[Opinion] Supreme Court’s decision on Secondment and its impact under Other Laws

FCA Ashish Karundia – [2022] 139 taxmann.com 528 (Article)

In the case of Northern Operating Systems (‘NOS’)1, the Supreme Court of India deliberated on the taxability of secondment arrangements in the context of Service Tax. The Supreme Court interalia observed the following:

(a) There is no single determinative factor for deciding whether a contract is for service or a contract of service,
(b) lien on employment, i.e., secondees are on the payrolls of their overseas employer and return to them after completion of the secondment tenure,
(c) Overseas entity’s service rule, i.e., Secondee’s terms of employment – even during the secondment – are in accord with the policy of the overseas entity.

In this background, the Supreme Court held that the overseas entity remains the employer and thus, concluded that there is a provision of manpower supply services from the overseas entity to the Indian entity, taxable under erstwhile service tax law.

Even though the decision is in the context of service tax, the decision will have implications under various laws such as income tax, transfer pricing, immigration, social security, exchange control etc. This article attempts to discuss the possible consequences:

1. Income Tax

1.1 Payment of salary of expatriate employees – Does not automatically qualify as reimbursements

It is generally claimed that recharge of the salary paid to the secondees from the Indian entity qualifies as ‘reimbursement’ as the overseas entity has not added any markup. Reimbursement, however, needs to be distinguished from recoupment, i.e., in cases where the recipient adds no markup, the transaction does not automatically qualify as reimbursement.2 In order to qualify as reimbursement, the following conditions should be satisfied cumulatively:

• • The actual liability to pay should be of the person who reimburses the money to the original payer.
  • The liability ought to have been clearly determined. It should not be an approximate or varying amount.
  • The liability ought to have crystallised. In other words, payments which were never required to be done but were done just to avoid a potential problem may not qualify.
  • There should be a clear ascertainable relationship between the paying and reimbursing parties. Thus, an alleged reimbursement by an unconnected person may not qualify.
  • The payment should first be made by somebody else whose liability it never was, and the repayment should then follow to that person to square off the account.
  • There should be three parties: the payer, the payee and the reimbursor.

Once it is established that there was a provision of services and payment is made to an overseas entity towards such provision only, the fact that no markup is charged over the cost does not change the nature of services and does not affect taxability. The said principle was upheld in the decision of Centrica India Offshore (P) Ltd.4. The Supreme Court, in the NOS case, has held that it is essential to identify the employer, i.e. the overseas entity or the Indian entity. Once the overseas entity is determined as the employer, the transaction will qualify as a provision of service to the Indian entity, and the defence of reimbursement will not be available.

1.2 Fees for Technical Services (FTS)

A common dispute between the tax authorities and the taxpayer is whether the amount representing secondees’ salaries paid to overseas entities constitutes FTS under Section 9 of the Income-tax Act, 1961 (‘IT Act’). Before the NOS decision, the taxpayer primarily (and successfully) argued that the Indian entity qualified as the economic employer, and thus, the receipt of money by the overseas entity was not FTS in its hand but was salary in the hands of the secondees. With the NOS decision, the economic employer theory may be difficult to sail through.

1.3 Permanent Establishment (PE)

Another issue that arises due to the secondment of employees is the existence of PE viz., Fixed Place PE, Service PE, and Agency PE of the overseas entity. In the past, PE has been triggered in several cases5 due to the presence of secondees in India. Thus, a PE may get triggered in secondment cases depending upon the facts involved in a particular case. If applying the principles led down in the NOS case, the overseas entity is held to be the employer, then the secondees in India would be accordingly treated as furthering the business interests of the overseas entity triggering the PE exposure.
It is often argued that even where the PE is held to be triggered but if the transaction between the group companies is at arm’s length, there may be no further tax implications. The author is, however, of the view that MAT implications may get triggered even in those situations.

1.4 Transfer Pricing

The Indian transfer pricing regulations require that the transaction between two associated enterprises be at arm’s length. In the NOS case, the Supreme held that the supply of manpower is a taxable service. One may be of the view that the mere supply of manpower may not qualify as an ‘international transaction’ and thus, may not warrant transfer pricing implications. The author is of the view that even the act of assigning employees by the overseas entity to an Indian entity may result in the transfer of a right to exploit valuable know-how6 and thus, may qualify as an international transaction between two associated enterprises subject to transfer pricing regulations in India.

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