Sharing insights. News Alert 8 June, 2011

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1 Sharing insights News Alert 8 June, 2011 Reimbursement of salary costs to Group company pertaining to seconded employees is taxable as fee for included services. In brief In a recent ruling, in the case of Verizon Data Services India Pvt Ltd 1 (the Applicant ), the Authority for Advance Rulings ( AAR ) has held that reimbursement of salary cost to a group company pertaining to seconded employees will be taxed as a Fees for Included Services ( FIS ) as per the Double Taxation Avoidance Agreement between India and USA (the tax treaty ), and accordingly, will be subject to Indian withholding tax provisions. Facts The applicant is engaged in providing services relating to development and maintenance of telecom software solutions and certain information technology enabled services to Verizon Data Services LLC, US ( Verizon US ). For business requirements, three of the employees of GTE Overseas Corporation, USA ( GTE US ), an affiliate company of Verizon US, were seconded to the applicant. In relation to this, a secondment agreement was entered into between the applicant and GTE US. 1 Verizon Data Services India Pvt. Ltd., In re [2011-TII-13-ARA-INTL] 1

2 As per the secondment agreement, each employee was to function and act exclusively under the direction, control and supervision of the applicant. GTE US was not responsible for the work of any employees and did not undertake any obligation or risk with respect to the quality of the results produced from the work performed by these employees. The first employee was appointed as Managing Director of the applicant and the role of the other two employees was to liaise between the applicant and Verizon US, to supervise and provide directions on the manner in which the activities of the applicant should be carried out. GTE US would remunerate the employees, and in turn the applicant was to reimburse GTE US for the salary paid or provided to the employees. The responsibility to bear the tax under the Indian tax laws on the remittances made would be that of the applicant. Issues Whether the amounts reimbursed by the applicant to GTE US are income and are liable to tax withholding in accordance with the provisions of section 195 of the Indian Income-tax Act, 1961 ( the Act ), and if so, what would be the rate at which tax is to be deducted at source? Whether the above is taxable as FIS under the Act, read with the tax treaty? Whether there is a permanent establishment of GTE US in India as per the tax treaty, and if so, whether the amount received by GTE US from the applicant is in the nature of business profits attributable to such permanent establishment in India. Whether the amount of taxable income is Nil, given that the reimbursements are at actual? Applicant s contentions Payments made were in the nature of reimbursement of salary and expenses paid by GTE US to the expatriate employees and constitute mere cost-to-cost reimbursement. The applicant is the economic employer of the seconded employees and is liable to withhold tax. The tax payable at source on the salary and benefits that accrue to the expatriate employees is paid in India. As the salary payment and benefits provided to the expatriate employees have suffered tax under section 192 of the Act, the same amount cannot be subject to tax withholding under section 195 of the Act. Personnel were deputed at the request of the applicant to work under its control. GTE US was not rendering any service to the applicant and the reimbursement of salary cost paid by GTE US, in respect of provision of personnel to the applicant, was for administrative convenience and would not qualify as FIS as per the tax treaty. As per Article 12 of the tax treaty, the consideration towards technical or consultancy services would be considered FIS only if it makes available technical knowledge, skills, etc. to the service recipient. The expatriate employees are engaged in rendering managerial services and not technical services; hence, the payment was not in the nature of FIS and not liable to tax in India. GTE US has no fixed place in India from where it was carrying on business. If it is held that GTE US has a fixed place of business, then salary and expenses incurred for expatriate employees would be deductible as an expense from the 2

3 income earned from the applicant. The net income would be Nil and there would be no requirement to withhold tax. Revenue s contentions The expatriate employees, in substance, represent the parent company (i.e. Verizon US) and the plea that the applicant is the economic employer, does not hold good. The applicant was exclusively providing all its services to Verizon US and thereby GTE US was not benefited in any way by this secondment agreement. GTE US has the powers to replace the seconded employees. The employees continue to remain on the payroll of GTE US which has the authority to terminate the employees with or without cause. In the event of a dispute, reference is to be made to Verizon US for the final decision. If the secondment agreement is independent of Verizon US, then there is no reason to refer the dispute to Verizon US. In light of this, the arrangement appears to be altruistic and not a commercial arrangement. Employees have been seconded to perform certain managerial or other services and activities in addition to mere managerial services. It is not correct to say that the Managing Director of the applicant will work under the control and supervision of the applicant. In fact, the control and supervision of the applicant vests with him. Clearly, GTE US has been rendering services to the applicant and the applicant was reimbursing the costs incurred by GTE US in providing such services. The payment was covered under FIS as per the tax treaty. It is not correct to say that persons occupying managerial positions cease to be technical personnel. The seconded employees have been given leadership positions only to render technical advice/guidance to the team. AAR ruling The secondment agreement specifically provides that the seconded employees shall remain the employees of GTE US. The payment of their salaries was not dependent on the applicant. These employees would continue to get their salaries from GTE US as long as they remain in its employment. Accordingly, these employees performed managerial services as employees of GTE US and not as employees of the applicant. The receipt in the hands of GTE US and the employees spring from different sources, are of a different character and represent different species of the income. Amounts remitted by the applicant accrue and arise to GTE US in India for providing services to the applicant. The sum which accrues and arises to the employees is by virtue of their employment with GTE US. While the services were managerial in nature, the AAR ruled that it disagreed with the view that consultancy services being managerial services, the requirement under Article 12(4) of the tax treaty that these must be made available, ought to be satisfied. The AAR ruled that from the Memorandum of Understanding of the tax treaty, it is quite clear that the make available clause applies to technical services. In the present case, since the services are managerial in nature, the payment made by the applicant is covered under FIS as per Article 12 of the 3

4 tax treaty. The payment is also covered as a Fees for Technical Services under section 9(1)(vii) of the Act. The payment would be subject to tax withholding as provided by Article 12 of the tax treaty. Conclusion The ruling has been pronounced by the AAR on the basis of specific facts. The AAR concluded that though employees have been seconded to India through a secondment agreement, the overseas entity continues to control the employment terms. Further, the payment made by the applicant was for managerial services; hence, the make available clause does not apply and the payment was covered as FIS. While the AAR ruling is applicable to the specific assessee and the specific transaction, it would have persuasive value for similar arrangements. This AAR ruling could have far reaching implications as it has held that the make available clause does not apply to managerial services. In light of conflicting judicial precedents, the question whether reimbursement of salary costs to overseas company ought to be categorised as a fees for technical/included services and be subject to withholding tax, is a debatable issue. As such, in cases where there are employment secondment arrangements in place, requiring remittance of salary costs by Indian employers overseas, the facts and circumstances of the arrangement would require to be analysed carefully, on a case to case basis, to determine the tax implications. This ruling follows the AAR s decision in the case of At & S India Pvt. Ltd. 2 wherein it was held that reimbursement of remuneration pertaining to qualified personnel seconded by a group company was taxable as fees for technical services. It may be noted that recently the Delhi tribunal in the case of Karlstorz Endoscopy India Pvt. Ltd 3 ruled that reimbursement of salary cost of the managing director who was seconded for providing technical services will not be considered as a fees for technical service. The decisions in the case of Cholamandalam Ms General Insurance Co. Ltd. 4 and IDS Software Solutions India Pvt. Ltd. 5 were also on the similar lines. 2 At & S India Pvt. Ltd., In re [2006] 287 ITR 421 (AAR) 3 ACIT v. Karlstorz Endoscopy India Pvt Ltd [2010-TII-135-ITAT-DEL-INTL] 4 Cholamandalam Ms General Insurance Co. Ltd., In re [2009] 309 ITR 356 (AAR) 5 IDS Software Solutions India Pvt. Ltd. v. ITO (IT) [2009] 122 TTJ 410 (Bang) 4

5 Our Offices For private circulation only Ahmedabad President Plaza, 1st Floor Plot No 36 Opp Muktidham Derasar Thaltej Cross Road, SG Highway Ahmedabad, Gujarat Phone Bangalore 6th Floor, Millenia Tower 'D' 1 & 2, Murphy Road, Ulsoor, Bangalore Phone Bhubaneswar IDCOL House, Sardar Patel Bhawan Block III, Ground Floor, Unit 2 Bhubaneswar Phone / 2296 Chennai PwC Center, 2nd Floor 32, Khader Nawaz Khan Road Nungambakkam Chennai Phone Hyderabad # /82/A/113A Road no. 36, Jubilee Hills, Hyderabad , Andhra Pradesh Phone Kolkata South City Pinnacle, 4th Floor, Plot XI/1, Block EP, Sector V Salt Lake Electronic Complex Bidhan Nagar Kolkata Phone / Mumbai PwC House, Plot No. 18A, Guru Nanak Road - (Station Road), Bandra (West), Mumbai Phone Gurgaon Building No. 10, Tower - C 17th & 18th Floor, DLF Cyber City, Gurgaon Haryana Phone : Pune GF-02, Tower C, Panchshil Tech Park, Don Bosco School Road, Yerwada, Pune Phone For more information contact us at, The above information is a summary of recent developments and is not intended to be advice on any particular matter. PricewaterhouseCoopers expressly disclaims liability to any person in respect of anything done in reliance of the contents of these publications. Professional advice should be sought before taking action on any of the information contained in it. Without prior permission of PricewaterhouseCoopers, this Alert may not be quoted in whole or in part or otherwise referred to in any documents 2011 PricewaterhouseCoopers. All rights reserved. "PwC", a registered trademark, refers to PricewaterhouseCoopers Private Limited (a limited company in India) or, as the context requires, other member firms of PricewaterhouseCoopers International Limited, each of which is a separate and independent legal entity. 5

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