The threshold for triggering company residency under the prevailing income tax laws is significantly restricted and requires whole of the control and management to be situated in India. Part control located outside India at any time during the year is cushion against trigger of residency in India.
The Residency Test proposed in draft DTC of 2009, had wide implications due to its skeletal threshold limit provided for foreign companies and could have perplexed the taxation of foreign companies in India. Such definition would have landed almost every foreign company falling into the Indian tax net, thus making their global income to be taxed regardless of situs of accrual or receipt of income.
Apprehensions received from industry players paved way for the second version of the DTC introduced in 2010, which strived to streamline the Indian laws of residency with model commentaries and international tax treaties. Section 4(3) of DTC provides a company to be resident in India if it is an Indian company or its Poem, at any time in the year, is in India.
The revised DTC defines Poem to be the place where the board of directors (BoD) of the company or its executive directors (ED), make their decisions; or in a case where the BoD routinely approve the commercial and strategic decisions made by the ED or officers of the company, the place where such ED or officers of the company perform their functions. It is imperative to bear in mind that the weight is not on routine or implementation of management decisions, but on a place where the effective management resides ie, a place where decision-level control over commercial and strategic decisions in relation to the affairs of an entity resides. Most tax jurisdictions interpret Poem as a place where strategic decisions are made.
An overseas company, which is a resident, will trigger tax implications / obligations as are applicable to an Indian company. To illustrate, a resident company pays tax in India on its global income regardless of situs of accrual or receipt of income. Another example is application of dividend distribution tax (DDT) applicable to resident company. There can be double whammy where a foreign company may end up paying branch profit tax as per draft DTC 2010, in year 1 and may expose itself to DDT in year 2, if it is regarded as resident in year 2. The exposure could be in respect of the same income without possible set off.
Although, introduction of Poem test in Indian legislation is an attempt to espouse internationally accepted principles, it is likely to have an impact on companies having Indian branches, foreign subsidiaries of Indian parents, overseas companies having global reporting structure in India, to name a few. Furthermore, the India-headquartered companies having outbound operations should gain grass root understanding of the Poem test and keep their management apprised of all developments to dilute the propensity of risk. Such companies should preempt repercussions of the Poem concept on their transactions that are likely to have an India connection and should take steps to insulate themselves from any uncertain tax positions. Dearth of a proactive approach could act as deterrent at the implementation stage of transactions and can prove to be fatal in terms of interest and penalties.
While the interpretation by Indian courts on the new test will be noteworthy, absence of any Indian jurisprudence on the issue may lead to complexities at the debut stage.
Till that time, lets wait whether the Poem will prove to be a sweet lullaby or a harsh monotone!
The writer is tax partner, Ernst & Young. These are his personal views. (Ankur Singla, senior tax professional, Ernst & Young, contributed to the article)