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Verizon Ruling in India – What is the Way Forward?
The secondment of expatriate employees to work in India is not new, and yet with robust growth in business opportunities and India's emergence as a global player, the frequency with which multinational companies have been regularly seconding its employees to their Indian subsidiaries and joint ventures ("JVs") in India has increased manifold. While such secondment arrangements are driven primarily by commercial considerations, tax implications for the parties involved and the seconded employee has been a subject matter of controversy in the last few years.
The genesis of some of these controversies is due to the lack of clear provisions in the Indian Income Tax Act, 1961 ("the Act") laying out the tax implications. In the absence of such well defined statutory principles or guidelines elaborating the tax treatment, the dependence on interpretation by Indian judiciary has been fairly pronounced. The recent ruling of the Authority for Advance Rulings ("AAR") in the case of Verizon Data Services has only resulted in creating greater divide in the judicial pronouncements on the issue of taxability of such reimbursements of salary cost to the foreign employer. Taxand India reviews the latest Verizon Ruling to establish what should be the way forward from here.
The issue before the AAR involved a foreign company ("GTE US") seconding three of its employees under a secondment agreement to work for the Indian subsidiary of its affiliate company, Verizon US. The employees were to perform managerial and other services in India under the control and supervision of the subsidiary. The salaries and other compensation were to be paid by GTE US and the same were to be reimbursed by the Indian subsidiary on a cost to cost basis. Further, GTE US did not assume any obligation or risk in respect of the work of the employees and retained the right to terminate the employment of the seconded employees. The salaries payable to the employees were subject to withholding of Indian taxes.
A ruling was sought by the Indian subsidiary in respect of its liability to withhold tax on the reimbursement of salary to GTE US. The Revenue Authority ("RA") contended that the seconded employees were occupying managerial positions and were rendering technical guidance to the Indian subsidiary and the payments made by the subsidiary to the foreign company were in the nature of "Fees for Included Services" ("FIS") under the India-US Tax Treaty.
The AAR noted that the secondment agreement provides for the seconded employees to remain as the employees of GTE US and payment of their salaries is not dependent on the Indian subsidiary. The employees would continue to be entitled to their salaries from GTE US so long as they remain in their employment. The AAR held that managerial services performed by them are as employees of GTE US and not as employees of the Indian subsidiary. Without GTE US, the seconded employees have no locus standi vis-?-vis the Indian subsidiary. By relying on the power of GTE US to terminate the employment, the AAR ruled that the seconded employees continued to be the employees of the foreign company. The AAR also concluded that the reimbursement of salary should be regarded as fees for included services under the Double Taxation Avoidance Agreement and should be liable to withholding of tax in India at the rate of 20 percent. In arriving at this conclusion, the AAR held that the functions performed by these seconded employees are managerial in nature, but such services would be covered even under the narrower meaning of 'Fees for included services' under the Tax Treaty.
In reaching its conclusion, the AAR has not applied the commentaries of the OECD Model Convention dealing with the concept of 'economic employer' in cross border secondment of an employee. This ruling is also contrary to the ruling of the Tax Tribunal in the case of IDS Software Solutions, where also the facts involved the salary of an individual who was deputed to act as the managing director of the Indian company. However, in the facts of IDS software, the Indian company had the power of terminating the services of the seconded employee.
In the landmark case of Morgan Stanley, the Indian Supreme Court made a distinction between employees on secondment and those that visit India to carry on "stewardship" functions for the shareholder. It went on to hold that in cases of secondment, a services PE would be constituted as long as the foreign employer has a "lien" on the employment of the individuals. The Court also went on to state that an arm's length compensation would extinguish the PE exposure.
The learning from these rulings is that the predominance of the secondment agreements in determining the tax outcomes cannot be undermined, both in form and in substance. The agreement can serve as a filter for any PE exposure, if it can be established that the economic employment is unequivocally transferred to the Indian company. Secondly, the termination clauses of the secondment agreement would specifically require certain level of validation so that the transfer of economic employment could be substantiated and the fact that during the secondment period, the entire control over the employee vests with the Indian company can be demonstrated. Further, the manner of remunerating the seconded employees could be planned, with the option of salary being paid by the Indian company itself also being explored.
Lastly, the consequences of service tax should also be considered while structuring these arrangements, as there is a specific category that seeks to tax supply of manpower, and often times, the objectives under income tax and service tax could be at crossed purposes.
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