The Finance Act 2015 had proposed to amend the test of residence for foreign companies to provide that a company would be treated as resident in India if its place of effective management in the previous year is in India. Earlier, section 6 of the Income-tax Act, 1961 (the Act) referred that, a company is considered to be an Indian resident company, only if it is incorporated in India or the control and management of its affairs is situated wholly in India.
As per the amendment, a company shall be considered an Indian resident company if:
- It is incorporated in India; or
- Place of effective management, in that year, is in India.
"Place of effective management" has been defined to mean a place where key management and commercial decisions that are necessary for the conduct of the business of an entity as a whole are, in substance, made. In the recent budget 2017 announced on February 1st 2017, the Government said it aims to target the shell companies that are created to evade taxes through the place of effective management (POEM) rules, but excluded firms with an annual turnover of less than Rs 500 million from its purview. The Central Board of Direct Taxes (CBDT) made public the long-pending "guiding principles" to determine place of effective management of a company, which have been effective April 1st 2016.
The PoEM rules with an aim to assess the tax liability was to come into effect in the current fiscal. The final guidelines have now been issued. The main objective of introducing PoEM, was to ensure that the companies incorporated outside India, but controlled and managed from India do not escape taxation in India. It also brings in the concept of residency of corporates in line with internationally-accepted principles said Neeraj Bhagat, founder of Neeraj Bhagat & Co, an Indian Chartered Accountancy firm serving various MNC'S from across the globe.
"The final guidelines on POEM contain some unique features. Active Business Outside India (ABOI) test has been provided so as not to cover companies outside India which are engaged in active business," CBDT said in a statement. The guidelines prescribed to determine PoEM of a non-resident is indeed welcome as it ushers in certainty for foreign investors in terms of applicability and the procedure to be followed by the revenue authorities. The final guidelines address some of the issues highlighted by the stakeholders, such as determination of PoEM in case of back-office/support services, existence of PE, meaning of certain terms, methods used in the active/passive business tests, shareholders’ activity, etc.
Tax payers likely to be affected by PoEM are:
- Foreign companies having Indian branches
- Foreign subsidiaries of Indian parents
- Foreign company having global reporting structure with an India connection
- Regional headquarters
Activities likely to trigger PoEM are:
- Board meeting in India
- Decisions taken by a Director, Executive Committee, Key Management Personnel in India Delegation of authority from India
- Regional roles e.g. Group CEOs / CFOs sitting in India and approving decisions for foreign affiliates
- Functions carried on in India e.g. Global Procurement Cell of foreign companies
Draft PoEM guidelines:
The place of effective management of a company conducting active business outside India shall be considered to be outside if majority of board of directors meetings of the company are held outside India or it its assets, employees, income, and employee expenses are from outside India. For a company whose directors are not involved in decision making and such decision making powers are exercised by a holding company or a person resident of India, then the company is considered as a resident under the place of effective management rules.
- For determining whether a company is active outside India, the average of past 3 years data are taken into consideration.
- In case if a company's board delegates its powers to a committee, then the location where the members of the committee formulating the key decisions is considered as the place of effective management of the company.
In case of use of technology such as telephone or video conferencing by the board members in conducting meetings, the location of head-office is considered as place of effective management. It is not necessary for the person taking decisions to be physically present at a particular location.
Further, Support function is an important part of the business, but is not the decisive part of the conduct of business and hence presence of support function in India shall not tantamount to effective management in India. Also, the concept of separate legal entity shall prevail and the corporate veil shall not be lifted.
A permanent establishment (PE) of a foreign company is a separate legal entity and shall not be considered as place of effective management of the foreign company in India.
It is imperative to note that having a PE in India is vastly different from having PoEM in India, since having a PE shall mean the income related to the PE is taxable in India; however, having PoEM in India means that the worldwide income of the foreign company is taxable in India.
However, overseas-incorporated entities held to have PoEM in India would face some of the following challenges:
- Tax rate to be applied on computed income
- Applicability of minimum alternate tax (MAT) provisions, given foreign companies are outside the ambit of MAT (in the absence of Permanent Establishment in India)
- Applicability of Dividend Distribution Tax on payments made by such companies to overseas group entities
- Set-off of claims for foreign taxes paid by such companies
- Applicability of transfer pricing provisions versus specified domestic transactions
- Consequential withholding tax implications
(Source: Neeraj Bhagat, at the Institute of Chartered Accountants of India)
