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PoEM: What To Expect?

Published on Wed, Aug 12,2015 | 19:00, Updated at Wed, Aug 12 at 19:00Source : 


By: Parikshit Datta, Senior Director, Deloitte Touche Tohmatsu India & Jatin Kanabar, Director, Deloitte Haskins & Sells

With a flurry of regulatory changes in the last couple of years, India Inc., is grappling with yet another new provision, viz, Place of effective management (PoEM) under the Income tax Act (ITA) which is effective 1 April 2015. PoEM regulations are relevant to determining residency of a foreign entity in India and more particularly could impact Indian headquartered businesses / Indian MNCs. A foreign entity having its PoEM in India would be exposed to Indian tax regime. PoEM has been defined under the ITA to mean ‘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’.

Under the erstwhile provisions, a foreign company would become resident in India, if control and management of its affairs was situated wholly in India during that year. As per this new law, a foreign company would become resident in India if its PoEM in that year is in India.  The Explanatory Memorandum (EM) to Finance Bill 2015 explains the need for this amendment. It was felt that in the erstwhile law, due to the requirement that ‘whole’ of control and management should be situated in India, the condition was rendered practically inapplicable as a company could easily avoid becoming a resident by simply holding a board meeting outside India. This facilitated creation of shell companies which are incorporated outside but controlled from India.

Internationally, the concept of PoEM is not new. The concept of PoEM is also present in the double tax avoidance agreements (DTA) entered into by India to determine the residency under the ‘tie breaker’ test. The definition of PoEM under the ITA is in line with the definition given under the OECD model commentary. As per the OECD, factors such as, place where board of directors or equivalent body usually meet, place where the CEO and other senior executives usually carry on their activities, place where the senior day to day management is carried on, where the person's headquarters are located, where its accounting records are kept, etc can be considered relevant for determining the PoEM. Determination of PoEM involves looking at de facto decision making and not a de jure decision making. Several countries including Switzerland, Germany, China, South Africa, Italy, etc. recognise PoEM as one of the criteria for determining residency of a company. The UK also has some landmark rulings in the context of PoEM determination which lays down important principles for determination of PoEM.

The EM states that a set of guiding principles will be issued to help the tax payers and the tax authorities.  It is expected that the guidelines will incorporate the international principles in determination of PoEM and help both the taxpayers and the tax authorities. It is also hoped that the guidelines will help reduce ambiguities and eventual litigation rather than increase it.

So what can we really expect from the guidelines? The guidelines should in the minimum provide clarity on the following aspects to avoid ambiguity with regards to determination of PoEM:

1.    The Finance Act, 2015 omitted the words 'at any time' from the definition of PoEM (as was initially proposed in the Finance Bill) to avoid unintended hardship. Nevertheless, a question may still arise that for a foreign company to be resident in India, is it necessary that the PoEM should be situated in India throughout the financial year under consideration or PoEM even for a part of the year could trigger residency under the ITA. Currently, the provisions of the ITA do not provide any clarity on this. Better view would be that entire year is considered for determining the PoEM in India. The determination should look at where the key management and commercial decisions are regularly and predominantly made during the whole year and not just a part of the year.

2.    The guidelines should define some of the key terms like ‘Key’, ‘Effective’, ‘Management and Commercial Decisions’, etc in order to avoid any ambiguity with regards to its interpretation.

3.    The proposed guidelines should clearly list out the key factors for determination of PoEM in India.

Relevant factors to be considered could primarily include, place of meeting of Board of Directors (BoD) and place where senior management and key management personnel are usually based.

If one is unable to determine the PoEM based on the above factors then auxiliary factors such as place where accounting records are kept, place of incorporation and the governing law, place where the key operational management decision is carried out could also be considered.

The place from where the support services / shared services are provided should be of limited relevance to determine PoEM as ordinarily it does not involve key management or commercial decision making. Similarly, the parent company laying down general guidance and policies for the group companies or performing stewardship activities for protecting its interest as a shareholder should not be relevant for determination of PoEM. Further, any activity performed by the parent company in the nature of non-binding advisory services for an arm’s length fee should also not be relevant for determination of PoEM so long as the ultimate decision making is with the respective foreign subsidiary.

The guidelines should recognize that what may be ‘key management and commercial decisions’ for one business may not be ‘key management and commercial decisions’ for a different business. Illustration may be provided in the guidelines for different kinds of business entities for clarity.

The guidelines should also deal with the issues emerging out of the current technological changes, like meetings through video conferencing, etc.

4.    The guidelines should make it clear that the test to be applied is for the ‘entity as a whole’. Thus, even if some part of the business function is found to be located in India, it should not create a PoEM in India provided the key decision making with regard to the other functions of the business are outside India.

5.    Safe harbor provisions may be prescribed to avoid unnecessary compliance burden with no corresponding tax collection in India. For instance, exemption from PoEM regulation can be considered in cases where the foreign company is incorporated in a jurisdiction with a minimum base tax rate, say 25%, as India will in any case be required to grant foreign tax credit and eventually not collect any substantial revenues.

6.    PoEM provision should be resorted to only in exceptional cases. As the EM suggests, the provisions should be viewed as an anti -avoidance measure to check on shell companies outside India. A process, similar to the process prescribed for General Anti-avoidance Rule can be prescribed for selecting cases for invoking PoEM.

7.    The guidelines should also include clarifications on mechanism to claim foreign tax credit and relevant compliances to be undertaken in India including withholding tax and transfer pricing compliances. The guidelines should seek to ease the compliance burden to encourage ease of doing business in India.

Determination of PoEM is a fact specific exercise involving evaluation of various facts, multiple locations and application of ‘substance over form’ principle. The determination becomes even more complex in this age of technology and communication revolution. While it is recognised that the guidelines cannot deal with all situations and different fact pattern, it would go a long way if they follow international principles and jurisprudence and takes a practical view of things considering the current business realities.

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