Author Advocate Dharan Gandhi in Part 3 of his article discusses nuances further to reimbursement in cases of secondment of employees and examines the possibility of constitution of various forms of PEs upon such secondment. Considering that when senior employees are seconded, they are mostly given a place in India which is at their disposal, and carry out business of the foreign company from such place for a longer period of time, the author opines that they could constitute a ‘fixed place PE’ of business in India. Similarly, the author contemplates a possibility of a ‘Service PE’ also where the payment is not in the nature of FTS/FIS considering that its common that employees are seconded for providing services to AEs and would stay for a period longer than 90 days. The author also examines the Transfer Pricing implications in cases where in a MNC, a single entity employs such employees who are seconded worldwide, leading to business of such companies being providing of employees, the TP provisions would require such company to earn something more than mere cost. 

“Secondment of employees and tax litigation – A perpetual battle" – Part 3

In the previous article [Part 1 & Part 2], I have dealt with the reimbursement angle of the secondment transaction as well as the FTS angle.

If the payment is not in the nature of FTS, then the taxability will arise only if there is a PE in India and the profits are connected to such PE in India. And, if the payment is in the nature of FTS, but there is a PE in India to which such payment is connected, then also, one has to tax such payment under Article 7 of the DTAA on net basis.  Thus, invariably, one has to analyse the issue of Permanent Establishment (‘PE’) and business profit.

Permanent Establishment 

There are various types of PE’s prescribed under the Treaty. For the purpose of the present topic, the relevant ones are Fixed Place PE and Service PE.

Fixed place PE is understood as a fixed place of business through which the business of an enterprise is wholly or partly carried on. The Apex Court in the landmark case of Formula One World Championship Ltd. vs. CIT [TS-5102-SC-2017-O], has given some important findings in this regard which is reproduced hereunder:

“As per sub-clause (1) of Article 5, a fixed place of business through which the business of an enterprise is wholly or partly carried on, is known as 'permanent establishment'. It requires that there has to be a fixed place of business. It also requires that from such a place business of an enterprise is carried on, whether wholly or partly”

The Court gave some important finding regarding the ‘disposal test’ which is reproduced hereunder:

“The principal test, in order to ascertain as to whether an establishment has a fixed place of business or not, is that such physically located premises have to be 'at the disposal' of the enterprise. For this purpose, it is not necessary that the premises are owned or even rented by the enterprise. It will be sufficient if the premises are put at the disposal of the enterprise. However, merely giving access to such a place to the enterprise for the purposes of the project would not suffice. The place would be treated as 'at the disposal' of the enterprise when the enterprise has right to use the said place and has control thereupon”

The Apex Court has in fact reproduced in para 35 of the judgment, the example from the OECD commentary as under:

“Second example is that of an employee of a company who, for a long period of time, is allowed to use an office in the headquarters of another company (e.g. a newly acquired subsidiary) in order to ensure that the latter company complies with its obligations under contracts concluded with the former company. In that case, the employee is carrying on activities related to the business of the former company and the office that is at his disposal at the headquarters of the other company will constitute a permanent establishment of his employer, provided that the office is at his disposal for a sufficiently long period of time so as to constitute a "fixed place of business" (see paragraphs 6 to 6.3) and that the activities that are performed there go beyond the activities referred to in paragraph 4 of the Article.”

If facts pertaining to secondment of senior employees are tested on the touchstone of the above findings, one may find that the

i. senior employees are given some place in India;

ii. such place is at the disposal of the senior employees;

iii. such senior employees are generally in India for sufficiently long period of time and

iv. such senior employee carry out the business of the foreign company from such place

and therefore, in my view, a fixed place of business can be said to be constituted in India. This proposition remains to be tested in context of secondment.

The issue of Service PE has somewhat taken a different coursein this context. The concept of Service PE is not privy to all the Treaties, it is present in some of treaties like DTAA with US, UK, Canada etc. Under a typical Service PE clause, to constitute a Service PE, the following conditions needs to be satisfied cumulatively:

i. provision of services other than FTS/ FIS

ii. services are performed for an Associated Enterprise (‘AE’)

iii. such services continue for a period of 90 days.

Thus, this clause is attracted only where the services are rendered to an AE, which generally happens in a typical secondment case. Further, even the threshold of 90 days gets fulfilled because the secondees are in India for sufficiently long period of time. However, if the services are in the nature of FTS/ FIS, then the Service PE clause is not attracted; which means one has to first assess whether the payment made under the secondment agreement is in the nature of FTS/ FIS. If the answer to the above is in positive, then one need not go to Service PE clause, however, where the services are not in the nature of FTS/ FIS, then one needs to ascertain the constitution of Service PE.

The Delhi High Court in [TS-237-HC-2014(DEL)-O] has, after holding the payment to be in the nature of FTS, also held that there exists Service PE. Similar finding is given by the Mumbai ITAT in [TS-6083-ITAT-2014(MUMBAI)-O].This finding, in my humble opinion is incorrect. 

The above judgments are relying upon the judgment of the Apex Court in case of Morgan Stanley (supra).However, the facts in case of Morgan Stanley were different in as much as, there the Court was not dealing with the question whether the service of deputionist constitutes FTS or not, but it was merely dealing with the issue of Service PE. Reliance, upon this judgment to hold that services in the nature of FTS leads to Service PE may not be correct. Service PE and FTS both cannot co-exist.

In conclusion, if the services are in the nature of FTS/ FIS then there may be a case of Fixed Place PE and in case where the services are not in the nature of FTS/ FIS then there may be a case of Fixed Place PE or Service PE. In either case, the income has to be computed as per Article 7.

Computation of profits on constitution of PE

Under Article 7, profits of foreign company which carries on business in India through a PE situated therein is taxable in India to the extent of profits which is directly or indirectly attributable to such PE. Further, the business profits are to be taxed on net basis after allowing deduction of expenses; subject to the condition that such computation of business profits has to be as per provisions of the Income-tax Act.

Under the Act, section 44D/ 44DA deals with computation of income which is in the nature of FTS/ FIS. Section 44D of the Act, deals with FTS/ royalty received by a foreign  company under an agreement entered before 1^st April, 2003, whereas section 44DA deals with  FTS/ royalty received by a foreign company or a non-resident under an agreement entered on or after 1^st April, 2003. Under section 44D, income in the nature of FTS is taxable on gross basis i.e. without any deduction but at a beneficial rate. Whereas under section 44DA, income is taxable on net basis.

Reimbursement of salary to the foreign company will entail no tax implication when profit is computed u/s 44DA on net basis, as the salary paid to the employee will be allowed as deduction from the income received from the Indian company (See [TS-6083-ITAT-2014(MUMBAI)-O]. However, u/s 44D, receipt of money from Indian company will invite income tax on gross basis without any deduction. This has been held in the recent decision of Mumbai ITAT in [TS-5440-ITAT-2020(MUMBAI)-O].Thus, under section 44D, reimbursement of the salary is taxed on gross basis without allowing any deduction thereby leading to absurdity.

A detailed analysis of section 44D vs. Article 7 is given in the article titled “Section 44D vs. Article 7 – A conundrum”which is published on Taxsutra’s website. In the said Article, I have given some way-out out of the provision of section 44D.

Transfer Pricing adjustment

Generally, in many MNCs, one single entity is the employer of the employees which are seconded world over to the group entities. Such company is into the business of providing employees to different group entities. If this is the very business of such entity, then the transfer pricing provision would require such company to earn something more than mere cost. Thus, in the hands of the foreign company, an adjustment would be required which would in turn be profit taxable in the hands of the foreign company.

Where, a foreign company is not into the business of deputing employees, it would be a good case to argue, that no transfer pricing adjustment is required for adding the profit element to the payments received.

In any case, no such adjustment would be required in the hands of the Indian company as for the Indian entity, such payment is an expense.

Conclusion

To summarise, if the payment made is mere reimbursement, then there will be no tax implications. Further, even if the payment is considered as FTS, on constitution of PE, the tax has to be computed on net basis, which will lead to deduction of the salary expense, again taking the case out of the tax net, subject to the transfer pricing adjustment. Sans the argument of reimbursement and the implication of transfer pricing adjustment, a flow chart is given to simplify as under: