By Arijit Chakravarty
Outbound investments by Indian Companies have grown over the years. These investments are made in jurisdictions having benefits by way of low tax rate, simple regulatory regime, strategic location and business advantage and other beneficial criteria. Often the investments are structured as SPVs. In the context of such outbound investments by Indian entities, the concept of POEM becomes relevant, which would go to determine the residential status in India of such SPVs. In this context, while the draft guidelines for determining POEM of a company was issued around December 2015, the Central Board of Direct Taxes (CBDT) has recently issued the final guidelines for determination of POEM of a company vide Circular 6 of 2017 dated January 24, 2017. The guidelines would be effective from Assessment Year 2017-18 relative to financial year 2016-17 as well as subsequent Assessment years. The views expressed are personal.
- POEM under the Act
Section 6(3) of the Income Tax Act defines a company as resident of India if
- It is an Indian Company; or
- Its place of effective management in that year is in India
The Explanation states that “Place of Effective management (POEM) means a place where key management & commercial decisions that are necessary for the conduct of the business of an entity as a whole are, in substance made.” The term ‘place of effective management’ is not defined. Hence guidelines have been made to guide the AO to determine POEM of a non-resident company.
- Meaning of ‘Company’ under the Act-section 2(17)
The term ‘company’ has been defined to mean (i) Any Indian Company; (ii) Any Body-corporate incorporated by or under the laws of a country outside India etc. The residential criteria based on place of effective management would therefore apply to foreign incorporated body corporates only who fall within the definition of company under the Act.
- POEM under the Double Taxation Avoidance Agreements (DTAA) encompasses a wider range of entities
- Normally clause 3 of Article 4 dealing with POEM provides for a tie breaker rule and states that “where by reason of the provision of paragraph 1, a person other than an individual is a resident of both Contracting States, then it shall be deemed to be resident of the Contracting State in which its place of effective management is situated.” It is relevant to note that clause 1 of Article 4 dealing with residence states that “for the purpose of this Convention, the term ‘resident of Contracting State’ means any person who, under the law of the State, is liable to taxation therein by reason of his domicile, residence, place of management or any other criterion of a similar nature.” relating to residence. However, since the term ‘place of effective management’ has not been defined in the treaties, the meaning assigned thereto under the domestic law shall be applied.
- The term ‘person’ is defined in the treaties as including an individual, a company, a body of persons and any other entity which is treated as a taxable unit under the taxation laws in force in the respective Contracting States. Hence, in a tie-breaker situation, where a person (other than an individual) is resident of both Contracting States, the place of residence of such a person shall be deemed to be the place in which its effective management is situated. It appears that the applicability of residential status based on place of effective management would be applicable to a wider range of entities under the treaty as compared to a restricted class of body corporates under the Act. Since the provisions of the Act, so far as it is beneficial to the assessee, would prevail over the provisions of the treaty, a foreign unincorporated AOP/BOI may choose to be governed by the Act and remain a non-resident under the Act.
- The UN MC provides that when establishing the place of effective management, circumstances which may, inter alia, be taken into account are the place where the company is actually managed and controlled, the place where the decision-making at the highest level on the important policies essential for the management of the company takes place, the place that plays a leading part in the management of the company from an economic and functional point of view, and the place where the most important accounting books are kept.
- “Any other criteria” to determine residential status of a company under the Treaties vis a vis POEM
- Some treaties mention other basis for determination of residential status of a company in a tie-breaker situation. These are commonly the place of incorporation, the head office of the entity or any other factors. The guidelines mentions that the location of the company’s head office will be a very important factor in the determination of the company’s place of effective management because often it represents the place where key company decisions are made.
- Some countries consider the cases of dual residence of persons who are not individual relatively rare and should be dealt on a case-to-case basis. For example, Italy holds the view that the place where the main and substantial activity of the entity is carried on is also to be taken into account when determining the place of effective management. France considers the place where the organs of direction, management and control of the entity are mainly located as its place of effective management. The United States of America reserves the right to use the place of incorporation test for determining the residence of the corporation, and failing which, to deny dual resident companies certain benefits under the Convention.
- The term ‘other similar factors’ could have possible two interpretations namely (i) the functional interpretation under which any domestic feature triggering unlimited tax liability or (ii) territorial nexus requiring both unlimited tax liability to tax and a territorial connection between the taxpayer and the State. In case of other such factors stated in the treaty with India, these factors are to be applied under treaty application, if found to be more beneficial to the assessee.
- India’s reservation on OECD commentary 2010
India had given its reservation to OECD MC in its status as observer stating that it does not adhere to the interpretation given that place of effective management is the place where the key management and commercial decisions that are necessary to the entity’s business as a whole are in substance made. It was of the view that the place where the main and substantial activity of the entity is carried on is also to be taken into account while determining place of effective management. It appears that the final guidelines are now in line with the OECD commentary now.
- Assessing Officer to seek prior approval before initiating any proceedings for holding a company incorporated outside India a resident of India on the basis of POEM
- There appears to be a safeguard embedded in the guidelines which provides that the AO shall, before initiating any proceedings for holding a company incorporated outside India as being a resident of India on the basis of POEM, seek prior approval of the Principal Commissioner or Commissioner, as the case may be. For seeking prior approval, the AO must have material to make a prima facie case. The step to seek approval as also the granting of approval by the Principal Commissioner/Commissioner, as the case may be, cannot be an empty formality and an administrative step. If the requisite basis is not demonstrated by a prima facie satisfaction reached on some objective basis, the initiation of any such proceedings may be struck down by the Courts. The relevance of materials or information available with the AO and their nexus to the satisfaction for initiation of any such proceeding would be subject to scrutiny of the Courts. The AO has to further seek another approval of the collegium of three members consisting of the Principal Commissioner/Commissioners to be constituted by the Principal Chief Commissioner of the region. The non-resident company shall be granted due opportunity of being heard by the collegium before issuing any direction in the matter.
- The decision to treat a non-resident company as a resident of India on the basis of POEM would have wide ramification for such non-resident companies. We are of the view that the basis of initiation of proceedings as well as the issue of directions by the collegium of Commissioners would be amenable to writ jurisdiction of the Courts as a more effective remedy.
- Place of effective management to be presumed to be outside India, in cases of a companies engaged in active business outside India, if the majority meetings of the board of directors of the company are held outside India
- Concept of ‘controlled foreign corporation (CFC)’ has been built into POEM. However, services income with AEs have been left out in the current guidelines.
- Place of effective management in case of a company which is engaged in active business outside India shall be presumed to be outside India, if the majority meetings of the board of directors of the company are held outside India. In the case of a non-resident company which is actively engaged in business outside India, there is only a presumption that such company has a place of effective management outside India and therefore may not be held to be resident of India under POEM test. Such presumption can be rebutted by the AO on the basis of material with him to the contrary.
- It has been stated that for the purpose of determining whether the company is engaged in active business outside India, the average data of the previous year and two years prior to that shall be taken into account. Rule of averaging should be used where the data is skewed for numerous reasons, such as, in the case of start-ups, also where the business activity of one year impacts the revenue in following years etc. Therefore, it is suggested that circumstances where rule of averaging can be employed may be built into the guidelines.
- Press note dated January 24, 2017 has put a threshold limit of turnover/gross receipts in excess of INR 50 crores for application of POEM guidelines. The same may be built in the Act/Rules.
- In case of a company which is not engaged in active business outside India
The determination of POEM shall be made in 2 stages:-
- Identification/ascertainment of the person or persons who actually make the key management and commercial decision for conduct of company’s business as a whole;
- Determination of the place where these decisions are in fact being made
For all practical purposes, even for a company which is engaged in active business outside India, the above 2 steps would be necessary for the AO to initiate and conclude that the place of effective management of the company is situated in India.
- Applicability of guidelines would be from Assessment year 2017-18
Though the guidelines have been given only at the end of the financial year 2016-17 relevant to assessment year 2017-18, these are only in the nature of guidance. Our view is that these shall be available for and utilised as guidance for determining the residential status of a non-resident company for AY 2017-18.
- Guiding principles which may be taken into account for determining the POEM
Broadly the guidelines pertain to the following:-
- Shareholders activities;
- Location of Head office;
- Video conferencing and modern technology;
- Circular resolution;
- Day to Day Operation versus key management and commercial decision making;
- POEM not based on isolated facts but considering overall facts and circumstances;
- Secondary factors for constituting POEM being place where main and substantial key activities are being carried or place where the accounting records of the company are kept
The guidelines now issued is more specific and would enable the determination of POEM of a non-resident company. The guidelines are not binding either on the assessee or on the Courts, but is only to be used as a guidance. In case the treaties have a different criteria for determination of POEM, these may have to be followed. Subjectively determining of POEM may be challenged in the Courts. The presumption that place of effective management of a non-resident company engaged in active business outside India is situated outside India is rebuttable on the basis of contrary material that may be available with the tax officers. Whether the rendering of services with AEs have been intentionally left out has to be seen. The process of ascertaining POEM on the basis of specified data that may be required to be submitted to the AO may be specified and a certificate from accountants may greatly reduce the task of the tax officers.
Arijit Chakravarty, [LL.B., CPA(USA), FCA,] is a Principal Associate at , Advaita Legal
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