The Bangalore Income Tax Appellate Tribunal (“ITAT”) in a recent case of Abbey Business Services (India) (P.) Ltd. v. Deputy Commissioner of Income-tax1 has held that reimbursements of salary and other administrative expenses by an Indian company to its foreign counterpart for secondment of employees by the latter to the former is not liable to withholding tax (“WHT”) requirements.

Facts

Abbey Business Services (India) Pvt. Ltd, (“the taxpayer”) is a subsidiary of M/s. Anitco Ltd, a foreign company, which is a group company of M/s. Abbey National Plc., UK (“Abbey UK”).  Abbey UK entered into an agreement with M/s. Msource (India) Pvt. Ltd. (“Msource India”) to outsource the provision of certain process and call centres to Msource.  In order to ensure that high quality services were provided by Msource, Abbey UK entered into a consultancy agreement with the taxpayer.  Further, to facilitate the outsourcing agreement between Abbey UK and Msource, Abbey UK entered into an agreement for secondment of employees (“Secondment Agreement”) from Abbey UK to the taxpayer.

Among other clauses, the important clauses of the Secondment Agreement were as follows:

Supervision and Control

The secondees shall be under the direct management, supervision and control of Abbey India and further agreed that:

  1. Abbey UK shall not be responsible and liable for any loss or damage occasioned by the Secondees’ work.
  2. the authority to instruct the Secondees shall lie with Abbey India, and
  3. the Secondees’ work shall be performed at such place as Abbey India may instruct.

Responsibility for Employment Liabilities

This Agreement shall not have the effect of constituting the Secondees as employees of Abbey India and the Secondees shall be and remain employees of Abbey UK during Secondment. The Secondees shall not be entitled to any remuneration nor employment benefits from Abbey India and it is agreed that Abbey UK shall, as employer of the Secondees, be responsible for all such remuneration and benefits and all other liabilities as employer to the Inland Revenue in the United Kingdom and all other authorities.

Payment for Secondment

In consideration of the Secondment of staff by Abbey UK, Abbey India shall make payments to Abbey UK equivalent to the Remuneration and any other sums incurred by Abbey UK applicable to each Secondee during his or her period of Secondment.  The payments shall be made quarterly in arrears against detailed invoice submitted by Abbey UK.

For the salaries paid by Abbey UK to the seconded employees, Indian income-tax was withheld under section 192 of the Income-tax Act, 1961 (“the Act”) and paid to the Central Government.  However, for the reimbursement of the salary and other administrative costs to Abbey UK, the taxpayer had not withheld taxes for financial years 2005-06 and 2006-07.  The Assessing Officer (“AO”) was of the view that the taxpayer ought to have withheld taxes in respect of the reimbursements made by the taxpayer to Abbey UK since they were in the nature of ‘fees for technical services’ (“FTS”).

Against the orders of the AO (for three appeals), the taxpayer preferred an appeal to the Commissioner of Income Tax (Appeals) (“CIT(A)”).  The CIT(A) partially upheld the decision of the AO by holding that only reimbursement of other administrative expenses was liable for WHT but the reimbursement of salary cost was not subject to WHT.

Against these orders, the taxpayer filed three appeals before the Bangalore ITAT and since the issues were same in all the appeals, ITAT clubbed all the appeals.

Arguments before the ITAT

Taxpayer’s arguments

The taxpayer put forth the following arguments:

  • The taxpayer contended (by referring to the relevant clauses of the Secondment Agreement) that it is clear that the taxpayer is the real and economic employer of the seconded employees since the taxpayer had direct control and supervision over the seconded employees despite the clause in the Secondment Agreement stating that the seconded employees would constitute as employees of Abbey UK.
  • The taxpayer reiterated the concept of dual employment wherein the legal employment continues with one employer and another person exercises control and supervision.  In support of the same, the taxpayer relied on OECD commentary and few cases.
  • The taxpayer relied on the decision of the Bangalore ITAT in IDS Software Solutions India P. Ltd. Vs. ITO2 (“IDS case”) and filed a table stating the similarities between the IDS case and the instant case and how the decision of the Bangalore ITAT in the IDS case squarely applies to the present case.
  • The taxpayer argued that the payments made by the taxpayer to Abbey UK do not constitute FTS neither under the Act nor under the Double Taxation Avoidance Agreement between India and UK (“DTAA”). The taxpayer further stated that the payments made by the taxpayer to Abbey UK are in the nature of reimbursements and do not amount to income in the hands of Abbey UK and hence no WHT liability arises.
  • The taxpayer distinguished the case relied on by CIT(A) namely AT & S (I) Pvt. Ltd. Vs. CIT3 by stating that in that case the foreign company retained control and supervision over the seconded employees unlike in the present case.

Revenue’s arguments

The Revenue did not prefer a cross appeal against the CIT(A) order in partially setting aside the AO’s order that salary reimbursements were also liable to WHT as FTS.  The Revenue placed reliance on the case relied on by CIT(A) and contended that the taxpayer has not put on record any material to establish that the payment made by the taxpayer was in the nature of pure reimbursement.  In response to the Revenue’s arguments, the taxpayer in the rejoinder stated that the Revenue’s contentions are contrary to law and facts and made reference to the Secondment Agreement.

Issues to be decided by the ITAT

The ITAT had to decide the following issues:

  1. Whether the taxpayer can be regarded as the real and economic employer of the seconded employees.
  2. Whether the payments made by the taxpayer to Abbey UK were pure reimbursement of expenses and if so, whether the said reimbursements constituted income to Abbey UK.
  3. Whether the payments made by the taxpayer to Abbey UK constituted FTS under section 9(1)(vii) of the Act and/ or under Article 13(4) of the DTAA between India & UK thereby requiring withholding taxes assuming income had arisen to Abbey UK as FTS.

Decision of ITAT

Issue 1: Whether the taxpayer can be regarded as the real and economic employer of the seconded employees

The ITAT reviewed the relevant clauses of the Secondment Agreement to determine with whom the direct control and supervision of the seconded employees was vested.  By virtue of the taxpayer’s control over the seconded employees and the obligation on the part of Abbey UK to withdraw any seconded employee should the taxpayer require the same (which is similar to the right of an employer to terminate an employment), the ITAT held that the direct control and supervision of the seconded employees was with the taxpayer.  As regards the clause which states that Abbey UK shall remain the employer of the seconded employees, the ITAT was of the view that this was solely for the purpose of ensuring social security and other benefits to the seconded employees and Abbey UK was a mere ‘legal employer’ and therefore, the same would not alter the position that the taxpayer was in fact the ‘real and economic employer’.

The ITAT accepted the taxpayer’s reliance on the IDS case and further asserted that the quantum of payments and/ or number of seconded employees is not relevant in determining the real and economic employer.

ISSUE 2: Whether the payments made by the taxpayer to Abbey UK were pure reimbursement of expenses and if so, whether the said reimbursements constituted income to Abbey UK

In determining whether the payments in question were in the nature of mere reimbursement of expenses, the ITAT looked at the Notes to Accounts which stated that the Company (i.e. the taxpayer) reimburses all expenses incurred by Abbey UK including payroll costs for the employees who are on secondment for the Company’s activities.  Based on this, the ITAT held that the payments were mere reimbursements of salary and other costs.

As regards the second prong of the issue, that is, whether these payments would be regarded as income chargeable in the hands of Abbey UK, the ITAT reiterated the principle laid down in the case of TISCO Vs. Union of India4 and other cases that reimbursement of salary cost and other expenses cannot be regarded as income in the hands of the recipient since there was no profit or gain element in it and therefore, were mere reimbursements.

ISSUE 3: Whether the payments made by the taxpayer to Abbey UK constituted FTS under section 9(1)(vii) of the Act and/ or under Article 13(4) of the DTAA between India & UK  thereby requiring withholding of taxes assuming income had arisen to Abbey UK as FTS

For any payment to be regarded as FTS under the IT Act, two requirements need to be fulfilled namely,

  1. rendering of managerial, technical or consultancy services; and
  2. consideration is paid for such services rendered.

The ITAT held that there was no rendering of services and there was merely secondment of employees to the assesse. Consequently, since both the requirements for a payment to be regarded as FTS was not fulfilled, the ITAT held that the payments in the present case cannot be treated as FTS.

On whether the payments would be liable to WHT under the DTAA, the ITAT examined the conditions under which a payment may be regarded as FTS which are as follows:

  1. payment is made as a consideration for rendering of any technical or consultancy services; and
  2. such services ‘make available’ technical knowledge, experience, skill, know-how or process or consist of the development and transfer of a technical plan or design.

As regards the first condition, the ITAT reiterated that there was no rendering of services. Even assuming that services were rendered, the services rendered by Abbey UK would be in the nature of ‘managerial services’ which is not contemplated under the DTAA. It clarified that unlike in the Act; the definition of FTS under the DTAA includes only technical or consultancy services and not managerial services.   Further, the ITAT held that no technology, process, skill, etc. was ‘made available’ by Abbey UK to the taxpayer which is a cumulative condition to be fulfilled under the definition of FTS in the DTAA and hence not liable to any Indian taxes. 

Based on the above conclusions, the ITAT held that since there was no requirement for the taxpayer to withhold any taxes on the payments made, the consequent disallowance of reimbursement costs under section 40(a)(i) of the Act for non-withholding of taxes was not applicable.

Analysis

This decision has again come as a relief to the secondment arrangements between Indian companies and their related companies.  It was crucial not only for the taxpayer to get the decision in their favor to avoid withholding tax requirements and consequent disallowance but also to the UK entity i.e. Abbey UK since if the ITAT would have held that Abbey UK was the actual employer then the seconded employees would have more likely become the service permanent establishment (‘service PE’) of the UK entity.  It may be noted that the employees were seconded to India for the benefit of the UK entity and if the same would have been considered as service PE then a significant portion of the income earned through the BPO business could have been taxed in India at a higher rate in the hands of Abbey UK.  

Also, it may be noted that in the AAR rulings of Verizon Data Services India Private Limited v. CIT5 and Centrica India Offshore Private Ltd. v. CIT6 it was held that the reimbursement of salary costs by the Indian company to its foreign counterpart under the secondment agreement was liable to WHT under section 195 of the Act.  However, in those cases the seconded employees came for the benefit of the Indian companies and therefore, the service provided by the seconded employees was considered as FTS.

Considering the fact that it is a common practice amongst multinational companies to second employees to their Indian counterparts and since the Bangalore ITAT has again distinguished between the ‘legal employer’ and the ‘real & economic employer’ in favor of the taxpayers by holding that the latter would be the actual employer for tax purposes, it would be appropriate for the multinationals to define the terms of the secondment agreement in such a way that the Indian company would have control, direction and supervision of the seconded employees to avoid WHT requirements and service PE exposure to the seconding foreign entity.