You control them daily, but you're not the employer: Supreme Court.

When an Employee is Not an Employee: The Secondment Trap That Cost Northern Operating Systems

Northern Operating Systems Pvt. Ltd. (NOS), a Bangalore-based Indian company, thought it was doing everything right. It deducted tax on salaries. Contributed to provident funds. Exercised day-to-day control over employees sent from its global parent, Northern Trust Company. For sixteen years, it treated these secondees as its own staff. Then the taxman arrived with a different story: NOS wasn't an employer at all. It was a customer, buying manpower from its own group companies. The Supreme Court of India, in a judgment dated May 19, 2022, agreed with the taxman. The result? A service tax demand that could reshape how every multinational structures its Indian back-office operations.

The Arrangement That Looked Like Employment

NOS provided IT-enabled back-office services to its overseas group companies. To do this, employees from those overseas entities were sent to work in India under secondment agreements. The paperwork looked like employment: NOS deducted tax at source on salaries, contributed to provident fund, and directed the employees' daily work. The overseas company paid the salaries and then claimed reimbursement from NOS. It was, on its face, a straightforward intra-group transfer of talent.

The Commissioner of Service Tax, Bangalore, didn't buy it. On March 3, 2014, the Commissioner confirmed service tax demands for the period October 2006 to March 2012, holding that the secondment arrangement was really a supply of manpower by the overseas company to NOS. The extended period of limitation under Section 73(1) proviso of the Finance Act, 1994 was invoked. But then, in a twist, the same Commissioner dropped demands for later periods (April 2012 to September 2014) on February 27, 2017, relying on the CESTAT ruling in Volkswagen India Pvt. Ltd. v. CCE, Pune-I (2014 (34) STR 135).

The Customs, Excise and Service Tax Appellate Tribunal (CESTAT) went further. On December 23, 2020, it allowed NOS's appeals entirely and rejected the Revenue's appeals. CESTAT held that the overseas companies were not in the business of supplying manpower, and that NOS was the real employer. The Revenue appealed to the Supreme Court.

What Each Side Argued

The Revenue's case was straightforward: look at the substance, not the form. The secondees remained on the overseas company's payroll for social security purposes. They had a right to revert to their original employer after the secondment period. Their salary structures followed global policies set by the overseas entity. This, the Revenue argued, was not a contract of service (employment) but a contract for service (manpower supply). The overseas company was providing a service to NOS, and NOS was liable for service tax under Section 65(68) read with Section 65(105)(k) of the Finance Act, 1994 (pre-2012) and under the negative list regime post-2012.

NOS countered with a simple proposition: control equals employment. The company pointed to its day-to-day supervision of the secondees, its deduction of tax, and its provident fund contributions. It relied on the classic control test from Dharangadhara Chemical Works Ltd. v. State of Saurashtra (1957 SCR 158), which held that the right to supervise and control the manner of work execution is the prima facie test for a master-servant relationship. NOS also cited Volkswagen and Computer Sciences Corporation India Pvt. Ltd. v. Commissioner of Service Tax (2014-TIOL-434-CESTAT DEL), where CESTAT had held that secondment expenses were not taxable as manpower supply service. The company argued that no country in the world levies VAT or GST on employment services.

The Witness Rule the Supreme Court Applied

The Supreme Court, in a judgment authored by Justice S. Ravindra Bhat (with Justice Uday Umesh Lalit and Justice Pamidighantam Sri Narasimha concurring), rejected NOS's argument. The Court held that the control test alone is not determinative. Instead, it applied the framework from Sushilaben Indravadan Gandhi v. New India Assurance Co. Ltd. (2021) 7 SCC 151: no single test determines a contract of service versus a contract for service; a conglomerate of all applicable tests on the totality of facts is required.

The Court examined the secondment agreements in detail. It found that the secondees remained on the overseas company's payroll for social security purposes. They had a right to repatriation. Their salary structures followed global policies set by the overseas entity. The overseas company bore the risk of non-payment. These factors, taken together, established that the overseas company was the real employer. NOS, despite its operational control, was merely the recipient of a manpower supply service.

The Court followed Commissioner of Income Tax v. M/s. Eli Lilly & Company India Pvt. Ltd. (2009) 15 SCC 1, which held that TDS provisions under the Income Tax Act apply to salary paid by a foreign employer to seconded expatriates in India. It also relied on Director Income Tax v. M/S Morgan Stanley & Co. Inc. (2007) 7 SCC 1, which held that a deputationist retains a lien on employment with the parent company and does not become an employee of the host entity. The Court overruled Volkswagen and Computer Sciences Corporation, noting that the Supreme Court had merely affirmed those decisions without independent reasoning.

THE TEST: To determine whether a secondment arrangement is manpower supply or employment, apply a conglomerate of tests: payroll retention, repatriation policy, salary structure, lien on employment, social security contributions, and risk allocation. Operational control by the host entity is not determinative.

Why the Substance-Over-Form Doctrine Won

The Court applied the substance-over-form doctrine, citing State of Orissa v. Titaghur Paper Mills Co. Ltd. (1985 Supp SCC 280): the nomenclature of a contract is not determinative; the nature is determined from all terms, clauses, and results. The secondment agreements were labelled as "secondment" or "deputation," but the economic reality was a supply of manpower. The overseas company provided a service—making its employees available to NOS—and NOS paid for that service through reimbursements.

The Court also addressed the post-2012 regime under Section 65B(44) of the Finance Act, 1994, which defines "service" broadly. The Court held that the arrangement fell within this definition, as it was an activity carried out by the overseas company for a consideration (the reimbursement). The fact that the overseas company was not in the business of supplying manpower was irrelevant; what mattered was that it supplied manpower to NOS as part of its group operations.

What This Means for Practitioners

This judgment is a game-changer for multinational companies operating in India through secondment arrangements. The key takeaway: if your secondees remain on the overseas payroll, have a right to revert, follow global salary structures, and are covered by the overseas entity's social security, you are likely a service recipient, not an employer. The service tax (now GST) liability falls on you.

The Court left open the question of valuation—whether the reimbursement of salary constitutes "consideration" and how to value the service under Section 67 of the Finance Act. This means that even if you accept liability, the quantum of tax may still be contested. But the liability itself is now settled.

For companies that have already paid service tax on secondment arrangements, the judgment may provide a basis for claiming refunds or credits. The Court noted but did not decide the applicability of Rule 5 of the CENVAT Credit Rules, 2004 for refund of CENVAT credit. This remains an open issue for future litigation.

The Bottom Line

If your company second employees from overseas group entities, and those employees remain on the overseas payroll with a right to revert, you are the recipient of a manpower supply service and must pay service tax (now GST) on the consideration paid to the overseas entity—regardless of how much operational control you exercise over those employees.