Multinational companies (“MNCs”), with a view to utilise available skill within the MNC group, often depute employees from a foreign entity to another entity of the same group. During the period of deputation, such employees often retain their employment with the original parent entity, typically to enjoy continued social security benefits. Employees under such arrangements (“Secondment Agreements”) are referred to as, inter alia, ‘seconded employees.’
Since the seconded employees retain their lien over employment with the foreign entity, determination of their relationship with the Indian entity often becomes a subject matter of litigation. It may be argued that the foreign entity merely performs services for the Indian entity by using its own technical personnel and no employer-employee relationship exists between the seconded employees and the Indian entity. Tax implications under both scenarios differ under the Income-tax Act, 1961 (“IT Act”).
Due to the cross-border nature of such Secondment Agreements, in certain instances, for administrative convenience, the Indian entity pays part of the salary due to the seconded employees, to the foreign entity. The foreign entity, in turn, makes the requisite payments directly to the overseas accounts of the seconded employees. The Income-tax Department (“ITD”) has, time and again, sought to tax the foreign entity on such amounts, claiming these to be payments for services rendered and to be taxed as ‘fees for technical services’ (“FTS”).
Recently, the Bangalore Income Tax Appellate Tribunal (“ITAT”), in the case of Toyota Boshoku,[1] ruled in favour of a taxpayer who had entered into a Secondment Agreement with its foreign parent company. The ITAT discussed numerous precedents on this issue and clarified the scope of taxation in the hands of the foreign parent.
Background
In Toyota Boshoku, the taxpayer is a company engaged in manufacturing automobile components in India. It carries out licensed manufacturing activities using the technology and technical knowhow, obtained from its associated enterprise (“AE”) in Japan. On assessment, the Assessing Officer (“AO”) did not agree with the benchmarking method used by the taxpayer for engaging in international transactions with the AE and recomputed the tax liability. Aggrieved by the AO’s order, the taxpayer filed its objections before the Dispute Resolution Panel (“DRP”). The AE and the taxpayer had entered into a Secondment Agreement. The DRP held that certain expenses, categorised as ‘reimbursement of salary’ by the taxpayer, were in fact in the nature of FTS paid to the AE towards the deputation of its employees and were accordingly, liable to withholding tax in India. Thus, along with the additions made by the AO, the DRP further increased the tax liability of the taxpayer. Being aggrieved by the order of the DRP, the taxpayer preferred an appeal before the Bangalore ITAT.
ITAT Ruling in Toyota Boshoku
Most appropriate method for benchmarking
The Bangalore ITAT noted that the issue had already been decided in Toyota Kirloskar,[2] which involved one of the taxpayer’s sister concerns operating under a similar business model. Accordingly, the ITAT held that the taxpayer used the most appropriate method and directed the AO to apply the said method to ascertain the arm’s length price for the transactions with the AE.
Nature of payment to the seconded employees
To determine this issue, the Bangalore ITAT referred to the specific terms and conditions agreed between the taxpayer and the AE (“Employee Contract”). Under the Employee Contract, the employees of the AE were ‘loaned’ to the taxpayer for a specified period (“Loaned Employees”). The Employee Contract, inter alia, gave the following rights to the taxpayer in relation to the Loaned Employees – (i) deciding working hours and leave policy; (ii) deciding code of conduct and other service regulations; (iii) deciding nature and scope of work performed; and (iv) termination/extension of employment. The Employee Contract further limited any direct or implied liability of the AE in relation to the services performed by the Loaned Employees.
The taxpayer was also responsible for deciding the quantum of salary and making all salary payments to the Loaned Employees. Part of this salary was paid in India and part was remitted to Japan, to the AE. The AE further remitted the salary to the overseas bank accounts of the Loaned Employees. The DRP considered the Loaned Employees to be the real employees of the AE and thus, reimbursement of salaries to the AE by the taxpayer was considered payment of FTS, liable to withholding tax under Section 195 (TDS on payments to non-residents) of the IT Act. Several precedents[3] were relied on by the ITD in support of the view taken by the DRP.
The ITAT discussed the scheme of the IT Act and the OECD Model Commentary on double taxation avoidance agreements (“DTAAs”) for the taxation of ‘salary’ income. Under the IT Act, salary paid for services rendered in India is taxable in India, irrespective of the residential status of the employee (subject to the employee’s staying in India in excess of the specified number of days). Further, under the OECD Model Commentary, specific guidelines have been issued to determine the relevant ‘employer’ and taxing State in the context of Secondment Agreements. According to the guidelines, control over the employees is crucial for determining the relevant employer under the DTAA.
Thus, taking the terms of Employee Contract into account, the ITAT held that the AE was the de jure employer while the taxpayer was the economic and de facto employer of the Loaned Employees since the taxpayer enjoyed complete operational control over them. The taxpayer had withheld tax while paying salary to the Loaned Employees under Section 192 (TDS on salaries) of the IT Act. Part of this salary, on which tax had already been deducted, was remitted indirectly to the overseas bank accounts of the Loaned Employees in Japan through the AE. The Loaned Employees, being residents of India during the relevant financial years and rendering services in India, were earning income under the head ‘salaries’ and were liable to tax in India. Further, the definition of FTS under the IT Act excluded any income chargeable under the head ‘salaries.’ No income was earned by the AE, and therefore, no withholding obligation arose on the taxpayer under Section 195 of the IT Act.
Significant Takeaways
Tax liability under the IT Act depends on the residential status of the taxpayer. An Indian resident is liable to tax on their worldwide income, while a non-resident can only be taxed on income received in or accruing from India. When no income is accrued in India, a non-resident is not liable to pay any tax in India. Income is said to accrue to a taxpayer when a debt becomes due in his/her favour.[4] In Toyota Boshoku, it was clear from the terms of the Employee Contract, that a debt had been created in favour for the Loaned Employees and no income had accrued to the AE. It was merely a case of payment of salaries which was liable to withholding under Section 192 of the IT Act. Subsequent reimbursements to the AE could not make the amount liable to further withholding under Section 195.
However, any sum paid to a foreign company under a Secondment Agreement may be taxable in the hands of such foreign company if such payment, or any part of it, actually accrued to the foreign company. Some ways in which this can be determined is if:
(i) The payment is not a simple reimbursement but compensation for services provided by the foreign entity;[5]
(ii) There is an existence of service permanent establishment in India;[6]
(iii) The foreign company remains responsible for paying the salaries of the seconded employees;[7]
(iv) The foreign company retains the right to terminate employment of the seconded employees (i.e., the Indian entity only gets a right to terminate period of secondment);[8]
(v) The foreign company retains control, direction, and supervision over the seconded employees;[9] or
(vi) The foreign company remains responsible for the work of the seconded employees or assumes any risk for their work results.[10]
Thus, foreign entities looking to engage in simple Secondment Agreements (i.e., with a view to share skilled staff within the group without receiving any monetary benefit) with their related entities in India need to ensure no income accrues to them under the such agreements to avoid any tax liability in India. The Indian company should have full operational control over the seconded employees, including the right to termination of employment. Further, the Indian company should also be solely responsible for making all salary payments to the seconded employees, i.e., the seconded employees should not retain any lien on employment with the foreign company, though this may not be acceptable to the concerned employees. Any reimbursement of salary between the Indian company and the foreign company must take place on a cost-to-cost basis.
To establish the above, recording and vetting of proper documentation becomes a crucial step before executing any Secondment Agreement. The terms of the Secondment Agreement should be clear, unambiguous, and complete. A separate employment contract between the Indian company and the seconded employees may also be helpful in establishing a clear employer-employee relationship.
Further, some DTAAs have a ‘make available’ clause for classification of income as FTS. This requires the service provider to offer certain technical knowledge, experience, skill, know-how, process, etc., so that the recipient is able to independently apply the technology. If the purpose of the Secondment Agreement is to empower the Indian entity to independently apply the expertise and skill learned/acquired from the ‘Loaned Employees’, then any reimbursement to the foreign company may be classified as FTS.[11] When the intention is such as stated above, then analysing the DTAA between the countries and incorporating adequate safeguards within the Secondment Agreement is another exercise that should be undertaken prior to execution of such agreements.
For further information, please contact:
S.R. Patnaik, Partner, Cyril Amarchand Mangaldas
srpatnaik@cyrilshroff.com
[1] M/s. Toyota Boshoku Automotive India Private Limited v. DCIT, IT(TP)A No. 1646/Bang/2017.
[2] Toyota Kirloskar Auto Parts Limited v. DCIT, (2020) 185 ITD 806.
[3] Centrica India Offshore Private Limited v. CIT, (2014) 44 taxmann.com 300; Verizon Data Services India Private Limited, In re, 337 ITR 192; Food World Supermarkets Limited v. DDIT (International Taxation), (2015) 63 taxman.com 43.
[4] E.D. Sassoon v. Commissioner of Income-tax, [1954] 26 ITR 27 (SC).
[5] Centrica India Offshore Private Limited v. CIT, (2014) 44 taxmann.com 300; AT & S India Private Limited, 287 ITR 421.
[6] DIT v. Morgan Stanley, (2007) 163 taxman 165; Teradata Operations Inc. v. DCIT, 116 taxmann.com 404 (Delhi-Trib.).
[7] Centrica India Offshore Private Limited v. CIT, (2014) 44 taxmann.com 300.
[8] Target Corporation India Private Limited, [TS-627-AAR-2012]; Emulex Design & Manufacturing Corporation v. DCIT, [TS-294-ITAT-2017(Bang)]; M/s Flughafen Zurich AG vs Deputy Director of Income Tax [TS-96-ITAT-2017(Bang)].
[9] Panasonic Corporation v. DCIT, [TS-531-ITAT-2018(CHNY)].
[10] DDIT v. Yum Restaurants (Asia) Pte. Ltd (ITA No.6018/Del/2012).
[11] Panasonic Corporation v. DCIT, [TS-531-ITAT-2018(CHNY)].
