The Finance Act, 2015, amended the provisions of the provisions of income tax act relating to determination of residence of a company. According to the amended provisions, a company would be said to be resident in India in any previous year, if it is an Indian company, or its Place of Effective Management (POEM) in that year is in India.
"Place of effective management means 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," states the draft guiding principles for determination of POEM, recently issued by Central Board of Direct Taxes (CBDT). Tax experts say POEM is an internationally recognised test for determination of residence of a company, incorporated in a foreign jurisdiction. "Most of the tax treaties entered into by India recognise the concept of 'place of effective management' for determination of residence of a company as a tie-breaker rule for avoidance of double taxation," adds the CBDT draft.
If the place of effective management of a foreign company is established in India, then it becomes tax resident as per domestic laws. Accordingly, the global income of such companies shall be taxable in India.
Over the past two decades many information technology, pharmaceutical, and manufacturing companies have set up marketing and sourcing arms in foreign countries, generally held through intermediate group companies. Some have set up companies outside India under the liberalised remittance scheme. Tax experts say these companies are likely to be impacted by the proposed POEM regulations.
"Unilateral imposition of tax by India based on POEM may result in double taxation, thereby increasing their global tax cost," noted Rakesh Nangia, managing director, Nangia &Co.
Experts point out that though the proposed rules prescribe a number of methods for determination of place of effective management, there is risk of subjectivity in implementation, leaving the adjudication to the judgment of the tax department. "This will only lead to a sharp increase in tax disputes and does not augur well for a country looking to cement a rules-based regime," said Pallav Pradyumn Narang, partner in chartered accountancy firm, Arkay & Arkay.
In the absence of established jurisprudence on this matter, tax experts expect a surge in litigation in this regard.
"The parties most impacted by this amendment shall be Indian individuals and companies which have set up foreign joint ventures or wholly-owned subsidiaries, and routinely take decisions for such entities from India, or where the executives of the Indian entity are also the decision makers for the foreign subsidiary," said Narang. Clearly, Indian companies with foreign shareholding will be impacted if such foreign shareholding company is effectively managed from India, in respect of income, such as capital gains or interest income, says Suresh Surana of RSM Astute Consulting Group.
According to Jayesh Sanghvi, partner & national leader (international tax services), the guidelines are primarily designed to impact Indian companies that have created foreign company structures to shelter profits in overseas jurisdictions, while their control and management may still be in India. Those overseas subsidiaries of Indian multinational corporations that act as pure holding companies are likely to see wide fluctuation in status as active business company due to instances of non-recurring capital gains. "The year-on-year evaluation would lead to different thresholds for compliance," said Sanghvi.
Boards of most large companies effectively function through delegated committees. "It would now be important to establish that the delegation is not of 'key-decision making' powers, but more of execution and monitoring within framework defined by the Board," said Sanghvi. Moreover companies would have to maintain robust documentation, such as minutes of meetings in support of key managerial and commercial decisions taken, points out Jiger Saiya, Partner, direct tax, BDO India.