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Salary reimbursement of seconded employees not taxable in the hands of foreign company

The Hon’ble Income Tax Appellate Tribunal (“ITAT”), Delhi has recently held that salary reimbursement of seconded employees paid to the original employer without any profit element is not taxable as fee for technical services.

This case[1] pertains to Ernst and Young LLP, USA (“EY USA”), which is set up in the US. It had sent its employees on secondment (“Seconded Personnel”) to work with various EY member firms in India (“EY India”). During the assessment proceedings, the tax officer held that the cost-to-cost reimbursement of salary of Seconded Personnel is taxable as fee for technical services (“FTS”) as per Article 12 of the India-US Double Taxation Avoidance Agreement (“DTAA”) in the hands of EY USA.

However, EY USA pleaded that the reimbursed amount should not be treated as FTS because EY India had merely reimbursed the salaries paid to the Seconded Personnel, without any mark-up (profit) on it. EY USA also explained that the Seconded Personnel were released from their obligations and rights of employment in the USA and were employed by EY India to work for them. During the term of secondment, EY India was solely responsible for paying their salaries and undertaking performance appraisals of such Seconded Personnel. Thus, the invoices raised by EY USA against expenses incurred towards salary reimbursement were for administrative convenience only and since there was no income or profit on it, it should not be taxed. Further, the salary paid to the Seconded Personnel had already been taxed and appropriate taxes were also withheld on the same.

Disagreeing with the above contention, the tax department had argued that the decision of the Hon’ble SC in Northern Operating Systems Pvt. Ltd.[2] was applicable, wherein the SC had held that such payments shall be subject to service tax.

The ITAT, however, observed that the decision delivered in Northern Operating Systems (supra) was not applicable as it was arrived at after analysing the relationship between the seconded employees and the original employer in the context of service tax. Relying on the Karnataka HC judgment in Flipkart Internet Pvt. Ltd.[3], it noted that the SC decision was in the context of service tax for manpower services provided by an overseas group company and it cannot be used in the instant case.

The ITAT thereafter carefully analysed the clauses of the deputation agreement entered between the Assessee and EY India, which provided that (i) the Seconded Personnel would function solely under the control, direction and supervision of EY India; (ii) EY India shall decide the nature of work to be given to the Seconded Personnel and shall remain responsible for such work; and (iii) the Assessee shall not take any responsibility or assume any risk for the results of such work.

The ITAT also relied on the coordinate bench decision in Boeing India [P] Ltd.[4], which was later affirmed by the Delhi HC[5], which held that once taxes have been appropriately withheld under Section 192 of the Income-tax Act, 1961 (“IT Act”) on salaries paid to the seconded employees, the question of any further liability to withhold taxes does not arise on the reimbursement of salary cost.

On the basis of these discussions, the Hon’ble Delhi ITAT concluded that cost-to-cost reimbursement of salary cost for Seconded Personnel cannot be considered as FTS under Article 12 of the DTAA. It also observed that Seconded Personnel should be construed as employees of EY India during the secondment period and their income should be subject to tax as salary in their hands. Thus, any further taxation of the same income in the hands of the Assessee, would lead to double taxation.

Significant takeaways

As per the facts of this case, the ITAT concluded that the Indian host is the real employer of the seconded employees during their secondment term as they worked under the control, supervision and direction of the host entity. In addition, the Indian host took the responsibility of the work done by the seconded employees, thereby becoming their real employer. This implies that the foreign entity i.e. original employer is not providing any services to the Indian host entity. Hence, the foreign entity cannot be taxed.

This is a welcoming judgment for secondment arrangements since it discusses the importance of real employer. Once it is ensured and achieved, through the various clauses in the deputation agreement and the actual conduct of the employer and the seconded employee, the issue becomes simple. Questions relating to the foreign company rendering services to the Indian host through the said personnel cannot arise, since they are already construed, as discussed above, to be employees of the Indian host entity.

It must also be noted that various other Benches of the Hon’ble ITAT have taken similar stances. The recent trend of tribunals holistically analysing the facts and circumstances of the relevant cases, rather than relying merely on other judicial precedents, is heartening. One hopes that this practice continues in the future and foreign entities do not have to litigate on these issues. The structure adopted by EY USA and EY India can become the accepted norm for secondment arrangements. This will help Indian entities to benefit from the guidance and training of people outside India, without subjecting the original employers to unnecessary tax litigations here.

Having said the above, the judgment reinforces the importance of maintaining appropriate documentation for secondment arrangements.

[1] Ernst & Young U.S. LLP vs. The A.C.I.T., International Taxation Circle (12(2) New Delhi [TS-335-ITAT-2023(DEL)]

[2] C.C.,C.E. & S.T. – Bangalore (Adjudication) Etc. Versus M/S Northern Operating Systems Pvt Ltd. [Civil Appeal No. 2289 – 2293 of 2021] [2022] 101 G S.T.R. 391 (SC)

[3] Flipkart Internet (P.) Ltd. v. Deputy Commissioner of Income-tax (International Taxation) [2022] 139 595 (Karnataka), 448 ITR 268

[4] Boeing India (P.) Ltd. v. Assistant Commissioner of Income-tax, Circle-5(1), New Delhi [2020] 121 276 (Delhi – Trib.)

[5] Principal Commissioner of Income-tax v. Boeing India (P.) Ltd. [2023] 146 131 (Delhi)