POEM is an abbreviation for "Place Of Effective Management" that plays a decisive role in determining the tax residency of a company.The Finance Bill 2015 has decided to move the goalpost and proposed an alteration in the definition of resident companies under section 6(3) of Income Tax Act,1961.Before knowing that,let us understand the present scenario.
Currently,as per section 6(3) of the act,a company is resident in India if,
a) it is an Indian company; or
b) during that year,control and management of its affairs is situated wholly in India.
Interpreting the same,a foreign company would be treated as resident only if control and management of its affairs is situated wholly in India during that year.That means,even if a part of control is outside India,company would be not be regarded as resident and henceforth,only Indian sourced income earned by it would be taxable and not its global income.
Let us be aware of the fact that control and management does not necessarily mean conducting routine affairs of the company.Instead,control and management is being referred as head and brain of the company that takes major decisions for effective functioning of the company.
Now,there is a loophole in this definition that helps corporates to escape the 'tax residency' and thus,taxability of its income.By incorporating a shell company outside India and diverting a part of control and management outside India facilitates escaping tax residency from India as management and control should be wholly in India to be covered under the definition of resident.
In order to fix the loopholes,the Finance Bill 2015 has come up with an amendment to replace 'the the control and management of its affairs wholly in India' with 'Place of management at any time during the year' as a tax residency criterion for companies incorporated abroad.
So,under new POEM rule,company shall be said to be resident in India if:
a) it is an Indian company,or
b) its place of effective management,at any time in the year,is in India
Place of effective management encompasses to mean a place where key management decisions for running the business of the company as a whole are made in 'substance'.Entire global income of the company shall be taxable once it meets the definition of resident.
Motive of the government behind bringing the POEM rule is not only to prevent companies from evading the tax,but also to align the provisions of the act with Double Taxation Avoidance Agreements (DTAA) with several countries and bring them at par with international standards.It is so because Organisation of Economic Cooperation and Development (OECD) accepts and recognises the POEM rule and is also used as a tie breaker rule for determining the place of residence of the company in case of company becoming dual resident of both the countries,one due to incorporation and other due to control and management.
Negative impact
The new definition would adversely impact Indian companies with foreign subsidiaries. Several large corporates in India have subsidiaries incorporated abroad which are controlled and manged from India.Such subsidiaries pay taxes in the country of incorporation and that income is not taxable in India.It gets taxable in India only when it is brought into India by way of dividend fro which dividend distribution tax is paid at the rate of 15%.Under new POEM rule,such income would be taxable in India at the rate of 30% in addition to tax paid abroad.
Another example can be,a board member of the foreign company is present in India and participates in the decision making process in India only in that single board meeting,it would cover the company under the definition of resident and would tax the global income of the company leading to double taxation of income as company would pay tax both in India as well as foreign country.
Also,there is a lot of uncertainty regarding the interpretation of words 'anytime during the year'.No clarity has been provided by the government on this subject yet and henceforth, major interpretation has been left at the discretion of Income Tax Department.
If company's board meeting is held through video conferencing,it would be difficult to detect the real place of effective management creating a lot of confusion in determining the place of residence.
Thus,ambiguity of new law may, instead of mitigation,increase the litigation in India as opposed to new government's objective of simplifying the tax laws and red tapism.
Effective planning
- Board of Directors of foreign company should be given complete autonomy and power of decision making should be delegated by the Indian company to the independent board. Board meetings related to foreign entity should be held in foreign countries only and all the key managerial decisions regarding the functioning of the entity should be taken in the foreign country.
- Board meetings and decision making should not be held in India so as to avoid the tax residency in India.Also,decisions in the meeting should be well documented to present a clear evidence of decisions made at the meeting.
- Heads and key managerial personnels should be based in foreign country.
- Business should be structured after appropriate planning to avoid tax residency in India in genuine cases to facilitate smooth conduct of business.
Nutshell
With lot of uncertainties hovering in this respect and the new definition clipping the wings of Indian large corporates,government should look into the bill again and bring more clarity and solutions in order to ensure free and fair conduct of business and at the same time contribute to development of the economy as a whole.
-Sagar Khubchandani
(kdanifinance@gmail.com)
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