Place of effective management guidelines – more clarity or more ambiguity?
Summary: In 2015, the Indian tax laws amended the residency test for foreign companies by introducing the concept of Place of Effective Management (POEM). Further, in the last two years the Central Board of Direct Taxes (CBDT) has provided guidelines to determine the POEM for companies. As per these guidelines, the CBDT has prescribed the monetary threshold for non-applicability of POEM to companies with turnover or gross receipts of INR 50 crore or less in a financial year. However, the CBDT has not provided any guidance on the definition of gross receipts and turnover. This clarity is essential, especially for investment companies/ holding companies. Given this lack of clarity, these guidelines to clarify POEM rules has resulted in more ambiguity for the taxpayer.
The increase in globalization and technological advancement has resulted in the international expansion of several multinational and Indian corporations. Over the years, these corporations have used their global presence to enter low-tax jurisdictions, primarily to reduce the overall effective tax costs. In the Indian context, this resulted in the spring up of several offshore companies in tax-friendly jurisdictions such as Singapore, Mauritius and Netherlands. In order to curb such tax evasion, there has been a need to monitor shell companies that are primarily incorporated outside India but are run and managed from India. While there have been suggestions in the past to introduce controlled foreign corporation regime in India, in 2015, the Government decided to introduce the concept of Place of Effective Management (POEM) to determine the residential status of non-resident companies.
Under the erstwhile provisions of the Income-tax Act, 1961 (Act), a company was said to be resident in India in any previous year if it is an Indian company or if, during that year, the control and management of its affairs are situated wholly in India. Because of the requirement that the whole of the control and management of the company should be situated in India for the whole year, this condition was practically inapplicable. This lacuna facilitated the creation of shell companies that are incorporated outside India but are effectively controlled from India. In light of this fact, as per the amended provisions of the Act in 2015, a company is said to be resident in India if it is an Indian company in any previous year and its POEM at any time in that year is in India. Further, a POEM is defined as 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. The concept of POEM is an internationally accepted concept, and hence there are state guiding principles for determination of POEM. However, the Government of India vide Circular No 6 of 2017 dated 24 January, 2017, has provided a set of guiding principles to be followed in determination of POEM.
The fundamental principles that emanate from these guidelines state that the process of determining POEM would primarily depend on the following:
> Active business outside India;
> Facts and circumstances of the case;
> Substance over form; and
> Place of taking decisions over implementation of decisions.
The process to determine the POEM of a company is summarized in the flowchart provided below:
Additionally, the Central Board of Direct Taxes (CBDT) has clarified vide Circular No 08 dated 23 February, 2017, that POEM would not apply to a company having a turnover or gross receipts of Rs. 50 crore or less in a financial year.
With regard to the above, while the CBDT has not defined the terms “turnover” or “gross receipts” in the aforesaid Circular and under the Act, despite these words being used in other provisions of the Act, the guidance note on tax audit under section 44AB of the Act provides guidance on what constitutes turnover and gross receipts. However, in this provision, the words have been specifically used in connection with a business and/ or profession.
The Guidance note on tax audits states that the words “Sales,” ‘Turnover” and “Gross receipts” are commercial terms and should be construed in accordance with the method of accounting regularly employed by the assessee. The guidance note draws reference to the Companies Act, 2013 (Co Act), for the definition of turnover. As per the Co Act, turnover means the aggregate value of the realisation of an amount made from the sale, supply or distribution of goods or on account of services rendered, or both, by a company during a financial year.
As regards “gross receipts,” while the Co Act does not define the term, the guidance note provides that “gross receipts” include all receipts whether in cash or kind arising from carrying on of the business that will normally be assessable as business income under the Act.
While the above ambiguity would not pose a challenge in determining the gross receipts/ turnover of operating companies, for investment holding companies, there still arises a challenge on what constitutes turnover/ gross receipts. For investment holding companies, the typical receipts would include interest on deposits (current and fixed), exchange gains/ losses, interest on intercorporate loans and gains arising on sale of investments. In view of this, the following questions would arise in the determination of gross receipts:
> Sale consideration – should the sale consideration or the net gain be included for the calculation of gross receipts?
> Interest on deposits – are these considered as gross receipts of the investment companies, which are normally assessable as business income?
> Exchange gains/ losses – while exchange gains should be included under gross receipts, can a view be taken that the losses have to be reduced from the gross receipts?
> Gain or loss on forward contracts
> Revaluation of investment and credit to the profit-and- loss account
> Treatment of income under different accounting standards – Ind AS vs IFRS
Given that the intent of the introduction of POEM was primarily to tackle tax evasion from such shell/ investment holding companies, it would imperative for the CBDT to provide additional clarifications on these aspects. Furthermore, the above challenges provide more uncertainty on what the tax authorities would consider as gross receipts, which is surely not the intent behind the change in legislation.
In 2015, the Indian tax laws amended the residency test for foreign companies by introducing the concept of Place of Effective Management (POEM). Further, in the last two years the Central Board of Direct Taxes (CBDT) has provided guidelines to determine the POEM for companies. As per these guidelines, the CBDT has prescribed the monetary threshold for non-applicability of POEM to companies with turnover or gross receipts of INR 50 crore or less in a financial year. However, the CBDT has not provided any guidance on the definition of gross receipts and turnover. This clarity is essential, especially for investment companies/ holding companies. Given this lack of clarity, these guidelines to clarify POEM rules has resulted in more ambiguity for the taxpayer.
(Above Article is Authored by Hiten Kotak, M&A Tax Leader, PwC India and Aditya Narwekar, Partner – M&A Tax, PwC India and Views expressed are personal to author. Article includes inputs from Lakshmisha S, Director – M&A Tax, PwC India and Siddarth Narendranath, Manager – M&A Tax, PwC India)