Secondment Agreement- Income Tax Implications

Secondment Agreement –Indian Income Tax implications.

Secondment Agreement

It is an agreement entered into between foreign Company (FC) and its India affiliate(IC) whereby foreign company depute its staff to Indian company for certain period, deputed/seconded staff remains on the payroll of foreign company. Indian company reimburse the salary and other cost of seconded staff to foreign company.  The reason for seconded staff being on payroll of foreign company is to maintain the continuity of their social benefits envisaged under employment terms. Further seconded employees salary remains taxable in India during seconded period.

The common terms and condition generally running across all secondment agreement are as under:-

a.       Seconded employees to be worked under the direct management, supervision and control and as per instructions of the IC during the period of secondment.

b.      Place of performance of duty and the manner in which the seconded employees had to work are decided by the IC.

c.       IC will be responsible and accountable to ensure proper performance of duty by the seconded employees. FC will not assume any risk for performance of seconded employees.

d.      IC has right to request for replacement of seconded employees, the right to terminate the employment of seconded employees will be with FC only.

e.      IC has to reimburse the salary and other cost of seconded employees to FC.

Income Tax Issue

Whether salary & other cost of seconded employees reimbursed to FC by IC is taxable in the hands of FC as “Fees for Technical Services” and consequently whether IC is required to deduct TDS u/s 195 of amount reimbursed to FC and also what should be the Tax rate for TDS deduction u/s 195.

IC Perspective:-

1.       IC is an economic employer of seconded employees, since they worked under control and supervision of IC and IC bear the cost of seconded employees.

2.       Further being economic employer, the amount reimburse to FC do not fall in the definition of FTS under section 9(1)(viii) and under relevant clause of DTAA. These clauses, inter-alia, provided that amount paid will be not be considered as FTS, if the same is taxable  in the hands of recipient as Salary

3.       The amount paid to FC are reimbursement and no income accrue to them.

4.       As a result, nothing is chargeable in the hands of FC and consequently no liability on the part of IC for deduction of  TDS u/s 195 on amount reimbursed to FC.

Assessing Office Stand:-

1.       IC is not an employer of seconded employee, because they are on the payroll of FC and only FC has right to terminate the employment of seconded employees.

2.       The amount reimbursed to FC is taxable as Fees for Technical Services and IC is required to deduct TDS on such reimbursement on Gross basis or else presence of seconded employee creates  SERVICE PE of FC in India and amount reimbursed to FC is taxable accordingly.

Till date, there are no unanimous rulings from judiciary on taxability of amount reimburse to FC on account of cost of seconded employees.

The summary of recent rulings from AAR and ITAT is summarised as under:-

Particulars	Target Corpn. India (P) Ltd –AAR Ruling	Centrica India Offshore (P) Ltd (CIO) – AAR Ruling	Abbey Business Services (P) Ltd- ITAT (Bangalore)
Decision Year	August 12	March 12	July 12
Country Involved	USA	UK and Canada.	UK
Facts	Employees were seconded to India Subsidiary by US parent company	Overseas entities had set up CIO an indirect wholly owned subsidiary in order to provide locally based interface between the overseas entities and the Indian service providers and have requested CIO to provide such services to them. 3 employees were seconded to CIO,who were overall responsible for activities and functions of CIO.	The U.K. Company agreed with the assessee an Indian Co. for outsourcing services. The U.K. Co. also provided trained staff to the assessee. The assessee reimbursed Salary cost and administrative expenses of the said staff.
Whether Indian company is Economic Employer	No, following the ruling in Centrica India Offshore	No, held that What is paid by the applicant to the overseas entity in view of this lending of service of certain employees, would really spell in the realm of compensation paid for managerial services.	Yes.
Whether services by seconded Employee is FTS u/s 9(1)(vii)	Issue was not raised	Services being managerial in nature, covered u/s 9(1)(vii)	No, held that the agreement entered into by the assessee with Abbey National Plc, UK was for secondment of staff and the consideration paid was for this purpose only and not for the rendering of any services
Whether Services by seconded employee is FIS under DTAA	Issue was not raised	Managerial Service being not covered under FIS and hence not taxable under relevant Article dealing with FIS	No, Held unless the service provider makes available his technical knowledge, experience, skill, know how or process to the recipient of the technical service, in view of the clauses in the DTAA, the liability to tax is not attracted.
Whether seconded employees presence in India create service PE of Foreign Company	Issue was not raised	Yes, Seconded employee presence in India, create service PE In India	Issue was not raised.
Whether salary cost of seconded employee reimbursed to foreign company is taxable in India in the hands of Foreign Co.	Yes.	Yes.	No.

Suggestion to deal with Income Tax issue involved in Secondment agreement:-

Before proceeding further, it is quintessential to have a look following Articles of DTAA  dealing with PE and Fees for Included Services:-

Article 5- Dealing with PE (UN Model)

Article 5(3)(b)

“The furnishing of services, including consultancy services, by an enterprise through employees or other personnel engaged by the enterprise for such purpose, but only if activities of that nature continue (for the same or a connected project) within a Contracting State for a period or periods aggregating more than 183 days in any 12-month period commencing or ending in the fiscal year concerned.”

Thus presence of employees of FC rendering service to IC may give to SERVICE PE as envisaged above.

Fees for Included Service (FIS)- There is no standard clause for FIS either in UN or OECD mode. For understanding purpose Article 13(4) of DTAA with UK is reiterated as under:-

“For the purposes of paragraph 2 of this Article, and subject to paragraph 5, of this Article, the term fees for technical services means payments of any kind of any person in consideration for the rendering of any technical or consultancy services (including the provision of services of technical or other personnel) which :

(a) are ancillary and subsidiary to the application or enjoyment of the right, property or information for which a payment described in paragraph 3(a) of this Article is received; or

(b) are ancillary and subsidiary to the enjoyment of the property for which a payment described in paragraph 3(b) of this Article is received; or

(c) make available technical knowledge, experience, skill, knowhow or processes, or consist of the development and transfer of a technical plan or technical design.”

On simple reading of above clause, two conclusions can be drawn

a)      FIS clause is not applicable for managerial service, as also held in Abbey Business Services, unless DTAA specifically covers managerial services.

b)      For technical service to fall under FIS, “make available” condition is must, unless otherwise provided.

Suggestion – The way forward is suggested in two scenarios: one where seconded employees are rendering managerial services, Second where they are rendering Technical Services.

1.       If services of seconded employees are managerial in nature and seconded employees are looking after Indian operations.

a)      Based on recent precedents, it seems difficult to justify that IC is an economic employer on facts of the case.

b)      We need to check, whether managerial services are covered under fees for included service clause. If Yes, amount paid to overseas entity may be subject to tax on gross basis.

c)       If not, we need to check, whether service PE clause is there is PE definition under DTAA. If yes, then presence of seconded employees will constitute PE of overseas entity.  The income attributable to PE will be computed as under:- Amount received from Indian entity less Amount paid by overseas entity to seconded employees plus any other income attributable to PE, if any. Thus if presence of seconded employee is treated as PE, then only miniscule income of overseas entity will be taxable in India.

d)      If there is no service PE clause in PE definition, then amount paid to overseas entity will not be taxable in India

2.       If service of seconded employees are Technical in Nature and it relates to core operations of Indian Entity.

a)      Based on recent precedents, it seems difficult to justify that IC is an economic employer on facts of the case.

b)      We need to check, whether “made available” concept is there in Fees for Included serviced definition. If Yes, then amount paid to FC will not be subject to tax, as no technology is made available to IC by seconded employees. Further in this case, SERVICE PE clause need to check in PE definition. If there is service clause, then above –mentioned point at (C) will prevail, over FIS clause.

c)       If no, then amount paid to overseas entity may be subject to tax in India on Gross basis.