When the Indian arm reimburses its foreign parent for the salary paid by the parent, Indian Revenue charges this payment to tax on the ground that the parent is rendering technical services to the Indian arm. Is this correct?
Multinational enterprises (MNEs) routinely depute, on secondment, managerial personnel working with the foreign parent—or another group company—to their Indian subsidiary. This helps replicate and consolidate the MNEs global practices and work culture in the Indian company, and facilitates communication with the global headquarters in the initial years when the Indian company is building the business in India. These expatriate employees may wish, for personal and financial reasons, to retain their employment with the parent company abroad. The MNE would also plan to have local management in place in the medium term and thereafter recall the expatriate employees. Since these employees are rendering their services in India, their salary—whether being paid by the Indian company or the foreign parent, or partly by both—is taxable in India. That the salary of an expatriate employee seconded to India is taxable in India even if it is paid abroad was settled by the Supreme Court in 2009 (CIT versus Eli Lilly).
In many MNEs, some component of the salary—for example, social security contribution—is being paid by the foreign parent in the home country. The Indian company deposits the withholding tax on this component with Indian Revenue. Thus, for expatriates of MNEs posted to India, the withholding tax on their entire salary—even if some part is paid abroad by the parent company—is deposited by the Indian company with Indian tax authorities. The Indian company could also be correspondingly reimbursing the parent company for this salary component paid abroad.
There is, however, a catch. Indian Revenue holds the reimbursement by the Indian company to the foreign company as a separate transaction of payment for ‘fees for technical services’. Under the Indian income-tax law, if a foreign company renders technical services in India, it is subject to a final tax of 10% of its gross receipts from such services.
The Indian entity, which avails these services, is mandated to deduct withholding tax when it makes the payment and deposits it with Indian Revenue. The Indian company, while reimbursing its parent (or an associate of the parent) for the salary of the seconded employees paid abroad—on which the Indian company has already deposited taxes in India—would not have made any tax withholding on this payment. It is, therefore, subject to penalties and the expense is also disallowed in computing its own tax liability on its profits on the ground that the payment to the parent company is ‘fees for technical services’.
So we have a piquant situation. The Indian company claims it has reimbursed the parent for the salary paid by the foreign parent or affiliate. It has deposited with Indian Revenue the withholding tax on this salary. The salary amount also forms a cost component on which the Indian company, if it is a captive, cost plus entity, charges a mark-up for its services to the foreign company, so there is no erosion of India’s tax base. The parent company is not claiming the salary payment to the seconded employee as an expense in its profit computation, so there is no double deduction of the salary expense. The Indian company’s stand is that it should not face any other tax obligation.
However, Indian Revenue claims that this payment to the parent company is for technical services rendered to the Indian company by the parent company’s seconded employees. The matter is now being litigated in different courts on issues such as whether the reimbursement can be held to be an income, legal employment versus economic employment of the expatriate employees, ‘contract of service’ versus ‘ contract for service’, the applicability of bilateral tax treaties, the non-taxability of ‘dependent personal services, etc. There are conflicting rulings of the High Courts and the matter is being agitated before the Supreme Court which may take up to three years.
From a policy perspective, Indian Revenue has collected taxes on the salary (whether paid in India or abroad) of the expatriate employee working in India. This salary is also included as a cost by the Indian company when charging an arm’s length mark-up from the parent company for services being rendered from India. It is only because of personal and administrative reasons that the employment of these seconded personnel remains with the foreign entity. It would, therefore, be invidious to again claim taxes on the reimbursement made by the Indian company to its parent (for the salary component paid abroad) as a separate income stream generated on account of technical services rendered by the parent company to the Indian company.
The right course of action for facilitating secondments and ease of doing business would be for Indian Revenue to ask assessing authorities to satisfy themselves that taxes on the salaries (whether paid in India or abroad) have been paid in India. And that salary costs for provision of services have been factored in the arm’s length price being charged to the foreign company, and not to fasten a further tax liability on the ground that the reimbursement payments to the foreign company are ‘fees for technical services’.
The author is Of Counsel, BMR & Associates LLP, and formerly Joint Secretary, Ministry of Finance