GST ON EMPLOYEE SECONDMENT ARRANGEMENTS: IS THE LAW MOVING BEYOND NORTHERN OPERATING SYSTEMS?

The author is Dipanshu Raj a 4th year student at Maharashtra National Law University

INTRODUCTION

In the world of globalization, cross-border business arrangements have become common practice. As a result, business organisations second their skilled workforce to their affiliated company to leverage their talent. A secondment arrangement generally involves the deployment of a foreign worker from a foreign corporation to an Indian subsidiary, according to the recipient's specific needs, for a period of time. Although the secondee remains on the foreign company payroll during the secondment period, however the secondee performs their duties as per the Indian company.  

In the Goods and Services Tax (“GST”) framework, the principal issue is whether the secondment arrangement represents the true employer- employee relationship which is excluded from GST by Entry 1 of Schedule III to the Central GST Act, 2017 (“CGST Act”) and whether the reimbursement of salary and related costs by an Indian company to the foreign company for the secondment constitutes a taxable manpower supply.

The Supreme Court (“SC”) in Commissioner of Central Excise & Service Tax v. Northern Operating Systems Pvt. Ltd.(“NOS”) held on the facts of the case that the secondment arrangement amounts to a taxable manpower supply service and salary-related reimbursements to a foreign affiliate amount to a consideration. However, the judgment led to uncertainty and fear, with tax authorities starting to issue Show Cause Notices (“SCN”) on all the secondment arrangements. Further development, such as CBIC clarifications, judgement, and the recent Delhi High Court decision in the Commissioner of Income Tax (International Taxation) v. Ernst & Young U.S. LLP, held on to put emphasis on examining the facts of the secondment arrangement rather than applying the NOS Judgement directly. In light of these developments, the blog examines the post-NOS judgement jurisprudence and implications for businesses.

THE REAL ISSUE: IDENTIFYING THE TRUE EMPLOYER

The dispute in the secondment arrangements arises from the determination of the real employer of the expatriate employee. Services rendered by the employee will be exempted from the scope of the GST by Entry 1 of Schedule III to the CGST Act if the recipient of the service is the real employer. Conversely, if the foreign entity is the real employer, the arrangement will be taxed as a manpower supply. 

The Hon’ble SC in Director Income Tax v. M/S Morgan Stanley & Co. Inc opined that the conventional “control test” is not a reliable test to determine the true employer. The control test was primarily developed for a simple master-servant relationship, like between agriculture labours and farmers. Modern employer-employee relationships have now yielded more complex arrangements. The court in Sushilaben Indravadan Gandhi v. New India Assurance Co. Ltd. further referred to the triple test, such as: who bears the responsibility to pay the salary; who has authority to exercise control over the employer; and other factors. The triple test expanded the inquiry from day-to-day supervision to the broader employment relationship, as day-to-day supervision may not provide the full picture.

Later, the SC in Silver Jubilee Tailoring House v. Chief Inspector of Shops & Establishments held that there is no universal or rigid test applicable for every case. Every case has different facts and situations. Therefore, the court needs to weigh all the facts, whether relevant or irrelevant, before deciding the case, as no single precedent can act as a pedestal in isolation. Since every arrangement has a specific feature that is distinct from the other.

NORTHERN OPERATING SYSTEMS: THE SC'S WATERSHED RULING

NOS was a part of the Northern Trust group and was a registered service provider that entered into a secondment arrangement with the foreign affiliate entities for deputing employees. Under this arrangement, the seconded employee worked under the day-to-day supervision of the Indian entity but remained on the payroll of the foreign affiliates, which were subsequently reimbursed by the Indian entity. The Department contended that these foreign affiliates are not transferring employees but providing manpower supply for consideration, hence taxable under “Manpower Recruitment Agency Service”.

The three-judge bench held that the secondment arrangement in question amounts to a taxable supply of manpower under the services tax and further rejected the NOS’s contention that the reimbursement was made as a salary payment. In holding, the court observed that they remained on the foreign payroll and that social security benefits were governed by a foreign entity. The court further held that control over the seconded employees will not be conclusive proof to identify who is the true employer. Therefore, the court concluded that the NOS’s arrangement was a manpower supply service. The Hon’ble Court's conclusion was purely based on an analysis of the features of the secondment arrangement. The continued role of the foreign entity in providing social security and handling payroll helped in determining the nature of the relationship.

THE POST-NOS: CBIC CIRCULATIONS AND EMERGING JUDGMENTS

After the SC's landmark judgment on the issue of taxation of secondment arrangements, the CBIC came up with Instruction No. 05/2023-GST, wherein the CBIC emphasised that the NOS judgment cannot be treated as a universal rule for every case; each case has different facts and should be examined with careful consideration rather than directly relying on the NOS judgment. The instruction further referred to the Commissioner of Central Excise, Mumbai Versus M/s Fiat India(P) Ltd case, where the SC held that the:

“ 66. ...........Each case depends on its own facts and a close similarity between one case and another is not enough because either a single significant detail may alter the entire aspect.”

The court observation in Fiat India signifies that the secondment arrangements can be found on a similar structure; however, the contractual clause and operational features may be different. Therefore, the CBIC clarified that NOS cannot be extended to every arrangement simply because the arrangement exhibits similar characteristics. In addition to that, CBIC issued Circular No.210/4/2024-GST to resolve unnecessary litigation where GST demands were raised against an Indian entity for receiving services from a foreign-related entity, where the recipient was entitled to full Input Tax Credit (ITC). The circular clarifies that when a foreign-related entity provides service to an Indian entity, the open market value will be the amount mentioned in the invoice, provided that the Indian entity is fully entitled to avail full ITC. If no invoice is issued, then the valued deemed to be declared as Nil under Rule 28 of the CGST Rules, 2017.

Emerging Judicial trend

The judicial stance shows that the court is determining the taxability of secondment while considering each fact carefully, not relying directly on the NOS Judgment. The Delhi High Court in the Metal One Corporation India (P.) Ltd. v. Union of India, where the department relied on the NOS judgment for the taxation on the secondment arrangement by Metal One from the Foreign parent entity. However, the court relied on Circular No.210/4/2024-GST and observed that since no GST invoice was issued by Metal One, and eligible for the full ITC. Therefore, the deemed value would be “Nil” and further quashed the interest and penalty.  The same reasoning was followed in the case of Thales India Private Limited vs Additional Commissioner of CGST, wherein the Delhi High Court quashed the Show Cause Notice (SCN), interest & penalty since no invoice was issued and the beneficiary qualified for the full ITC. Considering jointly, these cases signify that the taxability of the secondment can be turned down on the valuation if the Indian entity is eligible for full ITC and no invoice is raised. Even if the authorities rely on NOS judgment for taxability of arrangement, Circular No.210/4/2024-GST and Rule 28 may reduce the taxable liability to “Nil”.  However, the Karnataka High Court has even broadened the scope of approach in taxation of the secondment issue. The Court, in Alstom Transport India Limited v. Commissioner of Commercial Taxes, has carefully considered and examined the facts of the case and found that in the secondment arrangement, the employees were under the control of Alstom Transport and further they paid salaries to the expatriate employees, which was also subject to Tax Deducted at Source. In light of the facts above, the court held that it reflected an employer–employee relationship under Entry 1 of Schedule III to the CGST Act, 2017, and relied on Circular No.210/4/2024-GST, since no invoice has been issued by Alstom Transport. Therefore, it quashed the SCN, penalty, and interest. Likewise, in Commissioner of Income Tax v. Huawei Technologies India Private Limited, the Karnataka High Court relied on the same method, examined the facts, and further quashed the ₹85.51 crore Integrated Goods and Services Tax (IGST) demand on salaries paid to foreign-national employees.

The recent pronouncement by the Delhi High Court, in Commissioner of Income Tax(International Taxation) v. Ernst & Young U.S. LLP, while deciding the taxability of a secondment arrangement under the Income Tax Act, 1961, and the Ind-USA DTAA, carefully considered the secondment arrangement contract rather than applying the blanket approach. It was observed that the employees were working under the control of the Indian entity, and salary was cost reimbursement without any markup. Considering these facts, the court held that Ernst & Young US LLP was not providing any independent technical service, hence not taxable.

IMPLICATION ON BUSINESS

The post-developments following the NOS judgement, such as the CBIC instruction, the Circular, and the Court’s stance on the taxation of the secondment arrangement, will definitely provide relief to the Multi-National Companies (MNCs) involved in secondment arrangements. However, the post-development emphasised that every MNC must review its employment contracts, reporting structures, and leave approval processes to clearly establish that expatriate employees are under the control and supervision of the recipient. In addition to this, the MNC must ensure that the expatriate employee is on the Indian payroll, which is subject to the Indian tax system like other employees of the Indian entity, and demonstrate an employment relationship. Further, if a foreign parent entity incurs any employment-related costs, the Indian entity must reimburse only the costs, with no markup or profit.

Apart from this, the MNCs must also maintain proper documentation and day-to-day operations records that show an employee-employer relationship, control, and cost-only reimbursement. Proper documentation can provide relief to the Indian entity in defending GST demand in the secondment arrangement issue.

CONCLUSION

Due to globalization, employee secondment has been a common practice for MNCs and has emerged as a significant GST issue in recent years. The SC in the NOS judgment has reshaped the legal framework around secondment arrangements by holding, on the facts of the case, that reimbursement of salary to the foreign entity constitutes taxable supply of manpower. However, the post-CBIC Circular and judgments clarified that the NOS judgment doesn’t apply to all secondment arrangement cases. CBIC Instruction No. 05/2023-GST states that each arrangement has to be determined with careful consideration and review of each fact. The courts are now examining the employer-employee relationship, control, and cost reimbursement in deciding the taxability of secondment. The application of Circular No.210/4/2024-GST in Metal One and Thales signifies that the tax liability can be deemed to be “Nil” subject to the conditions of Rule 28.  The recent judicial trend affirms that courts are examining the facts and contractual clauses of the secondment arrangement and even the nature of the employment relationship; where an Indian entity acts as a genuine employer and provides social security, the arrangement will fall outside the ambit of GST. However, an arrangement lacking a genuine employer-employee relationship will attract GST under the manpower supply.