The introduction of UAE’s corporate tax– and a withholding tax regime in the near future – has put the spotlight on cross-border employee secondments.
Until last year, multinationals were not worried about employees from group entities being deputed to work in the UAE at one of their subsidiary companies. The physical presence of such employees in the UAE did not expose the overseas entity’s profits to any tax risks here.
Such global mobility arrangements with UAE companies merit a review considering the inherent tax challenges on cross-border secondments.
For multinationals, it is a common practice for employees of a group entity based in one country - say, in the US, which is where the corporate headquarters is - to be placed with a group entity in another geography to provide managerial and/or technical services.
For the continuity of employment tenure, retirement benefits, social security entitlements in the home country, the employees continued on the payroll of the home entity. It will have an inter-company agreement with the host entity to recover the payroll costs without any mark-up. The host entity recognises such costs as its own payroll costs in the books of account.
The seconded employees are operationally directed and supervised by the host entity under separate employment contracts especially for visa purposes. Once the secondment is over, the employees either return to the home entity or assigned to other group entities.
Permanent establishment
A foreign entity could fall under the scope of UAE corporate tax if it has a ‘permanent establishment’ in the UAE. This could be formed under various scenarios including ‘place of business permanent establishment’ and ‘service permanent establishment’.
Having a permanent establishment in the UAE obliges the foreign entity to pay corporate tax on its global profits as is attributable to such permanent establishments. And also ensure tax compliance, including tax registration.
The secondment agreements have been often challenged by tax authorities - in India, South Africa, China - as to whether it constitutes a ‘contract for service’ or a ‘contract of service’. If the contract is ‘for’ services by the home entity, the physical presence of its employees in the UAE to provide such services could result in a permanent establishment.
The tax authorities argue that secondment agreements constitute a contract for manpower supply services.
On the other hand, the corporations defend such agreements as a payment conduit on behalf of the host entity for primarily two reasons.
- The employees remains under the control and supervision of the host entity.
- No profit mark-up is charged on the recovery of the payroll costs.
India's Supreme Court recently made subtle distinctions to determine the tax implications. The host entity only has an operational relationship with seconded employees for daily work, but the legal control remains with the home entity including the right to terminate employment, relocate to another geography, etc.
The host entity can only ask an employee to return back to the home entity (for misconduct or failure to perform duties) but cannot terminate their employment. It does not even have a right to select employees who should be seconded by the home entity. The absence of ‘mark-up’ on the reimbursement of payroll cost has been held as not determining the nature of such a transaction.
These principles could directly impact the tax exposures of foreign entities deputing their employees to the UAE group companies.
VAT and withholding taxes
The secondment agreements were initially reviewed for determining reverse charge mechanism obligations under the UAE VAT laws. Many UAE companies have already recognised such payroll costs as a supply of service by the overseas/home entity in their VAT returns and reported reverse charge mechanism VAT thereon.
Once the withholding tax rates are increased from the current 0 per cent, the obligation to withhold tax from the remittance of such payroll costs would get immediately triggered. In the light of tax position taken by the host - the UAE entity - the home entity may face a significant challenge in defending that it does not form a permanent establishment in the UAE through its employees.
