Centrica India Offshore Pvt. Ltd vs. CIT (Delhi High Court)

Tax implications of employee secondment contracts explained

The High Court had to consider whether the consideration for secondment of employees by British Gas Trading Ltd, UK, (“BSTL”) and Director Energy Marketing Limited, Canada (“DEML”) to Centrica, India, for providing “business support services” constitutes “fees for technical/ included services” under Articles 12 & 13 of the India-Canada and India-UK DTAAs and whether the presence of the seconded employees created a “service PE” in India for the foreign employers. HELD by the High Court:

(i) The overseas entities required the Indian subsidiary, CIOP, to ensure quality control and management of their vendors of outsourced activity. For this activity to be carried out, CIOP required personnel with the necessary technical knowledge and expertise in the field, and thus, the secondment agreement was signed since CIOP did not have the necessary human resource. The secondees are not only providing services to CIOP, but rather tiding CIOP through the initial period, and ensuring that going forward, the skill set of CIOP’s other employees is built and these services may be continued by them without assistance. In essence, the secondees are imparting their technical expertise and know-how onto the other regular employees of CIOP. Indeed, it is admitted by CIOP that the reason for the secondment agreement was to provide support for the initial years of operation, till the necessary skill-set is acquired by the resident employee group. The activity of the secondees is thus to transfer their technical ability to ensure quality control vis-à-vis the Indian vendors, or in other words, “make available‟ their know-how of the field to CIOP for future consumption. The secondment, if viewed from this angle, actually leads to a benefit that transmits the knowledge possessed by the secondees to the regular employees. Indeed, any other reading would unduly restrict the Article 12 of the DTAA, which contemplates not only a formal transfer of intellectual property, but also other techniques and skills (“soft” intellectual property) required for the operation of a business. The skills and knowledge required to ensure that the task entrusted to CIOP – quality control – is carried on diligently certainly falls within the broad ambit of Article 12;

(ii) CIOP’s arguments that it is not liable to deduct income tax u/s 195 on the ground that (i) there is no service PE, since CIOP is the economic employer, whilst the overseas entities are only the legal employers, (ii) the payment made by CIOP to the overseas entities is only by way of reimbursement, which does not form part of the income of those entities, and in any case, (iii) that payment is not the income of the overseas entities on account of the doctrine of “diversion of income by overriding title” are not acceptable;

(iii) The argument that there is no “service PE” is not acceptable because though CIOP has operational control over these persons in terms of the daily work, and is responsible (in terms of the agreement) for their failures, these are limited and sparse factors which cannot displace the larger and established context that the persons continue to be employees of the foreign parties (Morgan Stanley, OECD Commentary & referred);

(iv) The argument that the payment is a “reimbursement” on the ground that it is described as such in the secondment agreement and that there is no mark-up is not acceptable. It would lead to an absurd conclusion if, all else constant, the fact that no payment is demanded negates accrual of income to the overseas entity. Instead, the various factors concerning the determination of the real employment link continue to operate, and the consequent finding that provision of employees to CIOP was the provision of services to CIOP by the overseas entities triggers the DTAAs. The nomenclature or lesser-than-expected amount charged for such services cannot change the nature of the services. Once it is established that there was a provision of services, the payment made may indeed be payment for services – which may be deducted in accordance with law – or reimbursement for costs incurred. This, however, cannot be used to claim that the entire amount is in the nature of reimbursement, for which the tax liability is not triggered in the first place.

(v) The argument that there is a “diversion of income by overriding title” on the basis that the payment made to the overseas entity is not income that accrues to the overseas entity, but rather, money that it is obligated to pass on to the secondees is also not acceptable for two reasons. One, in view of the findings that: (a) the payment is not in the nature of reimbursement, but rather, payment for services rendered, (b) the employment relationship between the overseas entities and CIOP – from which the former’s independent obligation to pay the secondees arises – continues to hold, no obligation to use money arising from the payment by CIOP to pay the secondees arises. The overseas entities’ obligation to pay the secondees arises under a separate agreement, based on independent conditions, in relation to CIOP’s obligation to pay the overseas entity. Assuming the agreement between CIOP and the overseas entity envisaged a certain payment for provision of services (and not styled as reimbursement). Surely no argument could be made that such payment is affected by the doctrine of diversion of income by overriding title. If that be the case, then the fact that the payment under the secondment agreement is styled as reimbursement, and limited on facts to that, without any additional charge for the service, cannot be hit by that doctrine either. The money paid by CIOP to the overseas entity accrues to the overseas entity, which may or may not apply it for payment to the secondees, based on its contractual relationship with them. This, at the very least, is independent of the relationship and payment between CIOP and the overseas entity.