Corporate Tax Compliance: A New Challenge for KMP

Summary: The intricate relationship between corporate law and tax law has evolved significantly, placing a greater emphasis on the personal accountability of Key Managerial Personnel (KMP). Modern fiscal rules have expanded beyond traditional tax compliance, requiring KMP to navigate complex legal landscapes and fulfill broader responsibilities. The “intention” and “objective” behind corporate tax decisions are now scrutinized closely, demanding transparency and careful record-keeping. The corporate veil, once sacrosanct, is being pierced more frequently in the context of anti-avoidance measures and indirect transfer taxes. Related party transactions, once primarily regulated by corporate law, are now subject to more rigorous scrutiny under tax regulations. The residential status of a company, determined by the “place of effective management,” has become increasingly important. Directors, regardless of their role, are held accountable for the company’s tax obligations, emphasizing the need for meticulous record-keeping. International tax cooperation and anti-money laundering regulations have further complicated the landscape for KMP. Overall, the intersection of corporate law and tax law has transformed the role of KMP, requiring them to adopt a more proactive and informed approach to tax compliance and fiscal strategy.

Modern fiscal rules are changing agenda of board: A Reflection

Overview

Since the separation of corporate ownership from management began, the corporate scene has changed significantly and professional management structures aiming at maximising shareholder profits have been developed. In response to consecutive legislative changes in corporation law and increased expectations for corporate governance, especially for publicly listed companies, a lot of statutory duties and standard operating procedures have developed and demand rigorous compliance from corporate management. Modern legal and regulatory systems, however, are growingly linked and extend the range of responsibilities beyond those defined just within the company law framework. Apart from the traditional tax compliances resulting from the tax law framework, the fiscal law paradigm has become one of the most important drivers of this expansion, hence extending the scope of obligations that corporate boards and important managerial individuals must fulfil. Given these important changes in fiscal policies, Key Managerial Personnel (KMP) find themselves in a complicated scenario fit for thorough review.

Emphasise specific roles

Now clearly established also under tax legislation is the basic corporate law premise arguing that a corporate body has a unique legal personality apart from its shareholders. Logically, this should mean that the non-compliant corporate body should bear only responsibility for the consequences of non-tax law non-compliance, including interest and penalties, without affecting the corporate management. Tax laws have gradually changed to specifically assign criminal liability to important managerial personnel of the company, though, in addressing the consequences of the Supreme Court’s historic decision in Standard Chartered Bank – a watershed moment in the junction of criminal law and corporate law foundations that highlighted lawmakers’ inability to incarcerate corporate personnel for company offences. Modern financial laws really expressly state KMP as personally “deemed to be guilty” of offences carried out by the corporation.

Beyond the legislative attribution of criminal behaviour to KMP, a thorough review of current tax laws in India reveals increased scrutiny of the individual affairs of KMP, particularly directors, to assign responsibility to them even in cases of company, civil infractions of which. Moreover, certain clauses in fiscal rules even assign the company’s tax obligation to the KMP under particular conditions. As such, the personal obligations and behaviour of KMP have become very crucial in deciding their vulnerability to financial regulations.

Finding ‘Intent’ and ‘Objective’ of the Corporate Taxpayer

Modern fiscal rules, underlined by court interpretation, give great weight on identifying the “intention” and “objective” of the taxpayer, so requiring an analysis of the justification behind specific tax policies taken by corporations. This need results in a careful evaluation of internal firm performance by tax officials. Revenue authorities so regularly search internal corporate records, especially board minutes clarifying the main causes underlying firm choices, and usually treat them as proof to support or ascribe claims of contumacious behaviour. In anti-avoidance investigations and cases of suspected tax cheating, where fiscal legislation allows the ascertainment of underlying intent and affixation of criminal intent to the KMP, respectively, the criticality of corporate data is especially obvious. Practically, this feature has driven corporate boards to regularly seek legal and expert opinions before formalising decisions, trying to clearly define possible tax consequences and carefully record bona fides in the decision-making process, especially in cases involving complicated fiscal rules and divisive tax positions.

Legislative Action Regarding Corporate Veil Piercing

Except in cases where court review has required piercing the corporate veil, the separate entity principle—the cornerstone of corporation law—has historically been maintained in fiscal laws as well. Though once regarded as an aberration, the breaching of the corporate veil is now progressively approved under fiscal laws. Whether in particular circumstances (such as the broad scope of “related persons’ in fiscal laws) or on an omnibus basis (as in the context of anti-avoidance rules), the legislature seems to have acknowledged the growing concerns voiced by Revenue authorities concerning the proliferation of tax avoidance through sham corporate structures. Beyond the anti-avoidance drive, this trend is seen in the substantive changes to income tax law to implement an indirect transfer tax (generating a tax charge in India even for offshore transactions), so reflecting legislative resolve in according sanction to disregard corporate structures for tax purposes. As such, tax issues are now regularly on the agendas of offshore corporation boards, which calls for careful thought and strategic preparation.

Related Party Transactions: The Common Fulcrum Linking Corporate and Tax Law

Corporate governance rules and tax regulations have an interesting interdependence since both fields give particular focus on analysing related party transactions (RPTs). From an approach point of view, the two legal systems differ conceptually. With the underlying goal of protecting company stakeholders’ interests against possibly negative promoter behaviour, corporate law provides a specialised structure for controlling RPTs, mandates particular scrutiny by the Audit Committee, and imposes additional reporting responsibilities. Although they insist on monitoring RPTs, tax regulations mostly serve to assure their subordination to market-rate benchmarking. Still, there is an interlaced interface between the two legal spheres whereby both generally follow the arm’s length criterion as the basic foundation for closely examining RPTs. But company law refrains from exploring the subtleties of arm’s length criteria, which are explained in great detail inside the fiscal law paradigm, therefore transforming the later’s ideas into the framework of the former. With regard to RPTs, the arm’s length concept essentially acts as a uniting link between company law and tax law, thus KMP should carefully review corporate law compliance with the RPT framework in view in respect to fiscal constraints as well.

Effective Management’s Place of Origin

Generally speaking, most countries tax locally generated income of non-residents alone while taxing the worldwide income of resident taxpayers. Therefore, knowing the residential status of the taxpayer becomes quite important in order to estimate the degree of the tax charge. Indian income tax legislation has changed its basis for identifying corporate tax residency about ten years ago. Previously the legislation used the “control and management” requirement; today a corporation is judged to be a tax resident if its “place of effective management” (POEM) is located in India. The law expressly states that POEM “refers to a location where key management and commercial decisions necessary for the conduct of the entity’s business as a whole are, in fact, made.” Consequently, the tax residence of a company has become intrinsically ambulatory, trail the movements and decision-making processes of its KMPs. Determining POEM requires a careful review of KMP operations to find where they “in substance” engage in “key management and commercial decisions” for the business. Beyond the broad concerns regarding the extent of POEM, recent court expositions expose an increasingly detailed and intense examination of KMP sites, sometimes superseded by the conventional focus on the physical location where corporate decisions are formally taken, in determining POEM and corporate residence. Consequently, the physical presence of KMP and the strategic selection of board meeting venues have become absolutely crucial to prevent inadvertent tax residence and its repercussions. Technological developments and business law relaxations allowing virtual meetings aggravate this issue even further and might cause KMP to be present concurrently in several countries.

Ignorance of Various Directorship Styles

The clauses under tax laws that assign liability upon directors do not consider the subtle differences between several types of directorship, such as executive and non-executive directors, nominee directors, or independent directors, so departing from accepted corporate law rules. This lack of distinction means that every director and KMP is burdened indiscriminately to prove the absence of neglect, misfeasance, or breach of duty on their side regarding the company’s business in order to prevent possible legal consequences. Therefore, it has become essential even for non-executive directors and other KMP to keep meticulous and unique records that precisely define the degree of their knowledge and involvement in the operations of the company, so essentially preparing in advance against the possible ultimate fate of corporate default.

Worldwide Tax Cooperation

Concurrent with the continuous drive towards globally aligned substantive tax rules targeted at efficiently taxing multinational corporations (MNEs), there has been a notable administrative push especially over the past decade to promote cooperation among tax administrations across jurisdictions in performing coordinated action against taxpayers. Thanks to international capacity-building programs and the creation of vast ‘exchange of information’ networks between countries at both multilateral and bilateral levels, tax officials are now far more suited to examine complicated tax positions and address country-specific deviations than they would be outside the mandatory tax reporting requirements for entire MNE groups. Furthermore, many bilateral tax treaties now specifically call for cooperation between tax authorities of several countries on diverse issues, including establishing beneficial ownership and deciding taxpayers’ right to Tax Residency Certificates. Even in the larger framework of worldwide multinational groupings, the growing cross-sharing of information between several regulatory authorities and improved international cooperation highlight the urgent requirement of a coordinated approach towards tax compliance.

Improving Interface between Fiscal Laws and Anti-Money Laundering

The unrelenting hunt of “black money” has become a major factor influencing modern fiscal policies and thereby leading to their strong interaction with anti-money laundering (AML) laws. Especially, some offences under fiscal laws now qualify as predicates offences under Indian AML rules, therefore assuming cascade AML penalties resulting from defaults under fiscal laws. Moreover, from a pragmatic point of view, concurrent studies under both fiscal and AML regulations have grown rather typical. These events highlight even more the need of company boards to give tax-related agendas top priority and use a more all-encompassing, rather than concurrent, monitoring approach for tax and corporate law compliance activities.

Additional Features

Tax rules interacting with corporate operations span many other spheres. Corporate boards find themselves negotiating an increasingly delicate path with fiscal considerations virtually redefining the board’s agenda in view of the sweeping developments within the fiscal law paradigm that substantially affect, or rather redefine, the scope of Merger and Acquisition (M&A) transactions. Furthermore, Indian fiscal rules are gradually extending their influence to include events beyond of their borders. One excellent example of this trend is the indirect transfer tax described here. Another relevant example is the widening scope of customs law, which now spans “any offence or contravention thereunder committed outside India by any person,” so assigning tax liabilities to non-residents involved in the exportation of goods to India or, in view of further expansions, affixing liability on non-residents engaged in the importation of goods into India. Thus, KMP’s roles and obligations—not only those of individuals stationed in India but also those of those working for the worldwide corporate group—call for thorough review.

Modern worldwide developments combining taxes with associated sectors provide further difficulties for corporation boards. For example, although not directly related to tax legislation, the increasing focus on Environmental, Social, and Governance (ESG) issues and the application of EU carbon border adjustment systems have important effects on corporate tax strategy. As is sometimes the case with regular tax compliance issues, these complex problems cannot be frequently assigned to mid-level business leaders. Rather, they want KMP to provide strategic advice and close supervision. Moreover, handling reputation issues resulting from tax investigations has become a major difficulty directly facing business boards and KMP, drawing more and more attention in popular media. The relationship between rising tax demands and increasing economic activity highlights public opinion problems even more, thereby clearly putting these topics first on board agendas.

Finally, Although they are only indicative rather than comprehensive, the many elements covered here show the progressively ubiquitous impact of fiscal law issues in almost dictating the operations of company management throughout a broad range of conditions and events. Not surprisingly, then, corporate boards and other KMP are looking for direct interactions with tax specialists more and more, probably in an attempt to have a detailed knowledge of the nuances and far-reaching effects of changing fiscal rules. Previously mostly limited to M&A transactions, the scope of such interactions has increased greatly in response to the awareness of the enormous stakes involved and the possibly harsh penalties for non-compliance. These developments now include even the most complex financial rules, which full examination was once frequently assigned to lower-level business leaders. Corporate boards and KMP must take a proactive, informed, strategic approach to effectively negotiate the increasingly complicated terrain of tax compliance and fiscal strategy as fiscal laws continue to change and cross with many aspects of corporate governance and operations. Clearly, long-term corporate performance and sustainability in the fast changing global business environment depend on our capacity to properly include these factors into general corporate decision-making processes.