09 Sep 2015 17:52 IST

Determining tax residency for foreign companies in India

However, there are no clear guidelines yet to determine Place of Effective Management

When writing this article, I realised that the concept I’m going to explain in this article, Place of Effective Management, abbreviated as POEM. A poem, by definition, is intended to convey a deeper meaning than the limited words it is expressed in. A short lyrical stanza conveys much more in emotions than the words use to explain it.The concept of PoEM is somewhat identical to its literary namesake.

Historically, a company was considered to be a resident in India if it was an Indian company (i.e. a company registered under the Indian corporate laws) or if the control and management was situated “wholly” in India. However, with effect from 01 April 2016 the criteria for determining the residential status of foreign companies under the Indian Income-tax laws was changed and the words “control and management” was substituted with the term “Place of Effective Management”.

In other words, a company is said to be a resident in India in any previous year if (a) it is an Indian company or (b) its place of effective management is in India.

Further, it has been clarified that PoEM refers to the place where the key management and commercial decisions that are essential to the overall functioning of the business are taken.

Why the Amendment?

It is a well-established fact that large Indian corporate houses are still largely promoter/ promoter family controlled entities. These corporate houses have overseas presence as well. The intent behind this amendment to the Indian tax laws is to ensure that these overseas subsidiaries of Indian corporate houses are also brought within the tax net, given the perception that these overseas subsidiaries are also “effectively managed” from India. These amendments, in some form, seek to extend the scope of source rule of taxation.

What does Place of Effective Management actually mean?

PoEM places more stress on where the key decisions (which could include strategic/ operational decision) are taken as against the control and management concept which is more aligned towards top/ strategic management. The distinction is fine – but it ensures that the stress is placed on substance as against form.

The concept of PoEM, even though has been around for a while, is still evolving given that there are no clear guidelines as to how to determine the existence of PoEM even in an international context. It is a highly subjective exercise and relies heavily on the manner in which the business works and decision-making chain is distributed

To give an example, say an Indian company has a wholly owned subsidiary in Singapore. Naturally, the Indian company will form a majority of the Board composition of the Singapore Company.

The decision to incorporate a subsidiary in Singapore was decided in India, what business they chose to do is also decided in India. Therefore, how do you establish that the effective management is not in India – or to put it the other way around, simply because the Singapore subsidiary will function within the overall corporate policies and manner of working of its Indian parent, can a PoEM said to be triggered in India for the Singapore subsidiary?

If that is the case, no Indian company can ever set-up a subsidiary abroad.

This brings to light the important element missing in the proposed law – unless there is a criteria which is quantifiable/ measurable, the applicability of any law becomes subjective, and any law which can be applied subjectively will by its very nature be against the interests of the taxpayer. Now, you can say that this is a very negative view I am taking of the matter, but history of Indian tax litigation proves otherwise. Rather than having Courts interpret the matter and set guidelines, one would prefer the tax authorities to issue clarifications – this would help in avoiding unnecessary litigation.

Additionally, the Government may also consider having a helpdesk which acts as a forum to resolve any queries from taxpayers on POEM trigger in their fact pattern.

What next?

In light of the recent changes, in terms of the level of control on the overseas subsidiary exercised out of India, caution needs to be maintained. Even though the guidelines in this regard are yet to be set out by the Indian tax authorities, it is safe to assume that the same would be in line with International standards, given that the intention behind this recent amendment was to make the Indian tax laws in line with international jurisprudence.

This amendment is critical for Indian corporate groups having outbound investments and in a scenario where the overseas entity is profitable and its PoEM is found to be in India, the risk is even higher given the tax and related compliances which may follow for such an entity.

Therefore, most companies have begun looking at their organisational structure to figure out areas of weakness and have begun addressing them in a systematic manner. Gone are the days when a “wait and watch” approach worked – prevention is better than cure is the mantra now.

Shravan Srinivasan of EY also contributed to the article.

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