One Supreme Court Ruling. Two Taxing Consequences

In a ruling that’ll impact multinationals deputing employees to their Indian affiliates, the Supreme Court has upheld the revenue department’s stand of imposing service tax on such arrangements. The principle laid down by the apex court will apply to the goods and services tax regime too. But more importantly it may have some unintended consequences under income tax law as well, experts BQ Prime spoke with said.

MNCs typically transfer employees on a temporary basis, referred to as secondment, to their Indian group companies. The employee's salary is disbursed by the overseas company, which is then reimbursed to it by the Indian entity.

The apex court has viewed this agreement in Northern Operating Systems’ case, with group companies in the U.S., the U.K., Ireland, Singapore, etc., as a contract of service involving supply of manpower by the foreign entity. The company’s argument that it’s an employer-employee relationship not liable to service tax was dismissed by the apex court.

The Supreme Court has gone into the substance of the transaction to conclude that the underlying contract is for provision of service and not an employer-employee relationship, Ritesh Kanodia, partner at ELP, said.

And that's the other worry for MNCs seconding employees to their Indian affiliates. Specifically, the treatment of payments or reimbursements made by the Indian company to the overseas entity.

Here’s why.

For such secondment arrangements, the apex court has noted, the principle of substance over form will apply.

Meaning, who is the real employer of the seconded employee. It’s the foreign entity in this case, the court said, since the salary was in foreign currency, employee received social security benefits, the secondment arrangement is a part of the foreign entity’s global policy of loaning its services, and the employee returned to the MNC after the secondment period was over.

In secondment cases, the persuasive argument from an income tax viewpoint is that the economic employment vested with the Indian affiliate and the legal employment with the foreign entity, Aseem Chawla, founder at ASC Legal, pointed out. This argument is not forthcoming in the order, he said.

Tarun Jain, partner at BMR Legal, holds a similar view. The court has disregarded the legal structure in order to find out the economic structure. And while the court has not dwelled into the income tax implications of this approach, the revenue department can surely do so, he pointed out.

The domestic law will start ignoring the employee and its tax consequences. It will start looking at the foreign company which supplied manpower to an Indian affiliate and has received payment, Jain explained.

The consequences will depend on the specifics of a case but the Supreme Court’s ruling forces a revisit of past positions and review of tax consequences assumed so far, Jain said.