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Tax Residency Provisions For Non-Indian Companies

Published on Tue, May 26,2015 | 23:42, Updated at Tue, May 26 at 23:42Source : 

By: Jayesh Sanghvi , Partner & Leader – International Tax Services, EY

When it comes to tax, all that matters is where you belong – “the residency”. The taxability of a company’s income in India, which adds to the treasure chest of tax receipts for Government, would depend on its residential status. For a resident company, global income becomes taxable while for a non-resident company, income sourced in India becomes taxable. Thus, determination of a Company’s residential status is of paramount importance in determining its tax incidence.  

The test of residency under Indian Tax Law (ITL) has evolved over a period of time. One constant criterion has been the incorporation of a company in India (i.e., an Indian company) which makes the company a resident by default. The debatable point has been the second criterion used to determine the residency of non-Indian companies i.e. the control and management (C&M) of the affairs of the company should be wholly situated in India. This ‘head and brain’ principle of C&M had proved to be a piece of cake for the foreign companies since it has been rendered practically inapplicable. Companies very easily avoided becoming resident in India by simply holding a board meeting outside India. Thus, this cushion which required the ‘whole’ of C&M to be situated in India for the ‘entire’ year was intended to be taken away by the proposed Direct Taxes Code (‘DTC’), 2009.

The DTC 2009 provided the C&M to be wholly or partly situated in India ‘at any time’ of the year. This proposal arrived as a cacophony for the foreign companies triggering a string of amendments leading to a misfortune for the foreign companies. To make matters worse, the DTC 2010 proposed the threshold of ‘place of effective management (‘POEM’)’ instead of C&M emphasising it to mean decision making by the board of directors. It was further carried forward to the DTC 2013 which brought the amendment on par with the OECD Commentary holding POEM to mean a place where key management and commercial decisions that are necessary for the conduct of the entity's business as a whole, are, in substance, made, ultimately leading to the amendment in Finance Bill 2015 (FB2015).   

The initially proposed amendment in FB 2015, to be made applicable from the tax year 2015-16, provided for a company to be a resident in India, if its “place of effective management, at any time in that year, is in India” (to be read with the above definition of POEM). This had thrown up two points of concern for international business — (i) India does not define the term “key management and commercial decisions” and therefore these are undefined and subjective (ii) “at any time,” criterion seem to run counter to generally the accepted principle of an overall central management – which now stands deleted shifting the focus to “that year”.

The deletion of the term “at any time” from the definition of POEM now synchronises the meaning with that suggested by the OECD Model Convention which is also the intent of the legislature as explained in the Explanatory Memorandum. One needs to be mindful that the OECD commentary does not refer to any specific period to determine POEM while the ITL now on the other hand requires that POEM should be with reference to the Indian tax year. It goes to suggest that the determination whether POEM of an entity is in India should be seen from a complete tax year’s perspective. One may need to wait for the CBDT guidelines to be issued for practical application on this aspect.   

Consider a scenario, where a board meeting is held on a day when one of the directors is present in India and he attends the meeting via video conferencing. Will the active participation of the director in decision making in “substance” amount to decisions being made in India? The personnel of multinational companies have become increasingly mobile and coupled with the advancement in technology and connectivity, there seems to be a potential risk by all travelling executives which could create significant unforeseen tax burdens in India.

Once there is a trigger of tax residency in India for a foreign company based on the above litmus test, the consequences could be significant! Being treated as resident company, the company will be liable to tax in India on its global income, which was otherwise liable to tax on Indian source income as a non-resident. However, it may still be regarded as a non-domestic/ foreign company (assuming the dividend declaration and payment arrangement is not made within India) and may be liable to tax at forty percent, though dividend paid by such company does not trigger dividend distribution tax in its hands in India. Though beneficial provisions of ITL to foreign companies such as lower withholding tax rate, concessional tax rate on capital gains etc., continue, there are adverse consequences such as applicability of transfer pricing provisions, withholding tax implications (i.e. payment made to foreign company u/s 195 versus payment to resident u/s 194C/J/etc) etc., could be a point of debate. Treaty override provisions will have to be analysed in specific facts to determine whether the trigger of POEM under the ITL will give way to a different criteria under Article 4 or equivalent in a Treaty.

The removal of the words “at any time” does reduce the rigour of POEM but still leaves room for interpretation. It is however expected that the Government shall come up with clarificatory rules which are more objective in application.

(Views expressed are personal)


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