TAXATION OF SECONDED EMPLOYEE SALARY REIMBURSEMENTS AND PERMANENT ESTABLISHMENT IMPACT
In the recent case of Yum Restaurants (Asia) Pte, the Delhi Income Tax Appellate Tribunal (Delhi Tribunal) has held that payments received by a Singapore company from an Indian group company towards salary reimbursement costs in the case of a seconded employee is not in the nature of “fees for technical services” and, therefore, not subject to withholding tax in India. Further, based on documentation submitted, the Delhi Tribunal has held that no profit attribution arises for the Singapore company in India on account of a service permanent establishment.
This is a positive decision. However, as there are a plethora of conflicting decisions on this subject, the issue of taxability of reimbursement of salary paid to a seconded employee is highly contentious. In order to achieve a tax-neutral position on such reimbursements, it is imperative that companies maintain robust documentation which can substantiate their actual conduct in the arrangement or transaction. In our experience, Indian tax authorities and courts have been guided significantly by documentary evidence.
The taxpayer is a company incorporated in Singapore (SCO) and is engaged in the business of franchising the KFC, Pizza Hut, and Taco Bell brands for a number of territories in the Asia Pacific region (including India). For the operation of restaurant outlets, SCO entered into certain technology license agreements with an Indian group company (ICO). ICO, in turn, appointed various franchisees to operate restaurants in India under the brand names, KFC and Pizza Hut. The royalty income earned by SCO under the technology license agreements was offered to tax in India, and there is no dispute on the royalty taxation front.
SCO entered into a deputation agreement with ICO to second one of its senior employees (Employee) to ICO. The Employee entered into an employment agreement with ICO as the director/senior legal counsel, and was vested with managerial, administrative, and supervisory responsibilities. Importantly, the Employee did not retain his lien on employment with SCO. A part of the Employee’s salary was paid in Singapore by SCO, but this was subsequently reimbursed to SCO by ICO. ICO withheld tax at source on the gross salary paid to the Employee, which also included the amounts subsequently reimbursed to SCO. On this basis, SCO contended that the amount received from ICO was purely “reimbursement of expenses” and not fees for technical services (FTS), and hence, not chargeable to tax in India.
However, the lower level Indian tax assessing authority (ITA) held that:
- tax withholding was required prior to making payment by ICO to SCO; and
- SCO had a service permanent establishment in India.
Therefore, the ITA sought to attribute profit on account of the marketing activities carried out by the Employee for SCO in India.
Decision of the Delhi Tribunal
Based on all the documentation entered into between SCO and ICO, in appeal, the Delhi Tribunal noted that:
- the Employee was working as the director/senior legal counsel under the control and supervision of ICO’s board of directors;
- the Employee’s remuneration was fixed under his employment agreement with ICO;
- the Employee was engaged in the day-to-day functioning of ICO;
- the Employee attended board meetings on a regular basis and signed the financial statements of ICO; and
- the Employee did not “make available” any technology, knowledge or skill to ICO.
In addition, no contrary evidence was produced by the ITA to prove that the Employee was working under the control, supervision or direction of SCO.
The Delhi Tribunal ruled that under the provisions of the Income-tax Act, 1961, the definition of FTS does not include that income of the recipient that is chargeable to tax under the head “salaries.” As the salary of the Employee (including the salary cost reimbursed by ICO to SCO) was assessed to tax by the ITA under the head “salaries,” applying a tax withholding on the reimbursement to SCO would amount to double taxation.
In reaching its conclusion, the Delhi Tribunal distinguished the 2014 Delhi High Court ruling in the Centrica case and observed that in Centrica, the monies paid by the Indian entity to the overseas entity accrued specifically to the overseas entity, and may or may not have been paid to the secondees. However, in the instant case, the money never accrued to SCO, but was only a reimbursement of costs. Therefore, it was not subject to tax withholding in India.
Separately, the Delhi Tribunal held that as there was no separate services agreement between SCO and ICO, given that the Employee carried out marketing activities only for ICO (and not SCO), a profit attribution to SCO on account of a service permanent establishment did not arise.
In the recent past, secondment arrangements have been under the scanner. An important factor to consider is which entity supervises and has control over the secondee.
In the Centrica case, the Delhi High Court held that reimbursement of salary costs to an overseas entity is liable to tax as FTS, as by seconding its employees Centrica provided technical knowledge and skills (through the head and brain of the experienced senior-level employees), and assisted the Indian entity in its quality control and management functions. Note that in the Centrica case, the secondee retained a right of lien on his employment with the overseas entity, who had a right to terminate his employment, and the Indian entity had no control over him on this aspect. This point was given significant weightage by the Delhi High Court in reaching its conclusion.
In the Marks & Spencer case, the Bombay High Court held that merely supplying employees or assisting the Indian entity in its business did not constitute making available technical or consultancy services. Further, once the Indian entity had withheld tax on the salaries of the seconded employees, the same salary income could not be subject to withholding tax a second time when it was reimbursed by the Indian entity to the foreign entity.
In the AT&T Communication case, the Delhi Tribunal distinguished the Centrica case and held that such reimbursements were not FTS as the seconded employees were working under the control and supervision of the Indian entity, and were not furthering the business of the overseas entity.
More recently in the Nippon case, the Chennai tribunal held that such reimbursements were taxable because the seconded employees temporarily exchange experience and skill, and do not lose the employer-employee relationship with the parent organization even after the secondment has ended.
In order to mitigate tax exposure in India on account of seconded employees, we recommend that employment and tax lawyers should be engaged and the following documents should be executed:
- letter of assignment/deputation agreement between the foreign company and the individual secondee, under which it should be stated that salary of the secondee will be paid by the Indian company, and there will be no lien on employment with the foreign company;
- employment contract issued by the Indian company to the individual secondee, which should include clauses on the independent functioning of the seconded employee; and
- an agreement between the foreign company and the Indian company under which it should be clarified that the secondee will be responsible only to the Indian company and will not be making available any technology to the Indian company on behalf of the foreign parent.
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