MARCH 18, 2015

By N C Hegde & Pooja Balachandar, Deloitte Haskins & Sells LLP 

THE much-awaited Budget by the Modi Government is here and is being welcomed on a positive note in spite of it not doling out tax freebies. The Government has shown a commitment towards a simple, predictable and robust tax regime as opposed to one that uses tax incentives for encouraging business.One of the cornerstones of the Budget is to curb tax evasion by making the tax regime robust and in line with the internationally accepted taxation principles. In pursuance of this objective, the Budget proposes to treat foreign companies having place of effective management (POEM) in India as Indian tax residents.

In the current era marked by advanced communication, POEM of a company could be situated in a country other than the country of incorporation i.e. a company can be managed remotely from a jurisdiction other than the country of its incorporation. This eliminates the need of physical presence of managers in the country of incorporation and allows incorporation of companies in tax havens while the real economic activity and control resides in another jurisdiction. The introduction of POEM would lead many Indian multinational companies to reconsider their overseas structures, especially where they have been formed with a view to retain profits in low cost overseas jurisdictions through the use of artificial tax structures. POEM in the current form may result in tax officers raising questions in case of foreign companies where key management activity takes place in India. However, it is worthwhile to note here that at a recent Chamber of Tax Consultants conference in Delhi, the CBDT officials were quoted as saying that the primary focus of the provisions would be on Indian companies holding meetings abroad to circumvent tax residency rules. It is imperative for companies to manage their affairs carefully to keep from inadvertently exposing the global profits of the company to taxation in India.

As per the Indian tax law, a company registered in India is always considered as an Indian tax resident and its global income is taxable in India. However, a foreign company is considered as a tax resident if 'the control and management of its affairs during the year is situated wholly in India'. The Budget proposes to substitute this provision to treat a foreign company as a tax resident if 'its place of effective management, at any time in a year , is in India'. Further, POEM 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'. Since, previously, the condition for being a resident required the 'whole' management of the foreign company to be in India 'during the year' (i.e. continuously throughout the year), many foreign companies avoided being a resident by conducting one Board meeting outside India. However, as per literal interpretation of the proposal, the residence could be formed even if any of the key decisions of the company are taken in India at any time during the year. In this case also, the CBDT officials clarified at the above-mentioned conference that soon-to-be issued guidelines on POEM would allay fears of such a narrow interpretation.

The first question with regard to application of POEM that arises is whether 'effective management' refers to management of day-to-day activities or management decisions of strategic/long-term importance.As per the Organisation for Economic Co-operation and Development's (OECD) and United Nations' (UN) commentaries (which contain the same definition of POEM as the proposed amendment), various factors play a role in determining the POEM– the place where the management decisions regarding the economic and functional policy of the company are taken, Board of Directors meetings are conducted, accounting books are maintained;location of senior management of the day-to-day activities; location of headquarters; country whose laws govern the legal status of the company, etc. It would depend on the facts of each case how much importance is given to each of these factors while deciding the POEM.

POEM forms a part of many tax treaties between India and other countries. The same is used as a tie-breaker to determine the taxing rights with respect to residence when a company is considered as a resident of both countries as per respective domestic tax laws. In case a company's POEM is determined to be in India as per Indian tax law, the company may be considered as an Indian resident under the treaty based on the tie-breaker test and treaty benefits may not be available to the company with respect to Indian income (treaty benefits may be obtained with respect to the foreign income).

Another interesting issue could be in the context of international transfer pricing provisions with respect to a transaction between an Indian company and a foreign company having POEM in India. Since international transfer pricing is not applicable for transactions between residents, it needs to be seen whether the international transfer pricing provisions will continue to apply in the said case or whether the domestic transfer pricing provisions would apply.

Since the POEM concept in its current form in the proposal is open to wide interpretation, the Memorandum to the Budget states that the guiding principles for implementation of the same will be issued in due course. As Indian entrepreneurs spread their wings globally, POEM will merit due consideration with regard to the way business is carried out.