In a recent ruling¹, the Income Tax Appellate Tribunal, Delhi (“Tribunal”) while differentiating the rulings in Centrica India Offshore²and Northern Operating Systems³ ruled that reimbursement of salaries of the ex-patriate employees of the Indian company to its foreign parent under a salary reimbursement agreement cannot be considered as Fees for Technical Services (“FTS”) and hence was not subject to withholding taxes.  The Tribunal acknowledged that since the Indian company has correctly withheld tax under Section 192 of the Income Tax Act, 1961 (“Act”), which applies to salaries, no addition or disallowance was required.

Background

Serco India (“Taxpayer”) is the Indian captive subsidiary of Serco UK established as a captive center to provide IT and IT Enabled Services (“ITES Services”) to the Serco Group. The Taxpayer is engaged in providing ITES Services such as research operations, business process outsourcing, and management consultancy support services to its Associated Enterprises (“AE”). To carry out its objectives, the Taxpayer recruited employees from Serco UK on a full-time basis to work exclusively for the Taxpayer. The employees entered into separate employment contracts with the Taxpayer, making the Taxpayer their sole employer and giving it complete control over them.

The Taxpayer also entered into an agreement with Serco UK for the reimbursement of salaries. As per the agreement, the Taxpayer was required to inform Serco UK about the foreign currency amounts to be paid as part of the salary to the seconded employees. Serco UK would then submit a reimbursement claim to the Taxpayer, which the Taxpayer then paid to Serco UK.

For the year in question, the Taxpayer’s return of income was selected for scrutiny assessment. On account of there being international transactions between the Taxpayer and its AEs, the AO referred the case to the Transfer Pricing Officer (“TPO”) to determine the Arm’s Length Price (“ALP”) for these transactions.

The TPO proposed an upward adjustment in the international transactions related to ITES Services while accepting the ALP for the Management Services segment.

Based on the TPO’s order, the AO issued a draft assessment order. The Taxpayer, dissatisfied with the order, filed objections before the Dispute Resolution Panel (“DRP”). The DRP while directing to make certain modifications to the draft order of the AO, observed that the Taxpayer has made payments for the reimbursement of salaries to the ex-patriate employees from Serco UK. The DRP considered this payment as potentially requiring TDS under section 195 of the Act. Consequently, the DRP issued a notice to enhance the income by fixing the case and held that the reimbursements of salaries for the expatriate employees qualified as FTS. The DRP deemed these sums chargeable to tax under section 9(1)(vii) and Article 12(4) (Fees for Included Services) of the Double Taxation Avoidance Agreement between India and USA (“DTAA”). As the Taxpayer had deducted TDS under section 192 and not under section 195, the DRP directed the AO to disallow the expenditure claimed by the Taxpayer for reimbursement of salaries.

Aggrieved by the order of DRP and AO, the Taxpayer challenged the said order before the Tribunal.

Ruling

The Tribunal, upon considering the appeal, ruled in favor of the Taxpayer on both issues. On the issue of transfer pricing, the Tribunal ordered deletion of certain comparables on the basis that they were not comparable companies as the services provided by them were different than the service provided by the Taxpayer.

On the issue of non-deduction of TDS, the Tribunal ruled that the payment made was in the nature of reimbursement of salaries that were paid to the Taxpayer’s employees and routed through Serco UK. Since the payment was in the nature of salaries which were paid by Serco India to its expatriate employees but paid via Serco UK under a reimbursement agreement, the Tribunal concluded that the reimbursement did not fall under the category of FTS and was not subject to withholding taxes. The Tribunal further recognized that the Taxpayer had correctly withheld tax under section 192 of the Act, which pertains to salaries and therefore held that no addition or disallowance, was warranted in this regard. The Tribunal made the following observations to come to its conclusion:

• Reliance on Employment Arrangements: Serco India had entered into employment agreements with the expatriate employees under which the employees were assigned administrative and supervisory functions by the Taxpayer. The Taxpayer had the right to terminate the employment of these employees, and Serco UK had no obligation to replace them. The employees were on the payroll of the Taxpayer, and any conflicts related to their employment were not the responsibility of Serco UK. Serco UK has released the individuals from its employment and had no lien on their employment.
• Employee-Employer Relationship: The employees under consideration had an employee-employer relationship with the Taxpayer only. They were appointed to act as per the directions of the Taxpayer and not as per Serco UK. These employees did not have any authority to act on behalf of or bind Serco UK in connection with their duties. The Taxpayer was both the legal and economic employer of these employees. The Taxpayer was responsible for paying their salaries, partly in India and partly in foreign currency, as specified in the salary reimbursement agreement with Serco UK.
• Classification of Payments for Taxation: The Taxpayer paid salary to the expatriate employees and withheld taxes on them as per the provisions of the Act. The salary was partly paid by Serco UK and then reimbursed by Serco India under the salary reimbursement agreement. There is agreement or document indicating that Serco UK provided any technical services. Therefore, the payments should not be classified as FTS and the deduction under Section 192 of the Act was the correct deduction made by the Taxpayer.
• Non-Applicability of Section 195: Income chargeable under the head ‘salaries’ is explicitly excluded from the purview of Section 195(1) of the Act. As a result, the taxpayer was not liable to deduct tax at source under Section 195 for the salary payments made to these employees.
• No loss of revenue for the tax department: The Taxpayer withheld tax at a rate of 30%, which is higher than the 15% rate applicable for FTS under Section 195 of the Act. Therefore, there is no loss of revenue due to the higher withholding tax.
• No disallowance: The conditions for making a disallowance under the Act require that tax should be deductible at source and not deducted or not paid on or before the due date. However, the Taxpayer deducted the tax at source under the head salaries and deposited it within the specified time. Hence, there can be no question of any disallowance under the Act.
• Clarification on deduction of tax under a single section: It took note of the circular⁴ that provides clarification on the deduction of tax on payments. The circular states that a payment should be liable for tax deduction under only one section. This aligns with the Taxpayer’s argument that since TDS was already deducted under Section 192 for expenses related to salaries paid to expatriate employees, there was no further obligation to deduct TDS under any other section.

The Tribunal also distinguished the cases relied on by the tax department (Centrica India⁵ and Northern Operating Systems⁶) on the following grounds:

Furthermore, the Tribunal while discussing the inapplicability of Northern Operating Systems Judgment in the context of the ITA relied on the case of M/s Flipkart Internet Private Limited v. DCIT (International Taxation)⁷, which considered an identical situation. The Tribunal in the said case held that the Northern Operating Systems judgment was rendered in the context of service tax and therefore not applicable for determining whether the payment made falls under the category of fees for included services under the ITA. Additionally, applying the rule of consistency, the Tribunal ruled that the case of the Taxpayer was accepted by the tax department in the earlier and later years and since there is no difference in the facts and circumstances in all the years no disallowance can be made in the year in question.

Analysis

This ruling has significant implications for secondment arrangements that are common between foreign parent and its Indian subsidiary. The analysis of the arrangement between the employees and the Indian company lays out factors and determinants that are important to be kept in mind while setting up secondment arrangements. The question of withholding tax in these situations is a vexed issue and whether the sums paid falls within the scope of FTS or salary needs to be identified clearly. However, taxation on provision of services by Serco UK of reimbursement of salaries is an aspect which has not been discussed in the ruling. As such, since the two entities are AEs, the service provided by Serco UK should be subject to transfer pricing and Serco India should be liable to pay Serco UK on arm’s length basis.

It is also interesting to note Tribunal’s view on conflicting judgment and how it states that when faced with conflicting views from different High Courts, the interpretation that favours the taxpayer should be followed. This principle ensures fairness and prevents undue burden on taxpayers, as it allows for a more consistent and predictable application of tax laws. By endorsing the view in favour of the taxpayer, the Tribunal emphasized the need for tax authorities to carefully consider and apply precedents that align with the taxpayer’s rights.

– Krishna Agarwal & Ashish Sodhani

1. Serco India Pvt. Ltd v. DCIT, TS-363-ITAT-2023 (DEL)
2. Centrica India Offshore Pvt. Ltd v. CIT, TS-237-HC-2014 (DEL)
3. C.C, CE & ST v. Northern Operating Systems Pvt. Ltd., (2022) 101 GSTR 391 (SC)
4. Circular No. 720 dated 30-08-1995, Central Board of Direct Taxes
5. Supra Note 2
6. Supra Note 3
7. TS-503-HC-2022(KAR)