In the Morgan Stanley & Co Inc. judgment,[1] the Supreme Court of India has established a clear distinction in the tax treatment of individuals engaged in stewardship functions as opposed to those involved in employee deputation. The Court has also endorsed the “single-entity approach” for profit attribution to a Permanent Establishment (PE). This approach signifies that when a non-resident pays an arm’s-length price to the PE, it eliminates any further requirement for profit attribution for taxation. Additionally, the judgment reiterates the paramount importance of considering an economic nexus before subjecting a non-resident’s global profits to taxation in India. This article tries to establish an illustrative and a non-exhaustive list of what can qualify as stewardship activity as to be brought under the ambit of Direct Taxation.
Prevailing Stance
It is necessary to primarily note that corporate structure involves various stakeholders with differing interests. While promoters primarily seek to maximize wealth, other stakeholders encompass public shareholders, society, and the environment. Institutional investors aim to optimize value for their clients and beneficiaries but must consider multiple factors, including strategy, governance, social and environmental aspects. They achieve this goal through active engagement with the companies they invest in. Due to their substantial holdings in publicly listed entities, institutional investors, such as mutual funds, alternative investment funds, public financial institutions, banks, and insurance companies, play a crucial role. These institutional investors serve as custodians since they manage the funds of the investing public, making their role highly significant. There is a noticeable trend towards a greater share of institutional equity ownership in publicly traded companies. According to OECD Working Paper on “Institutional investors and stewardship – 2022,” this shift is particularly evident in advanced economies such as the UK, US, and Japan. Regarding data, the OECD paper highlights that institutional investors now hold a significant portion of global equity ownership.
The UK Stewardship Code and similar codes in various jurisdictions outline a detailed set of responsibilities related to stewardship. Additionally, the International Corporate Governance Network (ICGN) has established “Global Stewardship Principles.” Meanwhile, the European Union introduced Directive 2007/36/EC concerning the exercise of specific shareholder rights in publicly listed companies, which was later amended through Directive (EU) 2017/828, known as the “Shareholders Rights Directive” (SRD). The SRD calls for comprehensive disclosure requirements for both institutional investors and asset managers. It also recognizes the influence of proxy advisors on the voting behavior of institutional investors and, as a result, imposes transparency requirements on these proxy advisors. These requirements pertain to disclosing essential information about their research, recommendations, and voting guidance, as well as any actual or potential conflicts of interest or business relationships that could impact the preparation of their research and recommendations.
In India, SEBI, through its regulations governing proxy advisors, investment managers, and other intermediaries in the capital markets, establishes a defined “code of conduct.” This code encompasses guidelines related to managing conflicts of interest. However, it does not explicitly require these intermediaries to:
(i) Undertake specific stewardship responsibilities, and (ii) Facilitate the fulfillment of stewardship responsibilities by their clients.
In contrast, the United Kingdom has implemented comprehensive reporting expectations for institutional investors. These expectations include assessing the effectiveness of the governance structures and processes they have adopted to support stewardship. Additionally, the UK guidelines emphasize the appropriateness of the resources allocated to stewardship activities and other related aspects.
Main Challenge
The global outsourcing industry has recently grappled with a contentious issue pertaining to whether services provided by companies, particularly captive service providers or manufacturers, would create a Permanent Establishment (PE) for the non-resident service recipient, as defined in relevant tax treaties. India has significantly benefited from the outsourcing industry. Therefore, if Indian tax authorities were to assert that such activities constitute a PE, the profits attributed to this PE would become subject to taxation in India. This could lead to uncertainties regarding the availability of a tax credit in the service recipient’s home jurisdiction, potentially resulting in double taxation and negating the economic advantages of outsourcing to India. Conversely, if no PE is established, no profits would be liable to Indian corporate tax.
Enigma to the Problem
Considering the notable tussle and challenges foreseen, it would be highly beneficial to draw a set of illustrative list (non-exhaustive) of activities which qualify as stewardship activity so that the Tax Payer can pre-cautionly categorize for the tax purpose. As the OECD guidelines/any other authorities do not illustratively provide for such detailed list, precedential inferences has to be drawn for the same which is as below.
|
Stewardship Activity |
Not a Stewardship Activity |
| One of the forms of stewardship activities is a shareholder activity, which takes place when some act or service is done by a shareholder to the company in order to ensure that his investment in the shares is safe and further such an act or service does not produce any effect to the company receiving it. For example, if company X is a shareholder in company Y and it does some activity to protect its investment therein, and the effect of such an activity is confined to it alone, the same would be construed as shareholder activity.[1] | SAP implementation services[2] |
| Stewardship activities involve briefing of the Morgan Stanley Advantages Services Pvt Ltd (MSAS) staff to ensure that the output meets the requirements of the Company. These activities include monitoring of the outsourcing operations at MSAS. The object is to protect the interest of the Company.[3] | Management services received from AE [4] |
| The provision of services to other group members, for example services that would be provided by a co-ordinating centre.[5] | Admin/IT support-services[6] |
But, Share Holder Activities****:
Activities which are ancillary to the corporate governance of the MNE Group.[7] |
Support services received from foreign AEs in the field of Headquarter Services and Technical Consultancy Services[8] |
| Corporate guarantee issued by Indian-parent for SPV[9] | Management/ Technical services[10] |
| Shareholder activities include financial, tax, HR and legal services provided for the management and operations of a group for the purpose of decision-making, monitoring, control and compliance. These services may not qualify under the benefit test in China. For example, a U.S. MNE may incur costs in ensuring that all its subsidiaries, including its Chinese subsidiary, comply with a particular U.S. regulation. In this case, the activities carried out and costs incurred by the MNE in ensuring that its Chinese subsidiary complies with the U.S. regulation are considered nonbeneficial services and would be treated as shareholder activities.[11] | Intra-group support service provided by AE[12] |
| Shared Support Services and Marketing and Sales Services[13] | |
| Deputed employees’ work[14] | |
| Detailed planning services for particular operations, emergency management or technical advice (trouble shooting), or in some cases assistance in day-to-day management.[15] | |
| Shared resources allocation agreement in the field of commercial, financial, accounting[16] | |
| If a subsidiary (AE in the instant case) could not borrow money from third party sources on its own standing and the guarantee provided by the parent (assessee in the instant case) enables it to make such borrowing, then the guarantee could be said to be a shareholder function[17] |
Typically, stewardship expenses refer to the costs that a company bears when it conducts activities aimed at supervising and managing its investments in another related company. These expenses serve the purpose of safeguarding and advancing the interests of the investing company in its relationship with the associated entity. In essence, they encompass various financial outlays incurred by the investor firm to ensure the well-being and performance of its investments in the affiliated company. Such expenses are integral to nurturing and maintaining a fruitful association between these interconnected entities, as they involve actions taken to protect and enhance the value of the investments.When evaluating the magnitude of stewardship expenses, it’s fundamental to recognize that such naturally offer a higher degree of precision compared to surveys or the process of allotting costs. In a broader context, organizations should adopt a comprehensive methodology that not only pinpoints the right level of stewardship expenses but also furnishes more precise strategies for dividing these expenses concerning tax credits. Additionally, it’s crucial for companies to remain attentive to how various aspects of the taxation rules interact with one another and ensure consistency in their stance on these matters.
[1] Nalco Water India Limited [TS-465-ITAT-2021(PUN)-TP]
[2] Wacker Metroark Chemicals Private Limited [TS-1164-ITAT-2019(Kol)-TP]
[3] Morgan Stanley [TS-5-SC-2007-TP]
[4] The services enable the assessee to meet the challenges of the business environment on an on-going basis and the same are rendered continuously and the assessee had been actually benefited out of those services.: Landis + Gyr Ltd [TS-711-ITAT-2017(Kol)-TP] the assessee had indeed derived commercial benefits out of rendering of intra group services by the AE and the payment made thereon are in the nature which any third party would be willing to pay and held that they are not in the nature of stewardship services.
[5] OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, 2022
[6] Almatis Alumina Pvt. Ltd [TS-550-ITAT-2022(Kol)-TP]
[7] SBS & Co LLP Blog Post on (Link)
[8] Nalco Water India Limited [TS-465-ITAT-2021(PUN)-TP]
[9] Tega Industries Ltd [TS-780-ITAT-2016(Kol)-TP]
[10] Vesuvius India Ltd [TS-435-ITAT-2020(Kol)-TP]
[12] Akzo Nobel India Limited [TS-379-ITAT-2017(Kol)-TP]
[13] Danisco India P. Ltd., [TS-237-ITAT-2021(DEL)-TP]
[14] Centrica India Offshore Pvt. Ltd
[15] OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, 2022
[16] Ipsos Research (P.) Ltd, [2020] 114 taxmann.com 732 (Mumbai – Trib.)& Carraro India (P.) Ltd [2020] 113 taxmann.com 257 (Pune – Trib.)., (cannot be categorized as shareholder activities)
[17] Micro Ink Limited [TS-568-ITAT-2015(Ahd)-TP]
[1] Civil Appeal No.2914 of 2007 (arising out of S.L.P.(C)No. 12907 of 2006) and Civil Appeal No. 2915 of 2007 (arising out of S.L.P.(C) No. 16163 of 2006).
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