BACKGROUND
In its recent judgment given on April 25, 2014 in the case of Centrica India Offshore (P.) Ltd v. CIT, the Delhi High Court, the division bench of the Delhi High Court has held that employees seconded by foreign enterprises to provide business support services constituted a Service PE in India.
INTRODUCTION
Service PE
Under the Income Tax Act, 1961 (“Act”), a non resident is liable to tax in India, if he has a business connection in India, as defined in section 9(1) of the Act. However, if India has entered into a double tax avoidance agreement (“DTAA”) with any country, a non resident of that country dealing with a resident of India may be liable to tax in India only if he has a permanent establishment (“PE”) in India. The provisions of the Act or of the DTAA, whichever is more beneficial to the non resident assessee will apply, except that the GAAR provisions override the benefits provided under the DTAA.
Under a DTAA, the term “PE” is usually articulated in Article 5 of DTAA to mean a fixed place of business through which a foreign enterprise wholly or partly carries on business in another country. A permanent establishment also encompasses situations wherein services are furnished by the foreign enterprise in India through employees or other personnel for period exceeding certain threshold limits (such as 90 days within any 12 months period etc). Such a PE is classified as a “Service PE”.
Deputation / Secondment arrangements and their taxability
Taxability in a deputation / secondment arrangement is a subject matter of discussion. Such arrangements involve basis issues on whether certain payments are income at all and then the taxability involves interplay of the Service PE or FTS article. Broadly, such arrangements would fall under the following 2 categories:
Foreign enterprises enters into an agreement for providing services to an Indian enterprise and deputes personnel to India for fulfilling its obligations. Ordinarily, the supervision and control of the employees is with the foreign employer, who is responsible for their performance; and
Foreign enterprises enter into an arrangement with an Indian enterprise to provide personnel for the work / services being rendered by the Indian enterprise to its own customers. In this case the employees work under the supervision and control of the Indian enterprise. The foreign enterprise is only responsible for supply of personnel as per the specification or requirement of the Indian enterprise.
As a matter of practice, typically salaries of such deputed / seconded employees are initially paid by the foreign employer, which is reimbursed by Indian company without any mark up. The taxability of receipts in the hands of foreign employer of the reimbursement of salaries (of the seconded employees) by the Indian enterprise to the foreign employees has been a subject matter of debate and at times pose difficulty in determining as to whether factually, the foreign enterprise is responsible for providing services to the Indian enterprise or simply responsible for providing of personnel. To determine the taxability in such arrangements, it would be essential to determine as to who is the real or economic player of the deputed / seconded employees.
FACTS OF THE CASE
The taxpayer, Centrica Offshore (P.) Ltd (“Centrica India”), an Indian Company, a wholly owned subsidiary of a UK based company (Centrica Plc) was established to overlook and manage certain back office functions (like debt collections, consumers’ billings, etc) outsourced to Indian vendors by two subsidiaries (one in UK and other in Canada) of the UK based parent (the said UK and Canadian subsidiaries of Centrica Plc are hereinafter collectively referred to as “Overseas Entities”).
To seek support during initial years of operations and to be guided in the processes and procedures of the overseas entity, the taxpayer sought some employees on secondment from the overseas entities and the overseas entity deputed or seconded some of its employees to the applicant to render their services in India. A secondment agreement was entered into between Centrica India and the overseas entities under which some managerial employees of the overseas entities were deputed to Centrica India for short term assignments ranging from three to nineteen months.
The seconded employees were to work under the supervision and control of the taxpayer. Overseas entities were not responsible for any error or omission of work of such employees and the taxpayer reimbursed the salary cost of the seconded employees to the overseas entities on a cost-to-cost basis and also withheld and paid tax in India on the salary paid to the seconded employees. All the rules, regulations, policies and other practices established by Centrica India for its employees were to apply to the seconded employees.
The seconded employees continued to participate in the overseas entities’ retirement and social security plans and other benefits in accordance with its applicable policies. To make sure the salaries were received uninterruptedly and to avoid any delay in payment, at the request of the seconded employees, the salary was paid directly by the overseas entities into their overseas bank account and claimed as reimbursement from Centrica India. Such salaries were offered to tax in India by the seconded employees after withholding tax obligations for employee taxes.
The taxpayer filed an application before the AAR, seeking a ruling on the issue of taxability of the sums reimbursed in the hands of the overseas entities and consequential withholding tax obligations on the taxpayer. The AAR ruled that he right of termination of services of seconded employees vested in, or rested with the overseas entities, even though control and supervision over them was with Centrica India and since the seconded employees were rendering services for the overseas entities by working for a specified period with Centrica India, the overseas entities constituted a Service PE in India under the relevant DTAA on account of employees deputed by overseas entities to Centrica India under the secondment agreement and hence Centrica India was obliged to withhold tax at source on the payments made by it to the overseas entities;
Aggrieved by the ruling given by the AAR, the taxpayer filed a writ petition before the High Court seeking to quash the ruling of the AAR.
ISSUE
Whether the secondment of employees by the overseas entities, falls within Article 12 of the India-Canada and Article 13 of the India-UK DTAAs, which embody the concept of a Service PE?
Article 5 of India-Canada DTAA
“xxxxx The term “permanent establishment” shall include especially; the furnishing of services other than included services as defined in Article 12, within a Contracting State by an enterprise through employees or other personnel ; and only if :—- activities of that nature continue, within that state for a period or periods aggregating more than 90 days within any twelve month period ; or xxxxx”
CONTENTIONS OF THE PARTIES
Contentions of the taxpayer (Centrica India)
The presence of the seconded employees did not create a PE of such overseas entities under the DTAA because Centrica India was the real and economic employer of the seconded employees, even though their legal employers were the concerned overseas entities. It was also urged that in terms of the secondment agreement, the overseas entities were not providing any service to the petitioner the payment to the seconded employees by the overseas entities was purely out of convenience which was in turn reimbursed on cost-basis. The reimbursement made to such overseas entities was not taxable as income in India because the taxes were already paid in respect of the seconded employees in India.
It was contended by the counsel of Centrica India that there was a difference between the concept of “legal employment” and “economic employment”. It was argued that a legal employer appoints someone and, therefore, has the right to terminate the employment. The economic employer, on the other hand, enjoys the fruits of the labour, possesses the authority to inspect and control and bears the risks and results of the work performed by the employee. The place of employment or work would also be that directed by the economic employer. The economic employer may not have the legal right to terminate the employment altogether, it would possess the right to terminate the contractual arrangement, i.e. the secondment agreement. The payment of salary of the seconded employee is charged from the economic employer. Based on the aforesaid differentiation, it was argued by Centrica India that the overall reading of the secondment agreement conclusively establishes that it was a real and economic employer of the seconded employees and that they were acting to its dictate in the performance of their job and not placed there to perform the tasks assigned by the overseas entities.
Contentions of the Income tax authorities
Centrica India could only terminate the seconded agreement but could not terminate the contract of those seconded employees. This proved that Centrica India was not the real employer and that the overseas entities were the real and legal employers. Consequently, there was no charge on Centrica India through the overseas entities in respect of the obligation of payment of remuneration to the seconded employees. It was, therefore, contended that the overseas entities would have PE under the DTAA.
DELHI HIGH COURT’S JUDGMENT
The High Court upheld the ruling of the AAR that the seconded employees create a Service PE of the overseas companies because though the control and supervision rested with Centrica India and they bore all risks in relation to their work; there was no employer – employee relationship between Centrica India and the deputed employees. No powers were vested with Centrica India to terminate the ultimate contract between the overseas entities and the deputed employees. Though Centrica India may have had operational control over these persons in terms of their daily work and may have been responsible for their failures (in terms of the secondment agreement), the seconded employees still continued to remain employed by the overseas entities which was their real employer and not Centrica India.
ANALYSIS AND COMMENTS
This judgment is important because of late, most rulings of Bangalore ITAT have held that the host entity (i.e. Indian entity) would be considered to be the economic employer of the secondee, despite the fact that the secondee continues on the payroll and legal employment of the home entity because the Indian employer had the right to hire or accept the secondment, right to control, supervise and instruct the secondee as to the manner, place, method of work and the right to terminate the secondment. These rulings have taken cognizance of dual employment and of personnel and have distinguished between legal and economic employer.
Another very important aspect which is linked with the concept of a Service PE is the nature of services furnished by the secondee. It is essential to note that under some DTAAs including the ones with USA, UK and Canada, a Service PE is not created if the services furnished by the secondees are of nature of “technical” or “included” services as defined under the respective DTAAs. In this judgment of Delhi High Court, the Court held that the services furnished by the overseas entities were of “technical” and “included” nature under the DTAAs of UK and Canada respectively. Considering that under Article 5 of both these DTAAs, a PE is not created if the secondees furnish services which are of “technical” and “included” services, it remains unclear to us as to why then the Court upheld the decision of AAR which has held that a Service PE was created by the overseas entities.
Considering that the formal documentation such as the secondment agreements and appointment letters have been extensively referred to in the rulings, it is imperative to document all roles, responsibilities and obligations of the home and host countries with respect to the secondment. Further, the rulings have also considered the objective of secondment and its inter linkage with other related business transactions to understand the essence of the arrangement rather than considering the secondment in isolation.
About Bulwark Solicitors
Bulwark Solicitors is a law firm pioneered by Solicitor Chirag Sancheti and Advocate Deep Shridharani. The firm has expertise in the areas of both Litigation and non-Litigation. Under the non-litigation Law practice, the firm practices in the areas of Corporate Law, Intellectual Property Law, Bankruptcy & Insolvency Law, Competition Law, Real Estate and Conveyancing and DTAA Advisory. Further, under Corporate Law area, we practice Company Law, Securities Law, Mergers and Amalgamations, Private Equity and Venture Capital Investment Transactions, Legal Due Diligence and Foreign Exchange Management Law.