[Analysis] Supreme Court Judgment in Northern Operating Systems

CA Sri Harsha – [2022] 139 taxmann.com 291 (Article)

Introduction

On 19th May 2022, the Supreme Court delivered two judgments that shaken the foundations of indirect taxation. One in the matter of Mohit Minerals Private Limited, which struck down the levy of reverse charge on the importer for ocean freight services (for more on this, please read our article here). Two, in the matter of Northern Operating Systems Private Limited, which upheld the revere charge on secondment of employees. Results of both the verdicts are opposite to the most popular public view, thus changing the way we look at the future of indirect taxation.

In this article, we wish to analyse the judgment of Supreme Court in the matter of Northern Operating Systems Private Limited (supra) and conclude with our remarks as to how the said judgment will impact the position under GST laws.

Issue in Brief

The facts were that Northern Operating Systems Private Limited (for brevity respondent/NOS) was registered with service tax authorities under the categories of ‘manpower recruitment agency service’ and other services. An audit was conducted by revenue which resulted in the proceedings against NOS alleging non-payment of service tax concerning agreements entered into by it with its group companies located in USA, UK, Dublin, Singapore etc to provide general back office and operational support to such group companies.

The nature and contents of the agreements which are subject matter of current discussion reveal that when required NOS requests the group companies for managerial and technical personnel to assist in its business and accordingly the employees (seconded employees) are selected by group company and they would be transferred to NOS. During the term of secondment, the seconded employees act in accordance with the instructions and directions of NOS and the seconded employees would devote their entire time and work to NOS. The seconded employees would continue to be on the payroll of the group company (foreign entity) for purpose of continuation of social security/retirement benefits, but for all practical purposes, NOS is the employer. The seconded employees would receive the salary, bonus, social benefits, out of pocket expenses and other expenses from group company and the group company raises a debit note on NOS to recover the said expenses without any mark-up. NOS would be issuing prescribed forms under the provisions of Income Tax Act, 1961 for the seconded employees. The seconded employees file their returns in India and contribute to the provident fund.

The tax authorities alleged that NOS has failed to pay service tax under reverse charge for the services of manpower supply received from the group entities which are located outside India. The tax authorities contention was that the seconded employee would revert to the group entity once the requirement with NOS is met. Hence, the seconded employee cannot be called as employee of NOS. Since there is no exclusion under the service tax law for a situation like which the NOS is in, there cannot be any relief from payment of tax under reverse charge. On the other hand, NOS argued that the group entities cannot be called as entities falling under the manpower recruitment or supply agency and after introduction of negative list, the definition of ‘service’ has excluded the services provided by employee to his employer from its ambit and since seconded employee is employee and NOS is the employer, their cannot be any tax either under pre or post negative list.

The CESTAT after hearing to both the parties, held that on reading of contracts and agreements, the group entities cannot be said to be engaged in supply of manpower. The seconded employees were receiving salaries from the group companies only for disbursement purposes and the employer – employee relationship existed and the activity, therefore, could not be termed as ‘manpower recruitment and supply agency’. The CESTAT further held that in the above circumstances, the overseas group companies which had contracted with NOS were not in the business of supply of manpower and NOS was not a service recipient and accordingly rejected the stand taken by the tax authorities. The Revenue appealed the CESTAT’s order before the Supreme Court.

Analysis by Supreme Court

The Supreme Court after hearing to both the parties has framed the issue as to whether the overseas group companies with whom NOS has entered into agreement, provide manpower services, for discharge of its functions through seconded employees? In simple words, the Supreme Court has to decide, as to, who is the employer of the seconded employee? If the Indian entity is treated as employer, then what is paid to the group entity is only a reimbursement and accordingly there is nothing to be taxed. On the contrary, if the foreign entity is treated as employer of the seconded employee, then the services provided by the foreign entity would be treated as service and becomes taxable. Hence, the crux is, who is the employer of the seconded employee?

The Supreme Court after referring to its previous judgments, wherein it was held that ‘control’ alone cannot be a factor to decide as to who is the employer has stated that there is no one single determinative factor, which the courts give primacy to, while deciding, whether an arrangement is a contract of service (as NOS pleads) or a contract for service (as the revenue pleads). The Supreme Court stated that one test has been consistently applied by them, which is ‘substance over form’, requiring a close look at the terms of the agreement.

The Court then stated that a vital fact which needs to be considered in the NOS case, is that the nature of overseas group companies business appears to be to secure contracts, which can be performed by its highly trained and skilled personnel. This business is providing certain specialised services and taking advantage of the globalised economy, and having regard to the locational advantages, the overseas group company enters into agreements with its affiliates or local companies, such as NOS and the role of NOS is to optimise the economic edge to perform the specific tasks given to it, by the overseas company. As part of this, the secondment contract is entered into, whereby the overseas company’s employees, possessing the specific required skill, are deployed for duration the task is estimated to be completed in. The Court stated it is in this context, it has to be decided, whether the secondment, for purpose of completion of the Indian entity’s job, amounts to supply of manpower?

The Supreme Court stated that for all appearances, the seconded employees, for the duration of secondment, is under the control of NOS and works under its direction. The fact remains that they are on the payrolls of their overseas employer and what is left unsaid and perhaps crucial, is that this is a legal requirement, since they are entitled to social security benefits in the country of their origin. The Court stated that it is doubtful whether without the comfort of this assurance, they would agree to the secondment. The Court further stated that, the reality is that the secondment is part of the global policy of the overseas employer loaning their services, on temporary basis and on cessation of secondment period, they have to be repatriated in accordance with the global repatriation policy. The Court further stated that the agreement between NOS and seconded employee nowhere states that latter would be treated as former’s employees after the seconded period and on contrary, they revert to their overseas employer.

The Court thus stated that the overall effect of the four agreements entered into by NOS with group companies, clearly points to the fact that the overseas company has a pool of highly skilled employees, who are entitled to a certain salary structure- as well as social security benefits. These employees, having regard to their expertise and specialization, are seconded to the concerned Indian entity for the use of their skills and upon cessation of terms of secondment, they return to their overseas employer, or are deployed on some other secondment.

The Court stated that while control (over performance of seconded employee’s work) and the right to ask them to return, if their functioning is not as is desired, is with NOS, the fact remains that their overseas employer in relation to its business, deploys them to NOS, on secondment. The Court further stated that overseas employer for whatever reason, pays them their salaries and their terms of employment even during the secondment are in accord with policy of overseas company, who is their employer and upon the end of period of secondment, they return to their original places, to await deployment or extension of secondment. Accordingly, the Court concluded that the overseas entity will continue to be the employer of the seconded employee and not the Indian entity.

The Court also rejected the argument put forward by NOS by stating that there was no consideration paid to the overseas entity (assuming that there is a service provided by overseas entity) and therefore no tax liability should accrue by stating that the mere payment in the form of remittances or amounts, either duration of the secondment, or per employee is just one of the way to reckon the consideration and the other way of looking at the arrangement is the economic benefit derived by NOS, which also secures specific job or assignments, from the overseas entities, which results in revenue and the quid pro quo for the secondment arrangement, where the NOS has benefits of the experts for limited period, is implicit in the overall things.

The Court also rejected the argument of revenue neutrality by stating that the judgments relied upon by NOS of the same court are unreasoned and merely affirming the CESTAT Orders. Hence, those judgments relied upon by NOS does not have precedential value and accordingly NOS cannot escape tax based on the ground of revenue neutrality. The Court also rejected the reliance of NOS on earlier judgments of Supreme Court in the matter of Volkswagen India Pvt. Ltd. v. CCE5 wherein it was held that the similar services provided by overseas entity is not a manpower recruitment and supply agency service by stating that such judgments are just confirmation of orders of CESTAT without any independent analysis and hence they do not have any precedential value.

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