Friday, July 29, 2011

Law Street in The Economic Times (29 July, 2011)

Dear Readers,

I am glad I have this blog. At times, The Economic Times online edition does not feature my column in the opinion section. It is rare, but this does happen on occasions. So it becomes a tad difficult to find the column online. The url which will take you to the column online is here.

Zenobia Aunty and indeed yours truly, often get into trouble for being plain outspoken. But, when it comes to rules, regulations, legislation, et al, while plan English is welcome as it aids proper interpretation, the latter is crucial. As of now, thanks to a recent Advance Ruling, Indian companies are quite perplexed. If they do not withhold tax at source on payments made to its foreign affiliates for employees seconded by them, the penal consequences for the Indian company would be high, including disallowance of this entire expenditure for tax purposes. Not a fine situation to be caught in.

Have a nice weekend.

Best regards,

Seconding tax problems

• There needs to be clarity on TDS on employee secondment
• Conflicting judgements have caused confusion
• The CBDT could bring out guidelines in this regard

Loyal readers of Zenobia Aunty’s columns are well aware that her favourite books are Alice in Wonderland and Through the Looking Glass. On umpteen occasions, she has taken these books down from the shelves, in an attempt to draw an analogy with tax laws and better grasp the tax situation on hand.

So just the other day, this columnist, found her Aunt rocking herself back and forth and reciting a paragraph from Alice in Wonderland, as quoted here: ‘When I use a word,’ Humpty Dumpty said in rather a scornful tone, ‘it means what I choose it to mean, neither more nor less.’ ‘The question is,’ said Alice, ‘whether you can make words mean so many different things.’

‘The question is,’ said Humpty Dumpty, ‘which is to be master – that’s all.’

Yes, words are important. Just recently, the US Congress enacted the Plain Writing Act, which will ensure that government documents are better understood. Less jargon, more clear, lucid, simple speak! Back home, the draft Direct Tax Code, 2010, was an attempt to move in a similar direction. But will plain writing help make sense of tax laws, be it in India or US or any other country?

Zenobia Aunty agrees with Alice - words can mean so many different things. Let us take a recent ruling given by the Authority for Advance Rulings (AAR). The AAR held that reimbursement made by an Indian company to its US affiliate company, who had seconded its employees to the Indian company would be treated as ‘Fees for Included Services’ under the India-US tax treaty. Thus, such payment (reimbursement of salary costs) to the US affiliate would be subject to withholding tax in India.

The US affiliate company sent three of its personnel to India, one of whom was the Managing Director of the Indian Company. The role of the other two was to liaise between the Indian company and the US Parent and to supervise and provide directions to the Indian company on its overall business strategies. The Indian company was obliged to reimburse salary expenses of the seconded employees on a monthly basis to its US affiliate. Such payment was required to be made on a ‘net of tax’ basis.

In its application and before the AAR, the Indian company contended that, the Indian company was the ‘economic employer’ of the personnel that had been deputed. In other words, the seconded employees remained the employees of the US affiliate which alone had the right to terminate the services.

In its capacity as economic employer, it had paid taxes under section 192 of the Income tax Act, 1961 (The IT Act) as applicable to salary disbursements and thus there should be no further withholding tax in India when the payment was made to the US affiliate.

In this context, The AAR held that the nature of the two receipts, one in the hands of the US affiliate for rendering services and the other in the hands of the seconded employees by way of salaries, spring from different sources, are of different character and represent different species of Income.

By correlating the two payments, neither the nature nor substance of the transaction would change to give it the character of reimbursement. The name given to transaction does not decide the nature of the transaction. Therefore the amounts reimbursed by the Indian company represent income accruing to the US affiliate. As the services rendered by the seconded employees was managerial in nature, it would be covered under the provisions relating to ‘Fees for Included Services ‘under the India-US tax treaty and subject to withholding tax in India, as per this Article in the tax treaty.

Secondment of personnel to India affiliate companies is quite a common practice adopted by global MNCs. The seconded personnel typically continue to remain on the payroll of the foreign company, even as they continue to work under the control and direction of the Indian company during their tenure in India. While the foreign employer pays the salary, the Indian affiliate reimburses the same to the foreign company.

Tax Tribunals in similar cases have held that there was no tax liability in the hands of the foreign affiliate company that had seconded employees to India, in respect of reimbursement payments made by the Indian company, thus no tax was to be withheld in India. Yet this ruling denotes otherwise. Rulings given by AAR do have a persuasive value in the course of assessment proceedings in similar cases.

Even if simple English is used in tax laws, varying interpretations will continue to perplex tax payers. The moot question now is: To what extent should an Indian tax payer take into considering this ruling? If it does not withhold tax at source on payments made to its foreign affiliates for employees seconded by them, the penal consequences for the Indian company would be high, including disallowance of this entire expenditure for tax purposes. Not a fine situation to be caught in.

Source of the photograph

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