Secondment of employees | VAT and PE issues

Secondment of employees refers to the temporary assignment of an employee to work for another company or in a different department within the same organization. This can happen for various reasons, such as filling a skills gap, providing training, or completing a specific project.

Indian Supreme Court judgement in M/s. Northern Operating Systems Pvt. Ltd. (‘Northern India’):

Facts of the case:

1. Northern India entered into agreements with its Group Companies located abroad, to provide general back office and operational support
2. Managerial and technical staff were deputed to the Indian Company by the overseas group entities for specified periods
3. Northern India also entered into Secondment Agreements with their Group Companies for secondment of employees and issued an Employment Letter to the seconded employee stipulating all the terms of the employment
4. The seconded employee remained on the payroll of the original employer (i.e. overseas group entity) only for social security contribution / retirement benefits
5. The overseas group entities would contribute for social security and raise a debit note on the Indian Company to recover such amounts (without any mark-up)
6. In respect of their Indian income, the seconded employees offered such income to taxation India
7. Service tax proceedings were initiated against Northern India in respect of expenses relating to secondment

Court's observations:

• Northern India had operational or functional control over the seconded employees
• The arrangement between Northern India and overseas group entities was a “Contract for Service” and not a “Contract of Service”
• The seconded employees were always retained on the payroll of the foreign entity. Secondment arrangement entailed loaning of employee services on a temporary basis
• The overseas entity deployed its employees to Northern India and and upon cessation of the arrangement, the seconded employees returned to their foreign employer or were deployed on some other secondment

Court's Ruling:

Under the above facts and observations, the Supreme Court of India held that Northern India was a recipient of service (manpower recruitment and supply services) from the overseas entities and thus, leviable to pay service tax in India. Please note that services tax has now been replaced by Goods and Services Tax (GST). Pursuant to the Supreme Court decision, GST authorities started issuing show cause notices to multinational corporations having a branch or subsidiary in India and have adjudicated GST liability on secondment of employees.

Citigroup Vs. South Africa Revenue Services:

Facts of the case:

Citigroup, a global financial conglomerate, routinely seconded employees to its various international entities, including Citigroup SA, by concluding assignment and intra-city service agreements with these respective international entities. In this matter, Citigroup SA sought a court order declaring that payments it made to the Citigroup foreign entities, in relation to seconded employees, comprised the reimbursement of salary costs paid to Citigroup SA’s employees on Citigroup SA’s behalf, which fell outside the scope of VAT, and which were exempt from section 7 (1)(c) of the VAT Act No 89 of 1991, in terms of section 14 (5) (d) of the VAT Act. SARS, on the other hand, argued that payments made by Citigroup SA for foreign staff seconded to South Africa should be categorised as payments for an “imported service” rather than a mere reimbursement of costs to the foreign entity.

In simpler terms, “imported services” as defined in the VAT Act, refer to services provided by a supplier or business located outside of South Africa to a recipient within South Africa. These services are subject to VAT if they are used or consumed within South Africa and are not used to make taxable supplies.

Given the nature of its business as a bank, Citigroup SA would generally be required to apportion its input claims. It follows that the payments made to other Citigroup entities abroad are thus partly used, and partly not used, to make taxable supplies.

Court's Ruling:

After considering the arguments raised by Citigroup SA and SARS, the court agreed with SARS’s view that the issue as to whether the secondees were employees should be determined under South African tax legislation, rather than under the South African labour laws. The court also considered the definitions of “employer” and “employee” as provided for in the South African Income Tax Act 58 of 1962 (“ITA”). According to the Fourth Schedule to the ITA, an “employee” is any natural person who receives remuneration. “Remuneration” includes various forms of compensation, such as salaries, wages, bonuses, commissions, etcetera.

The court finally ruled against Citigroup SA and this decision ultimately hinged on the failure of Citigroup SA to discharge the burden of proof on two crucial aspects: 1) that they were the “employers” of the seconded employees as defined by the ITA; and 2) the payments they made to the foreign entity constituted “remuneration.”

?On the first point, the court held that Citigroup SA had not provided compelling evidence to establish that the seconded employees were under their direct supervision and control. It noted that Citigroup SA’s assertion of supervision and control merely recited statutory language without demonstrating the practical aspects of such control over the seconded employees.

Implications of Northern Operating Systems and Citibank SA rulings:

Tax authorities have formed a view that secondment of employees entails import of service by the resident entity from the non-resident entity and this is subject to VAT. Courts in India and in South Africa have accepted this view and this has significant implications for multinational corporations. Other tax jurisdictions are expected to follow suit.

Further, the judgments underscore the intricate challenges faced by multinational corporations dealing with tax regulations, both local and international. The outcome of these cases could set a significant precedent, affecting how businesses structure their cross-border employment arrangements and navigate complex tax laws. It further demonstrates the need for taxpayers to seek clarity and consistency in cross border movement of people. This will also escalate the cost of secondment arrangements.

Secondment and PE exposure:

Secondment of employees can potentially lead to Permanent Establishment (PE) exposure for the original employer in the host country.

A Permanent Establishment is a fixed place of business where a company carries out part or all of its business activities. This can include offices, factories, branches, and other physical locations. If a company has a PE in a particular country, that country may have the right to tax the profits attributable to that PE.

When employees are seconded to work in a foreign country, they may carry out activities that, under certain circumstances, could create a PE for the original employer in the host country. This can happen if the activities of the seconded employees are of a nature that would be considered the regular business activities of the company and if they have a sufficient level of authority to make decisions on behalf of the company.

Here are some scenarios where secondment could potentially lead to PE exposure:

1. Authority to Conclude Contracts: If the seconded employee has the authority to conclude contracts or significantly influence contractual decisions on behalf of the original employer, this can contribute to PE exposure.
2. Length of Secondment: If the secondment is of an extended duration and involves the performance of significant business activities, it may increase the likelihood of creating a PE.
3. Nature of Activities: If the activities of the seconded employees go beyond support or auxiliary functions and involve core business operations, this can increase the risk of PE exposure.
4. Substantial Presence: If the seconded employees have a physical presence in the host country for an extended period, this may contribute to the establishment of a PE.

It's important to note that tax laws and regulations regarding PE can vary significantly between countries. Therefore, it's crucial to consult with tax professionals or legal experts who are knowledgeable about the specific tax laws of both the home and host countries involved in the secondment arrangement. To mitigate potential PE exposure, companies may need to carefully structure secondment agreements, monitor the activities of seconded employees, and seek professional advice to ensure compliance with local tax laws and regulations. If the control and direction over the employees is transferred to legal entity in the host country through a legal agreement, PE exposure could be mitigated substantially.