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In the era of Globalisation, it is common for many moderate to big companies to have presence of their operations spread over different parts of the Globe for different reasons, say optimisation of market potential, reduction in operating costs, exploitation of local talent, to take advantage of the beneficial tax laws wherever in force, etc.
Though all these arrangements preceded by a very detailed and thorough study of applicability and effect of various Statutes in force in each of the operating countries (or contracting state to say in another way), they must be a bit more cautious when it comes to various Tax laws in force. This is because, these tax laws are the guiding force to decide upon which type of operations are to be done from which country, so that their operating profit will bear the least possible tax burden or even the nil tax in a legitimate manner.
Why are employees seconded and what are the factors to be considered
For this purpose, one should take into consideration, along with the Tax laws of the specific countries, DTAAs or Tax Conventions mutually accepted and entered into between the home country and each of different countries where its operations are going to be present. In some cases, they can also think of seeking Advance Ruling on various aspects from the Tax authorities of the respective contracting states.
For example, an automobile manufacturing company which was incorporated in Germany has opened an Indian subsidiary.
While core business operations are being carried out in home country, Indian subsidiaries have been incorporated to take care of business supporting services like, billing to customers, accounting services, coordinating with the vendors to meet the global standards as required by the holding company etc.
During the initial period of its operations, Indian subsidiary being not well versed with the global standards of the holding company, requested the holding company to send some employees on deputation to train its employees, to ensure that the quality of deliverables are on par with the global standards.
So, the holding company seconded some of its employees to Indian subsidiary. For this arrangement, both the parties agreed that the Indian subsidiary has to reimburse the holding company costs incurred by it on the salary and other perks offered to employees sent on deputation or secondment, on cost-to-cost basis.
Now, if we need to check the effect of Tax Laws in India on this, we need to check relevant provisions of Indian Income Tax Act 1961, DTAA between India and Germany, any Advance Rulings passed by the AAR, any judgments by the Supreme Court of India or High courts etc on the similar issues.
Applicability of TDS provisions
As per Section 195 of Income Tax, 1961 any person who is liable to pay any interest, except interest u/s 194LB, 194LC OR 194LD, or any other sum not being the income chargeable under the head “Salaries”, shall deduct tax on such sum being paid or credited to the account of the payee at the rates in force at the time of such payment or credit.
There is a judgement by Delhi High court in the case of Centrica India Offshore Pvt. Ltd (CIOP) Vs. Commissioner of IT, with the similar facts, where in the petitioner being an Indian subsidiary of a UK company Centrica Plc., established for the purpose of supervising the quality of work outsourced to Indian Vendors.
During the first year of its operations CIOP requested its holding company to send employees on deputation in return to which it will reimburse the cost incurred by Centrica on their salaries and other benefits which they are entitled to as per their employment agreement with the holding company.
Authority for advance ruling
It sought advance ruling as to whether such reimbursement is taxable in India and TDS is liable to be deducted.
AAR held that such payment is income accruing form the services rendered through Service Establishment.
Aggrieved by the above, CIOP preferred a writ petition before Delhi High Court in which it contended that the mere reimbursement of cost incurred by holding company for the benefit of it, doesn’t take the form of income to the holding company by quoting the “Doctrine of diversion of income by overriding the Title”.
CIOP argued that the as secondment agreement was on principal-to-principal basis and also that the seconded employees have to train the Indian employees which is non-integral part of business of the holding company, and hence the salary paid was not in the form of fee for technical services.
Also, it was of the view that the employees were seconded under a contract entered into with the holding company on Principal-to-Principal basis hence it can’t be considered as Service Establishment.
But the IT department was of the view that the seconded employees are employed to bring into existence some standard set of processes and procedures while performing the agreed work so that the Indian subsidiary will be in a position to perform and deliver according to their acceptable standards after the completion of the secondment agreement. It means that they have some knowledge and expertise in the field which can be regarded as technical knowledge hence the services so rendered are technical in nature.
Also, the Income tax authorities were of the view that the seconded employees providing services will constitute a Permanent establishment in India, as per the applicable DTAA. Because of this reason, reimbursement of said cost incurred by holding co will take the form of “Fee for Technical services”. Hence, Sec 9(1) (vii) will be applicable, and according to sec 5(2) the amount so reimbursed will be deemed to accrue or arise in India and is taxable in India. So, Tax must be deducted at source before making such payment to the holding company.
It also contended that the salary and other allowances received by the seconded employees will be liable to tax in India based on the judgment given in the case of CIT Vs. Eli Lilly and co India Pvt. Ltd.
It was held in the above mentioned case law that the deciding factor for taxability of salary received by the seconded employees in foreign currency abroad will be the place where the services with respect to which the said salary is received for the period of secondment.
If such a place is in India, then the said salary and other allowances will be deemed to accrue or arise in India and taxable accordingly as per Sec 5 (2) and Sec 9 (1) (vii) read with Sec 192.
With respect to the PE concept, the employees continue to be under the control of their former original employer being the holding company once the secondment agreement comes to end though the Indian subsidiary has to bear the result of work performed by the seconded employees.
Also, Indian subsidiaries don’t have any lien on the termination of their employment. Seconded employees can execute their employment rights only against the holding company.
As per Article 5(2)(k) of DTAA with the UK, PE includes a place where services including Managerial services are provided for a period of more than 30 days in a twelve month period, in case of Associated enterprises.
Given the above mentioned facts and arguments by both the parties, the Delhi High court held that,
- The mere fact that the payment made to the holding company under secondment agreement is termed as reimbursement, it can’t be considered as a proof of the same. Also, the fact that the holding company doesn’t add mark-up over and above the cost, can’t change the nature of the transaction.
- Also petitioner’s stand which says that the amount paid is not income of the receiver is also made insubstantial by the court for the reasons that:
- The original employer is under no condition or compulsion to pay the salaries and allowances to the seconded employees only out of the money received from the Indian subsidiary. Such obligation arises under independent conditions, in relation to the subsidiary’s obligation to pay to the holding company. So, there is no doctrine of diversion of income by overriding the title applicable here.
- The payment is not reimbursement but payment for the services rendered.
So, based on the above facts and circumstances of the case and judgment by the Delhi High Court, we can conclude that:
Payment made by the Indian Subsidiary to the foreign holding company under the secondment agreement, is considered to be income from services rendered by the latter to the former. Hence, Tax must be deducted at source as per Sec 195 of Income Tax Act, 1961.
The salary received by the seconded employees for the services rendered while being in India is deemed to accrue or arise in India as per Sec 5(2) and the same is in the nature of Fee for Technical Services. Hence, tax must be deducted at source as per Sec 9(1)(vii), read with Sec 192 of Income Tax Act, 1961.
The Indian subsidiary is considered to be the SE as per provisions of DTAA.
Income Tax 1961
DTAA between India-UK
DTAA India and Canada
CIOP vs. Commissioner of IT and others
CIT vs. ELI LILLY and CO. India Pvt. Ltd
CIT vs. Bharathi Cellular Ltd
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