Volume 5, Issue 3

16th April, 2012

Tax Alert
Secondment of Managerial Staff constitutes Service PE of foreign company in India

This tax alert summarizes the recent ruling pronounced by the Authority for Advance Ruling (‘AAR’) where the question before the AAR was whether the reimbursement of salary costs by an Indian subsidiary company to its overseas parent under a secondment agreement (‘SA’) was in the nature of income of the overseas entities in India.

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Facts of the case :

  1. Centrica India Offshore Pvt. Ltd. (‘CIO’) is a company incorporated in India and a wholly owned subsidiary of Centrica Plc, United Kingdom. Centrica Plc along with its 2 other subsidiaries (one in Canada and one in UK) (‘Overseas Entities’) are engaged in the business of supplying Gas and Electricity to various consumers across UK.
  2. The overseas entities have outsourced their back office support functions such as consumers’ billings/debt collections/Monthly MIS job to third party vendors in India. CIO was incorporated for ensuring that the third party vendors operated as per the quality guidelines of the group. For these services, CIO was to receive remuneration at cost plus 15% markup from the overseas entities.
  3. Further as per the SA, CIO would ask the overseas entities to depute its staff to CIO. This staff would bring their knowledge of various processes and practices of the group and the experience in managing and applying such processes and practices in India. CIO was given the right to terminate the SA at its option.
  4. CIO was to designate the concerned seconded employees to fill certain positions in its organization, integrate them into CIO and authorize them to perform the duties. However to determine the specific scope and nature of seconded employee’s work and the desired result to be achieved, CIO could enter into separate secondee agreement with each of the seconded employees.
  5. CIO was to bear all the risks in respect of the work performed by seconded employees i.e. the overseas entities were not responsible for the work and actions of the seconded employees. Accordingly, the seconded employees were to work under the control and supervision of CIO.
  1. The overseas entities had deputed 4 personnel to CIO who were designated as General Manager, Operations Manager, Delivery Manager and the Relationship Manager of CIO.

  2. Since, the employees were coming to India on deputation for the short term and their families being in their home country, on their request and as per their convenience, salaries although paid by the overseas entities into their overseas bank account were being treated as reimbursable expenses by the overseas entities. These expenses were then being recharged by the overseas entities to CIO on a cost-to-cost basis.

Question before AAR:

In the background of the above facts, question raised before the AAR were as follows:

  • Whether the reimbursement of salary cost paid by CIO to the overseas entities is taxable in India?
  • If the same is in the nature of income, whether withholding of tax thereon was required u/s 195 of the Income Tax Act, 1961 (‘ITA’)?

Contentions of CIO:

  1. CIO was the economic employer of the seconded employees and that the contract between CIO and overseas entities was a contract of service and not contract for service.
  2. Being the economic employer, CIO was under an obligation to deduct tax u/s 192 of the Act, which it has duly complied with.
  3. The salary was being paid by the overseas entities in UK and Canada only for convenience and the payment made to the overseas entity by CIO was only a reimbursement and no income element was attached to it.
  4. Further, the reimbursement of salary cost to the overseas entities cannot be held to be ‘Fees for technical services’ in terms of the India-UK tax treaty or ‘Fees for included services’ in terms of the India-Canada tax treaty.

Contentions of the Revenue:

  1. The contract between CIO and the overseas entities is a contract for service and not a contract of service which is pre-requisite for developing employer-employee relationship. Accordingly, the overseas entities and not CIO are the economic employers of the seconded employees.
  2. The payment of salary cost to overseas entities was disguised as reimbursements to escape withholding tax liability in India. Further, adequate information was not given to the Revenue to determine whether the reimbursement contains any element of income.
  3. Payments made to the overseas entities are in the nature of ‘Fees for technical service’ in view of India-UK tax treaty and in view of India-Canada tax treaty, the same is in the nature of ‘fees for included services’ and are accordingly taxable in India.
  4. The overseas entities constitute a Service Permanent Establishment (‘PE’) in India.

AAR’s Ruling:

  1. The AAR observed that the right of the seconded employees to seek their salaries and other emoluments is against the overseas entities and not against CIO. Also, it is the overseas entities and not CIO who were liable to pay the salaries to the seconded employees.
  2. Although the control and supervision of employees is with CIO, it cannot terminate their employment. It could only terminate the SA with the overseas entities.
  3. The fact that the individual appointment letters given to the seconded employees by CIO were silent on the salary and other dues payable to the concerned employee confirms the fact that CIO has no economic control over the seconded employees. Further, merely naming the agreement as secondment agreement does not mean that CIO is the economic employer.
  4. Relying on the OECD Model commentary, the AAR observed that the enterprise to which the employee is sent does not qualify as an employer merely because the employee performs services for it, or because the enterprise gives the employee instructions regarding his work.
  5. Since the work of the seconded employees was to ensure that CIO and third party vendors performed activities as per the group policies and practices, the work performed by the seconded employees is for the original employer i.e. the overseas entities.
  6. The obligation to pay salary to an employee is different from an obligation undertaken to compensate their employer. In the absence of an obligation, CIO cannot be said to the economic and original employer.
  7. The contention that the reimbursement of salary costs to the overseas entities was a case of diversion of income by overriding title was not acceptable in light of the Supreme Court’s ruling in the case of Sitaldas Thirathdas1 where it was held that the true test is whether the amount sought to be deducted never reached the tax payer as his income. Where the income is to be applied for discharging an obligation, it cannot be said to diverted by overriding title. In this case, the obligation to pay the salaries was of the overseas entities and not CIO and hence it was not a case of diversion of income by overriding title.
  8. Merely because the overseas entity is not charging a markup on the salary and other emoluments paid to the concerned employee, does not make it a reimbursement. Accounting method or treatment of items cannot be conclusive evidence.
  9. Since the seconded employees were concerned with the managerial functions, the services rendered were in nature of managerial services. However,  the contention of the revenue that these services qualify as ‘fees for technical services’ by relying on the AAR ruling in case of Verizon Data Services  India Pvt. Ltd2 was not acceptable as the Madras HC has set aside the Verizon ruling for re-consideration.
  10. Accordingly, the amounts paid by CIO to the overseas entities could not be held to be fees for technical services under the tax treaty.
  11. However, relying on the decision of the Supreme Court in case of Morgan Stanley3, it was held that the secondment resulted in a ‘service PE’ in India, in terms of paragraph 2(k) of Article 5 of the India-UK tax treaty and paragraph 2(l) of Article 5 of the India-Canada tax treaty. Accordingly, the amounts paid by CIO to the overseas entities were liable to withholding tax in India.

Our Comments:

Though the AAR ruling applies only to the applicant concerned i.e. CIO, it has brought out a significant aspect that deputing employees to India even through a secondment agreement could amount to constitution of Service PE in India unless the secondment agreement is drafted carefully. In the background of this ruling, many existing secondment agreements would need to be reviewed to analyze the possible of PE exposure to the foreign enterprises deputing personnel to India.
1 CIT v. Sitaldas Thirathdas (41 ITR 367)
2 Verizon Data Services India Pvt. Ltd v. CIT – AAR No. 865 of 2010
3 Morgan Stanley 292 ITR 416