Zainab Bookwala & Paras Modi

Zainab Bookwala & Paras Modi

Place of Effective Management (‘PoEM’) has been one of the most deliberated aspects under the Indian Income Tax regime since its introduction vide Finance Act, 2015, especially for Indian transnational groups. Historically, the tax residency of companies was considered to be in India if either it is an Indian company or if its control and management was wholly situated in India. However, introduction of the concept of PoEM under the Income-tax Act, 1961, has broadened the scope of tax residency for companies and sought to align the parameter as stipulated under the model tax conventions and existing tax treaties. Currently, a foreign company shall be treated as a resident in India if it is an Indian company or if its place of effective management in the previous year is in India. The term “place of effective management” has been defined to mean a place where key management and commercial decisions necessary for the conduct of the business of an entity, as a whole, are in substance made.

The Finance Act, 2016 deferred the applicability of PoEM by one year to 1 April 2017 i.e. from AY 2017-18 on wards. The Memorandum to the Finance Bill 2015 had indicated that the guiding principles useful in determination of PoEM will be issued in the course of time. Thereby, the Central Board of Direct Taxes (CBDT), on 23 December 2015, issued the draft guidelines in this regard and on 24 January 2017 issued final guidelines for determination of PoEM. Additionally, CBDT clarified that the PoEM guidelines shall not apply to companies having turnover or gross receipts of INR 50 crore or less in a financial year thereby providing relief to small business corporates.

The snapshot of the final guidelines on PoEM is provided here under:-

Poem outside India

1. Notification No. 142/11/2015-TPL dated 23 December 2015

2. Circular No. 6 of 2017 dated 24 January 2017

As per the guidelines, a company is said to be engaged in active business outside India if the passive income is not more than 50% of its total income and –

– Less than 50% of its total assets are situated in India; and

– Less than 50% of its total employees are situated / resident in India; and

– Payroll expenses incurred on such employees is less than 50% of its total payroll expenditure

The guidelines also provide the explanation of the terms “income”, “value of assets”, “number of employees and “payroll” in relation to the above.

Further, passive income has been defined to mean aggregate of

– Income from transactions where both purchase and sale of goods is from /to associated enterprises; and

– Income by way of royalty, dividend, capital gains, interest or rental income.

PoEM of a company having active business outside India shall be presumed to be outside India if majority of the board meetings of the company are held outside India. However, if the Board is not exercising its powers of management and the same are being exercised by the holding company or any other person than PoEM shall be considered to be in India if the holding company is in India or that other person is a resident of India.

However, if active business of a company is not outside India then PoEM shall be determined by identifying the persons who make key management and commercial decisions and determine the place where such decisions are taken.

Certain relevant points for determination of POEM in case of foreign companies not having active business outside India have been discussed below:

1. Location of Board Meeting

The location where a company’s Board regularly meets and makes decisions would be relevant provided that the Board:

i. retains and exercises its authority to govern the company; and

ii. does, in substance, make the key management and commercial decisions necessary for the conduct of the company’s business as a whole.

2. Location of Head Office

i. Where senior management and its support staff is based out of single location – the place where the management is present

ii. Where senior management is decentralized i.e. operates from different places then location of head office will be where Senior Managers-

– are primarily and pre- dominantly based or

– Normally return to following travel to other location or

– Meet while formulating the key strategic decisions

iii. Where it is difficult to determine the company’s HO, then location would not be relevant for determining PoEM

3. Meetings through VC/technology

Place where the directors or the persons taking the decisions or majority of them usually reside may also be a relevant factor.

4. Circular resolution or round robin voting

The location of the person who has the authority and who exercises the authority to take decisions would be more important in determination of PoEM.

5. Delegation by Board

POEM would be determined based on the location of the person to whom the powers are delegated to make the strategic business decisions.

6. Shareholders activity

Shareholder’s activity pertaining to company law is not relevant for PoEM. However, where shareholder involvement is crossing the line into that of effective management then based on facts, PoEM might trigger.

Further, if PoEM of foreign company is determined in India, the foreign company would require to adhere to the various compliance requirements under the Income tax Act.

The Finance Act 2016 vide Section 115JH and Chapter XII-BC aimed to provide directional guidance about effect of PoEM determination for impacted companies. Section 115JH provided that conditions may be notified by the Central Government with respect to computation of total income, treatment of unabsorbed depreciation, set off or carry forward and set off of losses, collection and recovery and special provisions relating to avoidance of tax shall apply with such exceptions, modifications and adaptations as may be specified in that notification for the said previous year.

Accordingly, CBDT on 15 June 2017, issued a draft notification with respect to the exceptions, modifications and adaptations for application of provisions of the Act on a foreign company having PoEM in India. Comments and suggestions of stakeholders and general public have been invited on the draft notification which shall be deemed to have come into effect from 1 April 2017.

The important exceptions, modifications & adaptations are summarized below.

Particulars Guidelines
WDV of depreciable assets
  • WDV as per tax records in the foreign country on the 1st day of the previous year to be adopted as opening WDV
  • If the company is not assessed to tax in the foreign jurisdiction then WDV as appearing in the books maintained in accordance with the laws of the foreign jurisdiction shall be adopted
Brought forward loss or unabsorbed depreciation
  • As per tax records in the foreign country, the quantum shall be determined year wise on the 1st day of the previous year in which the foreign company is said to be a resident of India
  • If the company is not assessed to tax in the foreign jurisdiction then brought forward loss or unabsorbed depreciation shall be determined as per the books prepared in accordance with the laws of the foreign country on the 1st day of the previous year in which the foreign company is said to be a resident in India
Preparation of P&L Account and Balance Sheet

 

  • If the accounting year of the foreign company does not end on 31 March, it shall prepare financials from a specific date to 31 March of the year immediately preceding the year in which the foreign company turns resident in India e.g. if a foreign company follows calendar year and it has a PoEM in FY 2017-18 then financials for the broken period i.e. 1 January 2017 to 31 March 2017 needs to be prepared.
Foreign Tax Credit
  • Foreign company shall be entitled to relief or deduction of foreign taxes paid in accordance with section 90 or 91 of the Act.
Transfer Pricing

 

  • Any transaction between the foreign company having PoEM in India for the first time and its Indian AE shall qualify as an international transaction and not a specified domestic transaction
Exchange rate to be used for conversion
  • Rule 115 of the Income-tax Rules, 1962 shall be applicable for the conversion of foreign currency into INR
Corporate Tax Rate
  • Company having a PoEM in India would be subject to tax rate applicable to a foreign company i.e. 40% plus applicable surcharge and education cess
Deduction of tax at source

 

  • Where certain provisions of Chapter XVII-B apply to the company as both resident as well as a foreign company then provisions applicable to a foreign company shall apply
Applicability of section 195(2)
  • Foreign company, having PoEM in India, continues to be treated as a foreign company for the purposes of dispensation certificate

The above guidelines are helpful and brings additional clarity with respect to the applicability of the provisions of the Income-tax Act for foreign companies having PoEM in India, especially in the backdrop of lack of coherence in relation to the concept of place of effective management itself among st countries who have adopted similar corporate tax residency norms.

While it is commendable that the Government is conscious about the need to bring in certain degree of transparency in relation to the income tax provisions which would result in effective implementation of new subjective concepts and reduce ligation in relation to the application of PoEM rules, compliances and reporting for PoEM may still need further clarity.

The initiative to invite comments and suggestions of stakeholders also reflects the positive intent of the Indian Government. However, it will be interesting to observe how the Indian tax authorities apply this “substance over form” theory to practice, especially in this technological advanced communication era. There are expectations that the Indian Government will ensure that the Indian multinational groups having business footprints abroad would not be put at a competitive disadvantage, through any form of misapplication of this evolving PoEM law.

(Zainab Bookwala is a Manager and Paras Modi is a Deputy Manager with Deloitte Haskins & Sells LLP.)

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