Supreme Court clarifies service tax on seconded employees: C.C., C.E. & S.T. vs. M/s Northern Operating Systems Pvt Ltd (2022)

Date of the Judgment: May 19, 2022
Citation: 2022 INSC 457
Judges: Uday Umesh Lalit, J., S. Ravindra Bhat, J., Pamidighantam Sri Narasimha, J. The judgment was authored by S. Ravindra Bhat, J.

Can a company avoid service tax by claiming that employees seconded from its foreign parent company are actually their own employees? The Supreme Court recently addressed this complex issue in a case involving service tax on manpower supply. The court examined the nature of secondment arrangements and clarified when such arrangements attract service tax. This judgment clarifies the tax implications of secondment agreements, impacting multinational companies operating in India.

Case Background

The case involves M/s Northern Operating Systems Pvt Ltd (hereafter “NOS”), an Indian company, which received employees from its group companies located in the USA, UK, Dublin, and Singapore. These employees were provided to NOS under what was termed as a ‘secondment’ arrangement. The revenue department initiated proceedings against NOS, alleging that it had not paid service tax on these secondment arrangements, considering them as “manpower recruitment or supply agency services.”

The core of the dispute was whether the foreign group companies were providing manpower supply services to NOS or whether the seconded employees were, in effect, employees of NOS, thereby exempting the arrangement from service tax. The revenue department argued that the foreign entities were supplying manpower, while NOS contended that the seconded employees were under its control and direction, making them effectively its own employees.

Timeline

Course of Proceedings

The Commissioner of Service Tax confirmed the demands for service tax, interest, and penalty based on the show cause notices, holding that the secondment arrangement was indeed a manpower supply service. The Commissioner held that the foreign companies were service providers and NOS was the recipient. The Commissioner also held that the definition of manpower recruitment or supply agency does not have any exclusion clause requiring the service provider to possess a specific status.

Aggrieved by the Commissioner’s orders, NOS filed appeals before the Customs, Excise and Service Tax Appellate Tribunal (CESTAT). The revenue also filed appeals against the Commissioner’s order that discharged the proceedings for a subsequent period. The CESTAT rejected the revenue’s appeals and allowed NOS’s appeals, concluding that the secondment was not a manpower supply service.

Legal Framework

The case revolves around the interpretation of “manpower recruitment or supply agency service” under the Finance Act, 1994.

Section 65(68) of the Finance Act, 1994, defines “manpower recruitment or supply agency” as “any person engaged in providing any service, directly or indirectly, in any manner for recruitment or supply of manpower, temporarily or otherwise, to any other person.”

Section 65(105)(k) of the Finance Act, 1994, defines “taxable service” as “any service provided or to be provided, to any person, by a manpower recruitment or supply agency in relation to the recruitment or supply of manpower, temporarily or otherwise, in any manner.”

After the amendment in 2012, Section 65B(44) of the Finance Act, 1994, defines “service” as “any activity carried out by a person for another for consideration, and includes a declared service, but shall not include – (b) a provision of service by an employee to the employer in the course of or in relation to his employment.”

The core issue is whether the secondment arrangement falls under the ambit of “manpower recruitment or supply agency service” before 2012 and whether it can be excluded as a “service by an employee to the employer” after 2012.

Arguments

Revenue’s Submissions:

• The revenue argued that the agreements, including the Services Agreement, Master Service Agreement, and Secondment Agreement, clearly showed that the overseas employer provided services to NOS through its employees.
• The remuneration for the services was fixed at actual cost plus a 15% markup.
• The seconded employees were operationally under the control of NOS temporarily, but their real employer was the overseas company.
• The overseas company was using the skill sets of its employees to ensure the quality of work done by NOS.
• The revenue relied on Commissioner of Income Tax v. M/s. Eli Lilly & Company India Pvt. Ltd. [(2009) 15 SCC 1] to argue that the employees remained on the rolls of the foreign company and that their salaries were reimbursed.
• The revenue also relied on Klaus Vogel’s Treatise on Double Taxation, and judgments in Smt. Savita Garg v. The Director, National Heart Institute [(2004) 8 SCC 56], Workmen of Nilgiri Cooperative Marketing Limited v. State of Tamil Nadu & Ors. [(2004) 3 SCC 514], Silver Jubilee Tailoring House v. Chief Inspector of Shops [(1974) 3 SCC 498], Hussain Bhai Calicut v. Alath Factory Thozhilali [(1978) 4 SCC 257] and Sushilaben Indravadan Gandhi v. New India Assurance Co. Ltd. [(2021) 7 SCC 151] to argue that the control test is not the sole determinant of an employer-employee relationship.

Assessee’s Submissions:

• The assessee argued that the secondment of employees was not a supply of manpower but an employer-employee relationship, which is outside the scope of service tax.
• The assessee contended that the seconded personnel were contractually hired as its employees, with control over their work and remuneration.
• The assessee relied on Collector of Central Excise & Service Tax v. Nissin Brake India (P) Ltd. [Civil Appeal Diary No(s). 45344/2018] where similar facts were considered and the revenue’s appeal was dismissed.
• The assessee submitted that the group companies were not in the business of supplying manpower.
• The assessee also argued that service tax is leviable only on the gross amount charged for the provision of service, and the salaries paid to the expats cannot be considered as consideration for the service. The assessee relied on Intercontinental Consultants and Technocrats Pvt. Ltd. v. Union of India [2013 (29) S.T.R. 9 (Del.)] and Intercontinental Consultants and Technocrats Pvt. Ltd. [(2018) 4 SCC 669].
• The assessee contended that the amounts paid were reimbursements of salaries and allowances, without any markup.
• The assessee contended that it had a bona fide belief that the seconded employees were its employees and was entitled to avail a refund of service tax paid on input services.

The innovativeness of the argument by the assessee lies in its attempt to reframe the secondment arrangement as a direct employer-employee relationship, thereby seeking to avoid service tax liability.

Issues Framed by the Supreme Court

The Supreme Court framed the following issue:

1. Whether the overseas group company or companies, with whom the assessee has entered into agreements, provide it manpower services, for the discharge of its functions through seconded employees.

Treatment of the Issue by the Court

The following table demonstrates as to how the Court decided the issue:

Authorities

The Supreme Court considered the following authorities:

Judgment

How each authority was viewed by the Court:

• Commissioner of Income Tax v. M/s. Eli Lilly & Company India Pvt. Ltd. [(2009) 15 SCC 1]* was distinguished as it dealt with income tax, but the court agreed that the employees continued on the rolls of the foreign company.
• The court used the principles from Dharangadhara Chemical Works Ltd. v. State of Saurashtra [1957 SCR 158], D.C. Dewan Mohideen Sahib and Sons v. Secretary, United Beedi Workers’ Union [1964 (7) SCR 646], and Silver Jubilee Tailoring House v. Chief Inspector of Shops & Establishments [1974 (1) SCR 747] to emphasize that the control test is not the sole determinant of an employer-employee relationship.
• The court used Indian Banks Association v. Workmen of Syndicate Bank [2001 (1) SCR 1011] and Indian Overseas Bank v. Workmen [2006 (3) SCC 729] to highlight the flexibility in deciding whether a contract is one for service or one of service.
• The court used Sushilaben Indravadan Gandhi v. New India Assurance Co. Ltd. [(2021) 7 SCC 151] to emphasize that there is no single determinative test but a conglomerate of all applicable tests.
• The court used State of Orissa v. Titaghur Paper Mills Co. Ltd [1985 Supp SCC 280] and Prakash Roadlines (P) Ltd. v. Oriental Fire & General Insurance Co. Ltd. [(2000) 10 SCC 64] to highlight that the nomenclature of a contract is not decisive of its nature.
• The court used Cosmic Dye Chemical v. Collector of Central Excise [(1995) 6 SCC 117], Uniworth Textiles v. Commissioner of Central Excise [(2013) 9 SCC 753], Escorts v. Commissioner of Central Excise [(2015) 9 SCC 109] and Commissioner of Customs v. Magus Metals [(2017) 16 SCC 491] to interpret “wilful” suppression of facts, holding that it must be with intent to evade duty.

What weighed in the mind of the Court?

The Supreme Court emphasized that the employees remained on the payroll of the overseas employer, and the secondment was part of a global policy of the overseas entity. The court also considered the economic benefit derived by the assessee, which secured specific jobs from the overseas group companies. The court noted that the assessee had operational control over the seconded employees, but the real employer was the overseas entity. The court also emphasized that the nomenclature of the contract is not decisive, and the substance of the arrangement must be considered.

Logical Reasoning

The court considered alternative interpretations, such as the assessee’s argument that the seconded employees were its own employees. However, these interpretations were rejected because the employees remained on the payroll of the overseas employer, the secondment was part of a global policy, and the overseas employer deployed the employees for the assessee’s work. The final decision was reached by considering the substance of the agreements and the economic realities of the arrangement.

The Supreme Court held that the assessee was the service recipient of manpower supply services from the overseas group company. The court reasoned that while the assessee had operational control over the seconded employees, they remained on the payroll of the overseas employer and were deployed as part of a global policy. The court also held that the economic benefit derived by the assessee was consideration for the service.

The court also held that the extended period of limitation was not justified as there was no wilful suppression of facts or deliberate misstatement by the assessee. The court stated that “Misstatement or suppression of fact must be wilful.”, and in this case, the view held by the assessee about its liability was neither untenable nor mala fide. The court also observed, “The mere payment in the form of remittances or amounts, by whatever manner, either for the duration of the secondment, or per employee seconded, is just one method of reckoning if there is consideration.”, and “The quid pro quo for the secondment agreement, where the assessee has the benefit of experts for limited periods, is implicit in the overall scheme of things.”

The court did not find any majority or minority opinions in the judgment.

The court analyzed the reasoning, legal interpretation, and application of facts by stating that the nomenclature of the contracts is not decisive, and the substance of the arrangement must be considered. The court also analyzed the legal provisions and case laws to conclude that the secondment was a manpower supply service. The court also stated that the revenue neutrality is an irrelevant detail and that the incidence of taxation is entirely removed from whether, when and to what extent, Parliament chooses to recover the amount.

The judgment has potential implications for future cases involving secondment arrangements, as it clarifies that the substance of the arrangement, rather than the form, will be considered. This may lead to more companies being held liable for service tax on similar arrangements.

The court did not introduce any new doctrines or legal principles but rather applied existing principles to the facts of the case.

Key Takeaways

• Secondment arrangements can be considered as manpower supply services, attracting service tax.
• The substance of the arrangement, not just the form, is critical in determining tax liability.
• Operational control over seconded employees does not necessarily make them employees of the host entity.
• The economic benefit derived by the host entity can be considered as consideration for the service.
• Extended period of limitation can be invoked only if there is wilful suppression of facts or deliberate misstatement.

Directions

The Supreme Court directed that the assessee is liable to pay service tax for the periods specified in the show cause notices, but the extended period of limitation was not justified. The consequential demands shall be recovered from the assessee for the normal period or periods covered by the four show cause notices.

Development of Law

The ratio decidendi of the case is that secondment arrangements can be considered as manpower supply services, attracting service tax, if the substance of the arrangement indicates that the overseas entity is providing manpower supply services. The court clarified that the control test is not the sole determinant of an employer-employee relationship. This judgment clarifies the tax implications of secondment agreements, and it reaffirms the principle that the substance of the arrangement, not just the form, is critical in determining tax liability.

Conclusion

The Supreme Court’s judgment clarifies that secondment arrangements, where employees are temporarily deployed from a foreign entity to an Indian entity, can be considered as manpower supply services, attracting service tax. The court emphasized that the substance of the arrangement, not just the form, is critical in determining tax liability. The court also held that the extended period of limitation was not justified in this case.