Secondment contract as ‘services’: Supreme Court held under Indian taxation regime

– Neha Sinha, Assitant Legal Advisor | neha.sinha@vinodkothari.com 

Background

Secondment of employees have become increasingly popular amongst corporate entities which enter into secondment arrangements to leverage the expert knowledge and specific skill sets. The seconded employees work on a deputation basis in the seconded companies they are seconded to which require their technical expertise on certain matters. Since the seconded employee works for the seconded company during the secondment period, a pertinent question arises on whether the seconded employee becomes an employee of the seconded company. If yes, then what are the likely implications in the context of service tax. 

In the recent case of CC, CE & ST v. M/S Northern Operating Systems Pvt. Ltd. (“Northern Operating Systems”), the Supreme Court (“Court”) answered the question if secondment contracts had the effect of contract of service or contract for service for the taxability under Finance Act, 1994. 

In the Finance Act, 1994, before the amendment introduced in 2012, a service provided by a manpower recruitment or supply or recruitment agency was a taxable service under section 65(105)(k). ‘Manpower recruitment or supply agency’ refers to any person engaged in providing any service or recruitment or supply of manpower. With the amendment in 2012, section 65B laid down a negative list of activities/arrangements which are excluded from the scope of ‘service’ and are not taxable. All activities carried out by one person for another for consideration are deemed services. A contract of service, i.e., an employer-employee arrangement is excluded from the ambit of ‘service’ in terms of section 65B(44) of Finance Act, 1994. 

In the present case, the assessee had entered into a secondment contract with its overseas group companies whereby the overseas group company deployed its experts to the assessee on a secondment. The seconded employees continued to be in the payroll of the overseas company and it paid the salary to those seconded employees during the secondment, however, the overseas company was reimbursed by the assessee for such salary paid. The assessee was charged service tax under the ‘reverse charge mechanism’ for the services it received from the overseas company with respect to its seconded employees. Refuting the taxability of the service, the assessee contended that under the secondment agreement, the seconded employees came under the control and supervision of the assessee, thus creating an employer-employee relationship between the assessee and the seconded employees which is outside the purview of the service tax regime. 

To determine the taxability of service, the Court had to answer two questions- (i) what was the true nature of the relationship between the seconded employees and the assessee? (ii) what was the nature of the service provided by the seconded employees to the assessee?

Nature of secondment contract: contract of service or contract for service? 

Test of ‘control’

Mere test of control is not adequate to discern if an employer-employee relationship exists. Relying upon the Sushilaben Indravadan Gandhi v. New India Assurance Co. Ltd. case, the Court observed that one single test may not be adequate to discern the nature of the contract. A “conglomerate of all applicable tests taken on the totality of the fact situation” has to be applied in order to arrive at an answer. To determine whether the arrangement between the assessee and the seconded employees is a contract of service or contract for service, the Court applied the ‘substance over form’ test which requires a close examination of the terms of a contract. 

The Court noted the fact that the nature of the overseas group companies business is to secure contracts which can be performed by its highly skilled experts and deploy them to its affiliate companies on a secondment agreement to perform the contract with their requisite skill set. Further, as regards control over the seconded employee, the assessee had operational or functional control over the seconded employees who had to work under the directions of the assessee; the assessee had control over the performance of the seconded employees; the seconded employees performed tasks relating to the activities of the assessee and the assessee was within its right to ask the secondee employees to return if their performance was not as desired. The Court observed that notwithstanding the above facts, in the first place, the overseas employer had seconded its employees to the assessee in relation to its business. During the secondment, the terms of employment of the seconded employees remained in accordance with the policy of the overseas employer and upon the completion of the secondment, those employees returned to their original employers, i.e., the overseas employer. The overseas employer had only ‘loaned their services on a temporary basis’. 

Reimbursing employer for salary paid to secondee employee

Regarding the assessee reimbursing the overseas employer the salary paid by the latter to the seconded employees, the Court observed that the seconded employees were performing the tasks relating to the assessee’s activities and not the overseas employer. While the overseas employer was under the obligation to maintain the seconded employees under its payroll, it was rightly reimbursed for the salary it paid to the secondee employees for the duration of their secondment as during this period, the seconded employees were not performing tasks in relation to its business. That the seconded employees remained in the payroll of the overseas employer was a legal requirement since these employees were entitled to social security benefits in the country of their origin. 

In light of the nature of the transaction, the Court held that the assessee was not an employer to the seconded employees; the overseas group company continued to be the employer of the seconded employees. The assessee was a service recipient of the overseas group company which provided it with manpower supply service. The service provided by the overseas company to the assessee falls within the scope of manpower recruitment and supply services which is a taxable service. 

Closing Remarks 

This judgement is in variance with the decision pronounced by the CESTAT in M/S Volkswagen India (Pvt.) Tld v. Commissioner of Central Excise, Pune- I, (“Order”) wherein the CESTAT had held that where the employees of one company are deployed to another company under an agreement between the companies, the relationship between such deployed employees with the company they are deployed to is in the nature of employer-employee relationship and hence, not taxable under service tax. However, in the present case the Court held that the Order in Volkswagen has no precedential value as the Supreme Court had affirmed this Order without providing reasoning. Further, In Yutaka  Auto Parts India Private Limited v. Commissioner, Central Excise & Service Tax Commissionerate  case, the CESTAT had held: 

“…it is now a settled legal position that in an arrangement like this, the deputed employees will be working as employees of the Indian company. The parent company is not supplying manpower to Indian company. Therefore, no service tax is payable under Reverse Charge Mechanism by the Indian company on the salaries, etc. paid to the deputed employees.” 

However, the precedent set in Northern Operating Systems changes the position of law in respect of the secondment agreements. This judgement underscores the significance and need of going into the substance of a contract to determine the nature of the transaction for the purpose of taxability. The taxability would depend upon the true nature of the transaction and not the mere nomenclature of the transaction.