In this era of rapid globalization, the multinational companies (MNCs) are increasingly outsourcing ‘non-integral’ and ‘non-revenue generating’ (business support) functions to their subsidiaries or to third party vendors, located in low cost jurisdiction such as India. At times, MNCs send their employees, having expertise in the respective field to help the subsidiaries set up and carry out outsourced activities efficiently. Such secondment arrangements, unless carefully structured, can result in serious tax implications, both for the Indian subsidiary and the foreign company. In a recent decision in Centrica India Offshore Pvt. Ltd, the Delhi High Court has held that business support services provided by foreign company through seconded employees to Indian subsidiary constitutes ‘fees for technical services’(FTS). Surprisingly, the High Court further held that such services also create foreign company’s Service PE in India. The present article analyses the law laid down by the Court and its implications, with respect to secondment.

Key facts of the case

Centrica Plc., United Kingdom (Centrica UK) had subsidiaries in Canada and UK (hereinafter referred to as ‘overseas entities’) besides Centrica India. The overseas entities had outsourced some of their Business Support functionsviz., debt collections, consumer’s billings, monthly jobs etc. to Indian vendors. Centrica India acted as interface between overseas entities andIndian vendors. A service agreement was entered into between CentricaIndia and overseas entities in this regard providing for a cost plusremuneration. Centrica India requested overseas entities to provide staff with knowledge and experience of various processes and practicesemployed by Centrica UK. Managerial employees of the overseas entitieswere deputed to Centrica India, under secondment agreements, forassignments ranging from three to nineteen months. Centrica India,thereafter, entered into individual agreements (‘employment agreement’)with seconded employees (Secondees) reiterating the terms of thesecondment agreement and providing as under:Secondees have to function and act exclusively under the direction, control and supervision of Centrica India; Overseas Entities are not responsible for the work of Secondees andhave no responsibility for the errors/omissions or for the workperformed by them. Centrica India should bear all risks in respect of work performed by theSecondees and reap the benefit from their output.Rules, regulations, policies and other practices established by CentricaIndia for its employees apply to Secondees.Secondees continue to participate in retirement, social security plansand other benefits in accordance with overseas entities applicablepolicies.Centrica India had a right under the secondment agreement, to terminateSecondees from India assignments without any effect on the employment ofSecondees with overseas entities. Salary to Secondees was paid directly bythe overseas entities and claimed as ‘reimbursement’ from Centrica Indiaon a monthly basis. The reimbursement increased the cost base of CentricaIndia which was to be recovered as per service agreement after addingmark-up. The taxpayer was unsuccessful before Authority for AdvanceRuling (AAR) and filed a writ before Delhi High Court. Analysis of theserulings is as under.

Centrica India contended to be the economic employer of the Seconded,however the fact that control and supervision of the employees was fullywith Centrica India could not influence the court. The court instead laidemphasis on the fact that employees have a right to recover their salariesonly from overseas entities and their employment with overseas entitiesremains intact and un-affected by termination of secondment by CentricaIndia. The court relied on a passage from the authoritative book of Prof.Klaus Vogel written in the context of dual employment which suggested that merely because an employee works for an entity and receives instructions, tools etc from it are irrelevant except where the employees exclusively work for it during a period in which they are released by their legal employer. The court apparently equated the expression ‘released’ with severance of legal / formal employment. It was therefore concludedthat overseas entities are rendering service to Centrica India as againstmere hiring of labour. Having so held, the court added that the fact that there was no mark-up on the salary reimbursed does not alter the character of transaction.

Fees for technical services

 The AAR had held that payment is not in the nature of ‘fees for technical services’ (FTS) due to absence of the word ‘managerial’ in the treaty definition of FTS. The High Court observed that the definition in the Income tax Act includes ‘provision of services of technical personnel’ and concluded that the case before hand fits therein. It added that the Secondees are not only providing services but rather tiding Centrica India through the initial period and ensuring that going forward, the skill set of Centrica India’s other employees is built and these activities can be carriedout in future without the assistance of Secondees. For this reason it concluded that the criteria of ‘making available technical knowledge’ is met and even under treaty the services constitute ‘FTS’. In the process of its analysis the High Court observed that the criteria of ‘making available knowledge’, is not a pre-requisite to qualify FTS in India UK treaty. This observation though with due respect is incorrect yet until reversed, is likely to result in harsh consequences on transactions with UK based companies.

FTS constituting Service PE

 The Court in principle agreed that ‘substance’ and not the ‘form’ of the employment relationship has to be looked into so as to determine theexistence of a service PE. However extending their conclusion regarding‘rendition of service’, the Court concluded that overseas entities were legalas well as economic employers of Secondees and did have a service PE inIndia.

Conclusion

The conclusion of the court regarding ‘economic employment’ vis-à-vis‘legal employment’ is not in sync to the OECD as well as othercommentaries on the subject. With due respect, it appears that the court fellin error by applying (out of context) the passages from Klaus Vogel. In the absence of any other authoritative decision on the aspect of secondment,the view taken in this decision is likely to result in unwanted litigation.

Other taxpayers affected by these observations need to review their position and put in place an effective counter strategy.It is also noteworthy that Service PE clause under treaties is attracted onlywhere services other than FTS are provided. Hence, the view of the Courtthat the services of Secondees also created a Service PE, with due respect,requires reconsideration. Further, adding to the confusion, the lastparagraph of the judgment dismissing the writ states that ‘the ruling of theAAR stands’. As the AAR had ruled that the services do not constitute FTSand High Court held that to be FTS, this statement at the end is thusself-contradictory. Until clarified, the position regarding transactions withUK companies is likely to face unwarranted resistance from tax authorities.