Taxman’s definition of working relationship

The taxability of the salary cost reimbursed by a subsidiary to its parent for secondment of employees has been a subject of debate, with judicial bodies taking varying views on it. Recently, the Authority for Advance Ruling took up the issue in the case of an applicant, Target Corporation India Pvt Ltd. Some key features of the ruling are:

Facts

Based on a request from the applicant, its US parentwould second its employees to India, in line with its global mobility policy. The employee’s payroll would be processed by the US parent.

The applicant would reimburse the US parent for the payroll expense and a service charge of $15 per employee for payroll processing.

The employees would act in accordance with the instructions of the applicant.

The employees would devote their entire time to the applicant.

The risks and responsibilities of the employees’ work would rest with the applicant.

Theemployee would act on behalf of the applicant.

TheUS parent cannot terminate the secondment of any employee without prior consultation with the applicant.

A ruling was sought on whether withholding tax was applicable in India on — reimbursement of payroll expenses; and payment of payroll processing charge.

AAR’s observations:

Regarding reimbursement of payroll expenses, the AAR concluded that the applicant does not become the employer, based on the following:

The employees were employed by the US parent. After providing service to the applicant, the US parent continued to pay salary and service benefits. Hence, they never ceased to be employees of the US parent.

The right of dismissal remained with the US parent

The sure test to conclude whether an employer-employee relationship exists is that the employer has the right to terminate employment. The agreements in the present case did not show that the applicant had a right to terminate employment.

The recent AAR ruling of Centrica also specified that the right to terminate employment, and not secondment, is the key for determining employer-employee relationship. The absence of the obligation to pay salary is also relevant.

Hence, it concluded that the payment is not reimbursement of salary, but income which would be taxable as FTS (fee for technical services) or business profit. It was left to the assessing officer to decide on the same.

With respect to payroll processing charge, while the applicant contended that it should not be taxable as FTS because the services do not “make available” any technical knowledge, experience, skill and know-how to the applicant, the AAR declined to rule on it in the absence of details.

Impact

Recently, the Bangalore Tribunal also discussed this issue at length, in the case of Abbey Business Services (India) Pvt Ltd. It concluded that salary reimbursement was not taxable as FTS.

Relying on the tribunal’s decision for IDS Software Solutions India Pvt Ltd, the Indian company was considered the real and economic employer because:

the authority to instruct work vested with the Indian company;

the employees were under the direct supervision and control of the Indian entity;

the foreign company was regarded as employer only for the purpose of discharging statutory functions under the UK laws, such as pension and social security contributions;

the tools and materials required were placed at the employees’ disposal by the Indian company.

the deputing entity would not be responsible for loss and damage on account of the employees’ work.

Even in another recent ruling, in the case of Ariba Technologies (I) Pvt Ltd, the Bangalore Tribunal ruled that salary reimbursement does not constitute FTS.

The AAR in the case of Target Corporation India Pvt Ltd did not take into account the above factors argued by the applicant to conclude that it is the economic employer and, hence, the payment should only be considered as reimbursement and not FTS. The AAR instead concluded on the basis of who had the right to terminate employment.

While AAR rulings are binding on the applicant and the tax authority for that case, it would have persuasive value for others.

Hence, multinational companies with such secondment arrangements would need to review the impact of this ruling on their tax liability in India.

(Niji Arora is Manager, Deloitte Haskins & Sells.)

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