Not to ruffle the feathers of the investor community when it is hard-selling the Make- in-India concept, the government will likely put off activating the place of effective management (POEM) regime by a year to FY17, if not beyond.
The last Union Budget brought the POEM law with an intent to put it into effect from the current fiscal but the draft POEM rules — notified only in late December — caused a stir in the industry, which said these were nebulous, if not flawed.
According to sources privy to the Budget discussions in the finance ministry, the move followed a rethink on the desirability of employing POEM, a tool against tax avoidance, at a time when private investments are in the doldrums. Also, it is felt that given the element of subjectivity that is integral to the POEM rules, the intended residency tests of firms for tax purposes could be undertaken with less hassles to them through other means like, for instance, the proposed Controlled Foreign Corporation (CFC) Rules.
The fact that India Inc has not been given adequate time to prepare itself for the POEM regime also prompted the review, the sources added.
Acceding to the demand from foreign investors, finance minister Arun Jaitley had, in the last Budget, deferred the implementation of the dreaded General Anti-Avoidance Rules (GAAR) by two years to financial year 2017-18 (assessment year 2018-19) and subsequent years. GAAR was meant to reduce tax avoidance for investments made by entities based in tax havens.
The POEM principle — which has found traction with tax authorities in capital-exporting countries and the OECD — was included in India’s Income Tax Act with the express purpose of discouraging creation of shell companies — with Indian shareholders — in foreign jurisdictions to avoid tax residency in India. If a company is treated as resident in India, its worldwide income is taxable here, while only the India-sourced income of foreign companies is taxed. Although the tax rate on foreign companies is higher (40% versus the marginal rate of 30% for domestic firms), the prospect of subjecting worldwide income to taxation could potentially hit many MNCs with Indian stakeholders. Use of POEM rules to determine residency could hamper corporate India’s outbound investments and raise compliance costs, analysts have said.
The revenue department, however, has held that its POEM guidelines essentially stuck to the principle that whoever actually takes the commercial decisions in a company should be treated as its management and the POEM should be so determined. The rules would legitimately restrict the leeway of companies to create corporate structures to hide their POEM status, the department said.
The real reason behind the POEM implementation, analysts noted, is a move to tax passive foreign income — royalty, dividend, capital gains, interest income and the like — of firms incorporated in foreign countries. They said the size of such passive income and the gains to the revenue department from POEM application should be gauged and compared with the cost of antagonising the investor community before a final decision on this issue could be taken.
The difference between POEM and CFC Rules is the latter provide for taxing deferred incomes of foreign companies with Indian shareholders by treating them to be the income of these shareholders and taxing it in their hands. So far, the Modi government has not clearly expressed its views on the CFC Rules, which part of the Direct Taxes Code prepared by the UPA government.
* POEM law, a new tool to determine the residency of firms for tax pupose, was brought in last year
* The idea is to scuttle Indian promoters creating shell firms abroad to avoid paying taxes in India
* POEM hasn’t taken effect so far; draft rules released only in December 2015
* Industry says the rules need to be fine-tuned to reduce scope for discretion with taxman
* Some say deferred incomes of MNCs with Indian shareholders be taxed in the hands of the shareholders