The Central Board of Direct Taxes (CBDT) on Wednesday issued a set of draft guidelines for determining the place of effective management (POEM) of companies for taxation purpose. The new rules are significant because if POEM of a firm with operations in India and abroad is considered to be in India, its tax liability in India could potentially rise. If POEM of a firm is in India, then its worldwide income — not just income from Indian operations — would be taxed here.
According to the CBDT’s new guidelines, comments on which can be posted at the e-mail address firstname.lastname@example.org or sent by post to the board by January 2, a company would be said to do “active business outside India” if its passive income — income from transactions with related parties, royalty, dividend, capital gains, interest income and the like — is more than half of the total income and less than half of the assets are located in India. Also, firms with less than half of the employees are “situated or residing” in India and the payroll expenses on such people is less than half of the firm’s total payroll spend would also be subject to POEM rules.
The guidelines, which provides directional guidance on many controversial issues on the way the POEM concept should be applied, also defined terms like “head office” of firm, “senior management” and essentially stuck to the principle that whoever is actually taking the commercial decisions in a company should be considered its management and accordingly POEM will be determined. The new rules seeks to circumscribe the leeway of companies to create corporate structures to hide their POEM status.
While Indian-incorporated firms (Indian companies) are taxed at 30% plus dividend distribution tax (DDT), non-resident (foreign) companies are taxed at 40% on Indian income without DDT. Although the tax rates on foreign companies are higher, the prospect of subjecting the worldwide income to taxation here could have potentially hit many MNCs with Indian stakeholders.
In case of a company engaged in active business outside India, the POEM would be presumed to be outside India if majority of the board meetings are held outside the country. However, if it is found that the board of directors are standing aside and not exercising their powers and such powers are exercised by the holding company or any other person resident in India, then the POEM would be reckoned to be in India.
“If a board has de facto delegated the authority to make the key management or commercial decisions for the company to the senior management or any other person and does nothing more than rotinely ratifying the decisions,” the POEM, would ordinarily be the place where these senior managers make those decisions.
“While the guidelines are still in draft form, the CBDT has provided clarifications which should help reduce unnecessary litigation. These guidelines are broadly in line with international principles,” said Parikshit Datta, senior director, Deloitte in India. “The guidelines could be more illustrative giving case studies particularly in respect of passive income companies,” said Rahul Garg, leader-direct tax, PwC India. He added that active income factors to be considered are unreasonably strict as some of them have little relationship with control and management of entity as a whole.
Since residence is to be determined each year, POEM would also be determined on a year to year basis. The POEM concept that was included in the I-T Act early this fiscal had raised fears among many multinational companies with Indian promoters or major shareholders that New Delhi would lay claim to taxes on their incomes attributable to other geographies.