The Finance Act, 2015, amended the conditions for determining the corporate residency status by introducing the concept of Place of Effective Management (PoEM). The intent was to ensure that companies incorporated outside India but controlled from India do not escape taxation in the country, and to the bring the concept of residency of corporates with globally-accepted principles.
PoEM, as a criteria for evaluating the residential status of companies, has been made effective from financial year commencing April 1, 2015. The finance ministry recently issued draft guiding principles for determination of PoEM of a company. These principles establish that PoEM shall be determined on the basis of the ‘actual conduct’. It bifurcates the business of a foreign company into ‘active business outside India’ and ‘passive business outside India’, based on certain definitive conditions.
A company engaged in ‘active business outside India’ has been defined, inter alia, where the main business income is higher than the passive income (i.e. income from interest, dividend, royalty, rent, capital gains, etc).
These guidelines provide much-needed respite to companies engaged in active business outside India, as PoEM of such companies is assumed to be outside India where the majority of the Board of Director meetings are held abroad. However, where the Board of Directors is merely a ‘puppet’ and the powers of management are exercised by an Indian holding company or any person who is a resident in India, PoEM would be considered to be in India.
In sync with the intention of introducing PoEM—i.e. taxing conduit entities—the guiding principles emphasise on determining PoEM of companies engaged in passive business outside India by providing detailed guidance. It has been specified that determining PoEM of such companies is a twofold process—one, identifying the persons actually making key management and commercial decisions and, two, determining where such decisions are taken/concluded.
The guidelines provide factors such as location of regular key meetings of the company board, and designated executive committees, head office location, etc, as key determinants of establishing PoEM of companies engaged in passive business outside India. These also clarify that day-to-day routine operational decisions undertaken by junior and middle management shall not be relevant for the purpose of determination of PoEM.
An interesting point to note is that the guidelines stress upon the ‘physical location’ of key decision-makers for determining PoEM, i.e. these focus on where the key decisions are made in substance. For instance, in case of a foreign company in which Indians constitute the majority of Board of Directors, the location of conducting the Board of Director meeting loses relevance, since Indian directors virtually attend meetings from India. In such a scenario, PoEM of a foreign company may be the location where the majority of directors reside.
It provides that where general factors are incompetent for determining PoEM of a company, secondary factors—location of maintaining accounting records or place of undertaking substantial business activities—can be considered.
The overarching principle focusing on substance over form clarifies that isolated facts should not be considered for determining PoEM of a company. For instance, in cases such as (1) a foreign company being a wholly-owned subsidiary of an Indian company, or (2) some of the directors of the company residing in India, or (3) management decisions for India-specific activities of a foreign company being taken in India, etc, such factors should not be viewed in isolation for determining PoEM of a foreign company in India. In other words, determination of PoEM is a fact-specific exercise, wherein all factors need to be considered in combination in order to ensure a holistic view.
PoEM as a condition to determine the corporate residency has been implemented in various countries such as Germany, China, the Netherlands, South Africa, Spain and Russia, as well as in internationally-accepted model tax conventions. Factors for determining PoEM, as provided in finance ministry’s draft guiding principles, are broadly in sync with those already implemented in above-mentioned countries.
However, the ministry may consider providing specific guidance with regard to the impact of shareholder functions on determining PoEM of a foreign company in India.
The guidelines seem to have borrowed pointers from the concept of controlled foreign company (CFC) by bifurcating activities of foreign companies into active and passive businesses. Where this is finalised, CFCs of Indian companies satisfying the PoEM test would be brought under the ambit of domestic tax laws.
These principles provide much-needed guidance and clarifications with regard to establishment of PoEM of foreign companies in India. The liberal factors specified for foreign companies engaged in active business display the intent of the government to safeguard the bona fide and genuine interests of taxpayers—a welcome move in the prevailing industrial environment, where Indian companies are seeking to expand their global footprint.
(With inputs from Ashish Singhal, Direct Tax, PwC India)
The author is partner, Direct Tax, PwC India