Supreme Court rules reimbursed salary of certain seconded employees is subject to service tax
In a decision that has far-reaching implications for employee secondment contracts where salary is treated as a reimbursement, the Supreme Court of India ruled on 19 May 2022 that such agreements are service contracts and are subject to service tax.
It is a common practice in business conglomerates to temporarily transfer a person employed by one entity (transferor) to another entity (transferee) in the group; typically, employees of overseas group entities are seconded to an Indian entity. For practical purposes, such individuals act as employees of the transferee, are under the transferee’s control and direction, and are required to comply with the transferee’s rules. However, the employment contract of the seconded individuals continues to be with the transferor for purposes of the social security system of the employee’s original location, retirement benefits, etc. Thus, the salaries of seconded employees generally are reimbursed by the transferee to the transferor.
India levied service tax on the value of various types of services during the period 1994 to 2017 (starting at 5% in 1994 to as high as 15% in 2017). Service tax was subsequently subsumed in the Goods & Services Tax (GST) with effect from July 2017.
There have been many disputes on whether the arrangements described above amount to the provision of a service and whether the Indian entity is liable to pay service tax under the “reverse charge” on the salary of the seconded employee that is reimbursed to the overseas entity.
Facts of the case
The case before the Supreme Court involved a taxpayer in India that entered into agreements with overseas group companies to provide specific back-office and operational support services. When required, the Indian company requested the group companies to select and second managerial and technical persons to India for a specific period.
The Indian company sent a letter of understanding to the seconded employees that set out the terms of the employment. The seconded employees worked under the instruction and direction of the Indian company. Although the employees continued to remain on the payroll of the overseas group company, for all practical purposes, the Indian company was the employer.
The overseas group company paid the employees’ salary, bonus and social benefits, and reimbursed the employees for out-of-pocket and other expenses; it issued a debit note to the Indian company to recover the amounts paid to the seconded employees without any markup. Income tax was deducted from the employees’ salary and remitted to the Indian tax authorities. At issue, however, was whether the reimbursement payments made by the Indian company to the overseas group company were subject to India’s service tax.
Following an audit of the Indian company’s records by the Indian tax authorities, proceedings were initiated alleging a failure to pay service tax relating to the agreements the Indian company entered into with other group companies to provide general back-office and operational support to those companies. Following an adverse order from the lower authorities, the Indian company appealed to the Customs Excise and Service Tax Appellate Tribunal (CESTAT), which decided in favour of the Indian company. The tax authorities then filed an appeal with the Supreme Court.
Decision of the Supreme Court
Relying on the substance-over-form principle, the Supreme Court held that the Indian company was the recipient of “manpower recruitment and supply services” from the overseas company and, therefore, the reimbursement payments made by the Indian company are subject to service tax at the applicable rates. The salient points of the decision and the court’s rationale are as follows:
- The main question is whether the Indian company or the overseas group entity should be considered the employer of the seconded employees. If the Indian company is to be treated as the employer, the payment made to the group company would be a reimbursement, but if the group company is deemed to be the employer, the arrangement would be treated as the provision of a service by the group company to the Indian company and would be subject to service tax.
- The language of a contract or other relevant document is not decisive—an overall reading of all terms and language in a contract/document and their effect is required.
- The courts do not give primacy to any single determinative factor when analyzing whether an arrangement is a contract of service (as claimed by the taxpayer) or a contract for service. Instead, multiple tests are used based on the totality of the facts and circumstances and, depending on the case, all factors may not be relevant, or if relevant, may not be given the same weight. The Supreme Court has consistently applied the substance-over-form principle, which necessitates a close look at the terms of a contract or agreement to decide the issue.
- The overall effect of the agreements entered into by the Indian company with the overseas group company 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. The employees are seconded to the Indian company based on their expertise and specialization and at the end of the secondment period, they return to their overseas employer or are deployed on another secondment.
- The secondment is a part of the group’s global policy where a group company loans the services of employees on a temporary basis and upon completion of the secondment, the employees are repatriated in accordance with the policy. The letter of understanding between the Indian company and the seconded employee does not state that the employee would be treated as the employee of the Indian company after the secondment period.
- The Indian company has control over the seconded employees and has the right to ask them to return to the overseas company if their services are not considered satisfactory. The overseas group company simply deploys the employees to the Indian company on a secondment basis. The salary package with allowances, etc. is expressed in foreign currency and the terms of the employment are in line with those of the overseas group company, who is their employer.
- The remittance to the overseas group company is consideration for the supply of the secondment services.
Although the Supreme Court’s decision relates to the service tax, the court’s observations are equally relevant when determining whether GST should be imposed on secondment arrangements. The Supreme Court made various comments on the agreements in the case and proceeded to determine the issue based on the substance-over-form principle. Companies with secondment arrangements may need to revisit their positions in light of the Supreme Court decision.