The Mumbai bench of the Authority for Advance Rulings (“AAR”), held that reimbursement made by an Indian company, to a Foreign company for certain obligatory payments made to expatriate personnel (“Personnel”) on behalf of the Indian company, would not be taxable as fees for technical services (“FTS”) as:
- There was employer-employee relationship between the Indian company and Personnel.
- Payments made to reimburse obligated expenses such as social security contributions, insurance and relocation expenses held to be reimbursement since they do not accrue to the offshore company.
CTBT Pvt. Ltd. (“Applicant”), a company incorporated in India was a wholly owned subsidiary of PMK (Swiss Company). The Applicant had entered into a memorandum of understanding with one of the State government for establishing a manufacturing plant. In order to ensure consistent application of quality and safety standard, the Applicant requested KRP, another wholly owned subsidiary of PMK (Swiss Company), to supply experienced Personnel in order to run a manufacturing plant in India.
The Applicant entered into an intercompany agreement (“Agreement”) with KRP for disbursing social security contribution, insurance and relocation expenses in the home country of the Personnel. The Applicant stated that the arrangement of KRP making part payment of salary to the Personnel, on behalf of the Applicant, was only facilitative in nature and to facilitate the Personnel to meet their financial commitments in their home countries. The Applicant reimbursed KRP for these expenses and paid an additional administrative fee to KRP for managing the disbursements.
The Applicant paid the Personnel the substantive part of the salary directly. This salary was subjected to tax in India in the hands of the Personnel. The Applicant withheld tax under section 192 of the Income-tax Act, 1961 (“ITA”) on the entire amount paid by the Applicant which was inclusive of the reimbursement payment to KRP. The Applicant also withheld tax under section 195 of the ITA on the administration fee paid to KRP.
The Agreement between the Applicant and KRP laid down the rights the Applicant had vis-à-vis the Personnel.
- The Applicant was wholly responsible for the Personnel and execution of their duties;
- The Applicant had sole liability for every act or failure of the Personnel;
- KRP discharged the Personnel of all obligations and rights including any lien on employment;
- KRP could not recall any of the Personnel without obtaining the prior consent of the Applicant;
- Personnel were not in any way be subject to any kind of instructions or control of KRP; and
- Personnel would not be regarded as employees of KRP;
- The AAR observed that there was an employer-employee relationship between the Applicant and the Personnel since the Applicant exercised full operational control over them. Further, KRP was not making any performance related payments to the Personnel. The AAR characterized the payments made by KRP on behalf of the Applicant as “obligated payments” that the Personnel were liable to make in their home country. On this basis, the AAR held that the amount paid by the Applicant to KRP was in the nature of reimbursement and not FTS.
- The AAR distinguished the facts of the present case from that of Delhi High Court ruling in case of Centrica as well as the Bengaluru Tribunal’s ruling in Flughafen Zurich v. DDIT on the ground that the entire salary of the expatriate personnel was paid by the overseas companies and reimbursed by the Indian entity. In the present case, as noted by the AAR, the reimbursement amounts were a small fraction of the salary of the Personnel and no other payments took place outside India except for the minimal obligated payments. Further, the payments never accrued to KRP but were mandatorily paid to the respective accounts of the Personnel.
- The AAR held that the Applicant had no useful purpose to cloak a small fraction of obligated payments by routing them through an offshore company, as it had already paid the bulk of the salary in India.
The issue of whether reimbursements to offshore companies, for payments made to expatriate personnel, should be considered FTS has been a litigated issue. Whether the payment qualifies as FTS or not depends on the facts of each case and the relationship between the employee, the Indian company and offshore company.
The AAR ruling identified certain important principles which could be applied to distinguish between reimbursement and FTS in situations involving secondment of expatriate personnel.
- No Lien over Employment: The AAR relied on the Agreement between the Applicant and KRP and observed that the Agreement explicitly provided that KRP had no lien over employment. The Agreement specifically provided that KRP discharged the Personnel of all obligations and rights including any lien on employment, and from all actions, claims and demands towards KRP, while they were working as employees of the Applicant during the assignment.
- Accrual of Payment: In the present case as the payments never accrued to KRP for it to decide its application. They were mandatorily paid to the respective accounts for social security, insurance, and relocation commitments. The point of accrual as well as the nature of the payment would be relevant in deciding whether an Indian company is reimbursing an offshore company for payments made on its behalf or whether it is paying consideration to the offshore company for services rendered.
- Useful Purpose: The AAR observed that no useful purpose had been served even if the companies intended to cloak payments as reimbursement. The ‘useful purpose test’ may be used to substantiate the payment of certain non-substantive portions of salary to expatriate personnel, as the companies would gain little benefit from cloaking the nature of payment.
However, the useful purpose test should not be reduced to a ‘substantive salary’ test. Reimbursements to the offshore company should not be classified as FTS merely because they involved payment of substantive salary.
The AAR ruling indicates the importance of the nature of employment and accrual of payment, in order to determine whether a payment for seconded employees is mere reimbursement or FTS. It might be prudent to draft the secondment agreements carefully to correctly capture the nature and intent of payments being made, relationship with the seconded employees etc.
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