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SBS AND COMPANY LLP Blog 09 July 2022 Hits: 2179
ANALYSIS ON SUPREME COURT JUDGMENT IN NORTHERN OPERATING SYSTEMS – UPHOLDING RCM
ON MANPOWER SUPPLY FOR SECONDMENT EMPLOYEE
Introduction:
On 19th May 2022, the Supreme Court delivered two judgments that shaken the
foundations of indirect taxation. One in the matter of Mohit Minerals Private
Limited[1], which struck down the levy of reverse charge on the importer for
ocean freight services (for more on this, please read our article here[2]). Two,
in the matter of Northern Operating Systems Private Limited[3], which upheld the
revere charge on secondment of employees. Results of both the verdicts are
opposite to the most popular public view, thus changing the way we look at the
future of indirect taxation.
In this article, we wish to analyse the judgment of Supreme Court in the matter
of Northern Operating Systems Private Limited (supra) and conclude with our
remarks as to how the said judgment will impact the position under GST laws.
Issue in Brief:
The facts were that Northern Operating Systems Private Limited (for brevity
respondent/NOS) was registered with service tax authorities under the categories
of ‘manpower recruitment agency service’ and other services. An audit was
conducted by revenue which resulted in the proceedings against NOS alleging
non-payment of service tax concerning agreements entered into by it with its
group companies located in USA, UK, Dublin, Singapore etc to provide general
back office and operational support to such group companies.
The nature and contents of the agreements which are subject matter of current
discussion reveal that when required NOS requests the group companies for
managerial and technical personnel to assist in its business and accordingly the
employees (seconded employees) are selected by group company and they would be
transferred to NOS. During the term of secondment, the seconded employees act in
accordance with the instructions and directions of NOS and the seconded
employees would devote their entire time and work to NOS. The seconded employees
would continue to be on the payroll of the group company (foreign entity) for
purpose of continuation of social security/retirement benefits, but for all
practical purposes, NOS is the employer. The seconded employees would receive
the salary, bonus, social benefits, out of pocket expenses and other expenses
from group company and the group company raises a debit note on NOS to recover
the said expenses without any mark-up. NOS would be issuing prescribed forms
under the provisions of Income Tax Act, 1961 for the seconded employees. The
seconded employees file their returns in India and contribute to the provident
fund.
The tax authorities alleged that NOS has failed to pay service tax under reverse
charge for the services of manpower supply received from the group entities
which are located outside India. The tax authorities contention was that the
seconded employee would revert to the group entity once the requirement with NOS
is met. Hence, the seconded employee cannot be called as employee of NOS. Since
there is no exclusion under the service tax law for a situation like which the
NOS is in, there cannot be any relief from payment of tax under reverse charge.
On the other hand, NOS argued that the group entities cannot be called as
entities falling under the manpower recruitment or supply agency and after
introduction of negative list, the definition of ‘service’ has excluded the
services provided by employee to his employer from its ambit and since seconded
employee is employee and NOS is the employer, their cannot be any tax either
under pre or post negative list.
The CESTAT after hearing to both the parties, held that on reading of contracts
and agreements, the group entities cannot be said to be engaged in supply of
manpower. The seconded employees were receiving salaries from the group
companies only for disbursement purposes and the employer – employee
relationship existed and the activity, therefore, could not be termed as
‘manpower recruitment and supply agency’. The CESTAT further held that in the
above circumstances, the overseas group companies which had contracted with NOS
were not in the business of supply of manpower and NOS was not a service
recipient and accordingly rejected the stand taken by the tax authorities. The
Revenue appealed the CESTAT’s order before the Supreme Court.
Analysis by Supreme Court:
The Supreme Court after hearing to both the parties has framed the issue as to
whether the overseas group companies with whom NOS has entered into agreement,
provide manpower services, for discharge of its functions through seconded
employees? In simple words, the Supreme Court has to decide, as to, who is the
employer of the seconded employee? If the Indian entity is treated as employer,
then what is paid to the group entity is only a reimbursement and accordingly
there is nothing to be taxed. On the contrary, if the foreign entity is treated
as employer of the seconded employee, then the services provided by the foreign
entity would be treated as service and becomes taxable. Hence, the crux is, who
is the employer of the seconded employee?
The Supreme Court after referring to its previous judgments, wherein it was held
that ‘control’ alone cannot be a factor to decide as to who is the employer has
stated that there is no one single determinative factor, which the courts give
primacy to, while deciding, whether an arrangement is a contract of service (as
NOS pleads) or a contract for service (as the revenue pleads). The Supreme Court
stated that one test has been consistently applied by them, which is ‘substance
over form’, requiring a close look at the terms of the agreement.
The Court then stated that a vital fact which needs to be considered in the NOS
case, is that the nature of overseas group companies business appears to be to
secure contracts, which can be performed by its highly trained and skilled
personnel. This business is providing certain specialised services and taking
advantage of the globalised economy, and having regard to the locational
advantages, the overseas group company enters into agreements with its
affiliates or local companies, such as NOS and the role of NOS is to optimise
the economic edge to perform the specific tasks given to it, by the overseas
company. As part of this, the secondment contract is entered into, whereby the
overseas company’s employees, possessing the specific required skill, are
deployed for duration the task is estimated to be completed in. The Court stated
it is in this context, it has to be decided, whether the secondment, for purpose
of completion of the Indian entity’s job, amounts to supply of manpower?
The Supreme Court stated that for all appearances, the seconded employees, for
the duration of secondment, is under the control of NOS and works under its
direction. The fact remains that they are on the payrolls of their overseas
employer and what is left unsaid and perhaps crucial, is that this is a legal
requirement, since they are entitled to social security benefits in the country
of their origin. The Court stated that it is doubtful whether without the
comfort of this assurance, they would agree to the secondment. The Court further
stated that, the reality is that the secondment is part of the global policy of
the overseas employer loaning their services, on temporary basis and on
cessation of secondment period, they have to be repatriated in accordance with
the global repatriation policy. The Court further stated that the agreement
between NOS and seconded employee nowhere states that latter would be treated as
former’s employees after the seconded period and on contrary, they revert to
their overseas employer.
The Court thus stated that the overall effect of the four agreements entered
into by NOS with group companies, clearly points to the fact that the overseas
company has a pool of highly skilled employees, who are entitled to a certain
salary structure- as well as social security benefits. These employees, having
regard to their expertise and specialization, are seconded to the concerned
Indian entity for the use of their skills and upon cessation of terms of
secondment, they return to their overseas employer, or are deployed on some
other secondment.
The Court stated that while control (over performance of seconded employee’s
work) and the right to ask them to return, if their functioning is not as is
desired, is with NOS, the fact remains that their overseas employer in relation
to its business, deploys them to NOS, on secondment. The Court further stated
that overseas employer for whatever reason, pays them their salaries and their
terms of employment even during the secondment are in accord with policy of
overseas company, who is their employer and upon the end of period of
secondment, they return to their original places, to await deployment or
extension of secondment. Accordingly, the Court concluded that the overseas
entity will continue to be the employer of the seconded employee and not the
Indian entity.
The Court also rejected the argument put forward by NOS by stating that there
was no consideration paid to the overseas entity (assuming that there is a
service provided by overseas entity) and therefore no tax liability should
accrue by stating that the mere payment in the form of remittances or amounts,
either duration of the secondment, or per employee is just one of the way to
reckon the consideration and the other way of looking at the arrangement is the
economic benefit derived by NOS, which also secures specific job or assignments,
from the overseas entities, which results in revenue and the quid pro quo for
the secondment arrangement, where the NOS has benefits of the experts for
limited period, is implicit in the overall things.
The Court also rejected the argument of revenue neutrality[4] by stating that
the judgments relied upon by NOS of the same court are unreasoned and merely
affirming the CESTAT Orders. Hence, those judgments relied upon by NOS does not
have precedential value and accordingly NOS cannot escape tax based on the
ground of revenue neutrality. The Court also rejected the reliance of NOS on
earlier judgments of Supreme Court in the matter of Volkswagen India Private
Limited[5] wherein it was held that the similar services provided by overseas
entity is not a manpower recruitment and supply agency service by stating that
such judgments are just confirmation of orders of CESTAT without any independent
analysis and hence they do not have any precedential value.
Our Analysis:
As stated in the introduction of this article, this judgment is opposite to the
most popular public view. There are series of judgments where in the tribunals
have held that there cannot be any tax on similar transaction for the reason
that the overseas entity cannot be called as manpower supplier and the employer
shall be the Indian entity[6]. However, the Supreme Court overturned all such
rulings by single stroke. The predominant reason that appears for the Supreme
Court to arrive at above conclusion is the reliance on the judgment of Morgan
Stanley & Co (MSCo)[7].
The Supreme Court in Morgan Stanley & Co (supra) was dealing with inter alia, a
situation where an employee of MSCo when deputed to Indian entity Morgan Stanley
Advantages Services Private Limited (MSAS) would constitute a service permanent
establishment (PE) for MSCo in India? It was in this context the Supreme Court
held that a deputationist has a lien on his employment with MSCo and as long as
the lien remains with MSCo the said company retains control over the
deputationist’s terms and employment. The Court further stated that it is
important to note that where the activities of multinational enterprise entails
it being responsible for the work of deputationist and the employees continue to
be on payroll of multi-national enterprises or they continue to have their lien
on their jobs with multi-national enterprises, a service PE can emerge. By
applying such rationale to the facts of MSCo, the Supreme Court held that there
exists a service PE and accordingly concluded the income attributable to such
service PE is taxable in India.
The point to ponder is whether the judgment of Supreme Court in the context of
service PE can be used to determine, whether the employer would be the foreign
entity or Indian entity for the purposes of service tax law. The existence of PE
of a foreign entity in India is a factual exercise and changes from case to
case. Even in the case of Morgan Stanley (supra), the court held that provision
of stewards does not trigger service PE but provision of deputationist triggers.
Hence, how far the adoption of such a judgment which deals with service PE can
be applied to context of service tax law is not known. In addition to the above,
when there exists a service PE, it can be said at the best, there was a
provision of technical services by employees of MSCo to MSAS. However, in the
instant case, the service tax was not charged under the category of technical
services but under the category of manpower supplier.
Further, even under the direct taxation law, the seconded employees were treated
as employees of the Indian entity. Though the overseas entity continues to be a
legal employer, the Indian entity becomes an economic employer. OECD[8] in its
commentary on model convention on Article 15[9], while dealing with who is to be
treated as employer in international hiring-out of labour’ stated that the term
‘employer’ was not defined in the convention but it is understood that the
employer is the person having rights on the work produced and bearing the
relative responsibility and risks. The commentary further stated apart from the
above test, the contracting states have to refer to number of circumstances
enabling them to establish that the real employer is the user of labour, like:
* The hirer does not bear the responsibility or risk for the results produced
by employee’s work
* The authority to instruct the worker lies with the user
* The work is performed at a place which is under the control and
responsibility of user
* The number and qualifications of employees are not solely determined by hirer
On applying the above factors, it would be evident that the Indian entity is to
be treated as employer and accordingly the services provided should have been
out of service tax ambit. Further, there are numerous judgment under the direct
taxation law, where it has been consistently held that Indian entity is the
employer qua the seconded employees. Only in thin number of cases, where the
consideration is paid to the foreign entity without any evidence that the same
is again paid to seconded employees (Centrica India Offshore Private Limited[10]
by Delhi High Court) or where there is an additional amount paid to foreign
entity apart from the salary cost (AT&S India Private Limited[11]), the courts
have held that the said amounts are for provision of technical or other services
and not the reimbursement of cost of seconded employees.
The Supreme Court though stated that there cannot one test for determination as
to who the employer is, but ruled out that the Indian entity cannot be employer
for the only reason that he exercises the control on the seconded employee.
Though the agreement between NOS and its group entities clearly states that the
seconded employee would be on the payrolls for the overseas entities only for
purposes of salary disbursement and nothing else was set aside by stating that
they have adopted the substance over form approach. The Court nowhere stated why
the agreements should be discarded and a substance over form approach is to be
adopted. The Court has completely ignored the fact that the seconded employees
have been issued tax forms in India which shows the intent of NOS to treat them
as employees of NOS and concluded that the overseas entity will continue to be
the employer of the seconded employee only for the reason that there exists a
lien on such employment and seconded employee continues to be on payroll of the
overseas entity. This pick and choose approach of Supreme Court with due
respects requires a re-consideration.
The Court instead of rejecting the reliance on Volkswagen India Private Limited
(supra) and others should have gone into detail as to what the high courts or
CESTATs have held on similar issue and then should have concluded regarding the
taxability. To this extent, the conclusion of the Supreme Court in the matter of
NOS may require a re-consideration.
Further, another point that requires consideration is, whether the judgment of
Supreme Court in NOS (supra) is universally applicable for all secondment cases
or the Supreme Court did draw a distinction? Para 52 of the judgment states that
a vital fact that needs to be considered in the NOS case is that the overseas
entities are engaged in securing contracts which are then outsourced to NOS and
later performed by deputed/seconded employees. In this context, the Court framed
a question that whether the secondment, for the purpose of completion of NOS’s
job, amounts to manpower supply? The Court also stressed on the role of NOS to
be optimising the economic edge to perform the specific task given to it, by
overseas companies.
Taking clue from the above, can we state that the employer will be the overseas
entity, only in cases where the Indian entity places request for seconded
employees for completion of specific tasks which are outsourced by overseas
entity to Indian entity? In simple words, where seconded employees are not
engaged in any specific activity or involved in day to day management, can they
stand exclude by the judgment in NOS (supra). This question assumes significance
especially, when seen in the context of facts of Morgan Stanley (supra). In the
said case, MSCo sent two sets of employees to MSAS. One, the stewards and two,
the deputationists. The AAR[12] in MSCo case held that MSCo sending both the
sets of employees to MSAS triggers service PE for the former. However, the
Supreme Court after analysing the activities of stewards, stated that the
activities of steward are in the nature of merely protecting MSCo’s interest in
the competitive world by ensuring, the quality and confidentiality of MSAS
services. Hence, the Court held that there cannot be said that by providing
stewards MSCo has actually provided a service to MSAS. Then, the Court moved on
to the analysis of provision of deputationists and as discussed earlier, held
that the provision of such employees would trigger service PE for MSCo.
Hence, on a close reading of the judgment of NOS (supra) and Morgan Stanley
(supra), it appears that only in cases where the secondment employees are taken
for completion of specific task which earns a direct revenue to the Indian
entity, such cases will alone be falling for the payment of tax under reverse
charge. However, whether this is the interpretation of the Supreme Court or not
has to be waited and seen in the times to come.
Position under GST Laws:
Though the above judgment was delivered in the context of service tax law, it is
important to examine the impact that it will have under the GST laws. Similar to
the exclusion from the definition of ‘service’, the services provided by
employee to employer in the course of or in relation to his employment was
specified as Entry 1 in Schedule III to Section 7 of CT Act to be an activity or
transaction which shall be treated neither as supply of goods or services or
both. Hence, the services provided by employee to his employer are also not
subjected to tax under GST laws. However, the prime question that who is to be
treated as employer, the foreign entity or Indian entity remains unanswered.
Taking clue from the judgment of Supreme Court in NOS (supra), the overseas
entity would be the employer, there by the service provider. In terms of Section
13(1) and 13(2) of IT Act[13] read with Entry 1 of Notification No 10/2017 – CT
(R), the tax is required to be paid by the service recipient under reverse
charge. Further, the argument that there is no separate fee or consideration
charged by the overseas entity and hence there cannot be any tax (argument taken
by NOS before Supreme Court) will fail under the GST laws in light of Entry 2 of
Schedule I to Section 7 of CT Act. The said entry states that the activity of
supply of services when made in course or furtherance of business between
related person shall be treated as supply even when there is no consideration.
Assuming that the overseas entity and Indian entity falls under the definition
of ‘related person’ as laid down vide Explanation (a) to Section 15, then the
activity shall be treated as supply dehors the fact there is no consideration.
The value of supply has to be determined by the rules which deal with valuation.
On the other hand, if the employer is treated as Indian entity being the
economic employer, then the services provided by seconded employee would not be
subjected to tax.
Therefore, in all instances where the activity of the seconded employee is not
in achieving a specific task or job of the Indian entity, then there will be a
high chance that the taxpayer need not pay tax under reverse charge by placing
reliance on NOS (supra). In instances where the activity of seconded employee is
directly related to achieving a specific task or job, then there is a high
chance for the tax authorities to demand tax under reverse charge from the
Indian entity. If the Indian entity is in a situation that it is eligible for
credit, it is advisable on a conservative basis to remit the tax and avail as
credit. In cases, where Indian entity is not in a situation to avail the tax
paid as credit, then it has to prepare to face the litigation.
From the above analysis it is evident that, if a review petition is filed before
the Supreme Court, the chances of change in the outcome of the judgment are
high. Assuming that the review petition fails, then there will be a second round
of litigation, where the concept of economic employers and other connected
matters will be tested. Till then, this twist in the story continues to effect
the Indian entities.
[1] [2022] 138 taxmann.com 331 (SC)
[2] 2022] 138 taxmann.com 360 (Article)
[3] [2022] 138 taxmann.com 359 (SC)
[4] A situation where the tax if paid was available as input tax credit or
refund and hence making non-payment of such tax should be considered as revenue
neutral.
[5] 2014 (34) STR 135
[6] For reference, see recent ones in Komatsu India (P) Limited [2021] 131
taxmann.com 276 (Chennai – CESTAT), and Target Corporation India (P) Limited
[2021] 123 taxmann.com 444 (Bangalore – CESTAT).
[7] [2007] 162 Taxman 165 (SC)
[8] Organization for Economic Co-operation and Development
[9] OECD Commentary on Article 15
[10] [2014] 364 ITR 336 (Delhi)
[11] 287 ITR 421
[12] Authority for Advance Ruling
[13] Integrated Goods and Services Tax Act, 2017
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