The movement of employees across countries has become a common practice. Often, employees from one entity within a group are assigned to another entity in a host country. This can be for specific assignments, technical support, or to provide expertise in specific areas of operation. In most cases, a portion of the seconded employees' payroll remains in the home country to ensure the continuity of their social security benefits in their home country. The home company usually disburses the social security contributions, along with a portion of the employee's salary in the home country, which is later reimbursed by the host company to which the employee has been seconded, on a cost-to-cost basis.
In the secondment model, seconded employees work under the host company’s direction, supervision, and control. In such cases, the host company bears the entire salary and related costs, including social security contributions paid in the home country. The host company takes responsibility for the work done by the seconded employee during the period of secondment in India and usually retains the right to terminate the secondment.
Secondment has been a contentious issue in India, where the tax authorities argue that under the secondment arrangement, the home company provides services to its host company in India through the seconded employees. They claim that the reimbursement to the home company by the Indian host company, including social security contributions and salaries paid in the home country, qualifies as a “fee for technical services” (FTS) and is therefore taxable in India. As such, it is subject to withholding tax under Section 195 of the Income-tax Act, 1961.
Various courts have examined similar matters, and two key principles have emerged: each case needs to be analysed based on the facts, and the substance-over-form doctrine needs to be taken into consideration in determining whether the agreement is a “contract for service” or a “contract of service.”
The Delhi Tax Tribunal recently examined the applicability of the withholding tax provision on the reimbursement of salary costs in the case of a secondment. The Tax Tribunal’s ruling in Serco India Pvt. Ltd. v. DCIT is summarised below, followed by comments on the impact of this decision.
Facts of the case
The taxpayer, a company incorporated in India, is a subsidiary of a UK-based company and operates as a captive service centre to provide IT services (research operations, business process outsourcing, and management consultancy support services) to group entities.
The taxpayer recruited three UK company employees to work exclusively for it on a full-time basis as regional CEO, CFO, and HR officer. The employees were released by the UK company and subsequently entered into separate employment contracts with the taxpayer, so that during the period of employment, the taxpayer was the sole and exclusive employer of the employees, having complete control, while the hired employees ceased to be employees of the UK company. Further, the taxpayer had an unconditional right to terminate these employees, while the UK company had no obligation to replace them.
The taxpayer entered into a “salary reimbursement agreement” with the UK company whereby the UK company would pay 40% of the seconded employees’ salary in foreign currency and claim reimbursement thereof from the taxpayer for administrative -- and the employees’ -- convenience. For this purpose, the taxpayer was supposed to inform the UK company of the amount of foreign currency payable as salary to the seconded employees, as determined by and supposed to be reimbursed by the taxpayer. According to the appointment letters and salary reimbursement agreement, the taxpayer was exclusively and solely liable to pay salaries, allowances, and requisites to the seconded employees.
However, the Indian tax authorities disallowed the expenditure relating to reimbursement under Section 40(a)(i) of the IT Act on the grounds that the reimbursements of expenses for seconded employees is in the nature of fees for technical services and is liable to deducting tax at source (TDS) under Section 195 of the IT Act. The taxpayer filed an appeal of this order with the Delhi Tax Tribunal challenging the applicability of Section 195 of the IT Act, as well as the tax authorities’ classification of the reimbursement amount as FTS.
Delhi Tax Tribunal Ruling
While upholding the taxpayer’s claim and disregarding the applicability of Section 195 of the IT Act, the Delhi Tax Tribunal made the following observations.
The employees had an employee-employer relationship with the taxpayer only, and thus had no rights to act on behalf of the UK company or bind the UK company, which prompted the conclusion that the taxpayer was the legal and economic employer.
The employees’ salary is paid partly by the taxpayer and the remaining through the UK company at the taxpayer’s request only for administrative purposes, and is reimbursed by the taxpayer on a cost-to-cost basis. This salary was chargeable to tax as salary in the hands of the employees, and not as FTS because there was no agreement/document to prove that the UK company provided any technical services. Accordingly, TDS under section 192 of the IT Act is withheld by the taxpayer before making payment to the employees.
Emphasis can be placed on CBDT Circular 720, dated 30 August 1995 (PB-703), to observe that payment will be liable for TDS, only under one section, Section 192 of the IT Act in the instant case.
Accordingly, the salary reimbursement to the UK parent company need not be subjected to withholding tax under section 195 of the IT Act, because tax has already been deducted under section 192 of the IT Act on salary paid to the employees where the taxpayer is found to be the legal and economic employer.
The Delhi High Court judgement in the case of Centrica India Offshore (P.) Ltd. and the Supreme Court judgement in the case of Northern Operating Systems Pvt Ltd can be distinguished on the facts of the case.
The Centrica case involved a newly formed entity that did not have the requisite technically trained human resources. Secondees were not only providing services to Centrica India during the initial period but also trainded other employees of Centrica India so that these services could be continued by them without assistance from secondees. Centrica India had admitted that the reason for secondment was to provide support during the initial years until the resident employees acquired the necessary skillset. Therefore, the court held that the secondees had transferred their technical ability and had made available their technical know-how for future consumption. The seconded employees were not specifically taken into employment by Centrica India, but remained on the payroll of the overseas entities that paid and disbursed their salaries. The right of the seconded employees to seek their salaries and other emoluments was against the overseas entities. Also, the seconded employees were not released by the overseas entity during the period of secondment and had a lien on their employment with the overseas entity. Centrica India had no right to terminate the employment of expatriate employees with Centrica. In this case, the Delhi High Court observed that the money paid by Centrica India to the overseas entity accrued to the overseas entity, which may or may not employ it for payment to the secondees, based on its contractual relationship with them.
In the Northern Operating System case, the seconded employees were not released by the foreign company during the period of secondment. The foreign company issued a “letter of undertaking” to the seconded employees and salary and other allowances were decided by the foreign company. Moreover, the seconded employees remained on the payroll of the overseas entities that used to pay and disburse the salaries. The right of the seconded employees to seek their salaries and other emoluments was against the foreign company. If Northern Operating System rejected the employees selected for secondment, the foreign company would provide a replacement for those employees.
It should be noted that the judgment rendered in the Northern Operating System case was in the context of service tax. The only question for determination was whether the supply of manpower was covered under the taxable service and was to be treated as a service provided by a foreign company to an Indian company. However, in the present case, the legal requirement requires a finding on whether to treat a service as FTS.
Reliance can be placed on the Karnataka High Court ruling in Flipkart Internet Private Limited4 to hold that the Supreme Court ruling in Northern Operating Systems was rendered in the context of service tax and hence, was not applicable to the IT Act to determine if the payment is for FTS.
BDO in India Comments
The issue with respect to whether tax needs to be deducted from a reimbursement of salary cost under section 195 of the IT Act because of a secondment arrangement has been a matter of debate before the Indian courts and tax tribunals.
In industrial practice, it is a settled position that the mere reimbursement by an Indian entity to an overseas entity of the salary of seconded employees cannot be regarded as FTS, and the Indian entity therefore is under no obligation to withhold under Section 195 of IT Act. It is irrelevant whether any profit element is included in the income or not.
The Delhi Tax Tribunal in the present case also held that the reimbursement by an Indian company of salary and other costs of the seconded employees working in India to a foreign entity does not constitute FTS but it is only the reimbursement of salary by an Indian entity to a foreign entity. Hence, the taxpayer was not required to deduct TDS under Section 195 of the IT Act.
The terms and conditions of the secondment agreement between the home company and the Indian host company need to be carefully drafted and factually substantiated to take a position on the non-applicability of the TDS provision to the salary cost charge of seconded employees.
BDO in India