In this era of rapid globalization, the multinational companies (MNCs) are increasingly outsourcing ‘non-integral’ and ‘non-revenue generating’ (business support) functions to their subsidiaries or to third party vendors, located in low cost jurisdiction such as India. At times, MNCs send their employees, having expertise in the respective field to help the subsidiaries set up and carry out outsourced activities efficiently. Such secondment arrangements, unless carefully structured, can result in serious tax implications, both for the Indian subsidiary and the foreign company.
In a recent decision in Centrica India Offshore Pvt. Ltd. [WP (C ) No. 6807/2012 dated 25-4-2014], the Delhi High Court has held that business support services provided by foreign company through seconded employees to Indian subsidiary constitutes ‘fees for technical services’ (FTS). Surprisingly, the High Court further held that such services also create foreign company’s Service PE in India. The present article analyses the law laid down by the Court and its implications, with respect to secondment.
Key facts of the case
Centrica Plc., United Kingdom (Centrica UK) had subsidiaries in Canada and UK (hereinafter referred to as ‘overseas entities’) besides Centrica India. The overseas entities had outsourced some of their Business Support functions viz., debt collections, consumer’s billings, monthly jobs etc. to Indian vendors. Centrica India acted as interface between overseas entities and Indian vendors. A service agreement was entered into between Centrica India and overseas entities in this regard providing for a cost plus remuneration. Centrica India requested overseas entities to provide staff with knowledge and experience of various processes and practices employed by Centrica UK. Managerial employees of the overseas entities were deputed to Centrica India, under secondment agreements, for assignments ranging from three to nineteen months. Centrica India, thereafter, entered into individual agreements (‘employment agreement’) with seconded employees (Secondees) reiterating the terms of the secondment agreement and providing as under:
- Secondees have to function and act exclusively under the direction, control and supervision of Centrica India;
- Overseas Entities are not responsible for the work of Secondees and have no responsibility for the errors/omissions or for the work performed by them.
- Centrica India should bear all risks in respect of work performed by the Secondees and reap the benefit from their output.
- Rules, regulations, policies and other practices established by Centrica India for its employees apply to Secondees.
- Secondees continue to participate in retirement, social security plans and other benefits in accordance with overseas entities applicable policies.
Centrica India had a right under the secondment agreement, to terminate Secondees from India assignments without any effect on the employment of Secondees with overseas entities. Salary to Secondees was paid directly by the overseas entities and claimed as ‘reimbursement’ from Centrica India on a monthly basis. The reimbursement increased the cost base of Centrica India which was to be recovered as per service agreement after adding mark-up. The taxpayer was unsuccessful before Authority for Advance Ruling (AAR) and filed a writ before Delhi High Court. Analysis of these rulings is as under.
Services without profit motive
Centrica India contended to be the economic employer of the Secondees, however the fact that control and supervision of the employees was fully with Centrica India could not influence the court. The court instead laid emphasis on the fact that employees have a right to recover their salaries only from overseas entities and their employment with overseas entities remains intact and un-affected by termination of secondment by Centrica India. The court relied on a passage from the authoritative book of Prof. Klaus Vogel written in the context of dual employment which suggested that merely because an employee works for an entity and receives instructions, tools etc from it are irrelevant except where the employees exclusively work for it during a period in which they are released by their legal employer. The court apparently equated the expression ‘released’ with severance of legal / formal employment. It was therefore concluded that overseas entities are rendering service to Centrica India as against mere hiring of labour. Having so held, the court added that the fact that there was no mark-up on the salary reimbursed does not alter the character of transaction.
Fees for technical services
he AAR had held that payment is not in the nature of ‘fees for technical services’ (FTS) due to absence of the word ‘managerial’ in the treaty definition of FTS. The High Court observed that the definition in the Income tax Act includes ‘provision of services of technical personnel’ and concluded that the case before hand fits therein. It added that the Secondees are not only providing services but rather tiding Centrica India through the initial period and ensuring that going forward, the skill set of Centrica India's other employees is built and these activities can be carried out in future without the assistance of Secondees. For this reason it concluded that the criteria of ‘making available technical knowledge’ is met and even under treaty the services constitute ‘FTS’. In the process of its analysis the High Court observed that the criteria of ‘making available knowledge’, is not a pre-requisite to qualify FTS in India UK treaty. This observation though with due respect is incorrect yet until reversed, is likely to result in harsh consequences on transactions with UK based companies.
FTS constituting Service PE
The Court in principle agreed that ‘substance’ and not the ‘form’ of the employment relationship has to be looked into so as to determine the existence of a service PE. However extending their conclusion regarding ‘rendition of service’, the Court concluded that overseas entities were legal as well as economic employers of Secondees and did have a service PE in India.
The conclusion of the court regarding ‘economic employment’ vis-à-vis ‘legal employment’ is not in sync to the OECD as well as other commentaries on the subject. With due respect, it appears that the court fell in error by applying (out of context) the passages from Klaus Vogel. In the absence of any other authoritative decision on the aspect of secondment, the view taken in this decision is likely to result in unwanted litigation. Other taxpayers affected by these observations need to review their position and put in place an effective counter strategy.
It is also noteworthy that Service PE clause under treaties is attracted only where services other than FTS are provided. Hence, the view of the Court that the services of Secondees also created a Service PE, with due respect, requires reconsideration. Further, adding to the confusion, the last paragraph of the judgment dismissing the writ states that ‘the ruling of the AAR stands’. As the AAR had ruled that the services do not constitute FTS and High Court held that to be FTS, this statement at the end is thus self-contradictory. Until clarified, the position regarding transactions with UK companies is likely to face unwarranted resistance from tax authorities.
[The first author is a Joint Director, Lakshmikumaran & Sridharan, Chandigarh and the co-author is a Senior Associate, Lakshmikumaran & Sridharan, New Delhi]