The Mumbai bench of the Authority for Advance Rulings (“AAR”) decided that reimbursing a foreign firm for certain mandatory payments made to expatriate employees (“Personnel”) on the Indian company’s behalf would not be subject to the FTS tax because:
- The Indian corporation and its personnel had an employer-employee relationship.
- Payments made to reimburse obligated expenses. Reimbursement of insurance premiums and moving expenses as social security contributions. Since they do not accrue to the offshore company.
CTBT Pvt. Ltd. (“Applicant”), a business with Indian legal status, was PMK’s only completely owned subsidiary (Swiss Company). The applicant and one of the State governments established a memorandum of understanding for the establishment of a manufacturing facility. In order to ensure the consistent application of quality and safety standards, the Applicant requested KRP, another wholly owned subsidiary of PMK (Swiss Company), to supply experienced Personnel in order to run a manufacturing plant in India.
The Applicant entered into an intercompany agreement (“Agreement”) with KRP for disbursing social security contribution, insurance and relocation expenses in the home country of the Personnel. They stated that the arrangement of KRP making part payment of salary to the Personnel, on behalf of the Applicant. Who was only facilitative in nature and facilitated the Personnel to meet their financial commitments in their home countries? They reimbursed KRP for these expenses and paid an additional administrative fee to KRP for managing the disbursements.
The major portion of the employee’s compensation was paid directly by the applicant to the employee. This salary was taxable in India under the personnel’s control. On the whole, the sum paid by the applicant, which included the reimbursement payment to KRP, the applicant withheld tax in accordance with section 192 of the Income-tax Act, 1961 (“ITA”). In accordance with section 195 of the ITA, the applicant additionally withheld tax from the administration charge given to KRP.
The Agreement between the Applicant and KRP laid down the rights the Applicant had vis-à-vis the Personnel.
- The Applicant was wholly responsible for the Personnel and execution of their duties;
- The Applicant had sole liability for every act or failure of the Personnel;
- KRP discharged the Personnel of all obligations and rights including any lien on employment;
- KRP could not recall any of the Personnel without obtaining the prior consent of the Applicant;
- Personnel were not in any way subject to any kind of instructions or control of KRP; and
- Personnel is not considered employees of KRP;
Reimbursements to offshore corporations for payments made to expatriate employees have been a contentious legal issue in the past. Whether the payment qualifies as FTS or not depends on the facts of each case and the relationship between the employee, the Indian company and the offshore company.
The AAR ruling identified certain important principles which could be applied to distinguish between reimbursement and FTS. It happens in situations involving the secondment of expatriate personnel.
No Lien over Employment:
The AAR used the Applicant and KRP Agreement as support and noted that it clearly stated KRP had no claim on the employment. The point of accrual as well as the form of the payment would be significant in establishing whether an Indian corporation is paying an overseas company back for payments made on its behalf or if it is offering the offshore company consideration for services rendered.
Accrual of Payment:
In the present case, the payments never accrued to KRP for it to decide its application. They were forced into their respective accounts for social security, insurance, and transfer obligations. The point of accrual as well as the nature of the payment would be relevant in deciding whether an Indian company is reimbursing an offshore company for payments made on its behalf or whether it is paying consideration to the offshore company for services rendered.
AAR found that even though the companies intended to disguise the payment as a refund, it served no useful purpose. A “utility test” can be used to demonstrate that certain non-essential salary components are paid to expatriates, as companies gain little benefit from disguising the nature of their payments.
The beneficial purpose test should not, however, be boiled down to a “substantial salary” requirement. Simply because payments to the offshore corporation included paying substantial salaries, they shouldn’t be categorised as FTS.
The AAR ruling indicates the importance of the nature of employment and accrual of payment, in order to determine whether payment for seconded employees is mere reimbursement or FTS. It is wise to carefully draft a secondment agreement to accurately capture the content and intent of the payment and the relationship with the secondee.