The Central Board of Direct Taxes issued its final guidelines in January 2017 to determine the Place of Effective Management (POEM) of a company. The POEM guidelines came nearly two years after the government, in the 2015 budget, amended the provisions for tax residency of foreign companies.
Implementation of the POEM guidelines was deferred by a year in the 2016 Budget due to the absence of criteria to determine corporate residency. Why is POEM important? A simplified answer: Because if a company’s place of effective management is India, it will be treated as a local resident and its global income will be taxable in the country.
Concept of POEM
POEM is an internationally recognised test to determine residence of a company incorporated in a foreign jurisdiction. It works to check companies who set up shell subsidiaries abroad to evade taxes. POEM guidelines are effective from 1 April 2016 and became applicable from FY 2016-17 (assessment year 2017-18).
There are three broad criteria to establish corporate residency in several jurisdictions: Place of a company’s incorporation (POI), place of its central control and management (CCM) and the third is POEM. Almost all jurisdictions that impose tax on corporate entities determine the tax residence of such entities based on one of two types of tests or a combination thereof. The first type is formal and usually based on POI of the company. Under the POI test, for purposes of tax, a corporate entity is resident in the jurisdiction of its incorporation. The second type, which includes CCM and POEM, is substantive and based on the real seat of the corporation.
A corporation’s real seat depends on some combination of factual elements, such as the location of its administrative headquarters or the location of the firm’s centre of gravity (as determined by the location of the employees and assets). The dichotomy between ‘formal’ and ‘substantive’ criteria makes an interesting inquiry.
The concepts of POEM and POM (place of management) serve entirely different purposes. POM determines whether a company is resident in a particular country. POEM is a tiebreaker test whose purpose is to resolve cases of dual residence by determining in which of the two states it is to be found. In other words, the phrase POEM is to be approached by determining in which of the states the effective management or real management of a company is situated.
Indian POEM guidelines vs. OECD guidelines
Even though the concept of POEM as proposed in the Indian POEM guidelines is largely in line with the one defined by the Organisation of Economic Cooperation and Development, there is a marked departure from the OECD guidelines.
The proposed definition of POEM is much wider on account of the term “at any time during the year” being added. This would require foreign companies to be careful with regard to their Indian management and governance structures to ensure that taxability in India is not triggered. This provision is likely to lead to prolonged litigation due to subjectivity involved in its interpretation, in the absence of detailed guidelines.
Unique features of the POEM guidelines
The final POEM guidelines contain some unique features. The Active Business Outside India (ABOI) test has been provided, so as not to cover companies outside India which are engaged in active business.
The intent here is not to target Indian multinationals engaged in business activity outside the country. The intent is to target shell companies and companies which are created for retaining income outside India, although real control and management of affairs is located in India.
Further, POEM guidelines don’t suggest determining POEM by taking a “snapshot” view, but by considering activities performed over a period of time during the year for which POEM is determined.
Impact of the POEM guidelines on companies
Companies headquartered in India with subsidiaries, branch offices and other alliances across the globe will have to take note of their existing structures and review the additional compliance requirements that may get triggered due to the proposed changes in the definition of tax residency.
Interestingly, the final POEM guidelines also clarify that if POEM is triggered for an intermediate holding company, it does not mean that POEM of all downstream subsidiaries is in India. In respect of companies which do not fulfil the ABOI test, the circular has listed several criteria and multiple factors to determine POEM, however these criteria/factors don’t define the hierarchy of elimination or provide guidance on the weightage of each factor.
The Government of India has advocated a non-adversarial approach in tax administration. Thus, though the proposed change is in line with global tax practices, the implementation should also be on the lines of global tax practices.
Administrative safeguards in the final POEM guidelines mandate that the Assessing Officer, before initiating an inquiry for POEM, will seek approval from the Principal Commissioner or Commissioner of Income-tax. The Assessing Officer shall also obtain approval from the Collegium of Principal Commissioners of Income-tax before holding that POEM of a non-resident company is in India.
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Related reading: Case Study: International tax and transfer pricing for an Indian subsidiary of a European group International tax considerations before setting up a company in India CBDT circular covering the POEM guidelines (PDF)