiary companies. Afterward, the Indian company had reimbursed the entire salary paid by the assessee. The assessee did not paid any tax in India on the reimbursement made by the Indian company to the assessee.
The Assessing Officer held that the payment received by the assessee for rendering the services through its employee was taxable in India. The AO highlighted the article 12 (4) of the DTAA, being in the nature of ‘fees for included services’ (FIS).
“fees for included services” means payments of any kind to any person in consideration for the rendering of any technical or consultancy services (including through the provision of services of technical or other personnel) if such services:
a.are ancillary and subsidiary to the application or enjoyment of the right, property or information for which a payment described in paragraph 3 is received; or make available technical knowledge, experience, skill, know-how. or processes, or consist of the development and transfer of a technical plan or technical design.
Thus, the AO added the amount of reimbursement to the assessee’s income. On this, the assessee appealed to the Commissioner (Appeals). On reviewing the matter, the Commissioner (Appeals) upheld the AO’s order.
Aggrieved by the order, the assessee appealed to the Tribunal.
It was held that:
The Tribunal viewed that to extend the business worldwide, the international business entities have established their own subsidiaries from whom they have business arrangement. These overseas entities depute their technical staff in the other countries to support their global business functions.
The assessee made a seconded agreement. Under this, the seconded employees of the parent non-resident parent company are transferred to subsidiary company in the overseas countries to work for special assignments which are more technical and managerial in nature.  Though the control and supervision of these employees are with the Indian company, salaries are paid from the parent company. The salary cost and remuneration are reimbursed by the subsidiary company to the parent entity. Once the terms of secondment is over, they revert back to their parent company entity. It can be said that the subsidiary entity bears the salary cost of the seconded employees. The reimbursement of cost cannot be treated as payment for FTS or FIS, unless there is an explicit agreement between the parties that technical services would be provided through these employees.
In this case, the assessee has been that, seconded employees were under direct control and supervision of Indian entity who were managing their activities on day – to – day basis and the assessee was only paying their salary for the employees convenience and benefit. The Supreme Court in a case held that the employees of overseas entities to the Indian entity constitute services PE in India.
Thus, from the aforesaid decision it is amply clear that such deputed employees if continued to be on pay rolls of overseas entities or they continue to have their lien with jobs with overseas entities and are rendering their services in India, service PE will emerge. It is therefore, held that the seconded employees or deputationist working in India for the Indian entity will constitute a service PE in India. If this is the case then the reimbursement would be taxable under Article 12(4) of India-US DTAA.
Para 6 of Article 12 states that taxability of ‘royalty’ and ‘fees for included services’ shall not apply, if the resident of the contracting state (USA) carries on the business in other contracting states (India) in which FIS arises through PE situated therein, then in such case the provisions of article 7, i.e., ‘Business profits’ shall apply. In other words, if there is a PE, then royalty or FIS cannot be taxed under Article 12, albeit only under article 7 of the DTAA.
Thus, the payment made by the Indian entity to the assessee on account of reimbursement of salary cost of the seconded employees will have to be seen and examined under article 7 only, that is, while computing the profits under article 7, payment received by the assessee is to be treated as revenue receipt and any cost incurred has to be allowed as deduction because salary is a cost to the assessee which is to be allowed.
Accordingly, the Assessing Officer is directed to compute the payment strictly under terms of article 7 and not under article 12 of the DTAA. In view of the aforesaid finding, the grounds raised by the assessee is treated as allowed.