Karnataka HC Rules That Salary Paid To The Foreign Nationals Cannot Be Subjected To IGST As Import Of Service Where There Is A Direct Employer–employee Relationship Between The Indian Company And Foreign National

Karnataka HC rules that salary paid to the Foreign Nationals cannot be subjected to IGST as import of service where there is a direct employer–employee relationship between the Indian Company and Foreign National

BRIEF FACTS OF THE CASE

• The Petitioner is a part of the Huawei Group of Companies headquartered in China. It is engaged in providing Software Development Services and Information Technology Enabled Services to its related companies in India and abroad.
• When vacancies arise in any Huawei group company, including the Petitioner, the positions are first offered to employees within the Huawei Group to maintain organisational culture and preserve the specialised expertise of employees at a global level. The Petitioner hires employees through a standard process that includes the employment of foreign nationals.
• After receiving applications, the Petitioner evaluates candidates and issues offer letters to selected candidates. Once the offer is accepted, a formal employment contract is signed between the Petitioner and the candidate.
• The employment period of foreign nationals may be extended based on the Petitioner's business needs and the employee's visa renewal. After completing their work with the Petitioner, foreign nationals may also seek employment in other Huawei group entities abroad.
• The Department, while initiating the proceedings, sought information about payments made to foreign nationals working for the Petitioner. As a consequence, the Department issued the intimation requiring the Petitioner to pay IGST under the Reverse Charge Mechanism [RCM] on the salary paid to expatriate employees for the period 2018-19 to 2022-23, classifying the same as ‘import of service'.
• Despite Petitioner's rebuttal to the intimation, the Department issued the impugned Show Cause Notice (SCN) dated 23.12.2023 on the ground that the Petitioner had imported 'Manpower Recruitment and Supply Service' from the foreign nationals/employees, who were allegedly supplying the said services in the capacity of non-residenttaxable persons.
• Aggrieved by the Show Cause Notice, the Petitioner approached the Hon'ble Karnataka High Court through a Writ Petition, contending that salary payments to the foreign national employee do not attract IGST under GST law, as such employer-employee remuneration falls outside the definition of "supply" per Entry 1, Schedule III of the CGST Act, 2017, which explicitly excludes services provided by an employee to employer in the course of employment.

KEY OBSERVATIONS OF THE HON'BLE HIGH COURT

• The Hon'ble High Court of Karnataka, on examining the record, held that the case did not involve the secondment of employees from other entities in the group but a direct employer-employee relationship between the Petitioner and the Foreign Nationals/ Employees. Accordingly, the entire transaction is outside the ambit of GST as the transaction is covered under Entry 1 of Schedule III of the CGST Act, 2017, which states that services provided by an employee to the employer in the course of or in relation to his employment are neither a supply of goods nor a supply of services under the CGST Act, 2017.
• The Court found that the employer-employee relationship is clearly established through employment contracts stipulating the fixed tenure, reporting authority, working hours, cost to company and service conditions, the expatriates were on the Petitioner's Payroll with salary and benefits credits to their Indian Bank Accounts, deduction of income tax by the Petitioner and filing of returns in India by the Foreign Nationals and the Foreign Nationals were being treated at par with Indian employees in terms of remuneration and social security; in such circumstances, the Department could not adopt a different treatment for GST purposes.
• On that basis, the Court observed that the aforesaid facts and circumstances clearly indicate that the demand for IGST cannot be imposed on 'salary' paid in lieu of employment of the foreign national with the Petitioner. Consequently, the arrangement between the foreign national and the Petitioner is not a supply under the CGST Act, 2017, and is squarely covered under Entry 1 of Schedule III of the CGST Act. As such, the Petitioner is not liable to pay IGST on the present transaction, which is not a taxable supply in terms of Entry 1 of Schedule III of the CGST Act, and the impugned show cause notice deserves to be quashed.
• The Court further held that the foreign national employees cannot be considered as ‘non-resident taxable persons' under Section 2(77) of the CGST Act as they are not making occasional supplies; they are not performing transactions as principal or agent; they have a fixed place of residence in India (provided with fully furnished rent-free accommodation); and they qualify as ‘residents' under the Income-tax Act with their salaries being subjected to income tax. Since the supplier is located in India and is not a non-resident taxable person, the conditions under Section 2(11) of the IGST Act are not satisfied, and the subject transaction is not an import.
• The Court also relied on CBIC Circular No. 210/4/2024-GST dated 26.06.2024, which clarifies that where a supply is made between related parties and the recipient is eligible for full input tax credit, the taxable value is to be taken as the open market value declared in the invoice, and where no invoice is issued, the open market value is deemed to be “Nil”. Applying this clarification, the Court held that since the Petitioner had not raised any invoice, the value of the alleged supply had to be treated as Nil and, consequently, no tax was payable. It therefore followed that, in the absence of any tax liability, no interest or penalty could be levied on the Petitioner
• The judgment draws a fact-sensitive distinction from the Supreme Court's decision in CC, CE & ST, Bangalore (Adj), etc. vs. M/s Northern Operating Systems. In Northern Operating Systems, the Expatriates were treated as remaining closely anchored to the foreign group entity, with the Indian Company more like a host. They remained on the foreign employer's payroll, with the Indian Company merely reimbursing the overseas company for salary cost, and they retained a lien of their original employment with continued entitlement to social security benefits in their home country. In contrast, the Huawei involved a direct employer-employee relationship with no intermediary foreign entity. The foreign nationals were directly recruited by Huawei India through an employment contract, placed on the Indian entity's payroll, with salaries, bonuses, and provident fund paid directly into Indian Bank accounts, and subjected to TDS deductions and Indian tax filings as residents under the Income Tax Act. They were treated on par with Indian employees in terms of salary and social security benefits, demonstrating full integration into the Indian employment framework and distinguishing it from the temporary secondment at Northern Operating Systems.
• While the ruling does not directly conflict with the Supreme Court's Northern Operating Systems decision, it does create a fact-specific distinction that will influence future litigation. The Revenue authorities may still rely on Northern Operating Systems in cases where the factual matrix shows less integration of expatriates into the Indian entity. The Court has identified key differentiating factors such as execution of employment contracts with the Indian entity, payroll placement with TDS deduction, operational control by the Indian entity, provision of statutory employment benefits under Indian labour laws, and continuation of foreign social security obligations purely for regulatory reasons. These factual nuances will be central to determining whether the Schedule III exclusion applies in future cases.
• The Court's reliance on the Circular further indicates that GST is intended to apply to commercial supplies, and not to cut across genuine employment relationships that are expressly excluded from the scope of the supply. Thus, if, in substance, the expatriate functions as an employee of the Indian entity, the GST framework should not be stretched to characterise the same relationship as a cross-border manpower service merely because a group structure or cost-sharing mechanism exists in the background.

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