In India, employee secondment has been a contentious tax issue and a subject of protracted litigation. The Indian tax authorities have time and again sought to tax the reimbursements made to any foreign entity by an associate entity in India on the grounds that a secondment arrangement is essentially an arrangement for the provision of technical services by the foreign entity to the Indian entity effected through the seconded employees. The Indian tax authorities claim that these reimbursements should qualify as a fee for technical services, because the reimbursements represent the consideration paid for managerial, technical, or consultancy services received by the Indian entity and therefore should be subject to tax in India.

In some situations, the Indian tax authorities contend that the services provided by the secondees to an Indian entity create a permanent establishment of the foreign entity in India. This contention is based on the premise that services rendered by the secondees in India constitute a contract for service rather than a contract of service with the Indian entity.

This article analyzes recent court rulings on secondment arrangements. In these cases, employees were seconded to India by foreign group entities, but to preserve the social security benefits accruing to the secondees in their home countries, their salaries were disbursed by the foreign entity, and these costs were later reimbursed by the Indian entity. The article also looks at the factual considerations assessed by Indian courts when examining these secondment arrangements.

Secondment Tax Issues

Test for Effective Employment

Do secondees become employees of the Indian entity or continue to be employed by the foreign entity during the period of secondment? That is the core of the secondment arrangement tax controversy. If the secondees are deemed to remain employed by the foreign entity, then the services they render in India can result in adverse tax consequences for both the foreign entity and the Indian entity:

• The reimbursements made by the Indian entity to the foreign entity for the secondees’ services could become subject to income tax in India in the hands of the foreign entity because those reimbursements could then be deemed fees for technical services.

• If the reimbursements are treated as fees for technical services, it may result in a tax  withholding obligation for the Indian entity,  failing which there may be adverse tax  consequences for such entity, including  reimbursements being disallowed as a tax deductible expense in the hands of the  Indian entity.^[1]
• Alternatively, the secondees that remain employed by the foreign entity may expose the foreign entity to a service PE risk in India.

• From an indirect tax standpoint, if the reimbursements are treated as consideration for services rendered by the foreign entity through the secondees, then the Indian entity could be liable to pay goods and services tax on the reimbursements for importing services from the foreign entity.^[2]

However, if the secondees are deemed employees of the Indian entity during the period of secondment, then those adverse tax consequences may not arise because no income should accrue to the foreign entity through their services. Also, services rendered by employees within the course of employment are specifically excluded from the ambit of GST, and the Indian entity would not have any liability under the GST laws of India for the services rendered by the secondees.^[3]

There are no specific guidelines under Indian tax laws to determine whether a secondment arrangement is one of contract for service (an arrangement in which the secondees would remain under the employment of the foreign entity during the period of secondment) or a contract of service (in which the secondees would become employees of the Indian entity). The courts in India have considered the facts of specific arrangements on a case-by-case basis to arrive at such determination.

Relationship vs. Control

A recent ruling by the Supreme Court of India in the case of Northern Operating Systems^[4] reignited the tax debate on cross-border secondment of employees. The Court observed that the managerial and technical expertise provided by a secondee to the Indian entity qualifies as a provision of service by the foreign entity to the Indian entity. The Court thereby held that reimbursements made by the Indian entity represent the consideration paid for the services rendered by the foreign entity and were subject to service tax in India.^[5]

The Indian entity in Northern Operating Systems was providing back-office support services to its overseas group companies. Under the terms of the agreement, the Indian entity could request that the group companies provide managerial and technical personnel to assist the Indian entity in providing the required services. Employees were selected by the group companies and seconded to the Indian entity. During the period of secondment, the secondees worked under direct supervision and control of the Indian entity and answered to the Indian entity for their time and work. However, to preserve their social security, retirement, and health benefits accruing in their home country, the secondees remained on the payroll of the foreign group companies. Upon the conclusion of the secondment period, the secondees were required to return to their country of origin or were assigned to another host country.^[6]

The tax authorities claimed that the overall scheme of the arrangement was a contract for  service, that the overseas entities were rendering  services to the Indian entity through its secondees, and that service tax applied to this arrangement. ^[7]

After examining the facts of the secondment arrangement, the Supreme Court observed that the secondees remained employees of the foreign entity because:

• the secondees were under the operational control of the Indian entity in terms of their daily work only during the secondment period, and even during that period, the secondees legally remained employees of the overseas group company;
• the foreign entity deputed the secondees to their posts and paid their salaries;
• the Indian entity had the right to ask the secondees to return home (if they failed to  perform their duties satisfactorily);  however, even then the secondees remained   employees of the foreign entities ^[8]; and
• the secondees’ terms of employment during the secondment period were in accordance with the policies of the overseas group entities.^[9]

The Court observed that, because the secondees remained employees of the foreign entity, the secondment arrangement was essentially an arrangement for the provision of services to the Indian entity through the secondees. The expertise and specialized knowledge of the secondees were used for the economic benefit of the Indian entity, which constituted a quid pro quo under the secondment arrangement. The Court concluded that the reimbursements made by the Indian entity were thereby subject to service tax.^[10]

In Centrica India Offshore,^[11] an earlier ruling on the issue of secondment of employees, the Delhi High Court placed more importance on the legal relationship between the foreign entity and the secondees than the economic relationship between the secondees and the Indian entity. In Centrica, the court held that there was an absence of any employment relationship between the Indian entity and the secondees because direct costs of the secondees were borne by the overseas entities and the secondees could not sue the Indian entity for default in payment of salaries. The court noted that, although the Indian entity was empowered to terminate the secondment arrangement, the secondees’ underlying employment could not be terminated by the Indian entity. The court concluded that the employment relationship of secondees remained independent and beyond the Indian entity’s control, and the employment of secondees during the course of their secondment continued with the overseas entities.^[12] The court further relied on the ruling rendered in Morgan Stanley^[13] and held that because the foreign entity was rendering services in India through its employees, the secondees constituted a service PE in India.^[14]

The courts in these cases do not seem to have relied on the operation and managerial control exercised by the Indian entity to assess the scope of employment between the secondees and the Indian entity during the period of secondment. Instead, greater emphasis was placed on the legal relationship between the secondees and the foreign entity, which continues independently during the period of the secondment.

An alternative view was taken by the Karnataka High Court in Abbey.^[15] This court considered the functional and managerial control exercised by the Indian entity to determine the employment relationship between the secondees and the Indian entity. Although the facts in Abbey and Northern Operating Systems were similar, in Abbey the secondees were assigned supervisory positions. In Abbey the court observed that the secondees were under the control, direction, and supervision of the Indian entity and acted in accordance with the policy, rules, and guidelines applicable to the regular employees of the Indian entity. In Abbey the court also observed that, because the secondees were expected to control and supervise independent third parties in the  capacity of employees of the Indian entity, the  Indian entity had to be treated as the employer of  the secondees.^[16]

In Flipkart,^[17] another recent secondment  ruling, the Karnataka High Court deviated from  the reasons employed by courts before it. The court held, in light of the specific facts, that the  secondees retained dual employment with the  foreign entity and the Indian entity. The court  observed that the relationship between the  secondees and the Indian entity must be assessed  during the period of secondment, and any  employment with the foreign entity before or  after the secondment period should not be considered relevant to assess the secondees’ relationship with the Indian entity during the secondment period. It also observed that the Indian entity was a fully functional business that  later came to be acquired by the foreign entity, and  therefore, the secondment arrangement was not  one to give effect to back-office support services in  India. The court mentioned that in the event the Indian entity was incorporated to give effect to such services, then the foreign entity could have been treated as an employer.

These recent rulings emphasize that factors such as the legal relationship between the secondees and the concerned domestic and foreign entities, the specific nature of services rendered by the secondees, the autonomy exercised by the secondees while rendering those services, and the extent of control exercised by the entities over the secondees’ employments are likely to drive the tax implications of a cross border secondment arrangement.

Key Takeaways

The absence of any real legal relationship between the Indian entity and the secondees remains a key factor in determining the potential tax implications under Indian tax laws. The lack of clarity and suitable guidelines on the issue makes it necessary to exercise caution when structuring any secondment arrangement. Based on the available jurisprudence, the key takeaways are that the secondment arrangement should aim to establish a direct legal relationship between the Indian associate and the secondees to mitigate the possibilities of any recharacterization and to bring out clearly the substance of such an arrangement. This may require the associate entity to enter into separate employment agreements with secondees, wherein, in addition to exercising the right of control and management, the associate entity should have the right to terminate such an arrangement with the secondees. From the perspective of secondees, they should be provided with the option to legally receive their salaries from the Indian entities and the right to sue the Indian entity in case of any nonpayment. Also, the Indian entity should consider playing an active role in the recruitment and selection of secondees. Furthermore, the secondment agreement may also acknowledge the existence of clearly demarcated dual employment of secondees with the foreign entity and the Indian entity.

Because the tax jurisprudence concerning cross-border secondment of employees continues to evolve, it is always advisable to examine any proposed cross-border secondment arrangement in the context of the specific considerations relied upon by Indian courts in order to be clear on the potential tax implications for such an arrangement.

Footnotes:

[1] Sections 40 and 195 of the Indian Income Tax Act, 1961.

[2] Section 5(3) of the Indian Integrated Goods and Services Tax Act, 2017, read with Entry 1 of Notification No. 10/2017 — Integrated Tax (Rate) (June 28, 2017).

[3] Section 7 of the Central Goods and Services Tax Act, 2017, read with Entry 1 of Schedule III appended to the act.

[4] Commissioner of Customs, Central Excise and Service Tax, Bangalore (Adjudication) and Others v. Northern Operating Systems Pvt. Ltd., AIR 2022 SC 2450.

[5] Service tax was the applicable levy on provision of services within India before the introduction of GST on July 1, 2017.

[6] Northern Operating Systems, AIR 2022 SC 2450, at paras. 2-3.

[7] Id. at paras. 14-19.

[8] Id. at para. 57.

[9] Id.
[10] Id. at para. 58.

[11] Centrica India Offshore Pvt. Ltd. v. Commissioner of Income Tax-I and Others, (2014) 364 ITR 366 (Delhi).

[12] Id. at paras. 34-35.

[13] Morgan Stanley & Co., In Re., 2006 (284) ITR 260 (SC), at paras. 15-18. (The Supreme Court of India’s landmark Morgan Stanley judgment held that seconded employees rendering services in India resulted in formation of a service PE in India.)

[14] Centrica, 364 ITR 366, at para. 36.

[15] Director of Income Tax v. Abbey Business Services India (P) Ltd., [2020] 122 Taxmann.com 174.

[16] Id. at para. 2.

[17] Flipkart Internet Private Ltd. v. DCIT (International Taxation), [2022] 139 taxmann.com 595 (Karnataka).