7 May 2014 | Volume 7 Issue 1
Deputation of Employees Could Result in Permanent Establishment (PE) and Tax Implications in India

The secondment of employees by foreign companies to Indian affiliates is a common practice. Seconded employees typically work under the direction, control and supervision of the Indian affiliate during their secondment. The foreign company pays the salary of the seconded employees abroad (i) to continue the social security contribution and (ii) for convenience purposes. The said salary paid is then recovered from the Indian affiliate on a cost-to-cost basis.

Indian revenue authorities are closely monitoring these kinds of arrangements for possible Permanent Establishment (PE) exposure and for taxing the recharge of salary as Fees for Technical Services/Fees for Included Services (FTS/FIS).

Recently, the Delhi High Court (Delhi HC), in respect of the writ petition filed in the case of Centrica India Offshore Private Limited[1] (CIO), had to decide whether the reimbursement of salary cost paid by CIO to the overseas entities is taxable in India; if yes, whether withholding of tax thereon was required u/s 195 of
the Income-tax Act (the Act). A further issue raised was whether employees deputed to India created Service PE of a foreign company in India or not.
 
Facts of the Case: 
  • CIO, an Indian company, is a wholly owned subsidiary of Centrica plc, United Kingdom. Centrica plc along with its two other subsidiaries (one in Canada and one in the UK) (Overseas Entities), is engaged in the business of supplying gas and electricity to various consumers across the UK and Canada.
  • The overseas entities have outsourced their back office support functions such as consumers' billings/debt collections/monthly MIS to third party vendors in India. CIO was incorporated in order to ensure that the third party vendors comply with quality guidelines of the group. For these services, CIO received remuneration at cost plus 15% mark-up from the overseas entities.
  • A Secondment Agreement (SA) was simultaneously entered into between CIO and the overseas entities under which employees of the overseas entities were seconded to CIO to provide managerial support in its initial years. The seconded employees were to work under the control and supervision of CIO. CIO was to bear all the risks in respect of the work performed by the seconded employees i.e. the overseas entities were not responsible for the work and actions of the seconded employees.
  • The seconded employees would retain their entitlement to participate in the overseas entities' retirement and social security plans and other benefits.
  • CIO has withheld appropriate taxes u/s 192 of the Act from the salary paid to the secondees. Further, service income received by CIO from overseas entities would be offered to tax in India under the Act.
  • On the above transaction, CIO sought a ruling from the Authority of Advance Rulings (AAR). The AAR held that the recharge of salary does not constitute FTS/FIS, however, the overseas entities constituted Service PE in India on account of the secondment of employees to CIO[2].
  • Aggrieved by the said AAR ruling, CIO filed a writ petition before the Delhi HC challenging the AAR ruling.
Key Issues Before the Delhi HC:
  • Whether the overseas entities rendered technical services through seconded employees?
  • Whether overseas entities constituted Service PE in India on account of the secondment of employees?
  • Whether the payments made were in the nature of reimbursement of expenses?
CIO's Contention:
  • The services rendered are 'managerial services' and the same are not within the scope of meaning of FTS/FIS under the Double Taxation Avoidance Agreement (DTAA). Further, even if it is characterised as FTS/FIS, the same does not 'make available'.
  • The mere secondment of employees would not amount to rendition of services by the overseas entities.
  • The payment made to overseas entities is a mere reimbursement, which does not form part of its income.
  • The seconded employees are under CIO's control and supervision. The roles and the duties were dictated by CIO and it bore all risks in relation to the work of the seconded employees and reaped the benefit.
  • CIO relied on Klaus Vogel and the Organisation of Economic Co-operation and Development (OECD) Commentary on model tax convention to explain that 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). 
  • No Service PE is constituted as CIO is the economic employer and overseas entities are only legal employers.
  • Substance of the transaction has to be looked at and not the form.
  • The overseas entities have outsourced their non-integral and non-revenue generating business to India. CIO is providing support services in relation to such business and hence, cannot be considered as carrying on business on behalf of the overseas entities.
  • The payments made to overseas entities is not income that accrues to the overseas entity but rather money that it is obligated to pay the secondees and the money is overridden by the obligation to pay the secondees and therefore, is not income.
Revenue's Contention:
  • Managerial service is not included in the scope of technical services within the meaning of Article 13 of the DTAA. However, the services of the seconded employees should fall within the terms of technical services which includes 'make available'.
  • On a combined reading of the master service agreement and the SA, it can be inferred that the seconded employees are being sent with technical knowledge and expertise of various processes and practices employed by overseas entities as well as the experience in managing and applying such processes and practices. From this, it is very clear that the employees were in possession of technical knowledge.
  • Since CIO was in its start-up stage, the main objective of this arrangement was to train and familiarise the staff in India to the processes and practices of the group that could be applied by them once the seconded employees' term ended. Thus, the condition of 'make available' i.e. imparting technical knowledge to the employees of CIO would be satisfied. As a result, the same are in the nature of FTS/FIS under the DTAA with Canada and the UK.
  • These seconded employees retained their right to participate in the overseas retirement and social security plans. CIO could terminate only the secondment agreement and not the employment of the seconded employees. Further, the seconded employees could not sue CIO for default in payment of their salaries.
  • The Revenue further relied on OECD Commentary on Article 15 to state that the secondees were the regular employees of the overseas entities and that they had been seconded for a limited period. In the present case, on completion of the specified period of the secondment, the secondees will return to the overseas entities and will perform the usual state of affairs. This proves that the overseas entities were the economic employers of the secondees. 
  • Although the word 'reimbursement' is mentioned in the agreement, the nature of the payments under the secondment agreement has to satisfy the characteristic of reimbursement and that the term 'reimbursement' in the agreement will not be determinative of the nature of payments.
High Court's Ruling:
  • Overseas entities, through the seconded employees, have provided technical services to CIO, especially since the expression FTS/FIS includes provision of services of personnel.
  • The seconded employees who work for CIO are provided by overseas entities and the work conducted by them i.e. assistance in conducting business of CIO of quality control and management is through the overseas entities.
  • Business support services provided by CIO would fall within technical and consultancy services. The secondees would oversee these services and required application of technical knowledge and hence, their services would also fall within the meaning of technical services.  
  • Distinction drawn by CIO between provision of services by overseas entities themselves and mere secondment of employees does not make any difference, since the service provided by the overseas entities is a provision of technical services through the secondees.
  • Overseas entities required CIO to ensure quality control and management of their outsourced activities. In light of the same, employees were seconded to impart their technical expertise and know-how, till the necessary skill set was acquired by the employees of CIO. Thus, this qualifies as FTS/FIS under the Act and DTAA with Canada and the UK.
  • Seconded employees retained their rights to participate in the overseas entities' retirement and social security plans and other benefits.
  • CIO had the right only to terminate the secondment agreement and not the employment of the secondees. Also, the seconded employees could not sue CIO for default in payment of their salary. Thus, the employment relationship between the overseas entities and the secondees is, at no point of time, terminated nor is CIO given any authority to modify the same.  
  • CIO may have operational control over the secondees for their daily work and may be responsible for their failure. However, these limited factors cannot displace the larger and established context of employment abroad.
  • The court further distinguished between stewardship activities of employees and deputationists which have been highlighted in the decision of Morgan Stanley and Co[3] and M/s E-Funds IT Solutions[4]. It said that activities such as back office support functions, overseeing quality control, etc. could not be characterised as mere stewardship. The activities which CIO was supposed to do were done through seconded employees through their expertise. Hence, the overseas entities continue to be their real employer. As a result, the seconded employees constitute Service PE of the overseas entities.
  • The court observed that the term 'reimbursement of expenses' mentioned in the agreement could not determine the nature of the payment. Similarly, the fact that the overseas entities do not charge a mark-up also could not determine the nature of the payment.

[1] W.P. (C) No. 6807/2012 pronounced on 25 April 2014
[2] Our tax alert on the AAR Ruling
[3] 2006 (284) ITR 260 (SC)
[4] ITA 735/2011
 
SKP's Comments
Though this is a writ petition which applies only to the applicant i.e. CIO, it is important to note that:
  • There are decisions which have accepted that reimbursement of salary is not taxable as FTS; however the same were not relied upon by the applicant.
  • Typically as per the DTAA, Service PE is not constituted when the amount paid to overseas entities falls within the meaning of FTS/FIS. In the present case, the Court has held that the payment to overseas entities is taxable as FTS/FIS. Based on this, logically, the overseas entities should not constitute Service PE in India. However, this point has not been discussed in the present case.
In light of this decision, it would be pertinent that the current secondment agreement entered into by the Indian arm of foreign companies is reviewed, analysed and redrafted properly to mitigate the PE risk of the foreign entity in India.

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