Foreign Co. deputing employees to India: Possible tax issues

Many foreign companies set up business in India through a wholly owned subsidiary structure. The foreign company generally also provides an initial set up support to the subsidiary staff by deputing its employees to such subsidiary for a definite period.

Simple as it seems, this arrangement can bring a host of tax complications.

In this post, my aim is to bring across the possible tax issues raised by Indian Income Tax Department (ITD) in such arrangements which is based on my analysis of some key judgments available on this topic. This is with the hope that foreign companies planning to enter into such arrangements in India can plan their tax affairs in a better way and guard themselves against the litigation risk that is possible.


 Overview of arrangement

  1. Foreign company (FCo) sets up subsidiary company in India (ICo)
  2. FCo enters into a secondment agreement with ICo where some employees are deputed to ICo for a specified period.
  3. FCo deputes its employees to ICo in pursuance to such an arrangement.
  4. FCo continues to pay salaries to such employees. ICo in turn reimburses the salary payments to FCo

Judgments analysed by me on this issue

I’ve analysed the following judgments where these issues have been directly considered by the ITAT and courts. If there are any new judgments, I will try to update it in this post here.

  1. Burt Hill Design (P.) Ltd. v. Deputy Director of Income-tax (International Taxation), Ahmedabad [2017] 79 459 (Ahmedabad – Trib.)
  2. Centrica India Offshore (P.) Ltd. Commissioner of Income-tax –I [2014] 44 300 (Delhi)
  3. Director of Income-tax (International Taxation) v. Morgan Stanley & Co. [2007] 162 TAXMAN 165 (SC)

 Possible tax issues in such arrangements

Below are some of the tax issues that can arise in such arrangements, as derived from my analysis of above judgments:

#1: If ICo does not deduct TDS from payments made to FCo, it can be deemed as “assessee in default” u/s 201 of ITA:

Section 195 of ITA says that any payment to a non-resident of a “sum chargeable to tax” (except in nature of “income from salaries”) are liable for a TDS deduction.

However, when ICo made payments to FCo, it deemed it as a “reimbursement” of salary cost and since re-imbursement is not an income chargeable to tax, no TDS was deducted.

Here, the ITD took a counter argument by saying that these payments cannot be said to be “reimbursement” and these are actually Fee for Technical Services (FTS) – and given that FTS payments are taxable in India, ICo has violated Section 195 by making the payment without deducting TDS. Accordingly, ICo is liable as “assessee in default” and responsible for payment of tax, interest, late fee etc.

Here, while HC in Centrica case supported the ITD stand that nature of income is FTS, decision in Morgan Stanley case also termed the payment as taxable. However, ITAT in the recent Burt Hill case has ignored the earlier SC and HC decisions and supported the assessee’s stand that it qualifies as a “reimbursement”.

Extract from Burt Hill case on this point is as follows:

“………..What is relevant is that the income embedded in the payments in question is taxable in India under the head ‘Salaries’, and if that be so, there are not tax withholding obligations under section 195. The income embedded in the impugned payments being in the nature of income chargeable to tax under the head ‘income from salaries’, the assessee cannot be said to have any tax withholding………..”

My view: Most respectfully, decision of ITAT in Burt Hill case may not be correct – The “substance” of the transactions “generally” (there may be exceptions no doubt) that deputees are sent for a short period till the Indian employees are trained and equipped – this clearly falls into the “make available” clause in the FTS definition in DTAA – Also, ITAT ought to have at least deliberated on why it has substantially deviated from SC and HC view on taxability of such payments and thereby create a confusion on settled judicial position – On the contrary, those decisions did not even find a mention in the ITAT order. ITD is also at fault in not elaborating the fact how the FTS helps in “making available” technical knowledge and skill to Indian employees.

#2: Payment by ICo to FCo towards re-imbursement of salaries of deputed employees borne by FCo may be held as Fee for Technical Services

Further to my comments in point no. 1, the issue of whether such payments acquiring character of FTS have been considered at length in Centrica case – Below, I am reproducing an extract of the judgment where reasons were given why such payments should be construed as FTS (emphasis supplied at relevant places):


The term ‘technical’ services does not limit itself only to technological services, but rather, extends to know how, techniques and technical knowledge. This is supported by clause 4 of Article 12 itself, which lists these various sub-categories. Indeed, the term ‘technical’ has not been defined in the DTAA, and must be accorded its broader dictionary meaning, unless limited by the parties to the instrument.

In terms of India-Canada DTAA, the mere rendition of service is not an ‘included service’ that triggers tax liability. Instead, the enterprise must ‘make available’ the skill behind that service to the other party, i.e., the Indian recipient.

For this activity to be carried out, assessee required personnel with the necessary technical knowledge and expertise in the field, and thus, the secondment agreement was signed since assessee – as a newly formed company – did not have the necessary human resource. The secondees are not only providing services to assessee, but rather tiding assessee through the initial period, and ensuring that going forward, the skill set of assessee’s other employees is built and these services may be continued by them without assistance.

In essence, the secondees are imparting their technical expertise and know-how onto the other regular employees of assessee. Indeed, it is admitted by assessee that the reason for the secondment agreement was to provide support for the initial years of operation, till the necessary skill-set is acquired by the resident employee group.

The secondment, if viewed from this angle, actually leads to a benefit that transmits the knowledge possessed by the secondees to the regular employees. Indeed, any other reading would unduly restrict the Article 12 of the DTAA, which contemplates not only a formal transfer of intellectual property, but also other techniques and skills (‘soft’ intellectual property, if it can be called as such) required for the operation of a business. The skills and knowledge required to ensure that the task entrusted to assessee – quality control – is carried on diligently certainly falls within the broad ambit of Article 12 of India-Canada DTAA.


So, in an assessment, assessee needs to be prepared for such an argument whereby ITD claims the payments as FTS. Following important points emerge from above:

  1. If the services of deputed employees “make available” skill as per DTAA, then falls within four corners of FTS.
  2. The term “technical services” need to be interpreted in a broader manner so as to include even a quality control activity, as was in this case.
  3. If ICo proves it is not FTS, it needs to prove that sufficiently capable employees with same or better skill sets were available with it already in India.

#3: Deputation of employees by FCo may make such ICo as a “Service PE” for FCo

Even if the ITD fails to prove “make available” nature of services provided by deputed employees of FCo, it can still try to say that by virtue of presence of deputed employees in ICo, ICo qualifies as a “Permanent Establishment” (PE) for the FCo. Consequently, business income of ICo attributable to the work done by deputed employees qualifies as income of FCo in India and taxed as per the applicable rates (presently, 40%).

Here, it is important to see the wording of Article 5 of DTAA – for e.g. while India DTAA has a specific clause in Article 5 for a “service PE”, India Japan DTAA does not.

The concept of service PE was examined in Centrica case and in a very detailed way in Morgan Stanley case – extracts of both judgments are as follows:

Centrica case:

“….The assessee has advanced several arguments to negate any liability to deduct income tax under section 195. (1) there is no service PE, since assessee is the economic employer, whilst the overseas entities are only the legal employers, (2) the payment made by assessee to the overseas entities is only by way of reimbursement, which does not form part of the income of those entities, and in any case, (3) that payment is not the income of the overseas entities on account of the doctrine of ‘diversion of income by overriding title’.

To determine the existence of a service PE, assessee argues that the Court must look towards the substance of the employment relationship and not the form. This is correct. In the present case, the seconded employees are to be integrated into assessee, for the agreed period and are subject to its supervision and control. The rules, regulations, policies and other practices of assessee for its employees were applicable to these employees too. The seconded employee’s duties and functions were dictated by the instructions and directions of the assessee.

The overseas entities were not responsible for any errors or omissions of such seconded employees or for their work. Assessee bore all risks in relation to the work of seconded employees, and reaped the benefit from the output. Assessee also bore the cost of monthly remuneration and reimbursement of cost to seconded employees. However, crucially, these seconded employees retained their entitlement to participate in the overseas entities’ retirement and social security plans and other benefits in terms of its applicable policies, and the salary was properly payable by the overseas entities, which claimed the money from assessee. There was no purported employment relationship between assessee and the secondees


Morgan Stanley case:

As regards the question of deputation, an employee of MSCo when deputed to MSAS does not become an employee of MSAS. A deputationist has a lien on his employment with MSCo. As long as the lien remains with the MSCo the said company retains control over the deputationist’s terms and employment. The concept of a service PE finds place in the U.N. Convention. It is constituted if the multinational enterprise renders services through its employees in India provided the services are rendered for a specified period. In the instant case, it extends to two years on the request of MSAS. It is important to note that where the activities of the multinational enterprise entails it being responsible for the work of deputationists and the employees continue to be on the payroll of the multinational enterprise or they continue to have their lien on their jobs with the multinational enterprise, a service PE can emerge. Applying the above tests to the facts of instant case it is found that on request/requisition from MSAS the applicant deputes its staff. The request comes from MSAS depending upon its requirement. Generally, occasions do arise when MSAS needs the expertise of the staff of MSCo. In such circumstances, generally, MSAS makes a request to MSCo. A deputationist under such circumstances is expected to be experienced in banking and finance. On completion of his tenure he is repatriated to his parent job. He retains his lien when he comes to India. He lends his experience to MSAS in India as an employee of MSCo as he retains his lien and in that sense there is a service PE (MSAS) under Article 5(2)(l). There is no infirmity in the ruling of the ARR on this aspect. In the above situation, MSCo is rendering services through its employees to MSAS. Therefore, the Department is right in its contention that under the above situation there exists a Service PE in India (MSAS).



As we can see above, while the HC has not held Indian subsidiary as a service PE in Centrica case, SC has done the opposite in Morgan Stanley case. Important thing coming out here is that for constitution of service PE, it is vitally important that FCo is the one which “pulls the strings” and exercises control over the deputed employees. If no, then it cannot be said that a service PE exists.

An issue here: Is it possible that the same arrangement qualifies as a FTS as well as a Business Income under DTAA? Answer is generally no, because FTS and PE articles are generally “mutually exclusive” in most of the DTAAs.

Asides, given the tax rate for FTS @ 10% (mind you: on gross amount) vis a vis 40% (of net business income) in case of business income, it is highly likely that taxation as a FTS is a much better option for FCo from monetary point of view.

#4: Transfer pricing issues can result in income attribution and consequent tax liability in the hands of PE in India

In case of such payments, the FCo and ICo need to also be mindful of Transfer Pricing provisions u/s 92 of ITA. It is a settled principle that if the ICo qualifies as a PE, to the extent that the transactions between FCo and ICo are at arm’s length price (AMP), it will not be taxable for the FCo in India.  

The issue of transfer pricing was discussed threadbare in Morgan Stanley case, where Transactional Net Margin Method was held as the correct method for calculating AMP in the particular case. Extract from judgment is as follows:


As regards income attributable to the PE (MSAS), the Transactional Net Margin Method is the appropriate method for determination of the arm’s length price in respect of transaction between MSCo and MSAS. The computation of the remuneration based on cost plus mark-up worked out at 29 per cent on the operating costs of MSAS is correct. This position is also accepted by the Assessing Officer in his order dated 29-12-2006 (after the impugned ruling) and also by the transfer pricing officer vide order dated 22-9-2006. As regards attribution of further profits to the PE of MSCo where the transaction between the two are held to be at arm’s length, the ruling is correct in principle provided that an associated enterprise (that also constitutes a PE) is remunerated on arm’s length basis taking into account all the risk-taking functions of the multinational enterprise. In such a case nothing further would be left to attribute to the PE. The situation would be different if the transfer pricing analysis does not adequately reflect the functions performed and the risks assumed by the enterprise. In such a case, there would be need to attribute profits to the PE for those functions/risks that have not been considered. The entire exercise ultimately is to ascertain whether the service charges payable or paid to the service provider (MSAS in instant case) fully represents the value of the profit attributable to his service. In this connection, the Department has also to examine whether the PE has obtained services from the multinational enterprise at lower than the arm’s length cost? Therefore, the Department has to determine income, expense or cost allocations having regard to arm’s length prices to decide the applicability of the transfer pricing regulations.

Precautions to be taken while entering such arrangements

As you would have also understood by now, existing judgments have not been able to clear the tax position on such arrangements and a definite risk of litigation exists. Following are some pointers/precautions that a company can take to reduce that risk:

  1. The DTAA between the two countries must be referred to for checking whether the arrangement can fall within “Service PE” definition or FTS.
  2. Secondment agreement need to be carefully drafted – if deputed employees do not “make available” any technical knowledge/skill etc. to employees of ICo, then agreement should contain any contrary clauses that can weaken assessee’s argument that such payment is not FTS
  3. In some DTAA’s, for e.g. USA DTAA, if the deputees do not stay for > 90 days in a 12 month period, service PE does not come into existence. Companies can plan the stay of deputees accordingly if possible.
  4. If it can be demonstrated that the deputees were completely in ICo’s control and direction, that fact can go a long way to weaken ITD’s argument of service PE. The clauses in secondment agreement and deputation letters can be checked and reworded accordingly.
  5. Before entering into such an arrangement, FCo can try to obtain an advance ruling in India, to get clarity on the tax treatment of such a transaction in India.
  6. If after a proper analysis, the payment is agreed to be FTS/business income, then respective compliances of Section 195, TDS return, foreign company filing a tax return etc. should be ensured.
  7. Selection of acceptable transfer pricing method is very important and FCo need to pay particular attention to the same.

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