Secondment salary reimbursements not FTS under s. 9(1)(vii) and Art. 12(4); employer-employee relationship upheld

ITAT Delhi-AT held that payments received by the assessee from Indian entities towards salaries of seconded employees constituted pure reimbursement and not Fee for Technical Services (FTS) under s. 9(1)(vii) of the Income-tax Act or Art. 12(4) of the India-Japan DTAA. Relying on employment/appointment letters, control and supervision by Indian entities, right of termination, payment structure (partly in yen and partly in INR), and Form 16 showing TDS on salaries, the Tribunal concluded that an employer-employee relationship existed with the Indian entities. Consequently, salary payments could not be recharacterized as FTS, and the additions made by Revenue were deleted.

---

---

1. ISSUES PRESENTED AND CONSIDERED

1.1 Whether payments received in respect of salaries of seconded employees, reimbursed by Indian entities, are taxable in India as "fees for technical services" under section 9(1)(vii) of the Income-tax Act and Article 12(4) of the India-Japan DTAA, or are mere salary reimbursements outside the scope of "fees for technical services".

1.2 Whether the principles laid down in the decision concerning secondment arrangements in the context of service tax (Northern Operating Systems) can be applied to treat such salary reimbursements as "fees for technical services" under the Income-tax Act and the India-Japan DTAA.

2. ISSUE-WISE DETAILED ANALYSIS

Issue 1: Characterisation of payments relating to seconded employees - salary reimbursement vs. fees for technical services

Legal framework

2.1 The Court examined section 9(1)(vii) of the Income-tax Act along with Explanation 2 defining "fees for technical services", and Article 12(4) of the India-Japan DTAA defining "fees for technical services", together with the salary article (Article 15-type provision, as referred to in precedent relied upon).

2.2 Reference was made to judicial precedents holding that where payments are in the nature of salary, chargeable under the head "Salaries" and subjected to tax deduction under section 192, such payments cannot be characterised as "fees for technical services" either under section 9(1)(vii) or under the relevant DTAA provisions.

Interpretation and reasoning

2.3 The Court recorded that the assessee, a tax resident of Japan, had paid salaries in Japan to employees who were, for the relevant period, employed by and working under Indian entities, and that the Indian entities reimbursed such salary costs to the assessee without any mark-up.

2.4 On the basis of documents produced, including payroll agency agreement, employment contracts/appointment letters issued by Indian entities, Form 16s issued by Indian entities, invoices/debit notes for reimbursement, and Forms 15CA/15CB, the Court found that:

(a) seconded employees entered into independent contracts of employment with the Indian entities;

(b) salary was payable by the Indian entities, partly in foreign currency and partly in Indian rupees;

(c) the employees worked under the control and supervision of the Indian entities, which had the power to terminate their services for breach of employment terms; and

(d) tax was deducted at source by Indian entities on such salary payments as reflected in Form 16.

2.5 The Court noted that the appointment/contract terms specifically recorded that the assessee did not guarantee continued employment or availability of a position for the seconded employee at the end of the employment period, which militated against the inference that the assessee retained an overriding employer-employee relationship for the relevant period.

2.6 The Court held that the Assessing Officer had misread the appointment letters and secondment documentation in concluding that the assessee retained ultimate lien and that the arrangement connoted technical service provision. On proper reading, the relationship during the relevant period was that of employer-employee between the Indian entities and seconded employees.

2.7 Relying on prior decisions, the Court reiterated that:

(a) reimbursements representing pure salary cost without mark-up, where the underlying income is chargeable as salaries and taxed accordingly in India, cannot be treated as "fees for technical services";

(b) Explanation 2 to section 9(1)(vii) excludes from "fees for technical services" any consideration that is income chargeable under the head "Salaries"; and

(c) DTAA provisions defining "fees for technical services" similarly exclude payments made to employees of the payer, while salary-related income is governed by the specific salary article.

2.8 With reference to Article 12(4) of the India-Japan DTAA, the Court emphasised that "fees for technical services" excludes payments made to an employee of the person making the payment, and once it is established that payment is salary to employees of Indian entities for services exercised in India, the reimbursement to the foreign entity is outside the purview of Article 12(4).

Conclusions

2.9 The Court held that an employer-employee relationship existed between the seconded employees and the Indian entities, that the amounts in question were salary payments for services rendered in India, duly subjected to tax deduction at source as salary, and that the reimbursements by the Indian entities to the assessee were mere cost reimbursements without any mark-up.

2.10 Consequently, such reimbursements could not be recharacterised as "fees for technical services" under section 9(1)(vii) of the Income-tax Act or under Article 12(4) of the India-Japan DTAA, and the contrary treatment by the Assessing Officer was unsustainable.

Issue 2: Applicability of the service tax decision on secondment (Northern Operating Systems) to income-tax/DTAA characterisation of payments

Legal framework

2.11 The Court considered the reliance placed by the Revenue on the decision rendered in the context of service tax on secondment arrangements, where the issue was whether the arrangement constituted "manpower recruitment or supply services" for service tax purposes.

Interpretation and reasoning

2.12 The Court, following a High Court decision in an analogous context, noted that the decision concerning Northern Operating Systems was rendered in the specific context of indirect taxation and determination of taxable services, and that the test applied there, including how "employer" is to be viewed for service tax, does not directly control the income-tax/DTAA characterisation of a payment as "fees for technical services" or salary.

2.13 It was noted that the issue in the present case turned on whether the payments fell within the statutory and treaty definitions of "fees for technical services", which are subject to specific exclusions for salary and for payments to employees of the payer, as well as on the "make available" requirement considered in related jurisprudence, which was not the subject of consideration in the service tax context.

Conclusions

2.14 The Court held that the decision in Northern Operating Systems, rendered in the context of service tax on manpower supply, was distinguishable and could not be relied upon to recharacterise salary reimbursements as "fees for technical services" under the Income-tax Act or the India-Japan DTAA.

2.15 The additions made by treating such reimbursements as "fees for technical services" were therefore set aside, and the appeal was allowed to that extent.

---