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“Residence” is one of the primary factors to fasten the tax liability
on any tax payer in a country, be it an individual, a company or any
other entity. Determination of a residential status of an assessee
assumes significant importance in international taxation. Elaborate
rules are prescribed in tax laws of every country and/ or in tax
treaties prevalent worldwide. One of such rules for residence of
companies accepted and followed worldwide is that of Place of Effective
Management. Finance Act, 2015 amended Section 6(3)(ii) of the Income-tax
Act, 1961 dealing with Residence of companies from the “Control and
Management Principle” to the “Place of Effective Management” (POEM).
POEM is dealt with by both, the OECD and UN in their Model Commentaries.
In December 2015, CBDT came out with Draft Guidelines on determination
of POEM for a Company. This write-up highlights crucial aspects
regarding determination of residential status of a company taking into
account the concept of POEM.
Backdrop
Corporate
Residency has been one of the most important issues across the world.
With businesses moving across countries and with digital economy being
the flavour of the 21st century, countries are in a tiff to make sure
that they don’t lose their pie of taxes. The steps taken by the G20
Nations to prevent Base Erosion and Profit Shifting (BEPS) are in this
direction. In case of multinational companies, the structures adopted
are such that it becomes difficult to ascertain where its control and
management are situated. Countries worldwide have introduced various
concepts like POEM, Place of Management (POM), Control and Management (C
& M), Central Control & Management etc. to ascertain the
residency based on overall control and management of the company.
Concept of Corporate Residency before the Amendment
As
per Section 6(3) of the Act before the Amendment, the Income-tax law
was as under – “A company is said to be resident in India in any
previous year, if –
(i) It is an Indian company; or
(ii) During that year, the control and management of its affairs is situated wholly in India.” (Emphasis Supplied)
Hence,
a foreign company was treated as resident only if the control and
management of its affairs were situated wholly in India during that
year. It meant, even if a part of control was outside India, the company
was not regarded as resident and hence, it was subjected to tax only on
income sourced in India.
In the erstwhile definition it was
easy for a foreign company (which was controlled and managed from India)
to avoid Indian taxes on global income by artificially shifting/
retaining part of its C & M outside India. Typically, resident
Indians who have set up overseas companies could use the erstwhile
definition to their advantage.
It may be noted that the term
“Control and Management” was not defined in the Act. However, in general
parlance, it was understood that control and management did not mean
conducting day to day management of the company, but it referred to the
head and brain of the company that take major decisions for effective
functioning and managing of the company.
C & M being not
defined in the Act was a major bone of contention between the taxpayers
and revenue authorities. Let us look at some of the judicial rulings on
the interpretation of C & M:
C & M as per Indian Courts
In
Subbayya Chettiar (HUF) vs. CIT (19 ITR 168) (SC) Honourable Supreme
Court observed that C&M signifies the controlling and directive
power, the head and brain; and “situated” implies the functioning of
such power at a particular place with some degree of permanence.
In Narottam & Pereira Ltd. (23 ITR 454),
the Bombay High Court held that Control of a business does not
necessarily mean the carrying on of the business, and therefore, the
place where trading activities or physical operations are carried on is
not necessarily the place of control and Management. The High Court
disregarded the presence of strong manager overseas in favour of
controlling directors being situated in India. It was held that the
direction, management and control, ‘the head, seat and directing power’
of a company’s affair is situated at the place where the directors’
meetings are held and consequently, a company would be resident in India
if the meetings of directors who manage and control the business are
held in India.
In the case of Radha Rani Holdings (P) Ltd. [2007] 16 SOT 495 (Del),
it is provided that the situs of the Board of Directors of the company
and the place where the Board actually meets for the purpose of
determination of the key issues relating to the company, would be
relevant in determining the place of control and management of a
company1.
The meaning of the expression ‘control and management’
as used in section 6(3) (ii) of the Act was the subject matter of
judicial interpretation in the past. The legal position is well-settled
that the expression “control and management” means the place where the
‘head and brain’ of the company is situated and not the place where the
day-today business is conducted.
Professor Klaus Vogel, in his treatise, has observed that what is decisive is not the place where the management directives
take effect, but rather the place where they are given (Klaus Vogel on
Double Taxation Conventions, 3rd Edition, Para 105 on page 262). Thus,
it is “planning” and not “execution” which is decisive.
Finance Act – 2015 and Explanatory Memorandum on POEM
In
order to protect its tax base and to align provisions of the Act with
the Double Taxation Avoidance Agreements (DTAA s) entered into by India
with other countries, the concept of POEM was introduced vide amendment
to Section 6(3)(ii) of the Income-tax Act, 1961 (‘Act’).
According
to the amended definition, a company would be resident in India if it
is incorporated in India or its ‘place of effective management’ (POEM),
in that year, is situated in India.
POEM has been defined 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.
The said amendment has significant impact
on various foreign companies incorporated by Indian MNC’s for Outbound
Investments and business operations outside India.
POEM and its Implications
Some
questions which may come to readers’ mind are (i) whether POEM is
different from the concept of C & M and if yes, how? (ii) What is
the impact of such difference? Before answering these questions, let us
analyse the definition of POEM in detail. We may compare and contrast
the concept of C & M while dissecting the definition of POEM.
POEM as defined by the Finance Act, 2015 has four limbs as follows:-
- Key Managerial and Commercial decisions
- Necessary for the Conduct of Business
- Of an entity as a whole
- in substance made.
Important
Factors relevant to POEM in India 1) Place where Board Meetings are
held O ne of the primary factors which may lead to effective management
rests with the place where the board meetings are held. Key Managerial
and Commercial Decisions are always meant to be understood as strategic
ones taken by the highest authority of the company. The Board of every
company is considered to be the head and brain of the company. However,
mere holding of board meetings might not hold ground if decisions are
made/taken at some other place. C & M Many courts have ruled that
one of the most important factors to determine C & M of a company is
where its head and brain i.e. Board of Directors is situated. Thus
location of board and decisions taken by them was crucial even for
determination of C & M as it is in the case of POEM.
2) Key Managerial and Commercial Decisions:-
The
intention of the legislation becomes clear from the word “key” inserted
in the definition of POEM. It implies that the decisions should be more
of strategic and should be above the day to day operational decisions.
It tries to distinguish the secretarial decisions taken at the board
meetings.
Similar was the stand in determination of C & M.
3) Operational management vs. broader top level management
The
decisions taken by the Chief Executive Officer and Chief Operating
Officer might be managerial and commercial in nature but may not always
“key” in nature. For example, procurement of goods from vendors,
inventory management, offers and discounts for increase in sales etc.
would be classified as managerial and commercial decisions but not
strategic in nature. Such decisions might not be relevant for the
determination of POEM.
However, the decisions of opening a
new branch or launching of a new product, pricing policies, expansion of
the current facilities etc. which would have significant impact on the
business and on the company as a whole might be taken by the Board or
the Top Management of the Company. Such decisions would be more relevant
in establishing POEM.
All these factors are/were relevant in the determination of C & M as well.
4) Other relevant factors
There
are other relevant factors in the determination of POEM. They are the
place where the accounting records are maintained; the Place of
incorporation of the company; the primary residence of the directors of
the company, the details of the stewardship functions by the parent
company etc. The parent company should restrict itself from actual
running of the subsidiary. The guidance or influence of the parent
company should be limited.
All these factors are/were relevant in the determination of C & M as well.
From
the above discussion, one may conclude that POEM is a fact and
circumstance specific concept and hence, all relevant facts and
circumstances must be examined on case by case basis. POEM refers to
comprehensive control over the entity as a whole during the year and is
not the same thing as a part of the control of the entity residing in
India for the whole of the year. It may be possible that a MNC has a
flat structure and shared powers or large scale autonomy in the
organisation where there could be more than one place where C & M
are situated. However, when one looks at the Company as a whole (which
is the requirement under POEM) then, one would be able to narrow down
POEM to one place/country.
OECD/UN perspective on POEM
The
OECD Model Commentary2 states that “The place of effective management
is the place where key management and commercial decisions that are
necessary for the conduct of the entity’s business are in substance
made. The place of effective management will ordinarily be the place
where the most senior person or group or persons (for example Board of
Directors) make its decisions, the place where the actions to be taken
by the entity as a whole are determined”.
According to the UN Model Commentary in determining the POEM, the relevant factors are as follows:–
(i) the place where a company is actually managed and controlled;
(ii)
the place where the decision-making at the highest level on the
important policies essential for the management of the company takes
place;
(iii) the place that plays a leading part in the management of a company from an economic and functional point of view; and
(iv) the place where the most important accounting books are kept.
To summarise, the criteria generally adopted to identify POEM are:
– Where the head and the brain is situated.
– Where defacto control is exercised and not where the formal power of control exists.
– Where top level management is situated.
– Where business operations are carried out.
– Where directors reside.
– Where the entity is incorporated
– Where shareholders make key management & commercial decisions.
Different Shades of POEM, POM and PCMC
POEM
is interpreted differently by different countries. Countries like
China, Italy, South Africa, Russia etc. have adopted the concept of POEM
in their Domestic tax laws. However, countries like The U.K.,
Australia, Germany etc. although do not have the concept of POEM but
they have adopted the concept of ‘Central Management’ and ‘Control or Place of Management’
and control as residence test for companies in their Statutes. Further,
POEM has been interpreted by countries in their own ways. This
interpretation can be observed from the reservations and observations of
various countries to the OECD Commentary.
BEPS and POEM
Final
Report of OECD on Base Erosion and Profit Shifting (BEPS), [Action
Point 6 on “preventing the granting on treaty benefits in inappropriate
circumstances”] prefers that in case of Tie-breaker for the
determination of treaty residence of a person other than individual, be
done by the Competent Authorities of respective states.
Draft Guidelines by CBDT on POEM
The
CBDT released draft guidelines for determination of POEM of a Company
on 23rd December 2015. A brief summary of the principles enumerated in
the draft guidelines is as follows –
POEM adopts the concept of substance over form.
The Company may have more than one place of management but it can have only one POEM at any point of time.
Residential
status of a person under the Act is determined every year. Accordingly,
for the purpose of the Act, POEM must be determined on year to year
basis. The determination would be based on facts and circumstances of
each case.
The
process of determining the POEM would primarily be based on whether a
company is engaged in ‘active business’ outside India or otherwise.
For
this purpose, a company shall be said to be engaged in ‘active
business’ outside India if all of the above conditions are satisfied –
For this purpose, an average of the data of the current financial year and two years prior shall be taken into account.
POEM guidelines for companies engaged in active business outside India:
The
POEM of a company engaged in active business outside India shall be
presumed to be outside India if the majority of meetings of the
company’s Board of Directors (BOD) are held outside India.
However,
in case the Board of Directors are standing aside and not exercising
its powers of management and such powers are being exercised by the
holding company or by any other persons resident in India, the POEM
would be considered to be in India.
Issues: Indian
Guidelines provide both objective and subjective criteria. On the one
hand it provides to look at the objective criteria for operations of
business such as earnings, assets, employee base, etc. (see the diagram)
while on the other hand, it also looks at actual control &
Management by BOD. Worldwide only control & management criteria
(decision making by BOD) are used. Indian Provisions for POEM are a
departure from International practice in that sense. POEM guidelines for
companies other than those engaged in active business outside India For
companies other than those engaged in active business outside India
(i.e. passive business), determining the POEM would be a two-stage
process:
First stage would be identifying/ascertaining person or
persons who are making the key management and commercial decisions for
conducting the company’s business as a whole.
Second stage would be the place where these decisions are being made.
Thus,
the place where management decisions are taken would be more important
than the place where the decisions are implemented. Some guiding
principles for determining the POEM are as follows:
Location where the company’s Board regularly meets and makes decisions can be the POEM of the company, provided the Board:
• retains and exercises its authority to govern the company; and
• in substance, makes key management and commercial decisions necessary for the conduct of the company’s business as a whole.
•
However, mere holding of a formal Board meeting would not be
conclusive. If key decisions by the directors are taken at a place which
is different from the location of the Board meetings, then such place
would be relevant for POEM.
A company may delegate (either
through board resolution or by conduct) some or all authority to
executive committee consisting of key senior management. In these
situations, location of the key senior managers and the place where such
people develop policies and make decisions will be considered as POEM.
The location of the head office
will be very important in considering the POEM because it often
reflects the place where key decisions are made. The following points
need to be considered for determining the location of the head office:
•
The place where the company’s senior management (which may include the
Managing Director, Whole Time Director, CEO, CFO, COO, etc.) and support
staff are located and that which is considered as the company’s
principal place of business or headquarters would be considered as the
head office.
• If the company is decentralised, then the
company’s head office would be the location where senior managers are
predominantly based or normally return to, following travel to other
locations, or meet when formulating or deciding key strategies and
polices for the company as a whole.
• In cases where the senior
management participates in meetings via telephone or video conferencing,
the head office would be the location where the highest management and
their direct support staff are located.
• In cases where the
company is so decentralised that it is not possible to determine its
head office, then the same may not be considered for determining the
POEM.
• Day-to-day routine operational decisions undertaken by
junior/middle management would not be relevant for determining the POEM.
• In the present age, where physical presence is no longer
required for taking key management decisions, the place where the
majority of the directors/ persons taking the decisions usually reside
would be considered for the POEM.
• If the above guidelines do
not lead to clear identification of the POEM, then the place where the
main and substantial activity of the company is carried out or place
where accounting records of the company are kept would be considered.
POEM to be a fact-based exercise: Examples of isolated instances would not necessarily lead to POEM
Issues:
If
a MNC holds its one of the Global Board Meetings in India, where
significant decisions are taken for its worldwide operations say group
policies are framed – can it lead to POEM? Perhaps not, being isolated
or one of its kind of meetings.
Place where accounting records
are kept may be considered for determination of POEM. This may lead to a
practical problem. What if mirror accounts are kept at two places?
Merely keeping accounting records should not lead to establishment of POEM.
Passive
Income: – Trading with a group company is considered as passive income.
When Transfer Pricing Regulations are in place this kind of provision
is uncalled for.
Objective and Subjective Criteria: – Ultimately
nothing seems to be clear. Each provision is with a caveat leaving to
lot of subjectivity and powers to Assessing Officers.
Local
Management: – It is provided that place of local management may not lead
to POEM but what is ‘local management’ is not defined.
As POEM
is sought to be clarified by way of guidelines, a moot question arises
whether guidelines be binding or override the provisions of law? In
fact, it is provided in the guidelines that they are neither binding on
the Income-tax department nor on the taxpayers. In such an event, what
is the sanctity of such guidelines?
Some Silver Linings
A
foreign company being completely owned by an Indian company would not
necessarily lead to POEM in India (Example – TATA Motors owning Jaguar
PLC).
One or some of the directors of a foreign company residing in India would not necessarily lead to POEM in India.
Local management of the foreign company situated in India would not be conclusive evidence for establishing the POEM in India.
Mere
existence in India of support functions that are preparatory or
auxiliary in nature would not be conclusive evidence for establishing
the POEM in India.
Other key points of the Guidelines
Guidelines
provide that the principles enumerated in the guidelines are only for
the purpose of guidance. In such cases, no single principle will be
decisive in itself.
POEM to be a fact-based exercise – a
‘snapshot’ approach cannot be adopted and activities are to be seen over
a period of time and not at a particular time.
In case the POEM is in India as well as outside India, POEM shall be presumed to be in India if it is mainly/ predominantly in India.
Prior
approval of higher tax authorities would be required by the tax officer
in case he proposes to hold a foreign company as resident in India
based on its POEM. The taxpayer must be given the opportunity to be
heard.
Does Guidelines on POEM sound similar to CFC Rules?
POEM, a step closer to CFC rules
Various
efforts have been undertaken by the Government of India to simplify the
Income-tax law in India5. The Finance Minister Shri Arun Jaitley at the
time of scrapping the Direct Tax Code (DTC) had mentioned that there is
no need of introducing DTC. Suitable amendments to the Income-tax law
would be made for the purpose of simplification.
The erstwhile
DTC contained the ‘Controlled Foreign Corporation’ Rules (CFC rules).
CFC rules, in principle, targets the offshore entities which are used to
park income in low or NIL tax jurisdictions. Similarly, POEM too tries
to achieve a similar objective. The guidelines defining ‘active business
outside India’ and ‘passive income’ are akin to provisions or
objectives of CFC Rules. No country in the world has such conditions for
determination of POEM which tries to achieve dual purposes.
Comments on the draft POEM Guidelines
Arbitrary use of powers
–
POEM, as a provision in the law specifically targets the unacceptable
tax avoidance structure(s). The use of shell/conduit companies is
discouraged. Considering subjectivity involved while determining POEM,
the draft guidelines are issued to narrow down its wide scope. However,
it has been specified that the guidelines are not binding on tax
authorities nor it is binding on the taxpayers. In such a case
guidelines are infructuous. Tax payers may fear that the provisions of
POEM may be applied harshly and interpreted in the widest possible sense
in favour of revenue.
Residency assumed, unless proved otherwise?
– The draft guidelines in current form seem to suggest that it’s assumed that you are resident barring a few exceptions.
– The wide subjectivity of guidelines can hamper Indian Entrepreneurship in the long run.
– Subsidiaries of Indian MNC’s particularly wholly owned subsidiaries
outside India would be facing an uphill task of establishing that the
POEM is not in India.
– The definition of passive income seems to be very wide and hamper genuine business transactions.
Whether the guidelines would have a retrospect effect??
–
Considering the wide scope of POEM, it was mentioned in the Explanatory
Memorandum of the Finance Act 2015 that the guiding principles would be
followed soon. However, it is unfortunate that the guiding principles
(in a draft format) have been issued at the fag end of the Financial
Year. In such cases, a question arises that whether these principles
would be applicable with retrospective effect from 1st April, 2015? The
answer seems to be “yes” as these are merely guidelines and not the law.
There is no question of retrospective effect. In fact what guidelines
say is supposed to be followed by companies in the normal course.
Summation
For
the purpose of determining POEM, it is the de facto control and
management and not merely power to control which must be checked. In the
redefined corporate tax residency regime of the domestic tax law (in
line with international principles), place of effective management has
become one of the relevant factors for the purpose of determining
residential status of a company. In such a scenario, the company would
be deemed to be resident of the Contracting State from where it is
effectively controlled and managed. The draft guidelines leave much to
the discretion of the Income-tax Authorities. We hope that the tax au
thorities are made accountable for their actions and certain fundamental
binding principles are laid down so that unnecessary litigation is
avoided. It is expected that the final guidelines will be modified and
litigation prone issues would be addressed. It would be interesting to
see how the Government and Income-tax authorities would view or evaluate
structures of various companies going forward. Prudence suggests that
applicability must be postponed for at least one year so that
unnecessary hardships to tax payers can be avoided. Further, this would
give an opportunity for hygienic check to taxpayers for their outbound
structures.
