Direct Tax Alert

BACKGROUND

Entering into secondment arrangements is a standard practice among multinational enterprises, which involves the temporary move of skilled employees to another organisation for a specific period. While these arrangements may seem commercially straightforward, they are not free from litigation. Typically, in secondment arrangements, salary reimbursement is often made by the Indian entity to the foreign entity, where the home country (foreign entity) payroll is continued during the secondment period. The core dispute is whether the reimbursement of seconded employee costs received by a foreign entity is taxable in India.

In this regard, recently, the Delhi Tax Tribunal¹ had an opportunity to analyse whether payments made by the Indian entities to the Japanese taxpayer in respect of salaries paid to the seconded employees in Japan are in the nature of reimbursement of the salary for the services rendered in India or are in the nature of Fee for Technical Services (FTS). We, at BDO India, have summarised this ruling and provided our comments on the impact of this decision hereunder:

FACTS OF THE CASE

The taxpayer, a company resident in Japan, is engaged in the manufacturing and marketing of communications systems, electronic components, heavy electrical operators, consumer products, medical diagnostics, imaging equipment, etc. During Fiscal Year (FY) 2019-20, the taxpayer received reimbursements amounting to INR 107.63mn in respect of salary paid in Japan to the seconded employees of various Indian companies. The taxpayer made payment of salaries in Japan on behalf of Indian employer entities owing to administrative convenience. The tax officer treated the said amount as FTS under section 9(1)(vii) of the Income Tax Act, 1961 (IT Act) and Article 12(4) of the India-Japan Double Taxation Avoidance Agreement (DTAA) and made an addition to the income.

Aggrieved, the taxpayer preferred an appeal before the Delhi Tax Tribunal.

DELHI TAX TRIBUNAL RULING

The Delhi Tax Tribunal, while ruling in favour of the taxpayer, made the following observations:

• The Indian entities have made salary payments to the seconded employees only after they entered into a separate agreement/contract of employment.

• On perusal of the said contract/appointment letter, it shows that the payment of salary to the seconded employees is solely by the Indian company. The salary would be made partly in yen and partly in Indian rupees.

• The employees were working under the control of the Indian company, and the Indian company had the right to terminate the services of the seconded employee in case of breach of the terms and conditions of employment.

• Form No. 16 showed that the salary payment to the seconded employees is subject to tax deducted at source (TDS) provisions, and accordingly, taxes were withheld by the Indian companies.

• Reliance was placed on the Hon’ble Delhi High Court’s decision in the case of Boeing India (P.) Ltd². and Flipkart Internet (P.) Ltd³. wherein it was held that where the reimbursements are in the nature of salary, the same could not be treated as FTS.

• The term 'fees for technical services' is defined in Article 12(4) of the India-Japan DTAA to mean payments of any amount to any person other than payments to an employee of a person making payments and to any individual for independent personal services referred to in Article 14.

• Once it is established that the payments are made as salary to the employees for the services rendered in India, such payments are outside the purview of FTS.

BDO INDIA COMMENTS

This ruling has significant implications for multinational enterprises entering into secondment arrangements. It is common practice to continue the home country payroll or have a split payroll (as in the instant case) during the secondment period. This helps employer to reduce their payroll administrative burden and also provides seconded employees to continue with their financial obligations through their original bank account. The Delhi Tax Tribunal has upheld the principle that reimbursements without markup, when backed by genuine employment control and documentation, shall be outside the purview of FTS.

Under secondment arrangements, Indian entities actively conducting performance appraisals, bearing the risks of the work performed by employees, can demonstrate that the employees seconded to foreign entities are under the employment of Indian employer entities. Further, tax withheld under section 192 of the IT Act acts as a substantive factor to corroborate that the nature of the payment is salary and not FTS.
Furthermore, this decision is distinguishable from the Hon’ble Supreme Court’s ruling in the case of Northern Operating Systems⁴ since it was rendered in the context of indirect taxation for analysing whether service tax applies to a secondment agreement, which essentially is an agreement for manpower recruitment and supply services.