Indirect Tax Alert - Salary of ‘seconded’ employees recovered on actuals by overseas group company liable to Service tax – Supreme Court

Background facts of the case

It is a general practice in business conglomerates to transfer a person employed by one entity (transferor) to another entity (transferee) for a temporary period. For all practical purposes, such persons act as employees of the transferee, with all the rules and regulations of the transferee being applicable to them and they operate under the control and direction of the transferee. However, the employment contract of such persons continues to be with their transferor, for reasons such as the continuation of the Social security, Retiral benefits, etc. Thus, generally, the salary for such seconded employees is reimbursed on the actual basis by the transferee to the transferor. Typically, the employees from foreign entities are seconded to the Indian entities, in this manner.

There have been multiple disputes on whether such arrangement amounts to the provision of a service and whether the Indian entities are liable to pay Service tax under Reverse Charge, on a salary of the seconded employee reimbursed to the foreign entities. In the present case, the CESTAT had decided the issue in favour of the Indian transferee company and the tax authorities had filed an appeal to the Supreme Court. The key facts of the case are as under:

• The taxpayer in India had entered into agreements with their group companies to provide specified services.
• When required, the taxpayer requested the group companies to second managerial and technical persons. Such persons were selected by the group company and were seconded to the taxpayer company in India for a specified tenure. The taxpayer issued a letter of understanding to such seconded employees.
• The seconded employees worked under the instructions and directions of the transferee. While such employees continued to remain on the payroll of the overseas group, for all practical purposes the transferee will be the employer.
• The employee would receive their salary, bonus, social benefits, out of pocket expenses and other expenses from the overseas group company. The group company would raise a Debit Note on the transferee company in India to recover such amounts without any markup.
• Income tax was deducted from the salary of the employees and remitted to the authorities in India. Also, various statutory benefits such as Provident Fund, etc. were applicable in India for the seconded employees.

After hearing rival contentions, the Supreme Court of India pronounced its judgment in this case in favour of the tax authorities. The key takeaways of the judgment are as under:

• The main question to address is who should be reckoned as the employer of the seconded employee. If the transferee is to be treated as an employer, the payment made to the group company would be a reimbursement. If the group company is treated as an employer, the arrangement would be treated as a rendition of service by the group company to the assessee and would be subjected to Service tax.
• The nomenclature of any contract or document is not decisive of its nature. An overall reading of all the documents and their effect is required to be seen by the Courts.
• There is not one single determinative factor to which the Courts give primacy while deciding whether an arrangement is a contract of service (as claimed by the taxpayer) or a contract for service. What is relevant is multiple tests, taken on the totality of the fact situations in a given case and depending on the facts of each case, all the factors may not be relevant, or if relevant, may not be given the same weight to arrive at a conclusion. The Supreme Court has consistently applied the test of substance over form, requiring a close look at the terms of the contract or the agreements, to decide the issue.
• The Court observed that the overall effect of the four agreements entered into by the taxpayer, at various periods, with the Indian 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. These employees, having regard to their expertise and specialization, are seconded (a term synonymous with the commonly used term in India ‘deputation’) to the concerned geographies (in this case, India) for the use of their skills. Upon the cessation of the term of secondment, they return to their overseas employer or are deployed on some other secondment.
• The secondment is a part of the global policy where the group company loans the services of employees on a temporary basis and on completion of secondment period the employees are repatriated in accordance with the global repatriation policy. The letter of understanding between the taxpayer and the employee nowhere states that the employee would be treated as the transferee’s employee after the secondment period.
• While the control over the employees and the right to ask the employees to return, if their functioning is not as desired, is with the transferee; the group company, in relation to its business, deploys such employees to the transferee on secondment basis. The terms of employment of such employees are in line with the group company, who is their employer.
• The salary package with allowances, etc. are all expressed in foreign currency.
• The remittance to group company is a consideration.
• The argument that the demand would be revenue neutral since the taxpayer would have been able to claim refund of tax, had it been paid, was not considered since the Supreme Court was only adjudicating about the nature of transaction and the service tax levy.
• Certain decisions of the CESTAT¹ in favour of the various taxpayers, which were affirmed by the Supreme Court earlier, are unreasoned and thus has no precedential value.

BDO comments

While this judgment pertains to the Service tax regime, the observations made by the Supreme Court are equally relevant for determination of applicability of GST on such secondment arrangements. The Supreme Court has made various comments on the basis of the specific agreements and proceeded to determine the issue of selecting substance over form. The Supreme Court also mentioned that there is no single factor to determine this issue.

The companies having the secondment arrangements may be required to revisit the stands taken by them in light of the observations made in the judgment and pertinent to revisit the agreements. Lastly, while the judgment only deals with the applicability of Service tax, it might also be relevant to assess the impact of this judgment on the stands taken under other laws, including GST.

 

[CC, CE & ST – Bangalore (Adjudication) etc Vs Northern Operating Systems Pvt. Ltd. order dated 19 May 2022]