Secondment which is a fairly common practice in employment is created when employees are brought on contracts from overseas entities to their Indian affiliates for a fixed tenure. In terms of the secondment agreement, seconded employees work under the direction, control and supervision of the Indian affiliate’s board and management. Such employees receive salaries overseas in their home country, that is, they remain on the payroll of the overseas entities. The Indian affiliates reimburse their overseas principals or partners for such salary costs. This arrangement or the salary reimbursement is purely on cost basis.
The Indian affiliates reimburse the following to the overseas entities for their seconded employees.
1. Actual documented costs and expenses (monthly charges).
2. Monthly charges that comprise of:
a. Base salary and other compensations
b. Retirement, social security plans and other benefits (accrued in the host country)
c. Other costs as agreed between the overseas entity and the Indian affiliate.
Indian revenue authorities monitor these transactions closely to determine whether these give rise to any service Permanent Establishment (PE) and for taxing the salaries as Fees for Technical Services or Fees for Included Services (FTS or FIS). The tax scenario for these secondment agreements were till recently:
1. The salaries paid to the seconded employees are taxed by the Indian Employer.
2. The Indian Employer pays the ITR in India.
3. Hence the withheld taxes are calculated under section 192 of the Income Tax Act (the Act), under salaries.
The Indian affiliate receives a service income from the overseas entities as part of its terms in the service agreements.
On April 25, 2014, The Delhi High Court has passed a decision in the case of Centrica India Offshore Private Ltd. that has a far-reaching implications effect on the secondment issues that is it has been held that employee secondment arrangements give rise to a service PE exposure by challenging the economic employment concept.
Facts of the Case:
1. Centrica India Offshore Private Limited (CIOP) a company that is incorporated in India,is a wholly owned subsidiary of Centrica plc, United Kingdom (Centrica UK). British Gas Trading Ltd. (BSTL), UK and Director Energy Marketing Ltd. (DEML) Canada are also two other subsidiaries of Centrica UK both collectively referred to as entities overseas, both engaged in the business of supplying gas and electricity to various consumers across the UK and Canada.
2. The overseas entities outsource their back office support functions like debt collections/consumers’ billings/monthly jobs to third party vendors in India etc. To ensure that the Indian vendors comply with quality guidelines, CIOP was established in India on March 3, 2008 to act as service provider to these overseas entities. For these services, CIOP received remuneration at cost plus 15 percent mark-up from the overseas entities.
3. CIOP entered into a service agreement with the overseas entities to provide locally based interface between the overseas entities and the Indian vendors. The range of services provided in terms of the agreement are :
a. Management assistance for outsourced supplies in India and facilitating efficient interface back to the US business of Centrica Plc.
b. Ensure that outsourced suppliers adhered to best of practices and share them on optimal basis
c. Give expert advice on widening the scope of potential services in India to target work force through greater control and such other services as may be requested from Centrica plc from time to time.
4. CIOP, in order to seek support during initial year of its operation, entered into a Secondment Agreement with the overseas entities. CIOP entered in to individual agreements with the seconded employees which reiterate the terms of the Secondment Agreement. The seconded Employees would function and act under the direction,control and supervision of CIOP alone. Overseas entities are not responsible for the work of the seconded employees and have no responsibility for the errors/omissions or for the work performed by them. CIOP bears all risks and rewards associated with the work performed by such employees
5. The seconded employees continue to participate in the overseas entities retirement and social security plans and other benefits. The salaries of the seconded employees are paid directly into their overseas bank account and claimed as reimbursement on a monthly basis from CIOP.
6. CIOP is an income tax assesse and has been filing returns and paying income tax on the income earned out of the service agreement. CIOP has withheld appropriate taxes u/s 192 of the Income Tax Act from the salaries paid to the seconded employees. The service income received by CIOP from the overseas entities would be offered to tax in India under the Act.
Key Issues:
• Whether the seconded employees render technical services to the overseas entities?
• Whether overseas entities constituted service PE in India due to the secondment?
• Whether the payments made are actually reimbursement of expenses?
• Whether the reimbursement of salary costs of secondment employees by CIOP to overseas entities under the terms of the secondment agreement is in the nature of income accruing to the overseas entities?
• If so, whether tax is liable to be withheld by CIOP under section 195 of the Act?
CIOP’s Contentions:
1. CIOP claimed that in tune with the recognized international principles it is the real and economic employer of the seconded employees
2. The overseas entities are merely legal employers.
3. In terms of the Secondment Agreement, the overseas entities were not providing any service to CIOP.
4. The payment to the seconded employees by the overseas entities was purely out of convenience and the payment was reimbursed on cost basis
5. Reimbursement made to such overseas entities was not taxable as income in India, because taxes are already paid in respect of the seconded employees in India.
6. What is paid by the overseas entities is merely reimbursement of salaries paid to the seconded employees and therefore there is no element of income in it.
7. The reimbursement to the overseas entities could not be considered income under the time-tested doctrine of ‘diversion of income by over riding title’.
8. The two arrangements, that is the secondment agreement entered into between CIOP and the overseas entities on the principal-to-principal basis and theindividual agreements entered into with the seconded employees are distinct from each other. The first is a contract for service in general and the latter are contracts for service by each individual seconded employee with CIOP. CIOP only provides business support services in relation to the outsourced processes.
9. Services rendered are managerial not technical, so does not fall under FTS/FIS under Double Taxation Avoidance Agreement (DTAA). And the mere secondment of employees would not amount to services rendered by overseas entities.
10. The payments made are not fees for technical/ included services taxable in terms of tax treaty between India and UK/Canada.
11. The seconded employees are under the direction, control and supervision of CIOP. No Service PE is constituted as CIO is the economic employers and the overseas entities are the legal employers. Thus the right to terminate is with the legal employer (i.e. overseas entities) while supervision and control is with the economic employer (i.e. CIO) based on Klaus Vogel and the Organisation of Economic Co-operation and Development (OECD) Commentary on model tax convention.
Thus the presence of seconded employees did not create a permanent establishment (PE) of such overseas entities under DTAA.
AAR’s contention:
1. The seconded employees were providing monthly services. Hence the payments received by them was in India is salary and so taxable in India. The reimbursements made by CIOP to its overseas entities were in the nature of fees for technical services (FTS) covered under 9(1) (vii) of the IT Act and DTAA applicable to U. K. and Canada. Therefore the AAR’s contention is that the overseas entities have PE under DTAA.
2. The scope of the services indicate that the arrangement is not a simple secondment to familiarize the employee with the operations being carried out in other location, but where the expertise of the seconded employees to implement the processes and practices of the overseas entities in CIOP. Thus the seconded employees require technical expertise. The seconded employees were rendering managerial services but the remuneration payable was in the nature of fee for technical services (FTS). The seconded employees would also train and familiarize the staff in India to apply the same processes and practices in future, which falls within the purview of ‘make available’.
3. The seconded employees retained their right to participate in the overseas retirement and social security plans. CIOP could terminate the secondment agreement but not the contract of the seconded employees. Therefore CIOP would not be the real employer and the overseas entities would be the real and legal employers.
Consequently there was no charge on the petitioner through the overseas employer in respect of the obligations of payment of remuneration to the seconded employees.
This amounted to application of income not diversion of income by overriding title.
4. The payments made to the overseas entities were cleverly disguised as reimbursement of salary cost of the seconded employees to escape withholding tax u/s. 195 of the Act. Here the term reimbursement is not determinative of the nature of payments.
Ruling by the High Court:
i. The overseas entities have through the seconded employees, provided ‘technical’ services to CIOP, especially since the expression FTS/FIS expressly includes the provision of the services of personnel.
ii. The seconded employees who work for CIOP are provided by the overseas entities and work conducted by them that is assistance in conducting the business of CIOP of quality control and management is through the overseas entities.
iii. The “Business support Services” provided by CIOP would fall within technical or consultancy services. The seconded employees would oversee the services provided by vendors to the overseas entities. These seconded employees would thus apply their technical knowledge and hence their services would fall within the meaning of technical services.
iv. The distinction drawn by CIOP between the provision of services by the overseas entities themselves and the ”mere” secondment of employees does not make a difference, since the services provided the overseas entities is theprovision of technical services through the seconded employees – an instance envisaged under Article 13 itself.
v. Overseas entities have provided seconded employees to CIOP to ensure quality control and management of their outsourced activities. The seconded employees imparted technical expertise and know-how till the necessary skill-set was acquired by the Indian or resident employee group of CIOP. Thus they transferred their technical ability or ‘made available’ their know-how to CIOP for future use. Thus under article 12 of the India-UK DTAA and under article 12 of India-Canada DTAA, overseas entities have provided FTS/FIS under the Act.
vi. To determine the existence of a service PE, the court must look toward the substance of the employment relationship and not the form. Though the seconded employees’ duties and functions were dictated by the instructions and directions of the CIOP and the CIO bore all risks in relation to the work of the seconded employees, reaped the benefits and paid their salaries, yet, the seconded employees retained their entitlement to participate in the overseas entities retirement and social security plans and other benefits. Thus, the salary was properly payable by the overseas entity which claimed the money from CIOP. So no employment relationship is established between CIOP and the seconded employees.
vii. There is no obligation on the part of CIOP to bear the salary cost of the seconded employees. The seconded employees in turn, cannot sue the CIOP for default in payment of their salaries. All direct costs of such seconded employee's basic salary and other compensation, cost of participation in overseas entities' retirement and social security plans and other benefits in accordance with its applicable policies and other costs were ultimately paid by the overseas entity.
viii. The CIOP had the right to terminate the secondment agreement but not he employment of the seconded employees. Rather, that employment relationship between the overseas entities and he seconded employees remained independent, and beyond the control of CIOP.
ix. CIOP may have operational control over these persons in terms of the daily work, and may be responsible (in terms of the agreement) for their failures, these limited and sparse factors cannot displace the larger and established context of employment abroad.
x. The court noted that the term ‘reimbursement of expenses’ could not determine the nature of expenses. The fact that the overseas entity does not charge a mark-up is not relevant in itself so it cannot negate the nature of the payment.
xi. The court further distinguished between stewardship activities of employees and deputationists. It said that the activities such as back office support functions; overseeing quality control etc. could not be characterized as mere stewardship. The activities which CIOP was supposed to do were done through seconded employees through their expertise. Hence the overseas entities continued to be their real employer.
xii. Seconded employees constitute service PE of the overseas entities in terms of paragraph 2(K) of Article 5 of the India – UK tax treaty and paragraph 2(I) of Article 5 of the India-Canada tax treaty. Hence, it would be income accruing to the overseas entities and tax was therefore required to be withheld under section 195 of the Act.
Conclusion:
Reimbursement of salaries of seconded employees by the Indian affiliates to the overseas entities is taxable as FTS/FIS.
The employee secondment arrangements give rise to a service PE by challenging the economic employment concept.
It would be prudent to provide increased safeguards in contracts of secondment agreements entered into by the Indian affiliates of foreign companies. Such agreements should be reviewed, analyzed and redrafted properly to mitigate the PE risk of the foreign entity in India.
Tax liability is no longer under section 192, on salaries, but under section 195 of the Act.
Tax on the reimbursements is liable to be deducted at source under Section 195 of the Indian Income Tax Act, 1961
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