Friday, 2 May 2014

Delhi HC upholds AAR ruling; rules seconded employees create Service PE in India

This Tax Alert summarizes a recent ruling of the Delhi High Court (HC) in the case of Centrica India Offshore Pvt. Ltd. (Taxpayer) on the tax implications arising from secondment of employees to India. Based on the facts, the HC held that the employees (Assignees) seconded by overseas Group Entities to the Taxpayer in India did not become employees of the Taxpayer, but continued to remain employees of the Group Entities during the secondment period. Accordingly, the arrangement involved rendition of services by the overseas Group Entities to the Taxpayer through such Assignees. Furthermore, payments from the Taxpayer to the Group Entities for such services would be regarded as Fees for Technical Services (FTS)/Fees for Included Services (FIS) under the Indian Tax Laws (ITL), as well as under the relevant Double Taxation Avoidance Agreements (DTAAs). The HC also concluded that the overseas Group Entities created a Service Permanent Establishment (Service PE) in India under the applicable DTAAs by virtue of services rendered through the Assignees present in India. Hence, payments made by the Taxpayer to the overseas Group Entities were taxable in India and, consequentially, liable to withholding under the ITL.
Secondment of employees by foreign companies to Indian affiliates is a common practice amongst multinational groups. Seconded employees typically remain within the legal employment of the foreign company but work under the direction and control of the Indian affiliate during their secondment. Such arrangements have been under the constant scrutiny of the Tax Authority in India and have been the subject matter of controversy/litigation in the absence of specific provisions in the ITL. Various judicial precedents have looked at diverse factors to determine who is the “real” employer or “economic” employer of the seconded employees. The concept of “economic employer”, other than the “legal employer”, is also acknowledged in various international commentaries/rulings and it also assumes significance for determining tax liability of such employees in the host jurisdiction. In certain cases, where the Indian entity (which receives the seconded employees) is seen as the economic employer, presence of such employees has been held to be not triggering PE exposure or service arrangement for the overseas legal employer. Under such circumstances, a payment by the Indian entity to the overseas entity through which salary is disbursed is accepted to be a non-chargeable payment in the nature of reimbursement of salary costs. As against that, a contract of service through employees triggers tax liability, including transfer pricing and tax withholding obligation for the parties. The arrangement may also impact indirect tax liability.
This unfavourable ruling of the HC follows a different approach by considering the legal employment relationship, right to termination contract and right of employees to enforce payment of salary as crucial factors to determine the employer of the Assignees. Some observations of the HC appear to suggest the approach followed, since the arrangement is not abusive or a fa├žade and, in genuine cases, legal employment may not possibly be ignored.
The HC’s observations of interpretation of “make available” clause under the India-UK DTAA as different from that of the India-Canada DTAA, is worth noting and could be prone to alternative view. Also, taxation under Service PE may not be valid once taxation as FTS/FIS is upheld, as DTAAs specifically exclude services in the nature of FIS/FTS from the scope of Service PE.
Multinationals may need to critically consider and evaluate impact of this ruling on their existing/proposed secondment.

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