CONUNDRUM OF TAXING SECONDMENT OF EMPLOYEES: IMPLICATION OF NORTHERN OPERATIVE RULING ON DIRECT TAXATION

[Parth Gondia]

1. Introduction

The secondment of foreign workers has become a common scenario in today’s globalised economy. The Supreme Court by upholding the validity of the reverse charge on the secondment of employees in the case of C.C.,C.E. & S.T. – BANGALORE (ADJUDICATION) ETC. VERSUS M/S NORTHERN OPERATING SYSTEMS PVT LTD. - 2022 (5) TMI 967 - SUPREME COURT has opened a pandora box for multinational corporations which depute their employees to another company for work. This judgment is the first of its kind and is opposed to the series of previous judgments of tribunals, wherein in several cases the tribunal has held that there cannot be any tax on the secondment of employees. Even though the judgment was rendered in the context of service tax, it has consequences and implications under the Income Tax Act 1961 which remains unaddressed. This article endeavours to analyse the possible implication of the judgment under the Income Tax Act 1961. 

Before analysing its implication, the article first highlights the key issues involved in this case and the analysis given by The Supreme Court.

2. Issues Involved  

The assessee (Northern Operating Systems Private Limited) was registered under the service tax authorities in India. The assessee entered into an agreement with group companies located in Dublin, Singapore, UK, and USA to receive seconded employees from them on a termly basis. These group companies selected seconded employees and transferred them to the assessee when the assessee requested managerial and technical personnel assistance. 

During the term of secondment, the seconded employees would work for the assessee but for the purpose of social security benefits and other benefits, they remained on the payroll of the group companies. They received their bonus and salary from the group companies and the group companies would raise a debit note on the assessee to recover these expenses. However, the seconded employees filed their returns in India and also contributed to the provident fund. 

In response to this, The Tax authorities initiated the proceeding against the assessee for not paying service taxes on the services received of manpower supply from the group companies. Tax authorities alleged that the reimbursement of salary paid by the assessee to the group companies counts as import of manpower supply services on which service tax needs to be paid. On the other hand, the assessee argued that the assessee is not a “service recipient” because an “employer-employee” relationship existed between the assessee and the seconded employees and therefore, the group companies do not fall under the ambit of “manpower supplying agencies”. 

After hearing both sides, the CESTAT ruled that the assessee was not a “service-recipient” but an employer of the seconded employees, therefore, the assessee is not liable to pay service tax on the secondment of employees. Aggrieved by the order of the CESTAT, the tax authority appealed to the Supreme Court.

3. Analysis by the Supreme Court

In simple terms, the issue before The Supreme Court was to decide who was the employer of the seconded employees during the term of their secondment. If the group companies are treated as the employer, then the services provided by them would be liable to tax, On the contrary, if the assessee is treated as the employer, then the amount paid to group companies would be treated as reimbursement on which service tax cannot be levied.

The Supreme Court while acknowledging the agreements of “secondment of employees” as an integral part of today’s globalised world ruled that, even though the seconded employees were working for the assessee, their salary package and allowances were expressed in foreign currency and separate allowances were provided for working in India, which is only possible when the seconded employees were the employees of the global companies. The Supreme Court rejected the CESTAT ruling and held that the assessee did not have an “employer-employee” relationship with the seconded employee. Accordingly, the court concluded that the assessee was liable to pay service tax for such agreements.

4. Implication under the Income Tax Act 1961.

Though the judgment relates to the service tax regime, it will have implications for Income Tax laws as well. This part of the article highlights the provisions of the Income Tax Act 1961, where this judgment has fuelled a dispute between the taxpayers and the tax authorities due to conflicting opinions.

4.1) Section 195 of Income Tax Act, 1961: Issue of deducting tax at source

Deduction of tax at source is the easiest mechanism for tax management at the macro level. Section 195 of the Income Tax Act 1961 provides the liability to deduct tax at source when making payment to a non-resident, if the sum paid is chargeable to tax in India.

In the case of M/S. CENTRICA INDIA OFFSHORE PVT. LTD. VERSUS COMMISSIONER OF INCOME TAX-I & OTHERS - 2014 (5) TMI 154 - DELHI HIGH COURT. The High Court of Delhi held that the company that enters into a secondment agreement with a foreign company is liable to deduct tax at source under section 195 of the Income Tax Act 1961 when reimbursing the amount towards the salaries of the seconded employees to the foreign companies. In other words, the Supreme Court held that Indian companies cannot be called an employer of seconded employees and therefore, the services received by them is liable to be taxed.

Contrary to this decision, The Income Tax Appellate Tribunal (ITAT) in the recent case of TOYOTA BOSHOKU AUTOMOTIVE INDIA PVT. LTD. VERSUS ASSISTANT COMMISSIONER OF INCOME-TAX - 2022 (12) TMI 244 - ITAT BANGALORE held that there is no liability on the company to deduct tax at source under section 195 of the Income Tax Act 1961 when reimbursing the amount towards the salaries of the seconded employees to the foreign companies.

Given such contrary interpretations, the provision has huge ramifications for Indian companies who enter into agreements of secondment of employees with foreign companies. 

4.2) Section 9 of the Income Tax Act, 1961: Issue of “Fees for Technical Services”

section 9 of the Income Tax Act of 1961 provides for “fees for technical services”. As per Explanation 2 of section 9(1)(vii) of the Income Tax Act 1961, “fees for technical services” includes any consideration for the rendering of any technical, managerial, or consultancy services.

In secondment contracts, a common dispute between the taxpayer and the tax authorities is whether the reimbursement paid towards the salaries of the seconded employees would count as “fees for technical services” under section 9 of the Income Tax Act 1961. If it is treated as “fees for technical services” then it is liable to be taxed but if it is treated merely as “salary” then it is not liable to be taxed. Before the Northern Operating Systems Private Limited ruling, the settled position was that the receipt of money by foreign companies was not considered as “fees for technical services”.

The Income Tax Appellate Tribunal (Mumbai Bench) in the case of Temasek Holdings Advisors (P.) Ltd. v. Dy. CIT held that payment on account of reimbursement of salaries of seconded employees is not liable to be taxed as it does not fall within the ambit of section 9(1)(vi) of the Income Tax Act 1961 and therefore cannot be construed as “fees for technical services”. This judgment was followed by the Bombay High Court in the case of DIRECTOR OF INCOME TAX (INTERNATIONAL TAXATION) IL, MUMBAI VERSUS M/S. MARKS & SPENCER RELIANCE INDIA PVT. LTD. - 2017 (5) TMI 1638 - BOMBAY HIGH COURT

With the Northern Operating Systems judgment, the tax authorities may attempt to apply this ruling in the income tax matters also. However, when this issue will be raised in future litigation, it is desired that the court may distinguish the case based on specific facts and may support withholding of tax on reimbursement of salaries of seconded employees by excluding it from the scope of “fees for technical service”.

It is interesting to note that in a recent judgement pronounced by The Delhi High Court in the case of PRINCIPAL COMMISSIONER OF INCOME TAX, DELHI-2 VERSUS M/S. BOEING INDIA PVT. LTD. - 2022 (10) TMI 498 - DELHI HIGH COURT, The Delhi High Court held that reimbursement paid to foreign companies by the Indian companies for seconded employees would come under the head “salaries” and cannot be treated as “fees for technical services” under section 9(1)(vi) of the Income Tax Act 1961.

5. Parting Thoughts

A complex jurisprudence has emerged due to different interpretations given by different courts and tribunals on the issue of taxing secondment of employees. While the conundrum of taxing the secondment of employees remains unsettled with no concrete test available for determining whether such transactions are liable to be taxed or not, the ruling given by the Supreme Court in the case of CC, CE&ST v. Northern Operating Systems Private Limited is surely a game changer. This ruling is likely to bring hardship for the taxpayers involved in seconded contracts. It is possible that the tax authorities would exploit this judgment in the context of income tax matters, especially on the issue of deducting tax at source on such transactions. This judgment seems to be a triggering point to a great extent on the issue of whether or not the reimbursement received by foreign companies on account of seconded employees would be treated as “fees for technical service”. The Time is ripe when some clarifications are issued in line with the spirit of the law on the issue of “whether such reimbursement paid to foreign companies would count as fees for technical service” and “is there any liability to deduct tax at source on such transactions”. Till then, these unsettled issues are bound to bring a lot of litigation to the courts.