[Sumanth Sudharshan is a fourth-year B.B.A.,LL.B. student at Jindal Global Law School, Sonepat]
Secondments are employment arrangements where an organization sends its employees to another organization to work for them. With more businesses operating globally, secondments allow companies to hire from associated entities for specialized skills or specific technical requirements. Secondments are primarily of three models: (a) transfer of employment (contract of service, of employee serving the employer), (b) contract for service (where employer supplies the work of the employee to the recipient of such service), and (c) dual employment.
In May this year, the Supreme Court (“SC” or “Court”) provided an important ruling in the case of CCE&ST vs. Northern Operating Systems Pvt. Ltd (“NOS judgment”) which unsettles the existing position of law relating to applicability of indirect taxes to secondments. This post analyses the issue of who would be the employer in a secondment arrangement through the judgement and its implications on both GST and income tax in India.
Background
Northern Operating Systems (“NOS”), the assessee, had executed multiple secondment agreements with Northern Trust Company, the overseas group company (“OGC) for a specific period. As part of the arrangement, NOS could request OGC for personnel to assist with tasks requiring specialized skills and technical expertise. OGC would transfer its employees for a limited duration after which they would return to OGC. NOS would be liable for the secondees and supervise and control their work. They would be part of OGC payroll and NOS would reimburse OGC for salaries and other compensation without any mark-up on expenses.
The service tax authorities (“Revenue”) raised a demand against NOS for service taxes under reverse charge mechanism. Revenue contended that NOS is the recipient of manpower supply service from OGC. The Customs, Excise and Service Tax Appellate Tribunal (“Tribunal”) set aside Revenue’s demand which was appealed to the SC. The SC, by applying the legal provisions and reassessing the facts of the case, narrowed down relevant questions to be: Who the real employer of the secondee is and what would be the nature of the arrangement? Is it one of contract of service (employer-employee) or an underlying contract for service where the employer lends the employee’s services to another entity? The SC decided that OGC is the employer of the secondees, and the transaction is one of “contract for service”, making it chargeable for service taxes.
Analysis
This ruling reverses a series of tribunal rulings on the issue, including Volkswagen India Private Limited and Target Corporation India (P) Limited. In arriving at this conclusion, the SC, in this NOS judgment, has borrowed from existing direct taxation jurisprudence in relation to secondments including the Morgan Stanley & Co. Inc judgement. Here, the foreign company was taxed for income attributable to its Indian services for having a permanent establishment in India and no service tax was charged. By this analogy through permanent establishment, Morgan Stanley was held to be the employer.
This conclusion is also backed by OECD’s commentary on Article 15 according to which aspects to consider while determining real employer include examining the control and functions of both the foreign entity and local entity. These aspects, along with the Morgan Stanley judgement, would make NOS the employer and by applying this test in service taxes context, no service tax would be due.
There are limited examples of cases where courts have held the foreign entity to be the employer under international taxation. For example, in the case of AT&S India Private Limited, it was decided by the Authority for Advanced Rulings that foreign entity was the employer based on payment of technical services. This would apply only when the Indian entity has paid a mark-up as a service recipient, not as compensation directly to the employee.
In another example of Centrica India Offshore Private Limited, the Delhi High Court held that even with a lien on the secondee, if a payment is made under such service, it would be taxable if there’s no evidence of the secondee getting paid by the Indian entity. These are exceptions, which cannot be applied to the present case as there was neither a markup nor any documentation that showed that the arrangement was a part of service from OGC to NOS.
The SC has also attempted to make use of “substance over form approach” in this case which has rarely been used in indirect tax cases. In the case of Commr. of Customs v. Pundrick Ravindra Trivedi, the Court used this approach to deny tax benefits on the basis that the facts exhibited the transaction to be fraudulent in nature. In the landmark case of Union of India v. Azadi Bachao Andolan, the Court held that commercially genuine transactions should not be rejected or looked at with disfavour even when the parties make a lawful tax gain unless it is a colorable transaction. Further, as per the principles decided by the House of Lords (United Kingdom) in IRC v. Duke of Westminster, structuring a transaction to reduce tax burden is legitimate means of tax avoidance unless there is a clear violation of law for there to be evasion of taxes.
Courts have time and again come down hard against use of “substance over form approach” within the indirect taxes domain too, such as in the case of CCE v. Acer India Ltd. and Kone Elevator India (P) Ltd. v. State of T.N where the Court overruled judgements that made use of the approach. In this present case for NOS, the judgement doesn’t imply any possibility of a sham transaction or any implication of tax evasion, hence the use of this approach taken is problematic to say the least.
Implications
Under the Finance Act, 1994 (“Act”), employer-employee service was exempted from service taxes under the negative list of exceptions added to section 65 (44) of the Act. Under the present GST law too, employer-employee relationship has been exempted from GST, under Entry 1, Schedule III read with section 7 of Central Goods and Services Tax Act, 2017 (“CGST”).
While this case is based on erstwhile law, similarities between both laws mean similar implications under the present GST regime. The application of this judgement would make secondments taxable under the GST regime as OGC would be the employer and there would be an underlying service between the overseas entity and the Indian entity, the recipient of such service. When section 7(1)(b) is read with Entry 2, Schedule I of CGST, GST can be charged even when the transaction is on cost basis or when there is no mark-up or consideration implying more severe implications under the GST regime. A similar position was affirmed in the case of M/s. Tamil Nadu Generation and Distribution Corporation Limited by Tamil Nadu State Appellate Authority for GST.
This NOS judgement of the SC also fails to provide much clarity in terms of applicability and makes its ruling distinguishable from any future cases on this issue based on facts of that specific case, as is case in Flipkart Internet (P.) Ltd. v. DCIT (International Taxation) judgement, where the Karnataka High Court distinguished the NOS case from the facts before it in the Flipkart case. The correct position in this case would have been to hold the relationship between NOS and the secondees as that of employer-employee, similar to the ruling in the Volkswagen judgement of the Tribunal, but the SC has failed to bring in certainty and closure to this longstanding issue.
A similar issue would arise in case of international taxation, with respect to fees for technical services (“FTS”). Till now, in cases of secondments, income tax authorities have been contending that such income would constitute as FTS and assessees, the Indian entities, have been arguing that the payment made is for employing the secondees under employer-employee relationship, not for the service itself. Employer-employee relationship and income paid as salaries are outside the ambit of FTS (as per the definition contained in Explanation 2 to section 9(1)(vii) of Income Tax Act, 1961). Based on the “economic employer theory”, Indian entities have argued that as they are, for all practical purposes, the employers of such secondees, this income should be outside the ambit of FTS.
The NOS judgement has rejected the “economic employer theory” which means that future agreements based on this theory would also face the same fate as that of this case. This is in addition to the fact that some tax treaties include “provision of services of technical or other personnel” as part of the definition of FTS under the “make available” condition (article 12, para 4 (b) in the treaty with USA, for example) which makes such arrangements taxable under FTS, also supported by the judgement of Mumbai ITAT in General Motors Overseas Corporation vs DDIT. The scope of such income would include salaries, social security contributions, perquisites (such as housing, travel etc) and other payments in the form of charges, mark-up, consideration etc if any.
Conclusion
Under the present GST regime, the issue of taxability of secondments would continue to remain more contentious than ever, with revenue pushing for taxing more secondment agreements with the newly raised issues in this case and the assessees differentiating their case from this NOS one based on facts. The judgement would also have ripple effects under Income tax laws, on issues such as fees for technical services, permanent establishment and taxability of reimbursements.
Therefore, it is important that such arrangements be planned considering factual similarities with this judgement and revisiting aspects that overlap with existing issues. Parties would also have to document details that clearly indicate the intention of the parties about the arrangement being one of contract of service to avoid any doubts about existence of a contract for service arrangement.
– Sumanth Sudharshan