In a recent ruling in the case of Morgan Stanley International Incorporated v DDIT, the Mumbai Bench of the Income Tax Appellate Tribunal (Tribunal) seems to have given a different dimension to the debate arising out of seconding of employees by MNCs in India to their Indian subsidiaries. The Tribunal held that the employees of a foreign company seconded to its Indian subsidiary constitute the service permanent establishment (Service PE) of the foreign company in India and then concluded that the reimbursement payments were to be taxed as ‘business profits’ and not as fees for included services.
Morgan Stanley International Incorporated (MS USA) is a resident of the USA and its primary activity is to provide support services to various subsidiaries all over the world and in India.
MS USA deputed five of its employees to its Indian subsidiaries. The seconded employees were deputed to work under the control and supervision of the board of directors of the respective Indian subsidiaries, as the case may be. Further, day to day responsibility of the seconded employees was managed by the Indian subsidiaries, and they were accountable only to them. However, the salaries of the seconded employees were paid by MS USA and thereafter reimbursed by the Indian subsidiaries. At the time of such reimbursement, Indian subsidiaries did not withhold any tax.
MS USA, while paying the salaries of the seconded employees, had withheld applicable tax under the Indian tax laws and thus the salaries had been offered to tax in India.
The Tax Officer held that the reimbursement received by MS USA was in the nature of ‘fees for technical services’ (FTS) under the IT Act or ‘fees for included services’ (FIS) under Article 12 of the India – USA Tax Treaty (Treaty) and therefore taxable in India as this payment was received by MS USA for rendering technical services through the seconded employees. Aggrieved by this order of the Tax Officer, MS USA appealed before the Commissioner of Income Tax (Appeals) (CIT (A)) but the CIT (A) confirmed the order of the Tax Officer.
MS USA approached the Tribunal against the order of the CIT (A).
Relying on the rulings of the Delhi High Court in the case of Centrica India Offshore Private Limited (TS-237-HC-2014(DEL)) and the Supreme Court of India in the case of Morgan Stanley and Co ( 292 ITR 416 (SC)), the Tribunal held that the seconded employees were the ‘real employees’ of MS USA, “who have come to India to render services and once they are rendering services on behalf of assessee (i.e. MS USA) in India, they constitute Service PE in India” (Emphasis supplied).
The Tribunal relied on the rulings in the Centrica and Morgan Stanley cases (supra) to hold that if the seconded employees: (i) continue to be on the payroll of the overseas entities; or (ii) continue to have their lien with jobs with overseas entities, and are rendering services in India, then they would constitute the ‘Service PE’ of the overseas entities in India.
The Tribunal appears to have reached the conclusion of the seconded employees constituting a ‘Service PE’ of MS USA in India based on the decision of the Supreme Court in case of Morgan Stanley (supra) without an independent detailed examination of the facts to determine if the seconded employees were indeed the ‘real employees’ of MS USA. They seem not to have given cognition to the fact that: (a) the seconded employees were deputed to work under the control and supervision of the board of directors of the Indian subsidiaries; (b) the day to day responsibility of the seconded employees was managed by the Indian subsidiaries; and (c) the seconded employees were accountable only to the Indian subsidiaries.
While upholding the 'Service PE’ conclusion, the Tribunal has ruled as under:
- The seconded employees constituted the ‘Service PE’ of MS USA, and hence the payments received by MS USA from its Indian subsidiaries were in the nature of ‘business profits’ attributable to such ‘Service PE’.
- ‘Business profits’ were to be taxed under Article 7 and not as FIS under Article 12 of the Treaty as the Treaty specifically excludes any fees from the purview of Article 12 if such fees were attributable to PE.
- Distinguishing this aspect from the ruling of the Delhi High Court in Centrica (Supra), the Tribunal held that the Court in the said case did not examine this particular aspect of the matter.
The Tribunal held that in determining the taxability of the payments received by MS USA as business profits under Article 7, the salaries paid by MS USA to the seconded employees were to be treated as its cost and therefore were deductible while computing the taxable ‘business profits’ in India.
It is pertinent to note that neither the Tax Officer nor the CIT (A) had considered the aspect of PE on account of secondment of employees by MS USA. Resultantly, the grounds of appeal taken by MS USA before the Tribunal also did not deal with the PE aspect and the examination was focussed only on why the payment received by MS USA should not qualify as FIS under the Treaty. However, relying merely and purely on the ruling of the Supreme Court in the Morgan Stanley case and without evaluating the merits of the case, the Tribunal went ahead to rule in this case on the premise that the seconded employees were the ‘real employees’ of MS USA and constituted its ‘Service PE’ in India. The Tribunal reached this conclusion despite having acknowledged that the Indian subsidiaries of MS USA exercised control and supervision over the seconded employees and that the seconded employees would remain accountable only to the Indian subsidiaries. This has unfortunately added further fuel to the debate over the tax treatment of cross-border secondments in India.
Following a similar ruling of the Delhi High Court in the Centrica case, it is disheartening to note that the Tribunal has refused to attach any significance to the facts of the case and the concept of ‘economic employer’ and concluded the presence of a ‘Service PE’ in a seemingly casual manner which will escalate the uncertainty already prevailing in the tax treatment of cross-border secondment arrangements.
However, having ruled that the seconded employees constitute the ‘Service PE’ of MS USA in India, as a saving grace, the Tribunal has held that if the seconded employees are to be the PE of their parent in India, then it needs to be ensured that the amounts paid to the parent company are not treated as FIS but as ‘business profits’. This would result in the same being taxed on a net basis i.e. after allowing deduction for applicable expenses (in this case the salaries of the seconded employees borne by MS USA) and would avoid double taxation of the same income. To this extent, this ruling has taken the sting out of the Centrica ruling delivered by the Delhi High Court and comes as some reprieve for MNCs, for whom cross border secondment arrangements are necessitated by business reasons. Complete severance of the secondees from the parent company is usually not practicable where the employees need continuity of social security and other benefits in their home jurisdictions. Therefore, one would need to carefully weigh commercial and tax considerations while structuring the secondment arrangements and hope that the Government provides much-needed clarity in the upcoming Union Budget.
It is to be noted that while holding that the payments received by MS USA from its Indian subsidiaries were not in the nature of FIS as MSUS had a ‘Service PE’ in India, the Tribunal did not take into account another provision of the Treaty which stipulates that a ‘Service PE’ is not constituted when the payment for services rendered by the foreign entities are in the nature of FIS. Therefore, the ruling does not throw any light on the aspect of analysing the nature of services rendered under a secondment arrangement to determine if it constitutes a ‘Service PE’ or would fall under the ambit of FIS.