1. There has been some criticism expressed over the recent decision of the Hon’ble Supreme Court in the case of CCE Northern Operating Systems (P) Ltd. (Civil Appeal No. 2289-2293 of 2021). The criticism expressed is in respect of the Court applying the doctrine of substance over form to arrive at its decision. Apprehensions have been raised as regards whether the given doctrine (that appears to be subjective) will also be applied to settle the future indirect tax disputes.
2. We in the present article argue that the larger apprehensions as regards the application of the doctrine of substance over form are unfounded. We also deal with aspects of revenue neutrality as well as the limitation that has also been dealt with by the Court.
The controversy
3. The assessee (I Co.) is an Indian company that had entered into a Services Agreement with the overseas group entities to provide certain “IT enabled services supporting back-office banking and related operations” that are assigned by the group entities. The I Co. contracted to provide the said services for a consideration arrived at based on the actual costs plus a mark-up of 15.0%.
4. The I Co. also entered into a secondment agreement with a group company (F Co.) whereby it was agreed that the overseas employee of the F Co. shall be temporarily loaned to the I Co. Key factual aspects are as under:
a) During the period of secondment, the I Co. has control over the employee, i.e. it can require the seconded employee to return, and likewise, the employee has the discretion to terminate the relationship.
b) The I Co. is responsible for the work of the seconded employee, i.e., the overseas employer (F Co.), during the secondment period, is absolved of any liability for the job or work of its seconded employees.
c) The secondment is for a specified duration, and the employment with the I Co. ceases upon the expiration of that period.
d) The seconded employee remains on the payroll of the overseas employer (F Co.) and continues to enjoy the social security benefits. Further, the overseas employer (F Co.) pays the seconded employee, which is reimbursed by the I Co. without any mark-up.
e) The letter of understanding issued to the seconded employee specifies that the tenure with the I Co. is an assignment. The remuneration payable to the employee include the salary payable as well as other allowances, such as hardship allowance, vehicle allowance, servant allowance, paid leave, housing allowance, etc. The nature of salary and other perks indicates that the seconded employees are of a certain skill and possess the expertise, that the I Co. requires.
5. With the aforesaid brief factual background, the department issued three notices covering the period from October 2006 till September 2014 seeking to demand the service tax from I Co. under the reverse charge mechanism by considering the amount reimbursed by I Co. towards the salaries of the seconded employees as a consideration paid for availing the ‘Manpower Recruitment or Supply Agency Service’ from the F Co. The Commissioner confirmed the proposals of the initial two notices (covering the period till March 2012) but dropped the third notice covering the period from April 2012 to September 2014. The I Co. filed appeals against the two unfavourable orders whereas the Revenue filed the appeal against the decision of the Commissioner dropping the third notice. All the appeals were filed before the Hon’ble CESTAT which came to be decided in favour of the I Co. vide order dated 23.12.2020. Revenue being aggrieved by the said decision preferred an appeal before the Apex Court.
Before the Apex Court
6. The issue therefore before the Court was whether the amount paid by I Co. under the secondment agreement can be held to be liable to service tax or not? The law in question (i.e. Finance Act, 1994) for the disputed periods provided that the provision of service by an employee to the employer shall not be liable to tax either as ‘Manpower Recruitment or Supply Agency Service’ (till 30.06.2012) or as a ‘service’ (on and after 01.07.2012). Hence the question before the Apex Court was whether the seconded employee in question can be considered to be the employee of I Co. and hence outside the purview of taxability or is required to be considered as the employee of F Co. and hence to reason that it is the F Co. that has provided the services to I Co. that will be liable to tax. Before we examine the basis of the Apex Court in reaching the verdict, we need to address one important aspect.
Jurisdiction of the Apex Court
7. It is a settled proposition that the Apex Court while exercising the appellate function sits only in the review of the decisions of the lower authorities/Court and that too concerning the substantial questions of law.
8. In the given case the law as regards when a contract in question can be considered to be a contract ‘of service’ (employer-employee) and when it can be considered to be a contract ‘for service’ stands settled in numerous decisions of the Apex Court wherein the Court has indicated several factors that are to be considered for determining the nature of the contract. Therefore in any given situation what remains to be done by the fact finder is to find and determine the relevant facts and apply the test laid down by the Apex Court to the said facts to determine whether the transaction is ‘of service’ or ‘for service’.
9. A question will therefore arise in the context of the present case as to whether the Apex Court has exceeded the jurisdiction by finding and re-adjudicating the facts when as such there appears to be no substantial question of law involved. Also as regards the facts, the fact finder (adjudicating authority) in the context of the third notice had already found and held that the secondment of employees to the I Co. is in the nature of the employer-employee relationship and hence in the said context can the Apex Court assume jurisdiction to deal with the factual aspect and re-characterize the transaction in question as that of provision of services. Perhaps the aspect of jurisdiction ought to be considered in such disputes when it relates to the characterization of certain facts. The jurisdiction rests with the fact finder and the authorities above it only sits in appeal to review the process employed by the fact finder in arriving at the factual conclusion.
Characterization of the relationship
10. Now coming to the moot point of the controversy the Apex Court referred to several decisions (Sushilaben Indravadan Gandhi v. New India Assurance Co. Ltd. (2021) 7 SCC 151 – latest case summarizing the judicial view) to say whether the relationship in question between the I Co. and the seconded employee is of employer-employee or not is required to be determined based on several factors and not on the sole factor of control. It is in the said context that the Apex Court observed that the substance shall matter over form. Hence we submit that it is in the context of the dispute (wherein the law has not defined the term ’employer’ and ’employee’) that the Apex Court relying on precedents held that it is the substance of the factors in question that will determine the nature of the relationship. Hence we submit that to extrapolate the said observations to suggest that the said test of substance over form can be applied to every other transaction for the determination of tax implications is not correct. It is only in the given context that the said observations are to be read.
11. Now having determined that several factors are to be considered to determine whether the relationship in question between the I Co. and the seconded employee is employer-employee or not the Apex Court in paragraph 52 of the decision referred to the peculiarity with which the transaction in question was undertaken and considered the same for reaching the verdict. The Apex Court observed that in the given case it is the overseas entities that secure contracts that can be performed by highly trained and skilled personnel. Court then observed that to take the locational advantage of the globalized economy, the overseas group entities then enter into a contract with its affiliates or local companies, such as I Co. to perform the specific tasks given it. As part of this agreement, a secondment contract is entered into, whereby the overseas company’s employees, possessing the specific required skill, are deployed for the duration of the task that is estimated to be completed. The Court then in paragraph 53 observes that even though the control of the seconded employee is with the I Co. still the said employee continues to remain on the payroll of F Co. and enjoy the social security benefits in the country of their origin which acts as a comfort to agree to the secondment. The Court then in paragraph 54 referred to the letter of understanding between the I Co. and the seconded employee to observe that the salary package is expressed in foreign currency and also includes a hardship allowance of 20% of the basic salary for working in India. The Court, therefore, held that the seconded employees cannot be considered to be the employees of I Co. and hence reversed the decisions of the CESTAT by confirming the demands of tax.
12. The above context reveals that the Apex Court stood influenced by the fact that it is the overseas group entities who have created the given business model and operate by having a standardized policy and hence reached the verdict to say that the seconded employees are not the employees of I Co. We, therefore, submit that the said view cannot be automatically applied to other fact situations involving the secondment of the employees. The given view is only limited to the peculiar facts highlighted above.
Critique of the Apex Court approach
13. Although as observed earlier, the substance over form doctrine as remarked by the Apex Court is required to be considered in the given context, still the emphasis on the business model to say that even if the control of the seconded employees is with the I Co. still the same will not be considered as the employees of the said I Co. requires to be revisited. The concept of joint employment (which includes secondment arrangements) is very much prevalent in the trade as it gives the flexibility to move employees across group entities without losing the essential character of the relationship i.e. employer-employee and is required to be applied in such situations where the Court finds difficulty in determining a singular employer. Also, the Court must be privy to the application of other relevant laws as under the said laws the I Co. may continue to remain vicariously liable as the employer for the acts of the seconded employee and also I Co., as well as the seconded employees, may have reciprocal rights with the remedies as regards the legal obligations arising from the secondment arrangement.
Revenue Neutrality
14. It was also contended that the situation in question is revenue neutral since even if I Co. would have paid the service tax, it would be entitled to the cash refund of the same owing to the use of the alleged input services towards the export of services. The Apex Court rejected the contention on the basis that the incidence of taxation is independent of the recovery of the said amount and the consequent rights of the taxpayer. Apex Court also held that the earlier rulings in the case of SRF Ltd. v. Commissioner (2016 (331) ELT A 138 (S.C.) and Commissioner of Central Excise v. Coca Cola India Pvt. Ltd (2007 (213) ELT 490 (S.C) merely affirmed the rulings of the CESTAT on the issue of revenue neutrality but without any independent reasoning and hence their precedential value will be limited. We shall submit that although the divergent views exist as regards the contention of revenue neutrality to excuse oneself from any payment at all, the law is yet to fully develop and settle. However, although it was not contended in the present case the proposition that in a revenue-neutral situation there cannot be an intent to evade so as to permit the invocation of a larger period of limitation and impose a penalty has been fairly settled.
Limitation
15. It was also contended that the demands beyond the normal limitation period cannot be sustained as there have been no mala fides in the case. Apex Court agreed with the contention relying on several precedents (Cosmic Dye Chemical v. Collector of Central Excise ((1995) 6 SCC 117)) to hold that demands beyond the normal period of limitation cannot be sustained.
Conclusion
16. All in all, we would say that the given decision rests only on the particular set of facts involved in the case. It cannot be considered as gospel so as to apply to every secondment arrangement. Also, the doctrine of substance over form as remarked in the given decision has to be read in the context of interpreting the nature of the contractual relationship between the parties considering the specific provisions of law involved and the same also cannot be considered as gospel so as to permit the application in each and every situation. A form of a transaction has to be inferred to be the substance in the absence of fraud or overwhelmingly compelling factual circumstances indicating otherwise.
17 In the end, we refer to the decision in the case of Union of India and Others v. Play World Electronics Pvt. Ltd. and Another (1989) 3 SCC 181 wherein the Supreme Court has held that the taxing authorities cannot ignore the legal character of the transaction and tax it on the basis of what may be called ‘substance of the matter’. One must find the true nature of the transaction. The said principle deserves to be followed.
(Views are strictly personal)
Author Bio
