Short Forms:
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BVI
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:
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British
Virgin Island.
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CIT
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:
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Commissioner
of Income-Tax.
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DTA
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:
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Double
Tax Avoidance Agreement.
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DTC
|
:
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Direct
Taxes Code.
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FEMA
|
:
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Foreign
Exchange Management Act.
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ISP
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:
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Internet
Service Provider.
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ITA
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:
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Income-tax
Act.
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Key
Management
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:
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See
Paragraph 4.2 below.
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SPV
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:
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Special
Purpose Vehicles.
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TP
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:
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Transfer
Pricing.
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Place of Effective Management
Foreign Company’s Residence.
The concept of Place of Effective Management (POEM) is used to determine a foreign Company’s Residential Status.
Macro Perspective: Central
Government of India has launched two separate attacks:
(i) Attack on “Tax Evasion” (Black Money). We are preparing a separate paper on the subject. And it will be presented on our website.
(ii) Attack on “Tax Planning”. This
is avoidance of Indian tax which is permitted under the Law. Now the Government
is changing the law and extending the net of Indian Income-tax. Concept of POEM
is part of the attack on “Tax Planning”.
Importance:
If a company’s POEM is situated in India; it
will be treated as Indian resident. Its global income will be taxable in India.
It will have to file its tax returns, audit reports etc. with Indian tax
department. If it does not file its income-tax return in India; consequences
will be: Its global income will be considered as concealed income. The Company
will be considered to be an assessee in default. Hence relevant provisions of
the Income-tax Act as well as the Black Money Law - will apply. This is the
importance of determining and proving POEM.
Paragraphs 3 to 5 below discuss the concept
of POEM. Para 6 discusses consequences. Para 7 to 17 explain steps to be taken
to prove non-residential status.
Executive Summary completed.
A Company’s Residential Status determines
its global tax liability. If a company is Resident in India, its
global income is taxable in India. If it is non-resident of India, it is liable
to tax only on income sourced (earned) in India.
How does one determine tax residential
status? Residential status is different under Indian tax law and under Foreign
Exchange Management Act (FEMA). Residential status is also different from citizenship,
domicile, etc. We are focusing purely on residential status under Income-tax.
For an individual, the
residential status is determined by the physical presence of the individual
within India or outside India. For a company, how does one determine whether
the company is within India or outside India?
Income-tax department is concerned about
foreign companies managed by Indian Residents escaping Indian Income-tax. Hence
the department would like to consider such foreign companies as resident in
India. Under what circumstances can a foreign company be treated as Indian
resident? There are two factors to determine residential status:
(i) Country of Incorporation.
Incorporation gives to the company its legal
status, legal rights and all regulatory supervision. Normally countries
consider place of incorporation as the primary factor to determine residential
status. Hence a company incorporated in India is always considered to be
Resident in India. Conversely, a company incorporated outside India, is prima
facie considered a Non-Resident company.
(ii) Seat of Management:
It is normally presumed that the seat of
management is in the same country where the company is incorporated. In the
modern times, it is easy to have the place of incorporation and place of
management in different countries. In fact, many companies plan this.
It is possible that the Country of Ownership
(shareholders’ normal residence) and Country of Management (place where
directors normally function) are in India. But the company is incorporated
outside India. This is especially more convenient where the company’s business
and or investments are outside India.
For Residential status, it is normally
considered that – Country of Ownership – shareholders’ residence is NOT
relevant. Even for directors, their country of residence is not important.
Where they actually function, is more important. When the directors reside in
one country and their place of functioning/ management is in another country;
it will be for the company to prove its place of management.
2. Present Position: Under
the Indian Income-tax Act, Section 6 (3) (ii) provides following definition:
“S.6 (3) (ii) A company is said to be
resident in India in any previous year, if….. during that year, the control
and management of its affairs is situated
wholly in India.”
2.1 The
implications of this definition are such that even if a foreign company had a
small fraction of its management situated outside India, it would not be having
“the whole of its management in India”. Hence a company could avoid
Indian tax by having one director outside India, holding some board meeting
outside India etc.
2.2 Indians
have opened thousands of Special Purpose Vehicles (SPVs) for
foreign projects/business or investments. These are companies incorporated
outside India for a special purpose. 100% of the shares may be held by Indian
residents. The Board of Directors may be of Indian residents. Most of the
decisions may be taken in India. Yet, such a company would avoid Indian
Income-tax on its foreign income and Indian wealth tax on its foreign wealth by
keeping a part of its management outside India.
3.1 The proposed
definition of corporate residence changes the situation. For treating a foreign
company as resident in India, from
1st April 2015, it will not be necessary to have the whole of its Control & Management to be situated in India. If its effective management is situated in India, the foreign company will be treated as Indian resident.
1st April 2015, it will not be necessary to have the whole of its Control & Management to be situated in India. If its effective management is situated in India, the foreign company will be treated as Indian resident.
This would mean that thousands of foreign
SPVs created by Indians may be treated as Indian Residents.
Under the Finance Bill as presented on 28th February,
2015, the definition included the phrase: “at any time”. There was an
apprehension that due to this phrase, if the POEM is situated in India even for
a day, the company will be treated as Indian Resident. The Finance Minister has
removed the phrase at the time of moving the bill in Lok Sabha on 30thApril,
2015. This makes it clear that government does not intend to cover occasional/
casual decision taking from India. POEM will be considered to be situated
where, the Key Management is exercised in substance.
4 Important Phrases:
4.1 Effective management:
4.1 Effective management:
The words Effective Management refer to
actual management and not just formal or ostensible management. For example, in
some SPVs, the consultants may be the directors. One consultant/ solicitor/
banker may be managing a thousand companies. The clerical staff of this company
may be on the board of all the thousand companies. This is management for the
sake of name. They cannot be considered as effective directors. To establish
effective management, one will have to appoint directors who are competent to
take business decisions. Having just one or a minority of professional
directors to comply with local regulations would be ok. However, the Key
Management should comprise of genuine business managers.
4.2 Key Management:
(i) The term “Key Management” has
significance. The definition does not use the term “Board
of Directors”. The Board may meet only once in a few months. Actual
management of the company on a regular basis may be conducted by the managing
or executive directors and CEO or similar other important executives. Key
persons who actually manage the company are to be considered and not the Board
of Directors. If the key managerial persons conduct management from a specific
place; that will be the POEM of the company.
(ii) A company may have several
business functions. It may have a few factories, several shops, different
offices for purchase and administration, and one head office where the
directors and chief executive officers function. The day-to-day operations and
business transactions will take place at all the factories, sales offices and
purchase offices. However, those operations are not important while determining
the key management. Directors and CEOs take key managerial decisions. Hence
company’s POEM will be considered where the key managers function. This group
is referred to in this article as “Key Management”.
4.3 POEM outside India:
It may be noted that for the purposes of
Income-tax Act, Section 6; what is important is determining that the POEM
is not situated in India. Technically, it is not necessary to prove
that the POEM of the company is situated at some specific place outside India.
This situation can be compared to: “Negative Evidence” & “Positive
Evidence”. Proving that the POEM does not lie in India – requires
Negative Evidence. It may be difficult to prove. However, proving that the POEM
lies in a specific country is positive proof and can be established more
easily. Hence having the POEM in a specific country is a tremendous help, but
not legal necessity.
A company may hold its meetings in different
hotels and in fact in different countries. The company will have registered
office with some consultant outside India. For the board and shareholders’
meetings, it will keep meeting in different countries depending upon its
business requirements. Key Management may be spread over a few countries. They
may hold meetings by Virtual Conferences. It is not legally necessary that
there should be one specified, identified place of management. It should be sufficient
that the office is not situated in India. Company has to plan to prove that its
POEM is not situated in India. If the company finds that proving this is
difficult, it may prove that the POEM is situated outside India.
4.4 Place:
The term Place refers to a geographical
location within a specified country or territory. If the Place of Effective
Management is in India, the company will be treated as an Indian resident. Once
the POEM is not situated in India; outside India it can be anywhere and in any
mode. Thus outside India, the office may be a “Virtual Office”.
In case of companies having substantial
business, the place of management will refer to the place from where the Key
Management normally functions. The directors would have their office. This may
be the registered office of the company or any other office. The place where
the directors actually manage the business will be considered to be the place
of management.
The place of management of the company may
be different from the place of residence of the directors and residence
of the shareholders. For example, the directors may be residing in Abu
Dhabi. The company may have office in Dubai. In such a case, the place of
management for the company will be in Dubai. Within European union and other
places where movement of citizens from one country to another country is
unrestricted and regularly taking place, this issue becomes important.
The residence of shareholders is normally
irrelevant. Shareholder level control is not the management level control of
the company. In some cases, if the shareholders actually take even management
decisions, then the place of effective management may be affected. Even in this
case, if the shareholders travel to the office of the company and take company
management decisions in that office, then the shareholders’ residence will not
be relevant for determining POEM. Illustration: Mr. A and his family hold 100%
equity of an SPV incorporated in Singapore. The SPV has its own office and a
board of directors situated in Singapore. Mr. A regularly travels to Singapore
and attends the board meetings at Singapore. In those board meetings when
management decisions are taken, Mr. A participates in the decision making
process. He does not take any decisions while he is present in India. In such a
case, the management is situated in Singapore and not in India.
4.5 Commercial Decisions:
The company may have a registered office.
This office may be doing the secretarial function of complying with the
regulations. This is not important for determining POEM. The place where the
Key Management takes important commercial decisions is the place where POEM is
situated.
4.6 Conduct of the Business of an entity as
a whole:
In the illustration given above, the
factory, the shop, the administrative office – all the offices may be taking
commercial and operational decisions. However, each such office will be largely
taking decisions restricted to its own area of work. It is only the Key
Management that takes decisions for the entity as a whole. And hence it is the
office of the Key Management which is relevant in determining POEM.
4.7 In Substance:
These words may refer to several factors.
(a) Key Management may be
assisted by several managers, accountants and secretaries. They may be even
taking certain commercial decisions. However, in substance, the key managerial
decisions will be taken by the key management. The location of the office of other
managers etc. is not important in determining the POEM.
(b) Some individual/ occasional
decisions may be taken in India. However, if majority of the decisions
are taken abroad; then the decisions are “in substance” taken abroad.
(c) “….. decisions ….. in substance are
made” also refers to actual, real decision making. If the decisions are, in
substance made by some people in one country; and then formally minuted by the
Board of Directors in another country; then the correct criteria is – where the
decisions were actually taken.
Conclusion: For
determining the POEM, the office where the Key Management actually functions is
the most important factor to consider.
4.8 SPV:
Many Indian residents have incorporated SPVs
outside India. Some of these SPVs may be acting as holding companies to hold
the shares of step down subsidiaries or to hold other investments. The SPV may
not have full time executive directors/Key Managers. Most of the directors may
be having their own separate businesses /activities. Hence this SPV may be
operating from the office of a consultant. How does one determine
the Place of Effective Management of such an SPV? Prima facie, such a company
does not have a regular office from where the directors function. If the
company makes a regular practice, so that atleast two or three times a year, the
Board of Directors meets outside India, then the company can claim that its
POEM is situated outside India. .
If the day to day management does not take
place; and if only place of meetings are to be considered; we have to consider
the place where the Board of Directors are meeting. All the
directors may be physically outside India when the meeting takes place. Then
the meeting may be by Video conferencing or telephone or Skype or any other
means of communication.
5. When does
the question of proving POEM arise?
(i) Normally, a company incorporated outside
India should be treated as a Non-Resident. Company does not have to prove
anything.
(ii) When the company itself considers its
POEM to be situated in India; it should suo-moto file income-tax return in
India and comply with the Income-tax Act.
(iii) When the company genuinely has a
foreign office and actually all management happens outside India, it need not
do anything under the Indian Income-tax Act. Except that – it may maintain
evidence for the office being situated outside India.
(iv) When some management happens in India
and some management happens outside India; it will be necessary for the
company: to decide where its POEM is situated; and to
prove where its POEM is situated.
6.1 When
foreign companies are treated as Indian Residents, the consequences will be as
under.
(i) All these foreign companies will have to
file their regular income-tax returns in India. They will have
to obtain Indian PAN.
(ii) Their global incomes will be
taxable in India. The companies have to pay advance tax and
self-assessment tax as applicable.
(iii) They will have to maintain regular books
of accounts, vouchers and documents like any other Indian resident
companies. It will be no use to say that in the country of its incorporation,
the accounts are not required.
(iv) These companies will have to get their accounts
audited – statutory Audit, Tax Audit and where applicable – Transfer
Pricing Audit. All these reports have to be submitted to Indian CIT. Again, it
will not be an excuse to say that in the country of its incorporation, audit is
not required.
(v) These companies have to obtain TAN and
comply with Indian TDS requirements.
(vi) Several other anti-avoidance provisions
will apply. For example, cash expenses will be disallowed, loans taken or
repaid in cash will be considered as taxable income; excessive remuneration to
relatives of people substantially interested in the company will be disallowed,
Section 2(22) of the ITA – deemed dividend will apply and so on.
6.2 Dual Residence:
The country in which they are incorporated
will still consider them as residents. Hence they will have dual
residence – in India and abroad. Resolving the dual residence will be
an issue. If there is a Double Tax Avoidance Agreement (DTA) with
that country, Article 4(3) of the DTA – “Tie-Breaking Provision” will apply. In
absence of the DTA, India will apply Indian Tax Law. There can be Double
Taxation. Section 91 will apply and appropriate relief may be available.
The SPV may earn income from a third
country. For example, Indian investors have incorporated an SPV in Dubai. The
Dubai SPV earns income from Britain. For the British income, which DTA will be
applicable?
India will apply India- UK DTA.
Having considered the company as Indian
resident, the Indian Income-tax department should give a certificate that the
company is Indian Resident.
Based on this Indian Tax Residence
Certificate, the company should be able to claim the benefit of India – UK DTA
before the UK tax authorities.
Since there is no income-tax in Dubai, the
company does not have to prove anything in Dubai.
6.3 Let us
consider the Dual Residence of a foreign company. In the DTA,
the “Tie Breaking Provision” – Article 4(3) will provide that the company’s
residence will be where its POEM is situated. Now the term POEM is NOT
defined in the OECD and U.N. Models of DTA. So which definition will
apply?
DTA models – Article 3(2) provide that -
where any particular term is not defined in the DTA; the definition provided in
the domestic tax law of the country applying the DTA - will be applicable.
Hence Indian tax law will be applicable.
6.4 Transfer Pricing:
6.4.1 International
Transfer Pricing Rules do not apply to transactions between Indian residents.
Once the SPV is treated as an Indian resident, its transactions with other
Indian residents will not be subject to TP rules. However, domestic transfer
pricing rules can apply.
6.4.2 The group
may have several companies outside India. Some may be SPVs and some may have
substantial business abroad. The SPVs may be considered to be Indian residents.
The foreign companies having substantial business abroad may be considered
non-residents. The transactions between foreign SPVs and foreign substantial
companies will be subject to International TP rules.
6.5 This is
just a list of some of the difficulties. It is hoped that the Government will
make some rules providing relief from unintended consequences.
What should a company management do so that
the foreign company is not treated an Indian Resident?
The first action to be taken is to ensure
that in reality, the foreign company’s management is not
situated in India. This first step is the most important step. The way,
Indian tax law is progressing, “facts and substance” will be more important
than “form and paper work”. In some cases, proving that the POEM is not
situated in India may be difficult. But if the company can prove that its POEM
is situated outside India, the corollary will be that the POEM is not situated
in India in substance.
Our submission is:
(i) Have actual effective management outside
India.
(ii) Have proper documentary
evidence to establish before the Indian Commissioner of Income-Tax
(CIT) that the foreign company’s management is actually situated outside India.
We are listing below the steps to be taken for both these factors: Paragraphs 8
to 17.
8. Physical
Office:
As seen earlier in paragraph No. 4.4 above,
it is not a legal necessity that the company should have a place of business
outside India. However, where the company decides to prove that it has a place
of management outside India; and hence claim that it has no place of business
in India; then following issues may be considered.
If the company does have a specific physical
office outside India, it may be owned by the company or may
berented by the company. The foreign company need not have a
physical office outside India. Some free zones in UAE permit setting up of virtual
office. Some free zones provide office in a business center.
That also should be part of the total evidence.
9. Have atleast two
directors on the Board of Directors who are non-residents of India.
Practically it will be better if these directors are also residing in the same
country, same city where the location of the foreign company’s POEM is to be
situated. It would be beneficial in terms of actual cost reduction if the
directors are also residing in the same place. However, where this is not
practical, directors may be resident anywhere in the world but outside India .
For example, an SPV may be incorporated in British
Virgin Island (BVI). It would be impractical to find directors who are
residents in BVI and are actually participating in business management. Hence
the management may decide to locate its POEM in Dubai, Singapore, Hong Kong or
any other offshore financial centre.
Care may be taken to ensure that the POEM is
not in other taxing countries like Britain, USA, etc. Otherwise those countries
will claim their rights to tax the company.
10 . It is not
legally necessary that POEM should be situated in the same place where the
company is incorporated.
11. In our
view, professional directors like solicitors, CAs, bankers or
their staff will not qualify as Key, Effective Management. The directors should
be genuine businessmen who will actually conduct the business of the SPV.
12. Board meetings of
the company should generally be held outside India. Note: as seen earlier in
paragraphs 4.2 and 4.4, what is more important is – where the Key Management
functions. Board meetings and Share Holders’ meetings are additional factors of
persuasive value.
13. Shareholders’
meetings should generally be held outside India.
14. Licence:
If the foreign company claims a physical
POEM outside India, it should actually have a licence/Municipal
registration/regulatory permission to operate in the relevant area where it
claims its POEM is situated.
Illustration: A
foreign company may be registered in BVI. The management may claim that its
head office is situated in a free zone in UAE. However, the management may not
take a proper regulatory permission for the specific company to have an office
in UAE. This would not be adequate evidence.
15. All the books
of accounts, voucher files, etc. should be maintained at the POEM
office. Many jurisdictions like BVI, UAE etc. do not insist upon
maintenance of accounts nor audit of books of accounts. This is no argument for
the company for not maintaining books of accounts. One should understand that
when it is exposed to Indian tax laws, it should maintain records and evidences
that are considered adequate under Indian tax law.
The company should maintain proper Minutes
books for the Board of Directors as well as shareholders. Company
seal should be maintained at the POEM office. Proper share
certificates should be issued by the company. These certificates may be
physically kept with the shareholders – who may be in India. However, the shareholders’
register should be maintained outside India.
And the management should be able to prove
that all these documents are actually maintained outside India. A practical way
to do this is: Auditor may physically verify these documents and then give a
certificate.
16. Management Information Systems (MIS):
While the main accounts are maintained
outside India and while the management functions outside India, regular
management information reports may be sent to the directors in India. It is a
good management to have proper MIS.
17. Telephone
Instructions:
There are people who take such issues
casually. While formally, a Board of Directors would be situated outside India,
Indian shareholders may be in the habit of giving instructions by telephone or
by emails/ by any other communication medium. It should be noted that if
regular instructions are given from India, it may be considered that the POEM
is situated in India.
How will the Income-tax department know it?
All internet communications are stored by
the Internet Service Provider (ISP) for ten years. If at any
time, the income-tax department wants to investigate, it will be able to access
the record of telephone calls, emails and faxes. Face Book and WhatsApp
communications also travel through the internet. They will be available.
We may consider an internet communication to
be more open than a post card. Consider a person who sends post
card from Mumbai to Assam. The post card will pass through the hands of, say,
ten employees of the postal department. These ten employees may be able to read
the post cards. Once the post card reaches the addressee, the matter ends.
However, in the case of internet communication, any number of people can have
excess to the communication. The addressee may or may not receive the
communication. After receipt, the addressee may delete the communication from his
computer / mobile phone. But the ISP would have stored it for the next ten
years. Beware. Whatever you do on the internet is available to several
regulatory agencies and to several hackers.
Note:
It may be noted that solitary instructions
do not amount to shifting of the POEM. Once in a while, it may be necessary to
give some instruction from within India. Legally it should not be a problem.
There is a substantial different between (i) Management
control which is exercised by directors; & (ii) owner /
shareholder control which is exercised by shareholders. The ownership
control will of course remain in India. That should not affect POEM.
Creating any Non-Corporate entities abroad
will be even more risky. Any trust, partnership firm, Association of Persons
(AOP), Body of Individuals (BOI) etc. will be covered by Section 6 (2). As per
Section 6(2), even if a small fraction of its management and control is
situated in India, it will be treated as Indian Resident. All consequences
discussed above will follow.
In USA ‘S’ Corporations are allowed. Many
countries permit LLCs which are treated as transparent entities. All these
entities will be directly taxable in India (If Indian residents manage the same
even partially.).
POEM will now be the factor determining
Indian residence of foreign companies. In essence, if a foreign company is
managed from India, it will become Indian resident and tax consequences will
follow.
This article gives a list of precautions to
be taken. Where it is not practical to take majority of these precautions, it
will be better to treat the SPV as an Indian resident. Start preparing books of
accounts and file returns. Pay advance tax etc.
Of course, wait till the Finance Bill
becomes Finance Act and relevant rules etc. are announced.
1. Under the Income-tax Act, 1961, the
definition is as under:
Residence in India.
Section 6. For the purposes of this Act, -
(1) An individual is said …..
(2) A Hindu undivided family …..
(3) A company is said to be resident in
Indian 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.
2. Direct Taxes Code, 2009 provided the definition as under.
Residence in India.
Section 4 (1) An individual shall be
resident …..
(2) The provisions of clause (b) of
sub-section (1) shall …..
(3) A company shall be resident in India in
any financial year, if –
(a) it is an Indian company; or
(b) its place of control and management, at
any time in the year, is situated wholly or partly, in India.
3. Direct Taxes Code Bill 2010 proposed a definition as under:
Section 4 (b): its place of effective management, at any time in the year, is in India.
Section 314 (192) “place of effective management” means –
(i) the place where the board of directors
of the company or its executive directors, as the case may be, make their
decisions; or
(ii) in a case where the board of directors
routinely approve the commercial and strategic decisions made by the executive
directors or officers of the company, the place where such executive directors
or officers of the company perform their functions.
4. Finance Bill 2015 – as presented on 28th February, 2015 proposed as under:
Section 6 (3) A company is said to be resident in India in any previous year, if –
(i) it is an Indian company; or
(ii) its place of effective management, at
any time in that year, is in India.
Explanation – For the purposes of this clause “place of effective management” means 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.
5. Finance Bill 2015 – as moved on 30th April, 2015 proposed as under:
Section 6 (3) A company is said to be resident in India in any previous year, if –
(i) it is an Indian company; or
(ii) its place of effective management, in
that year, is in India.
Explanation – For the purposes of this clause “place of effective management” means 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.
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