Tax Update 2018 (Not Mine)
Tax Update 2018 (Not Mine)
Dilemmas Explained
September 2018
www.pwc.in
Table of Contents
1. Foreword ................................................................................................................................ 3
10. Documentation..................................................................................................................... 21
11. Takeaways............................................................................................................................. 22
12. References............................................................................................................................ 23
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1. Foreword
2.1. The term ‘reimbursement’ has not been defined in the Act), although references of the term can be found
Income-tax Act, 1961 (IT Act). It is also not defined in within the concept of a ‘pure agent’. It has been
the Central Goods and Service Tax Act, 2017 (CGST defined in various dictionaries, as given below:
Black’s Law Dictionary To pay back; to make return or restoration of an equivalent for something paid,
(second edition) expended or lost; to indemnify or make whole
Cambridge Learner’s Dictionary To pay money back to someone, especially money that they have spent because
of their work
2.2. According to these dictionary meanings, •• The payment should first be made by somebody
reimbursement can be considered repayment whose liability it never was and the repayment
of what has already been spent or incurred. should then be made to that person to square off
Therefore, it should not be considered a reward the account.
or compensation for a service rendered. The •• Three parties should exist in a case of
determinative factor to be considered is the reimbursement–a payer, a payee and a
obligation of a party to bear expenses. reimburser (i.e., the person reimbursing the
2.3. The Bangalore Tribunal, in the case of Bovis Lend amount to the payer).
Lease (I) P Ltd vs ITO, noted that the following 2.4. In view of this broad understanding, let us seek to
parameters are essential for a payment to be analyse some of the Direct Tax-, Transfer Pricing-
regarded as reimbursement: and Indirect Tax-related issues arising under various
•• The actual liability to pay should be of the types of transactions with respect to reimbursement.
person who reimburses the money to the
original payer.
•• The liability should be clearly determined.
It should not be an approximate or varying
amount.
•• The liability should have crystallised. In other
words, the reason given that payments that were
never required but were made just to avoid a
potential problem may not qualify.
•• There should be a clear ascertainable
relationship between the paying and
reimbursing parties. Therefore, alleged
reimbursement by an unconnected person may
not qualify.
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Overview of relevant legal
3. provisions
A. Direct Tax
3.9. Section 92 of the IT Act provides that any income Selection of most appropriate method
arising from an international transaction will be
computed in regard to the arm’s length price. 3.15. Earlier, prior to the introduction of Rule 10AB
in the Rules, i.e., before the introduction of
3.10. Section 92B defines the term ‘international
the ‘Other Method’ as the sixth method for
transaction’ exhaustively to include “a mutual
determination of the arm’s length price, the
agreement or arrangement between two or more
Comparable Uncontrolled Price Method (CUP
AEs for the allocation or apportionment of, or any
Method) was generally selected as the most
contribution to, any cost or expense incurred or to
appropriate mode of establishing the arm’s
be incurred in connection with a benefit, service
length nature of reimbursement transactions.
or facility provided or to be provided to any one or
This was typically based on the premise that
more of such enterprises…”
reimbursement transactions:
3.11. In view of the above, a reimbursement- or recovery- •• are undertaken on a cost-to-cost basis (i.e.,
related transaction of expenses at cost constitutes not on a mark-up basis).
an international transaction, subject to Transfer
•• represent expenses or charges incurred by
Pricing regulations. Moreover, this transaction
one AE on behalf of another (mainly for
needs to be reported under clause 19 of Form 3CEB
administrative convenience).
(Accountant’s Report), which requires reporting
of any international transaction with the AE not •• do not entail a service element.
reported in any other clause, including a transaction •• do not require any significant functions to be
that has a bearing on the profits, income, losses or performed, noteworthy risks to be assumed
assets of the taxpayer. or important assets to be deployed.
3.12. In the past, certain taxpayers did not report their However, after introduction of the Other Method
reimbursement transactions in Form 3CEB. As (which was meant to be applicable from the
mentioned above, reimbursement is an international Assessment Year 2012-13 onwards), there was
transaction. Therefore, it ought to be reported even some debate on what the most appropriate
if it does not include a profit element. method should be for such reimbursement-
related transactions, i.e., should it continue to
3.13. An analogy can be also drawn from the decision of be the CUP Method or should it be the Other
the Mumbai Tribunal7, wherein it was held that the Method?
taxpayer was not right in reporting the recoupment
received from the AE only as a note in Form 3CEB. 3.16. Typically, in a reimbursement transaction, the
This should have been reported in the relevant primary requirement for application of the
clause to Form 3CEB. The recoupment was received, CUP Method (i.e., for the same or almost the
since the taxpayer had incurred losses, while the same property or service for which there is a
agreement with the AE for import of the product charge) is usually not met. This is because of the
allowed a minimum margin of 4%. The Transfer fundamental difference between the underlying
Pricing Officer (TPO) was directed to consider nature of such transactions with third parties and
recoupment for determination of the arm’s length the subsequent transaction of cross-charge to
price, since it was an international transaction. the group entity. It may not however be possible
to make adjustments for such fundamental
3.14. Therefore, in view of stringent penal provisions for differences. Accordingly, use of the CUP Method
non-reporting of transactions and non-maintenance may not be appropriate.
of documentation, it is prudent for taxpayers to
report such transactions and maintain relevant 3.17. For a relatively less stringent comparison, the
data to justify the arm’s length’s nature of Other Method (which is also a “price” based
their transactions. method and a variant of the CUP Method) may be
resorted to. Unlike the CUP Method, Rule 10AB
which governs the applicability of Other Method,
does not emphasise on comparability of “property
transferred or services provided” and can thus
be interpreted more liberally. The Other Method,
Form 3CEB reporting–a must
therefore, appears to be the more appropriate
method in these cases.
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C. Indirect Tax
3.18. Under the CGST Act, a transaction will attract Goods or services procured as a pure agent
GST only if it qualifies as a ‘supply’ (as defined).
The term ‘supply’ has been defined8 to include all 3.23. As in the case of legislation relating to Service Tax,
forms of supply of goods or services, such as sale, the CGST Act also provides that tax is to be payable
transfer, barter, license, or lease made or agreed to on the value of services, including incidental
be made for a consideration in the course of or in expenses charged by the supplier to the recipient,
furtherance of business. The term ‘supply’ also seeks for the purpose of payment of tax. However, the law
to include within its purview transactions in goods or makes an exception to this rule by incorporating the
services between related parties or distinct persons concept of ‘pure agency’13.
(including the offices of an entity in different states 3.24. A supplier may be known as a ‘pure agent’ when he
with separate GST registrations), when provided enters a contract with the recipient in order to incur
with or without consideration. expenditure or costs in the course of, and in addition
3.19. Therefore, it appears that for an activity to be to supply of goods or services to the recipient on
treated as a ‘supply’ it should be a transaction in his or her own account. In view of the fact that the
either goods or services. While ‘goods’9 have been supplies are procured on behalf of the recipient,
defined as movable property, the definition of the pure agent should not hold a title or use such
services10 includes within its ambit ‘anything other supplies for his or her own interests and should
than goods’, which widens the scope of the term only recoup from the recipient the actual amount
and has the effect of including within its purview a incurred (i.e., without any mark-up).
wide variety of activities. Additionally, by virtue of 3.25. In order to qualify as a pure agent, the supplier has
a deeming fiction11, the CGST Act clarifies that if a the obligation to (a) substantiate that the supplies
supplier agrees to an obligation to engage in an act, procured are in addition to supplies made on his
such activity will be construed as a service. or her own account, (b) the payment is made to
3.20. In view of this position, reimbursements can be the vendor as an agent of the recipient and (c) the
made, subject to tax only if it can be established payment is indicated separately on the invoice issued
that these are made towards provision of goods or by the supplier.
services. 3.26. An in-depth analysis of the contractual arrangement
3.21. Moreover, reimbursements should qualify as a between the parties and the nature of the activity
consideration12 , i.e., the payment should be in being undertaken (against which reimbursement is
respect of, in response to or for inducement of supply being made) becomes critical in taking a decision
in a contractual framework. about whether such reimbursement should be
subject to GST.
3.22. This leads to the suggestion that a reimbursement
will be subject to tax only if the payment has been
made in exchange (on account of a contractual
liability) for the positive act of a supply of goods or
services. In sum, the test for provision of goods or
services for a consideration should be satisfied for
reimbursements to be subject to the GST.
Foreign Third
company party
Payment
Reimbursement
of expenses Outside India
India
Payment
Indian Third
company party
A. Direct Tax
4.1. Various Courts14 have held that the amount received cases, the Indian companies were held to be liable to
by the taxpayer by way of reimbursement cannot be Withholding Tax on their payment to their foreign
regarded as income, particularly if it was found that group companies.
the taxpayer had received no money in excess of the 4.3. Therefore, it appears that while deciding on the
expenses he or she had incurred. In the absence of alleged taxability of reimbursement, Tribunals have
the profit element, the Courts have been of the view gone ahead and analysed the nature of underlying
that such payments are reimbursements that are not expenses. And if underlying expenses were liable
taxable in India. Consequently, no Withholding Tax to Withholding Tax, which was not applied,
needs to be applied on such payments. the reimbursement was held to be subject to it.
4.2. However, a contrary view has been adopted by the Interestingly, these principles have yet to be tested
Tribunals in some cases15, wherein it was found before the higher courts.
that the Indian companies were availing services
from a third party overseas, but payment for these
services were being routed through their foreign
group companies, which claimed such receipts to be
plain reimbursements. In such cases it was observed
that had the Indian companies directly incurred such Important to evaluate taxability
expenses, and therefore Withholding Tax Provisions of underlying expenses
should have applied to these. Therefore, it is clear
that just because a transaction is routed through a
foreign group company this cannot alter the nature
of the payment made as reimbursement. In such
14. CIT vs Siemens Aktiongesellschaft (Bombay High Court); CIT vs IDFC Investment Advisors Ltd (Bombay High Court); DIT vs WNS Global
Services (UK) Ltd (Bombay High Court) ; DCIT vs UPS Jetair Express (Mumbai Tribunal)
15. C.U. Inspection (I) P Ltd vs DCIT (Mumbai Tribunal); DCIT (TDS) vs Kodak India P Ltd ( Mumbai Tribunal); Ershisanye Construction Group
India P Ltd vs DCIT (Kolkata Tribunal)
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B. Transfer Pricing
C. Indirect Tax
4.17. As stated above, there can be numerous instances 4.18. In each of these cases, the underlying activity
where foreign group entities cross-charge their and transactional framework (if any) should be
related Indian entities, for example, in the following analysed to determine whether the reimbursement
instances: can be treated as consideration for supply of goods
i. Salary discharged by a non-resident entity to or services. Where the reimbursement is towards
an expatriate seconded to India (where the taxable supply of goods or services by a provider
expatriate is employed by the resident entity) outside India to a recipient in the country, the latter
ii. Cost- sharing arrangements is required to pay GST on such supplies if the place of
supply is deemed to be within India.
iii. Centralised procurements undertaken by an
entity for its group companies 4.19. On the recipient paying the GST and on fulfilment of
iv. Expenditure incurred due to administrative the prescribed conditions, it will be eligible to claim
convenience, e.g., as hotel or travel expenses input tax credit, to be set off against its output tax
incurred by the visiting employees of an Indian liability.
company
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Payment under cost-sharing
5. arrangements
Background
5.1. Cost-sharing or cost-contribution agreements typically refer to an arrangement between a number of
companies, generally a part of one group of companies, wherein certain functions such as finance, HR, IT and
R&D are carried out centrally by one entity, but with all the participating entities being its beneficiaries. The
lead entity cross charges the beneficiaries, based on the usage or benefit they derive from the central functions.
This practice is widely prevalent across industries, since it brings about synergies and cost-efficiency.
A. Direct Tax
5.2. From the perspective of Income Tax, the issue that as well as head office organisation, was shared.
arises is whether allocation or sharing of costs is Therefore, the payments received by the taxpayer
taxable in the hands of the recipient entity. were held to be in the nature of reimbursements not
constituting income in its hands.
5.3. The Supreme Court of India22, while analysing the
taxability of pro-rata IT costs recharged to Indian 5.5. In another case24, the group companies of an entity
agents by a foreign shipping company, held that once shared the cost of basic R&D, based on an allocation
the character of the payment was found to be in the key under a cost-contribution agreement. The
nature of reimbursement of expenses, it could not group entities were allowed royalty-free unlimited
be charged to tax in India. In this case, the foreign access to research results and the IPR generated was
shipping company had furnished its calculation of owned by the entity undertaking the R&D (i.e., the
total costs and their pro-rata division among the applicant). The Authority for Advance Rulings
agents (which was done without any mark-up). (AAR) held that reimbursement received by the
Moreover, the TPO had accepted that the payment applicant towards R&D costs was not taxable in
was at an arm’s length price. India and noted that the resources were pooled by
all the group entities for common benefit (and not
5.4. In one case23, the taxpayer (a non-resident company)
for conferment of any right on the applicant). It also
conducted extensive research activities and
held that since all the participating group entities
communicated the latest inventions, information,
had the right to reap the benefits of research, the
processes, etc., to its group companies. The taxpayer
payment made towards their own share of R&D costs
imparted information, processes and inventions
could not be taxed in India. Similar views have been
under the agreement, and the expenses incurred in
expressed by Tribunals in other judgments25.
relation to communication of this information were
proportionately reimbursed by the Indian subsidiary. 5.6. Similarly, cost-sharing arrangements for recoupment
The High Court held that the amounts received by of other expenses such as software license costs and
the taxpayer were by way of recoupment of expenses intranet charges26 have been held to be not taxable
incurred on its research department, which it in the hands of the entity initially incurring such
maintained in London. The research carried out by expenses. Even in the context of reimbursement of
the taxpayer was for the benefit of all concerned, rental expenses where office premises were shared,
including the Indian subsidiary. The expense of the Delhi Tribunal27 held that Withholding Tax
the research, which was utilised by the subsidiaries provisions were not applicable in the absence of any
lessor-lessee relationship.
B. Transfer Pricing
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C. Indirect Tax
5.10. As stated above, under cost-sharing arrangements, a 5.13. In a particular case, the Delhi Tribunal31 held
lead group company may: that since there was no element of service, the
i. Undertake a common function, the benefit of reimbursement would not be subject to Service Tax,
which is received by its various group entities since the taxpayer procured infrastructure facilities
ii. Centrally procure goods or services for itself and from a third party and subsequently apportioned
other companies in the group, e.g., by obtaining the expenditure between the group companies.
software licenses to be used by the entire group It was held that the taxpayer did not provide
infrastructure facilities to the group companies
5.11. While in several cases the Courts have analysed and the facilities were availed from a third party
the taxability of Service Tax on cost-sharing and were received from it by the group companies.
arrangements, these have largely been in the context The taxpayer merely made a payment on behalf of
of examining classification of the arrangements the group and subsequently recovered the amount
under the specified service categories prevalent prior from the group. Accordingly, the Tribunal held that
to 1 July 2012. Therefore, the principle emerging there was no element of service, and therefore, the
from these precedents is that there should be a reimbursement would not be subject to Service Tax.
relationship of service provider and service recipient
between the lead group company and the recipient 5.14. The ratio of these rulings, although rendered in the
in order for the a cost-sharing arrangements to be context of Service Tax law, can be equally relevant
made taxable. under the prevalent GST regime. To reiterate, it
needs to be tested whether (or not) (a) there is
In one case, the IT systems and leased lines of an an intention to provide services so that there is a
Indian taxpayer was managed centrally by the IT relationship of service provider and service recipient
department of its group company located outside between the parties and (b) the lead group entity is
India. The cost of management of IT for the group, merely making payment on behalf of other entities
was recharged to all the companies on an agreed and therefore satisfying the ‘pure agent’ criterion.
upon basis. A dispute arose whether the taxpayer Moreover, adopting a simplistic view that all cost-
was liable to pay Service Tax under reverse charge sharing arrangements are in the nature of services
for the period April 2006 to May 2008. The Mumbai may lead to a situation where expenses such as
Tribunal29 held that there was an element of service electricity, which are otherwise not subject to the
being rendered by the group company outside India GST, may be included in the value of the supply and
vis-à-vis the group, including the taxpayer, and be subject to the GST.
there was a clear relationship of a service provider
and service recipient. In view of this, the Tribunal
concluded that the taxpayer was liable to pay Service
Tax under reverse charge.
5.12. On the other hand, where a lead group company was
engaged in procuring goods or services on behalf of
the group, the Courts held that there was no element
of service between the lead procuring entity and
the group, and therefore Service Tax may not apply
in such a scenario. In one of the cases, the Mumbai
Tribunal held that the cost recharged to group
entities would not be subject to Service Tax30, since
the taxpayer had entered contractual arrangements
with participating group companies to procure
services on their behalf and consequently share the
cost of these. In this context, the Tribunal held that
the taxpayer acted in the capacity of an agent of
the participating group companies while procuring
goods and services on their behalf. Furthermore, it
went on to conclude that the taxpayer was acting in
the capacity of a pure agent, and therefore, the costs
recharged to the group entities would not be subject
to Service Tax. This approach is in line with the
historical European Union VAT judicial precedent on
non-taxability of classic cost-sharing arrangements.
29. Vishay Components (I) P Ltd vs Commissioner of Central Excise (Mumbai Tribunal)
30. Reliance ADA Group P Ltd vs Commissioner of Service Tax (Mumbai Tribunal)
31. HT Media Ltd vs Commissioner of Service Tax (Delhi Tribunal)
6.1. At times, there can be a thin line of distinction of a technical nature may be rendered, the
between reimbursement of cost vs a service compensation for which was agreed on at
that is rendered at cost. For example, services cost earlier.
A. Direct Tax
6.2. From the standpoint of Income Tax, taxability may whether or not the service provider profits. A similar
arise if services are in the nature of FTS even though conclusion was reached by the AAR in another
recovery is restricted to the extent of the actual case35 while analysing the taxability of recoupment
expenses incurred32. In one such case, the Mumbai of market research expenses. It held that even if the
Tribunal33 noted that even if the consideration was fees charged by the parent company was equivalent
received at cost, it affected the cost of the services to the expenses incurred by it in providing such
to the service recipient and not the character of services and there was no profit element, this would
the payment. On a similar fact pattern, the AAR34 still be a case of quid pro quo for the service fees and
held that the income is to be taxable, irrespective of not a reimbursement.
B. Transfer Pricing
6.3. Transactions relating to provision of services at cost are market support services and incurred significant
not treated as reimbursement under Transfer Pricing reimbursement costs (approx. 80% of the total cost),
regulations. Accordingly, this should be reported in which it recovered from group companies at cost
clause 13 of Form 3CEB, which requires transactions without any mark up. In order to calculate the net
pertaining to provision of services to be reported. profit, the TPO made adjustment by considering
such reimbursed expenses as a part of the cost. The
Reimbursement warranting a mark-up Tribunal upheld the action of the TPO and held
that reimbursements ought to be considered while
6.4. Where a recharge does not pertain to reimbursement
computing the profitability of a taxpayer, thereby
of third-party costs (incurred by a taxpayer on behalf
upholding the rule that the taxpayer should earn a
of the AE for administrative convenience), but where
mark-up on such cost.
the Indian taxpayer has, in fact, performed value
addition or was responsible and accountable for the The Tribunal distinguished the case of Cheil
service provided by the third party, then a mark-up Communications and pointed out that in this case
can be insisted on. the taxpayer was not bearing any risk, whereas in the
present case, the taxpayer (and not the AE) was the
6.5. Interestingly, the Delhi Tribunal36 took a contrary
one who was bearing all the risk and was rendering
view in its earlier ruling in the case of Cheil
overall marketing support services to its AE.
Communications. In this case, the taxpayer provided
32. Bovis Lend Lease (I) P Ltd vs ITO (Bangalore Tribunal), Shell India Markets P Ltd (AAR)
33. Cotecna Inspection India P Ltd vs ACIT (Mumbai Tribunal)
34. Timken India Ltd (AAR)
35. Danfoss Industries P Ltd (AAR)
36. Seagram Manufacturing P Ltd vs ACIT (Delhi Tribunal)
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6.6. The Bangalore Tribunal37 rejected the taxpayer’s 6.7. Similarly, the Hyderabad Tribunal38 held that
contention for exclusion of expense-related implementing ERP systems for an AE group does not
reimbursement in operating costs or revenue constitute pure cost reimbursement, but is a cost-
and held that relevant expenses were incurred in sharing exercise, and accordingly, the cost warrants
connection with provision of services to the AE. a mark-up.
It also observed that the fact that expenses were
taken directly to the balance sheet without routing
it through the profit and loss account cannot change
the nature and purpose of the expenses.
C. Indirect Tax
Background
7.1. The taxability of reimbursements in cases where the income of a foreign entity is to be computed under special
presumptive provisions has been a debated issue. Typically, under these provisions39, gross receipts need to be
considered for computation of taxable income under a presumptive mechanism.
7.2. Here, the question that arises is whether reimbursements are to be included in the gross receipts for the purpose
of computing deemed income. Let us look at some key court rulings that have elaborated on this controversy:
A. Direct Tax
7.3. The Supreme Court of India recently had occasion to receipts of the taxpayer. According to the Delhi Tribunal, it
consider the argument of non-applicability of presumptive is elementary that any sum to be assessed under this section
provisions (i.e., section 44BB–deeming provision dealing must be connected with the activities mentioned in the
with non-resident’s income in connection with business particular section. In another case42, the Delhi Tribunal noted
of exploration, etc., of mineral oils) for a batch of appeals that reimbursement of expenses was based on expenditure
on expenses reimbursed by service recipients to foreign actually incurred by the taxpayer for providing boarding and
service providers. The Supreme Court40 rejected the lodging facilities to the employees of the service recipient.
taxpayers’ argument regarding reimbursement and Since these expenses were incurred by the taxpayer on behalf
held that the mobilisation and demobilisation fees of the service recipient, it was held to be in the nature of
paid to the foreign service provider formed a part of reimbursement and was not taxable under section 44BB.
the gross receipts (for the purpose of computing the 7.5. Similarly, in the context of recovery of statutory levies (such
deemed income). The Court observed that a fixed sum as as Service Tax and Customs Duty) and their inclusion in
mobilisation and demobilisation fees was stipulated in the the gross receipts, the High Court43 held that Service Tax
contract, regardless of the actual expenditure incurred by collected by the taxpayer cannot be included in the gross
the taxpayer. receipts, since Service Tax is neither paid for provision of
In relation to reimbursement of the cost of lost tools, the services and nor does it include an element of income. The
Supreme Court held that the amount was not covered taxpayer merely collects the Service Tax to pay it to the
by the presumptive provisions. Interestingly, the Court Government. A similar view was reiterated in some other
also summarily dismissed the other grounds which, judicial pronouncements44, although a contrary view has also
inter alia, involved reimbursement of other expenses been expressed by a Delhi Tribunal45. In some other cases,
including catering, boarding and lodging, and customs the Tribunals46 held that in the event Service Tax and/or
duty, without specifically adjudicating on these at length. VAT have been separately charged in the bills and accounted
A review petition filed before the Supreme Court to for, such sums would not form part of the gross receipts, but
reconsider these issues has been recently dismissed. if the sum has been included in the consolidated amount of
7.4. Prior to the Supreme Court’s decision (given above), the bill (i.e., no bifurcation is provided), then Service Tax
the Delhi Tribunal41 held that the nexus of the and/or VAT should form a part of the gross receipts for the
expenses being reimbursed with the main activities of purpose of presumptive taxation.
the taxpayer is an important parameter that needs to be 7.6. In sum, considering that the decision of the Supreme Court
considered. In the absence of a profit element and no is the law of the land, it will be interesting to see how the tax
direct nexus with activities mentioned in section 44BB, authorities and lower courts interpret its decision as far as
the reimbursement should not be included in the gross taxability of reimbursements under presumptive provisions
is concerned.
Background
8.1. In an agreement for provision of services, certain expenses such as travel, lodging, accommodation, etc.,
are usually incurred by the service provider while providing services. These expenses can be reclaimed
contractually from the service recipient as reimbursement in the form of out of pocket expenses.
A. Direct Tax
8.2. As discussed earlier, in the absence of any profit 8.4. On the other hand, Withholding Tax is not required
element, a receipt cannot be generally classified as if the taxpayer (service recipient) directly incurred
income. Therefore, a position may be taken that such the travelling and hotel expenses on foreign
reimbursements towards OPE are not taxable in the technicians and this amount was not reimbursed
absence of an income element. In another case, the to the service providers.50 However, if the expenses
Delhi Tribunal47 held that reimbursement of actual have been reimbursed they cannot be separated from
OPE cannot be regarded as income, and therefore, no the fees because these were incurred in the course of
tax needs to be deducted on such reimbursement. earning the fees.
8.3. In the context of reimbursement of OPE, the courts48 8.5. Consequently, considering the CBDT Circular and
have held that reimbursement of OPE is incidental judicial precedents discussed above, it may be
to an agreement to provide technical services, plausible to contend that no Withholding Tax should
and therefore, do not constitute FTS. However, be applied on OPE if it is separately identified in
contrary to this view, some courts49 have held that the invoice. However, in the case of an FTS, since
reimbursement of OPE in relation to FTS derives contrary views have been expressed it would be
its character from the nature of the FTS, since such advisable to evaluate the contractual arrangements
payments are considered expenses incurred in the amongst the parties to determine the liability to
process of providing technical services. withhold tax on the OPE.
8.6. The CGST Act prescribes that the value of taxable for a consideration in money terms, the value of such
supply should include incidental expenses charged service (for the purpose of payment of tax) is the gross
by the supplier to the recipient for the purpose of amount charged by the service provider for the service.
payment of tax. As a result, OPE such as travel and The Court held that since reimbursement of expenses
accommodation incurred during provision of goods is not for provision of services, but only to recover
or services should be included in the value of the expenses incurred in the course of providing services,
supplies and be subject to the GST. Rule 5 of the Service Tax Valuation Rules (which
8.7. The only exception to this rule is when the prescribe that such reimbursements should be included
expenditure is incurred by a supplier on behalf of in the value of the service) is ultra vires, and therefore,
a recipient as a ‘pure agent’, i.e., the prescribed the value to be considered for the purpose of payment
conditions for it to qualify as a pure agent have of Service Tax should not be more than quid pro quo for
been satisfied. In this case, the OPE is not subject receipt of services. However, the Court acknowledged
to the GST. that with effect from 14 May 2015, the definition of
‘consideration’ includes reimbursable expenses, and
8.8. In this regard, it is worthwhile to refer to the therefore, reimbursement may be included in the value
landmark judgement of the Supreme Court in the of services, for payment of tax with prospective effect.
case of the Union of India vs Intercontinental
Consultants and Technocrats P Ltd., where 8.9. Therefore, in the context of the CGST Act, this
Supreme Court examined the provision for valuation judgment may no longer hold good, since the
under Service Tax law to determine whether valuation-related provision under the Act now
reimbursable expenses should be included in the specifically provides that GST is to be payable on the
value of the services for payment of Service Tax. The transaction value of supply of goods or services. The
valuation-related provision in force under Service term ‘value’ has been defined to include incidental
Tax law provides that where provision of service is expenses for this purpose.
18 PwC
Reimbursement of cost of salary in
9. secondment arrangements
Background
9.1. The Indian subsidiaries of foreign MNCs often seek to utilise the skills and experience of a global talent pool
through inbound secondment or deputation of foreign personnel to India. In a typical secondment arrangement,
the overseas entity seconds such individuals to India. After this, the Indian entity takes on the individual onboard
by issuing a letter of employment. The Indian entity is responsible for payment of the salary of the individual and
applies Withholding Tax to it. Overseas entities frequently facilitate payment of salaries to the overseas accounts
of the seconded employees. This is purely for administrative convenience. In this case, salary costs are reimbursed
by the Indian entities to the overseas ones.
Reimbursement Secondment
Outside India
In India
Indian
company Employee
Letter of employment
Direct Tax
9.2. In the recent past, secondment arrangements have this payment is, in essence, compensation for
been under the scanner, primarily due to whether managerial services provided. An SLP filed by the
the presence of secondees triggers Permanent taxpayer before the Supreme Court against the
Establishment-related exposure for foreign High Court judgement was summarily dismissed51.
companies and/or whether the foreign companies’ Technically, dismissal of the SLP by the Supreme
receipts can be taxed as FTS. Court, especially in a ‘non-speaking manner’ neither
9.3. An important factor to consider here is about confirms the High Court’s judgment nor makes it
which entity supervises and has control over such a law of the land; it only means that the Supreme
secondees. In a landmark judgement, in the case Court has refrained from adjudicating this case.
of Centrica India Offshore P Ltd. vs CIT, it was Here, the secondee retained a right of lien on his
held by the Delhi High Court that reimbursement employment with the overseas entity, which had
of salary costs to an overseas entity is liable to the right to terminate his employment, and the
tax as ‘FTS’, since by seconding its employees it Indian entity had no control on him in terms of
is providing technical knowledge and skills, and employment, continuation of employment, etc. This
assisting the taxpayer in the latter’s quality control was an important aspect considered by the Court.
and management functions. The court held that
B. Transfer Pricing
9.7. The Transfer Pricing principles discussed above on employees did not constitute an FTS under the IT Act
reimbursements also apply to a secondment-related as well as the India-Singapore DTAA. In view of this,
scenario. The Mumbai Tribunal55 held that payment it observed that payment by an Indian AE constitutes
received by a Singapore company from its India AE ‘pure’ reimbursement of salary costs, and therefore,
towards reimbursement of salaries for seconded deleted the mark-up on reimbursement of salary.
C. Indirect Tax
9.8. The following scenarios may arise when an as Provident Fund. Moreover, control over and
expatriate from a foreign group company is supervision of the expatriate employee was always
seconded to an Indian entity: with the taxpayer. Therefore, since there was
i. The individual is employed by the Indian entity an employer-employee relationship between the
and is subject to the benefits and regulations expatriate and the Indian entity, it could not be said
applicable to an employee in India. In such a that manpower recruitment services were provided
case, the employee works under the control by the foreign company. Reimbursement of salary by
and supervision of the Indian entity and not the the taxpayer Indian company to the foreign company
foreign group company. and for the activities undertaken by the expatriate
ii. Indian entity appoints the foreign group during the course of his or her employment was
company for a specific service or activity, in made by the Indian entity at cost in its capacity as
the course of which an expatriate is deployed the employer.
to India, but continues to work under the 9.11. Similarly, under the CGST Act, reimbursement of the
supervision and control of the foreign company. salary cost of such an employee to the overseas entity
9.9. The first scenario was the subject of litigation is undertaken by the Indian entity in its capacity as the
under the erstwhile Service Tax law. The issue in employer. Since the services provided by an employee
dispute was whether services qualified as manpower to an employer are specifically excluded from the
recruitment services and if the recipients were purview of the GST, reimbursement of the salary cost
required to pay Service Tax on these under the of the employee may not be subject to this tax.
reverse charge mechanism. 9.12. However, in the latter scenario, where the employee
9.10. This matter has been adjudicated by the Supreme continues to be employed by the foreign company
Court56, High Courts57 and Tribunals58. In such and the objective of the arrangement between the
cases, the Courts have observed that the Indian companies is to provide manpower or services to the
company (i.e., the taxpayer) paid the salaries of the Indian company (due to which the employee of the
employees in India, deducted tax and contributed foreign entity is seconded to India), the nature of the
to their statutory social security benefits such services and the consequent GST-related liability on
such services needs to be assessed.
52. Morgan Stanley (Asia) Singapore Pte Ltd vs DDIT (Mumbai Tribunal)
53. DIT vs Marks & Spencer Reliance India P Ltd (Bombay High Court)
54. IDS Software Solutions India P Ltd vs ITO (International Taxation)(Bangalore Tribunal)
55. Morgan Stanley Asia (Singapore) Pte Ltd vs DDIT (Mumbai Tribunal)
56. Commissioner vs Kronhe Marshall P Ltd (Supreme Court); CIT vs Volkswagen (I) P Ltd. (Supreme Court)
57. Commissioner of Service Tax vs Arvind Mills (Gujarat High Court)
58. Johnson & Johnson P Ltd vs Commissioner of Central Excise & ST (LTU) (Mumbai Tribunal)
20 PwC
10. Documentation
10.1. As is apparent from the details given above, • In a cost-sharing agreement between group
the issue about taxability of reimbursement companies, documents to substantiate basis of
is highly contentious and litigative. And since allocation of costs, i.e., the allocation key and an
parties generally desire a tax-neutral position on agreement between the parties to share costs
reimbursements, it is imperative they maintain • For reimbursement of salary costs in
robust documentation to substantiate their actual secondment arrangements:
conduct in the arrangement or transaction. It is – Letter of assignment issued by foreign
important to remember that more often than not, the company to individual secondees
Courts have been guided by documentary evidence
– Employment contract issued by Indian
produced to arrive at a decision on taxability.
company to individual secondees
10.2. If expenses are routine in nature and are incurred – Agreement between the foreign company
for administrative convenience on behalf of the AE, and the Indian company to facilitate
the taxpayer should maintain documentation in payment of salaries to the individual
support of the expenses it has incurred, the benefit secondees
(if any) derived by the AE, rationale for incurring the – Salary slips of secondees and proof of taxes
expenses, etc. withheld by the Indian company
10.3. The relevance of documentary evidence has been – Debit notes raised by the overseas company
emphasised by the Delhi Tribunal59, wherein due to on the Indian company for cross-charges
the absence of relevant documents, the adjustment
on salary reimbursement was upheld. The Mumbai
Tribunal60 has also upheld the relevance of
documentary evidence, wherein the matter was
remanded to the AO to determine the arm’s length Robust documentation the
price of reimbursement after considering evidence differentiator
produced by the taxpayer. Furthermore, the Delhi
Tribunal61 held that reimbursement for a software
license constitutes royalty in the absence of
proper documentation.
10.4. Some examples of documents to be considered in the
context of transactions or arrangements involving
‘reimbursements’ are listed below:
• Written agreement between the parties
• Invoices or debit notes raised by the parties
• Agreement entered by lead company with third
parties and invoices raised by the third parties
towards reimbursable expense incurred by the
lead company
• An accountant or auditor’s certificate to
substantiate that there is no profit element in
the amount reimbursed by the Indian service
recipient to its foreign group company or parent
11.1. To sum up, there is very little debate or controversy 11.3. There is no thumb rule for determining taxability
on what constitutes ‘reimbursement’. Several of reimbursements in India. The solution lies
dictionary meanings and principles laid down by in maintaining meticulous documentation that
the courts help in fostering an understanding of records the intention of the parties and the purpose
this concept. and nature of expenditure incurred. The initial
11.2. The challenge, however, lies in determining the burden, of course, lies on the taxpayers, to prove
taxability of such reimbursements. While there are the bonafides of payments on the basis of the
a plethora of rulings now from the Indian judiciary, documentation they have maintained and the actual
which provide directional guidance, uncertainty still conduct of their business.
persists. Issues generally arise due to the different 11.4. MNCs seeking to achieve a tax-neutral position
interpretations of the taxpayers, the tax authorities on their intra-group reimbursement-related
and the courts, based on the facts of every case. transactions should continue to focus on such
arrangements from the perspective of Direct Tax,
Transfer Pricing and Indirect Tax and closely monitor
legal developments in India in these areas.
22 PwC
12. References
24 PwC
Notes
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26 PwC
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