The financial year 2017-2018 is a significant period, especially from an Indian taxation point of view. Along with Goods and Services Tax (GST) (expected to revolutionise the Indirect Taxation field of law, application and administration), some core principles applicable to Direct Taxation (Income Tax) are also being redefined, one of which is the ‘tax residency’ (residential status) criteria for Companies under section 6(3) of the Income Tax Act 1961 (the Act).
Place of Effective Management (POEM)
Prior to its amendment, the above said provision determined a Company as a resident in India for any previous year, if either, it was an Indian Company (incorporated under the Companies Act 2013/1956 as such) or, if during the said year, the control and management of its affairs was situated wholly in India. The latter criterion thus easily enabled many such Companies avoid such residency and the full application of the Act, whilst they simultaneously also continued to benefit from favourable Tax Treaties (DTAAs etc.).
The rules of the game now are expected to change significantly through the ‘Place of Effective Management’ (POEM) criterion with effect from 1 April 2017 (Assessment Year 2017-18 onwards), wherein the said provision will apply as follows —
“Residence in India
6. For the purposes of this Act,—
(3) A company is said to be a resident in India in any previous year, if—
(i) it is an Indian company; or
(ii) its place of effective management, in that year, is in India.
Explanation.— For the purposes of this clause “place of effective management” means a place where key management and commercial decisions that are necessary for the conduct of business of an entity as a whole are, in substance made.
The POEM criterion is however not unknown to many other taxation jurisdictions and also finds mention in many international tax treaties to which India is also a signatory, which now seeks to closely align the relevant provision of the Act with this international yardstick or standard.
Guiding Principles for Determination of Place of Effective Management (POEM) of a Company (Guidelines)
The Indian Government has recently (24 January 2017) released the ‘Guidelines’ (click for link) to determine the tax residential status of a Company under POEM, which through its Official Press Release (click for link) states the following features —
- ‘Active Business Outside India’ (ABOI) Test provided, so as not to cover companies outside India which are engaged in ‘active business’.
- The intent is not to target Indian Multi Nationals which are engaged in business activity outside India, the intent is to target ‘shell’ Companies and Companies which are created for retaining income outside India although real control and management of affairs is located in India.
- The Guidelines are not intended to cover foreign Companies or to tax their global income, merely on the ground of presence of ‘Permanent Establishment’ or ‘Business Connection’ in India.
- Adequate administrative safeguards incorporated in the Guidelines by mandating that the Assessing officer (AO), before initiating inquiry for POEM in a case of a taxpayer, seek approval from Principal Commissioner of Income Tax/ Commissioner of Income-tax.
- The AO to also obtain approval from ‘Collegium’ of Principal Commissioners of Income-tax before holding that POEM of a non-resident Company is in India.
- Further decided that the POEM guidelines shall not apply to companies having turnover or gross receipts of Rs.50 Crore or less in a financial year.
The ‘ABOI’ Test is the principal test and the satisfaction of which may enable the concerned Company avoid being declared a resident of India under the Act and POEM thereunder.
> This test defines and relies on the share of ‘Passive Income’ to ‘Total Income’, location and valuation of ‘Total Assets’ and the location and ‘Payroll Expenses’ of the Employees, of the concerned Company.
> Further, for such a Company, the Guidelines provide a rebuttable legal presumption that its POEM is outside India if the majority meetings of the Board of Directors are held outside India.
However, mere satisfaction of the above said objective criteria may not get the Company over the line, as the Guidelines themselves state the following —
“6. Any determination of the POEM will depend upon the facts and circumstances of a given case. The POEM concept is one of substance over form. It may be noted that an entity may have more than one place of management, but it can have only one place of effective management at any point of time. Since “residence” is to be determined for each year, POEM will also be required to be determined on year to year basis. The process of determination of POEM would be primarily based on the fact as to whether or not the company is engaged in active business outside India.
7.1 However, if on the basis of facts and circumstances it is established that the Board of directors of the company are standing aside and not exercising their powers of management and such powers are being exercised by either the holding company or any other person (s) resident in India, then the place of effective management shall be considered to be in India. ………….”
For Companies not engaged in ‘active business outside India’ as determined under the Guidelines, they can still meet the POEM criterion for being considered non-resident under the Act through a ‘two stage process’ (the Process) as follows —
First stage> The identification or ascertaining of the person(s) who actually make the key management and commercial decision for conduct of the Company’s business as a whole.
Second stage> The determination of place where these decisions are in fact being made.
Other Important Factors and Relevancy for Internet/Online/eCommerce Foreign Companies
The Guidelines state that the place where these management decisions are taken would be more important than the place where such decisions are implemented. The Guidelines then lists some of the guiding principles which may be taken into account for determining the POEM, which include the following (directly relevant for internet/online and ecommerce based Foreign Companies with Indian subsidiaries/AEs/PEs/Trade Partners/BPOs etc.) —
- The location of a company’s ‘Head Office’ (defined by the Guidelines) will be a very important factor in the determination of the company’s place of effective management.
- Members of the ‘Senior Management’ (defined by the Guidelines) may operate from different locations on a more or less permanent basis and the Members may participate in various meetings via telephone or video conferencing rather than by being physically present at meetings in a particular location. In such situation, the head office would normally be the location, if any, where the highest level of management (for example, the Managing Director and Financial Director) and their direct support staff are located.
- In situations where the Senior Management is so decentralised that it is not possible to determine the Company’s Head Office with a reasonable degree of certainty, the location of a company’s Head Office would not be of much relevance in determining that Company’s place of effective management.
- The use of modern technology impacts the place of effective management in many ways. It is no longer necessary for the persons taking decision to be physically present at a particular location. Therefore, physical location of board meeting or executive committee meeting or meeting of senior management may not be where the key decisions are in substance being made. In such cases the place where the directors or the persons taking the decisions or majority of them usually reside may also be a relevant factor.
If the above said criteria or factors do not lead to clear identification of POEM for a subject Company, then the Guidelines provide ‘secondary factors’ for consideration as follows —
- Place where main and substantial activity of the Company is carried out; or
- Place where the accounting records of the Company are kept.
Scope for Subjective Interpretation
Contrary to the need for certainty and clarity in Taxation, the Guidelines through the words and language used in certain provisions (as reproduced below), provides opportunities for subjective (and potentially arbitrary) interpretation of its provisions by the relevant authorities despite some procedural safeguards against the Assessing Officers (AOs), which could lead to consequential and constant litigation on the matter and not serve any purpose.
“9. It needs to be emphasized that the determination of POEM is to be based on all relevant facts related to the management and control of the company, and is not to be determined on the basis of isolated facts that by itself do not establish effective management, as illustrated by the following examples:
10. It is reiterated that the above principles for determining the POEM are for guidance only. No single principle will be decisive in itself. The above principles are not to be seen with reference to any particular moment in time rather activities performed over a period of time, during the previous year, need to be considered. In other words a “snapshot” approach is not to be adopted. Further, based on the facts and circumstances if it is determined that during the previous year the POEM is in India and also outside India then POEM shall be presumed to be in India if it has been mainly /predominantly in India. ……..”
The Guidelines have been structured in a manner and drafted in a language that would constantly encourage subjective interpretation of the same and lead to consequential litigation. Furthermore, the late release of these Guidelines provides very little time to established Companies to adapt accordingly. Newly setup Companies, especially online/internet and ecommerce based, may also find the Guidelines complex, challenging and uncertain.
I was recently pressed for a ‘magic formula’ on the matter by a potential client seeking corporate restructuring, my view unchanged is that there is ‘no one size fits all’. At the very least, much would depend on an in-depth understanding of the concerned Company’s ‘mechanics’, priorities (and that of its Stakeholders) as well as the benefits targeted in exchange for those sacrificed for achieving the same. This view is further informed by recent developments in the field which includes implementation of anti-avoidance measures such as General Anti Avoidance Rules (GAAR) with effect from 1 April 2017 and BEPS initiatives of various Governments, including to pre-empt situations like the ‘Panama Papers‘.
Important Note – The ”Guidelines‘ and ‘Official Press Release‘ have been edited by the author and only parts of the same have been reproduced (in italics) or commented upon in this Article. It is therefore advised and recommended that both the documents be read and analysed in their entirety and that this Article not be relied on in any manner, including as a comprehensive commentary or analysis of the said documents or subject matter.