This article has been published in the Taxsutra Expert Column at Beyond Boundaries : The Tax Troubles of Secondment | Taxsutra

Introduction:

In this intricate world of globalisation and mobilisation of human resource, secondment has become an essential tool for businesses to deploy skilled personnel across different entities within the Group. The tax issues surrounding secondment of employees have added unnecessary complexity to secondment arrangements, often leaving taxpayers confused and uncertain about the tax treatment. This article delves into various facets of secondment, tracing the trajectory of tax issues and exploring judicial pronouncements that have left the issue hanging in balance.

Understanding the secondment arrangement:

Secondment generally involves temporary transfer of employee from one entity to another entity within the Group for a specified duration and as per agreed terms and conditions. The need for secondment often arises to address the skill gaps or meet with the requirement of a specific project, allowing the sharing of expertise across entities and jurisdictions within a Group. Secondment agreements are typically structured in a way that the seconded employee operates under the direct control and supervision of the receiving entity but remains on payroll of the sending entity for legal and administrative purposes. This structure ensures that seconded employee has the desired job security from legal employer and retains entitlement and continuity of social security benefits / welfare schemes without interruption. The sending entity continues to process the salary of seconded employee along with contribution to social security schemes and claims reimbursement of expenses so incurred from the receiving entity (in most cases, on an actual costs basis and without profit mark-up).

Tax jurisprudence on secondment of employees:

The historical backdrop of the tax issues on secondment can be traced back to the Supreme Court’s landmark judgment in the case of DIT (International Taxation) vs. Morgan Stanley & Co. [2007] 292 ITR 416 (SC). In this judgment, the Supreme Court examined two set of activities, stewardship activities (mainly for quality control) and the activities performed by the employees who were deputed to Indian entity by foreign entity. The activities of employees on deputation are relevant to examine the issues on secondment of employees. Supreme Court held that since seconded employees continue to be on payroll of foreign enterprise, they retain lien on job with foreign enterprise. The foreign enterprise is responsible for work of seconded / deputed employees and a service permanent establishment (“PE”) of foreign enterprise can emerge.

Further, ruling of Delhi High Court in the case of Centrica India Offshore (P.) Ltd. vs. Commissioner of Income Tax – I, [2014] 364 ITR 336 (Delhi) deals with another interesting aspect of the secondment of employees, i.e. tax withholding obligation of Indian entity on reimbursement of salary and related costs of seconded employee to foreign entity (which continues to pay salary and social security benefits to seconded employee). While dealing with withholding tax aspect, High court also touched upon the issue of service PE due to secondment arrangement. It was held by the High Court that amounts reimbursed by Indian entity to overseas entity for seconded employees’ salaries constitute ‘fee for technical services’ (“FTS”) subject to tax in India. While holding reimbursement as FTS, the High Court affirms the ruling of the Authority for Advance Rulings (“AAR”). Notably, AAR in its ruling held that the reimbursement would not qualify as FTS and services rendered by seconded employees would give rise to Service PE. The High Court judgment, with due respect, has caused some confusion as service PE clause under the tax treaties is applicable only when services do not qualify as FTS and these two concepts are mutually exclusive to each other. If reimbursement qualifies as FTS, it cannot result in Service PE of foreign enterprise. The special leave petition filed by Centrica, against the judgment of High Court, was dismissed by the Supreme Court

The interplay of these rulings adds to complexity of taxation in a secondment arrangement leaving taxpayers and tax practitioners grappling with the implications of Centrica judgment and its alignment with AAR ruling. The subsequent judgments of Income Tax Appellate Tribunals provided much needed guidance and clarity on secondment of employees. For instance, Delhi Tribunal in the case of DDIT vs. Yum Restaurants (Asia) Pte Ltd., ITA No. 6018/Del/2012, held that, as per facts and circumstances of the case and clauses of deputation agreement, foreign entity had no right or lien over the employment of seconded employee including any right to recall the employee. The seconded employee was working under the direct control and supervision of Indian entity and salary paid to him by the foreign entity was reimbursed by Indian entity on actual cost basis. Since seconded employee is considered as employee of Indian entity, there cannot be a service PE of foreign enterprise. The Tribunal also held that existence of service PE and provision of technical services cannot co-exist. It was held that the amount paid by Indian entity is not liable to tax in India as FTS. Further, in the absence of fulfilment of “make available”, amount paid cannot be taxed as FTS. The Tribunal observed that the facts of this case are at variance from the facts of the judgment of Centrica (supra).

Further, Supreme Court’s judgment in the case of C.C. C.C.,C.E. & S.T. Bangalore vs. Northern Operating Systems (P.) Ltd. (2022) 61 GSTL 129 (SC) has added new dimensions, particularly in the realm of service tax (now subsumed under GST regime). The Court held that Indian entity was, for the relevant period, service recipient of overseas group company concerned, which can be said to have provided manpower supply service, or a taxable service and Indian entity was liable to discharge the obligation of service tax. This judgment is relied upon by Revenue, while arguing income tax cases, to assert that if GST is discharged on import of manpower supply service from foreign entity in secondment arrangement, it should also be considered as taxable service from income tax perspective.

Tax issues emanating from secondment of employees:

The judgments on secondment of employees have dealt with various issues and concepts, including the concept of ‘legal employer’ and ‘real / economic employer.’ The ‘legal employer’ is the entity on whose payroll the employee is and which exercises lien over the employment, while ‘economic employer’ is the entity that bears economic burden of the employee and under whose control and supervision the employee works. Where foreign enterprise makes salary payments to seconded employee and claims reimbursement from Indian entity, it may be contended that such payment represents FTS and Indian entity has obligation to withhold tax. In cases where services do not qualify as FTS, it may be contended that foreign enterprise is rendering services to Indian entity through its employees and it results in establishment of service PE of foreign enterprise in India.

Even if Service PE of foreign entity is established due to the services rendered by seconded employees, no income can be attributed to such PE if foreign enterprise is not deriving profit from the activities performed by the seconded employee (i.e. cost of secondment is recovered on actual cost basis, without profit mark-up).

Under indirect tax, services rendered by an employee to the employer are neither considered as supply of goods nor supply of services and they fall outside the purview of GST. The services rendered by seconded employees to Indian entity may not be subject to GST if seconded employee is considered as employee of Indian entity. However, if secondment arrangement is not construed as employment arrangement, it may be considered as import of services by Indian entity from foreign entity, subject to GST under reverse charge mechanism.

Simple and direct arrangement:

A simple and direct arrangement for deployment of skilled workforce within the Group is cessation of employment by foreign entity and hiring of such employee by the Indian entity directly, if employee is required for a longer duration. However, it defeats the very objective of secondment of employee. In most of the cases, secondment is resorted to fill the skill gap for a shorter duration, coupled with the fact that seconded employee prefers to continue with his social security benefits abroad. Therefore, a simple and direct arrangement may not be feasible in those situations.

Suggestions:

Considering the income tax issues (i.e., risk of foreign entity establishing a service PE in India or risk of recovery of cost of seconded employee being considered as FTS), secondment agreement should clearly capture the terms of arrangement between sending and receiving entity. The agreement should define the roles and responsibilities of entities involved, entity exercising control and supervision on seconded employee, whether employee would retain lien on his employment with foreign entity, whether foreign entity would have a right to recall the seconded employee etc.

Indirect tax considerations, such as those highlighted in the Northern Operating (supra), add additional complexity that requires careful attention in structuring secondment agreements. It is pertinent to note that if Indian entity is entitled to refund of GST paid on import of services, such refund can  be claimed if GST was discharged upfront on import. No refund will be available if GST is discharged subsequent to reclassification by the tax authorities.

Central Board of Indirect Taxes and Customs vide instruction no. 05/2023-GST dated December 13, 2023, has given direction that the decision of Hon’ble Supreme Court in Northern Operating (supra) should not be applied mechanically in all the cases. It has been instructed that the investigation in each case requires a careful consideration of its distinct factual matrix, including the terms of contract between overseas company and Indian entity, to determine taxability or its extent under GST and applicability of the principles laid down by the Supreme Court in Northern Operating case.

Conclusion:

The secondment of employees requires a nuanced approach considering legal landscape and principles laid down by Courts while deciding the tax issues surrounding secondment arrangements. As businesses increasingly rely on secondment to meet their global talent needs, it is crucial to strike a delicate balance by adopting a position aligning both direct and indirect tax considerations. Crafting well thought-out and clearly defined secondment agreement that takes into account the intricacies highlighted in judicial pronouncements is the key to navigating this complex terrain and ensuring a seamless global workforce deployment strategy.