Crossing the tax borders

Companies engaging expatriates should proactively review their secondment agreements for possible tax leakages.

Cross-border assignment (secondment) of employees between affiliate companies is common among multinational groups. Such arrangements bring forth unique challenges from a tax perspective. Taxpayers feel that a seconded employee virtually becomes an employee of the Indian company and, hence, payments to the home country entity are essentially reimbursement of the employment costs borne by the Indian company. This has attracted controversy and litigation.

Indian tax law, as well as several tax treaties define Fee for Technical Services, or FTS, as payment for managerial, technical or consultancy services, including the personnel for it. Tax authorities argue that salary reimbursement should be considered as FTS on the ground that the foreign company has been paid for providing personnel for technical services.

The crux of the issue is which entity should be reckoned as the ‘employer’ of the secondee: Is it the entity with which the employee has an employment contract, or should other aspects be considered too?

Based on the OECD (Organisation for Economic Cooperation and Development) commentary, substance should prevail over form, which means that the term ‘employer’ should be seen in a broader sense and the whole context of the employment reviewed to determine which entity is the “economic employer” under the treaty. Historically, Indian courts (including the Supreme Court) have laid down tests to determine whether an employee-employer relationship exists or not. In a recent trend, tax authorities have been closely scrutinising such arrangements on the basis of terms of agreements, conduct of parties and so on. The Authority for Advance Rulings, or AAR, in the case of Verizon Data Services and Centrica India Offshore Pvt Ltd treated the payments as taxable in India based on certain aspects of the arrangement. Consequently, there has been growing concern among global HR managers and tax heads with regard to additional tax cost for secondments.

However, recent rulings in the case of Marks & Spencer Reliance India Pvt Ltd and Temasek Holdings Advisors (India) Pvt Ltd have held that there was no need to withhold taxes under section 195 of the Income-tax Act at the time of reimbursing salary paid to seconded employees, when it was already withheld under section 192. The tax tribunal also held that the payments did not qualify as FTS under the tax treaty as the overseas entity is not providing service to the Indian entity. The tribunal, in fact, noted that it was the Indian entity that provided service to the overseas parent on a cost-plus basis, and that there could be a service Permanent Establishment (PE) of the overseas entity only when it provided services in India through its seconded employees. This has brought some relief to taxpayers.

China recently issued guidance that a non-resident entity (home country entity) will deem to have a PE in China when the foreign seconding entity assumes a part or all of the responsibility and risk associated with the secondees’ work and evaluates the work. In essence, China has formally legislated the concept of ‘economic employer’, which is recognised in many countries. Interestingly, in Russia a cross-border secondment is expressly exempt from the definition of PE. However, Russian migration authorities require a seconded individual to provide an employment agreement with a Russian employer to get a work permit. This negates the entire idea of secondment. While a split payroll structure or complete transfer of the payroll could be looked at, there are other tax aspects and risks to this. Some multinationals adopt a PE blocker, which includes drafting the secondment agreement in such a way that the non-resident entity acts as the “payroll agent” and not the employer of the seconded employee. Given the emphasis on facts and the conduct of parties in the rulings, taxpayers should be proactive in their documentation and be able to demonstrate the substance of agreements through actual conduct.

To summarise, a cross-border secondment calls for a careful review of several regulations and, in the current context, it should also be tested for arm’s length under transfer pricing regulations where it concerns payments to directors (expatriate directors, in this context). Especially given the current tendency of tax authorities to scrutinise cross-border payments, companies engaging expatriates should proactively review their secondment agreements for possible tax leakages, maintain benefit documentation and firm up a clear tax position by obtaining a certificate under section 195.

Deepti Chabria, Assistant Manager contributed to the article.

The author is Executive Director — Tax and Regulatory Services, PwC India

Published on October 20, 2013

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