place of effective management – redefining corporate residency material/itf-pinakin de… · 2.7....

1 19TH INTERNATIONAL TAX & FINANCE CONFERENCE, 2015

Place of Effective Management – Redefining Corporate Residency

Place of Effective Management – Redefining Corporate Residency CA Pinakin Desai

INDEX

Sr. Particulars Page No. No.1. Background ........................................................................................................................... 22. Paradigm shift: Concept of POEM in Indian Income Tax Act, 1961 .............................. 33. DTC and POEM .................................................................................................................... 54. Analyzing the Definition of POEM .................................................................................... 65. Desire is to align with International understanding of POEM. ..................................... 76. POEM as understood under domestic law residency in some other jurisdictions

(illustratively, China, Netherlands, Germany, Russia, Spain, South Africa) ................ 107. POEM: Leading to internationally prevalent ambiguity? ............................................... 118. Interplay of ITA with DTAAs (Art. 3(2)) ......................................................................... 119. Illustrative (and not exhaustive) consequences of a foreign company becoming

resident ............................................................................................................................... 1210. Overseas LLP – a Company? ............................................................................................. 1311. Indian Judicial Precedents on C&M or on POEM as tie-breaker ................................... 1412. POEM represents appraisal of conduct over a duration ................................................ 1613. ‘Entity as a whole’ ............................................................................................................. 1714. Decision making: What matters is ‘de facto’ and not ‘de jure’ decisions ..................... 1815. Decision making – Role of directors and other Key Managerial Personnel (KMPs):

Significance of Corporate Law ......................................................................................... 1916. Parental Control in decision making ................................................................................ 2117. Investment Companies / SPVs .......................................................................................... 2218. Captive Subsidiaries .......................................................................................................... 2319. Support Service companies ............................................................................................... 2420. Factors of relevance while appraising actual place of de facto management and

control ................................................................................................................................. 2421. Onus of proof ..................................................................................................................... 2722. POEM and BEPS ................................................................................................................ 2723. Digitalization, e-Commerce activities and modern practices ......................................... 2724. Health check for relative comfort ................................................................................... 2825. Conclusion .......................................................................................................................... 29Case Study 1: Dividend distribution by Step Down Subsidiary triggering POEM in India and onward distribution by subsidiary to Indian parent .............................................. 30Case Study 2: POEM in case of Investment SPV (Outbound structure) ................................ 33Case Study 3: Overseas holding company for investment in downstream operating entities by Indian Group ........................................................................................................... 37Case Study 4: Indian operations of foreign company with strong management personnel in India (Inbound structure) ..................................................................................... 40Annexure – A – Explanatory Memorandum to Finance Bill, 2015 ........................................ 44



1. Background1.1. The scope of income which becomes subject to tax depends upon a taxpayer’s

residential status. Every jurisdiction has a test of residence defined in its domestic tax law. Different yardsticks are applied to reckon the residential status of different taxpayers (individuals, firm, company, etc.).

1.2. Generally, for a company, the place of incorporation of a company determines its residency. For example, USA regards test of incorporation as the test of residency. However, it has the vice of a company being incorporated in a low tax jurisdiction while it continues to be virtually controlled from another jurisdiction. In order to tackle this, another alternative popular test which has evolved is the test of ‘control and management (C&M)’ or the ‘place of effective management (POEM)’ of a company. Under this test, a company which is controlled and managed in a country may be considered to be a resident of that country irrespective of where the company is actually incorporated.

1.3. Residential status is not a static concept. It may need to be reviewed every year. It may depend on the factual aspects that transpire in a particular tax year. For example, an individual may be a resident of different countries over a period of time. Similarly, a company may acquire new residence if it migrates or if it shifts the locale of its C&M.

1.4. It is the prerogative of a sovereign jurisdiction to define the threshold level of C&M as per which it wants to treat a foreign company as a tax resident of its jurisdiction. For example, under the ITA, a foreign non-corporate entity was, and is treated as a tax resident if ‘part’ of the C&M of that entity is in India at ‘any time’ during a given previous year. [s.6(2) of Income Tax Act, 1961 (ITA)]. Thus, threshold of C&M has always been very low for non-corporate entities. On the other hand, a foreign company was a resident of India (up to 2015) only if ‘whole’ of C&M of that company was in India throughout the year. This indicates that the sovereign power can determine the desired level of threshold for determining the residency of an entity.

1.5. Pursuant to sovereign power, countries have used the concept of place of management or the concept of POEM as a test for regarding companies as resident as per domestic law. In the interpretation of POEM, countries may adopt certain factors which may or may not tally with the factors which are internationally recognized. In such a case, while, for the purpose of domestic law, the sovereign power may prevail, it is doubtful whether the country would be right in adopting the same rigid stand while resolving the tie-breaker test of a treaty. The better view is that, while resolving the tie-breaker, one should yield in favour of international understanding.

1.6. Corporate residency is important considering that it has the capability of bringing overseas companies within the fold of comprehensive income tax levy in the other jurisdiction. But for residency, usually, a country reserves the right to tax income that has a source in that country. Also, different provisions and compliances apply depending upon the residential status of the company.

1.7. Any company incorporated in India is a domestic company under s.2(22A), while s.2(23A) of the ITA defines the term ‘foreign company’ to mean a company which is not a domestic company.



1.8. A company incorporated in India is always a resident company. [S. 6(3)(ii)]. On the other hand, a foreign company may be a resident of India if it has a POEM in India. However, such overseas company would still continue to qualify as a ‘foreign company’ under ITA and will not be treated as a ‘domestic company’ unless it makes arrangements for declaration and payment of dividend out of its income taxable in India and becomes a domestic company [s. 2(23A) read with Rule 27 of IT Rules, 1962]. In other words, it remains a ‘resident foreign’ company.

2. Paradigm shift: Concept of POEM in Indian Income-tax Act, 19612.1. Finance Act, 2015 (FA 2015) has brought about a paradigm shift by introducing the

‘Place of Effective Management’ (POEM) rule to determine residency of overseas companies, in India.

2.2. This Paper deals with the meaning, scope and ramifications of the new defined terms of POEM, its harmony with international experience, and the consequences that follow. It also attempts to discuss various practical issues surrounding determination of POEM of a company, by way of case studies.

2.3. As aforesaid, the residential status of companies is determined under section 6(3) of the ITA. Prior to Finance Act (FA), 2015, a foreign company was held to be a resident in India if during that year, the control and management of its affairs was situated wholly in India.

2.4. FA2015 amended sub-section section 6(3) of the Act with the test of POEM. The amendment has overhauled the mechanics of determination of the residential status for a foreign company. S.6(3), as amended, reads as under:

“(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 the 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.”

2.5. The Explanatory Memorandum (EM) to FA 2015 gives rationale for the amendment as under:

• The pre-amended condition of residency linked to whole of C&M in India is too strict and practically inapplicable, permitting companies to avoid residency by simply holding a BOD meeting outside India.

• The present condition facilitates creation of Shell Companies outside India.

• POEM is an internationally recognized residency concept adopted in tie-breaker Rule of Indian treaties as also adopted in many jurisdictions.

• POEM is also recognized and accepted by OECD which defines POEM to mean the place where key management and commercial decisions necessary for the conduct of the business of the entity as a whole, are, in substance, made.

• POEM is a fact dependent exercise.



• As POEM is internationally recognized, there are well recognized guiding principles for POEM determination.

• Many countries prefer the POEM test to be appropriate test for determination of residence of a company.

• In due course, set of guidelines will be rolled out for determination of POEM for the benefit of the taxpayers as well as the tax administration1.

The text of EM to FB 2015 is attached at Annexure – A.

2.6. The legislature consciously notes that the erstwhile threshold of C&M was considerably low, such that even ‘part’ C&M of the foreign company (FCo) outside India (say, holding a Board meeting outside India) could suffice to avoid tax residency in India.

2.7. The legislative concern behind the introduction of concept of POEM appears to be to check attempted cases of tax avoidance and act as an anti-abuse weapon.

2.8. If SC in the case of Sati Oil Udyog [TS-136-SC-2015] is any guide, Courts may, perhaps, interpret the provision keeping in view such ‘anti-avoidant’ intent. The issue before SC in the case of Sati Oil dealt with retrospective amendment to s.143(1A) which provides that, even a reduction of loss on account of a prima facie adjustment would entail levy of additional tax. Taking a cue from SC ruling in the case of K.P. Varghese vs. ITO, (1982) 1 SCR 629, SC held that the deterrent provision of s.143(1A) cannot be applied equally to both honest and tax evaders.

SC held that,

“S. 143(1A) can only be invoked where it is found on facts that the lesser amount stated in the return filed by the assessee is a result of an attempt to evade tax lawfully payable by the assessee. The burden of proving that the assessee has so attempted to evade tax is on the revenue which may be discharged by the revenue by establishing facts and circumstances from which a reasonable inference can be drawn that the assessee has, in fact, attempted to evade tax lawfully payable by it.

…We feel that since the provision has the deterrent effect of preventing tax evasion, it should be made to apply only to tax evaders.”

2.9. Is it, therefore, likely that POEM provisions may be made applicable only to blatant cases of shell companies which are incorporated outside India but controlled and managed from India. Would courts prevent Tax Authority from using the provision as a free wielding weapon of revenue generation?

1. However, unlike GAAR rules, POEM Guidelines may not be binding on the taxpayers as well as the tax Authority. They may act as directive principles to be applied to facts of the case in evaluation of POEM.



3. DTC and POEM3.1. DTC 2009 had proposed a flexible and wide definition of POEM which provided for

residency trigger based on presence of part of management to be in India. In deference to the objections, the Government, in its reply to SCF, had acknowledged that the intent is to insert an internationally accepted principle of POEM. The Government also submitted that, in their understanding, POEM would mean as under:

“(a) Generally, the test of residence for foreign companies is the ‘place of effective management’ or ‘place of central control and management’. At the same time, it is noted that the existing definition of residence of a company in the Income Tax Act, 1961 based on the control and management of its affairs being situated wholly in India is too high a threshold.

‘Place of effective management’ is an internationally recognized concept for determination of residence of a company incorporated in a foreign jurisdiction.

Most of our tax treaties recognize the concept of ‘place of effective management‘ for determination of residence of a company as a tie-breaker rule for avoidance of double taxation. It is an internationally accepted principle that the place of effective management is the place where key management and commercial decisions that are necessary for the conduct of the entity‘s business as a whole, are, in substance, made. In case of a company incorporated outside India, the current domestic law is too narrow compared to our tax treaties as the test of residence of a foreign company is based on – whole of control and management – lying in India. However a test of residence based on control and management of the foreign company being situated – wholly or partly in India as proposed in the draft DTC of 2009 was much wider and could have led to unintended consequences.

Therefore, it has been proposed in the DTC2 that a company incorporated outside India will be treated as resident in India if its ‘place of effective management‘ is situated in India. The term will have the meaning as under:

• the place where the board of directors of the company or its executive directors, as the case may be, make their decisions; or

• 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”.

3.2. In its recommendations of 2010 which dealt with stakeholders’ representations on aforestated POEM definition, the Standing Committee on Finance (SCF) observed as under:

“The Committee, therefore, recommend that the definition of POEM may be amended in the light of the aforestated reasons. The reference to ED or officer may be removed

2. The proposed definition was the definition found in DTC, 2010 draft



from the definition of POEM and residency should instead be determined on the basis of internationally accepted standards and judicially settled principles, where the focus is on the place, where the key management and commercial decisions as a whole are made or where the “head and brain of the company is situated.”

3.3. In totality, the SCF may be understood to have accepted that POEM needs to be equated with “head and brain” of the company and the place where key management/ commercial decisions are made is the place where BOD of the company makes its decisions. By proposing to delete the reference to ED and Officers, SCF seems to have consolidated its thrust on BOD as the head and brain of the company.

4. Analyzing the Definition of POEM4.1. Dissection of the definition,

• ‘Place of effective management’ is in India, if:

• Key management and commercial decisions - Decision Test

• That are necessary for conduct of business - Necessity Test

• Of an entity as a whole - Pervasiveness Test

• Are in substance made - Substance Test

• All above conditions are satisfied during the relevant year.

4.2. So long as POEM of an entity is held to be outside India, the purpose of evaluation may be regarded as met. From an Indian context, it is not relevant to find out in which country the POEM of the entity lies, so long as it is not in India. No further roving enquiries may be made by the Tax Authority. For example, in an inbound structure, so long as Mauritius company is not controlled from India, it may not be necessary, for the purpose of POEM, to find out whether it is controlled in Mauritius or in US. Also, in an outbound structure, so long as overseas operating company is not found to be controlled in India, it may not matter whether it is controlled in its own jurisdiction or by the regional headquarter company in a third jurisdiction.

4.3. While it is clarified in EM that the concept of POEM is to be aligned to the meaning as provided in the OECD, the OECD itself does not have definition of POEM. It may hence not be out of place to look at dictionary meanings of some of the terms.

• ‘Key’: of central importance; a key figure; A vital element; Strategic

• ‘Management’: Management is defined as Government, control, superintendence, physical or manual handling or guidance, the act of managing by direction or regulation, or administration; as the management of a family, or of a household, or of servants, or of great enterprises, or of great affairs.

• ‘Commercial’: Commercial of, in, or relating to commerce; occupied with or engaged in commerce; related to or dealing with commerce; from the point of view of profit; having profit as the primary aim, sacrificing artistic principles for qualities that bring financial success.

• ‘In substance’: In essence; the material or essential part of a thing, as distinguished from ‘form’.



• ‘Made’: Cause to exist or happen; bring about; to establish or enact; put into existence.

4.4. The terms ‘key’, ‘managerial’ and ‘commercial decisions’ should support that the overall focus is on the managerial and commercial decisions. The terms are cumulative and cannot be seen in isolation.

4.5. Illustrations of management decisions3 • Appointment / Termination of key management personnel and their remuneration

• Organizational reporting structure and key organization / management policy decisions

• Code of Conduct, Group ethos and Ethics

• Global IT systems policy and MIS reporting

• M&A and company restructuring decisions, including divestment

• Common procurement or sourcing for the group, including master agreements

4.6. Illustrations of commercial decisions3

• Sourcing of Raw Materials, selection of distributors and its quality control. Procedure and manner in relation to negotiations/execution of contracts, particularly long term contracts, including on lease-in, lease-out.

• Borrowings, Debt Financing, Capital Sourcing

• Product Portfolio, methods of manufacture

• Pricing of products and services

• Expansion and modernization

• Accounting policies, R&D, Brand / patents registration (licenses)

4.7. While there is no reference to ‘strategic’, implicit in reference to adjective ‘key’ commercial and management decisions is reference to decisions of vital significance and hence strategic in nature.

5. Desire is to align with International understanding of POEM5.1. The EM explains that POEM is sought to be introduced as understood by OECD and

internationally recognized principles. Refer the following extract from the EM to FB2015:

“The modification in the condition of residence in respect of company by including the concept of effective management would align the provisions of the Act with the Double Taxation Avoidance Agreements (DTAAs) entered into by India with other countries

3. It would be necessary to study the business of each respective company and draw up a list from the standpoint of a man in business. It is likely that the two may overlap.



and would also be in line with international standards. It would also be a measure to deal with cases of creation of shell companies outside India but being controlled and managed from India.”

5.2. The OECD as well as the UN Model Commentaries as well as OECD TAG Report4 provide for POEM as a test of residence tie-breaker in Article 4.

5.3. The OECD MC provides that POEM is the place where key management and commercial decisions that are necessary for the conduct of the business as a whole are in substance made and that all relevant facts must be examined to determine POEM. The OECD MC at para 24.1 states that some countries feel that such cases of dual residency are rare and should be dealt with on a case-by-case basis by mutual agreement by the CAs of both countries, basis place of incorporation, POEM and other relevant factors. In case a country decides to opt for this approach, the OECD states that CAs would be expected to take account of various factors, such as:

• The place where key management and commercial decisions that are necessary for the conduct of the entity’s business as a whole are in substance made.

• The place where the actions to be taken by the entity as a whole are determined.

• Place where majority of the board of directors or equivalent body usually meet.

• Location of and functions performed at head-quarters of the entity.

• The place where the chief executive officer and other senior executives usually carry on their activities.

• Corporate books are located.

• Which country’s laws govern the legal status of the person.

• Whether determining POEM in one contracting state would lead to improper use of benefits under DTAA.

5.4. There is recognition of the place where decisions are made; where the actions are determined; where the BOD meets; where the decision making functions are performed. There is also a reference to the place of incorporation and the place where the corporate documents are kept. Apart from that there is reference to the place where CEO and senior executives carry on the activity. This last factor will need to be tested in the backdrop that SCF has proposed deletion of this factor from DTC 2010 draft.

5.5. UN MC (1979) in the context of residency tie-breaker, reads as under:

“It may therefore be inferred that in the OECD Model Convention the term “place of effective management” is to be interpreted as meaning the place where the business of a body corporate is managed and controlled, that is, for example, where the business has offices in which the regular managerial activities are carried out on a permanent basis.”

4. OECD draft on the impact of the Communications Revolution on the Application of ‘POEM’



The updated UN MC (2011) provides the following guidelines on determination of POEM:

• Place where a company is actually managed and controlled,

• Place where the decision-making at the highest level on the important policies essential for the management of the company takes place,

• Place that plays a leading part in the management of a company from an economic and functional point of view.

• Place where the most important accounting books are kept.

5.6. Reference may also be made to Protocol to the India-Belarus DTAA, which provides the understanding of POEM in Article 4 of that DTAA. The protocol to the treaty provides following understanding of the treaty negotiators :

“With reference to Article 4, it is understood that when establishing the “place of effective management” as used in paragraph 3 of Article 4, circumstances which may, inter alia, be taken into account are the place where a company is actually managed and controlled, the place where the decision making at the highest level on important policies essential for the management of a company takes place, the place that plays a leading part in the management of a company from an economic and functional point of view and the place where the relevant accounting books are kept.”

5.7. The factors are similar to those enlisted above by UN Commentary. These may throw light on the term as understood by Indian treaty negotiations. If the protocol to India-Belarus treaty is understood to be providing general understanding of the term POEM as envisaged by Indian authorities, the same may be made equally applicable to the other treaties on the basis of parallel treaty interpretation.

5.8. India’s position on the OECD Model Commentary5.8.1. Article 4(1) of the OECD and UN MC provide for residency test of the entity as

per the domestic law of the Contracting States. However, if residency is found to be existing in both the states under Article 4(1), both the models provide for a tie-breaker test for resolution of treaty residency for non-individuals in Article 4(3) as under:

“Where by reason of the provisions of paragraph 1 a person other than an individual is a resident of both contracting States, then it shall be deemed to be a resident only of the State in which its place of effective management is situated.”

5.8.2. The OECD MC Comm. (2008) on Article 4(3) (as also adopted by India) reads as under:

“24. As a result of these considerations, the “place of effective management” has been adopted as the preference criterion for persons other than individuals. The place of effective management is the place where key management and commercial decisions that are necessary for the conduct of the entity’s business as a whole are in substance made. All relevant facts and circumstances must be examined to determine the place of effective



management. An entity may have more than one place of management, but it can have only one place of effective management at any one time.

5.8.3. India’s position on OECD Commentary on Article 4(3) reads as follows:

“11. India does not adhere to the interpretation given in paragraph 24 that the place of effective management is the place where key management and commercial decisions that are necessary for the conduct of the entity’s business as a whole are in substance made. It is of the view that the place where the main and substantial activity of the entity is carried on is also to be taken into account when determining the place of effective management.”

5.8.4. Despite the reservation, Indian domestic law has, in fact, retained the requirement of decision making and has not taken credence of the factor of main and substantial activity while defining POEM. It may hence be possible to urge that India domestic law will not regard the reservation to be a factor having influence on interpretation.

6. POEM as understood under domestic law residency in some other jurisdictions (illustratively China, Netherlands, Germany, Russia, Spain, South Africa)

6.1. Since POEM is sought to be aligned with international understanding, it may be useful to refer to guidance / understanding provided some select jurisdictions. In this regard, it may be noted that historically, even in absence of any statutory guidance definition, UK Courts considered the concept of ‘control and management’; “head and brain” or the place where company ‘eats and sleeps’ as the factors relevant for determination of residency. Even today, to our understanding, most jurisdictions do not define POEM in their domestic law. However, guidance is to be found by way of administrative circulars, guidance notes or judicial principles for the features to be considered while determining POEM of an entity even when POEM is the test in the domestic law. The following is a list of various factors adopted as per domestic practices of various countries:

• Place where majority of the board of directors or equivalent body usually meet.

• The place of implementation of the entity’s overall group vision and objectives.

• The place where company’s financial decisions (e.g. borrowing, lending, raising capital and financial risk control, etc.) are made.

• Location of and functions performed at headquarters of the company.

• Where controlling shareholders/ parties other than board of directors make key management decisions.

• The place where the chief executive officer and other senior executives usually carry on their activities.

• Location of senior managers home.

• Place where the members of the managing bodies are residents.

• Hiring and supervision of personnel is conducted.

• Place where minutes of board meetings and shareholders meetings are located.



• Place where Corporate Books are Located.

• The place where company’s records and other administrative documents are managed.

• The place where Balance sheet, P/L and Annual accounts are drawn.

• Location where the official seals of the company are located.

• The place where the company is recorded in the commercial register and the statutory seat is situated.

• Company’s major properties/ assets are located.

6.2. Many of these factors recognize the role of BOD or equivalent authority if it is visualized that: BOD (or comparable organ) is the senior management; BOD functions at the headquarters of the company; the senior executives are hired by BOD; key decisions are made by BOD, etc. Significance is also attached to the place where corporate records and corporate books are kept or the accounts are drawn up and maintained. We also find references to the place where the assets are located or the activities are carried on.

7. POEM: Leading to internationally prevalent ambiguity?7.1.1. Though internationally seen and accepted, there is no fixed set of rules, or a consensus

on the universal meaning and scope of POEM. It appears that there is still some ambiguity on the interpretation and at times, the meaning accorded is coloured or influenced by internal approach of various jurisdictions. Such was also the view at the 2004 IFA Convention at Vienna.

7.1.2. Learned authors Prof. Klaus Vogel and Philip Baker also acknowledge that there is no unanimity as to the factors to be taken into account for determination of POEM. Refer, the following observations from the commentary of Klaus Vogel:

“The POEM criterion is a factual test following the ‘substance over form’ principle. As stated in No. 24 OECD MC Comm. On Article 4, the POEM ‘is the place where key management and commercial decisions that are necessary for the conduct of the entity’s business as a whole are in substance made. All relevant facts and circumstances must be examined to determine the place of effective management’. However, no further guidance is given on its meaning. Even though the POEM serves as the tiebreaker criterion in most DTCs, there is no unanimity as to which facts are to be considered and what weight should be given thereto.”

7.1.3. Further, the issue is regarded fact sensitive and requires determination, on a subjective basis, of the place where top most decisions concerning the business are taken.

8. Interplay of ITA with DTAAs (Article 3(2))8.1. In order that a treaty applies, a person has to be resident of one of the two contracting

states to DTAA. Article 4(1) confers residence based on a variety of criteria, one of which is the ‘place of management’. It is as per domestic law of respective country that the sovereign power may determine the threshold of compliance which attracts residence in that country. In all those Indian treaties where place of management is one of the tests of tax residence, with the introduction of the test of POEM in domestic



law, a company would have to be considered as resident for ITA purposes either based on incorporation in India or based on POEM in India. For this purpose, the term POEM will need to be understood as per the meaning provided under s.6(3) of ITA.

8.2. However, if under Article 4(1), a company is a resident in both the countries (say – in India basis POEM and in Country B based on incorporation), one may resort to residency tie-breaker under Article 4(3) of the DTAA. Issue arises when both countries (along the UN / OECD Models) have POEM as a test of residence. OECD MC or DTAAs do not specifically define the term ‘POEM’ for the purpose of Article 4(3). Therefore, it may so happen that each of the country may seek to rely on Article 3(2) to claim that, in absence of specific meaning assigned under the Treaty, POEM is to be understood as per the respective domestic laws. This may lead to no conclusion.

Participants may debate, whether Article 3(2) may be invoked to interpret POEM under Article 4(3) and how the two may reconcile in tie-breaking residency?

9. Illustrative (and not exhaustive) consequences of a foreign company becoming resident The following table summarizes applicability of tax rate, DDT, the position under

ITL:

Particulars Resident / NR Domestic Company?

Tax Rate DDT applicable?

Indian Company Resident Yes 30% + SC Yes

Foreign Company

POEM in India Resident No 40%+ SC5 No

POEM outside India NR No 40%+ SC6 No

Any company in the tier may be picked up to test whether its POEM is in India or not. For instance, in a multi-layer outbound structure, it is not necessary that only the immediate subsidiary of the Indian company may be tested, it is possible any further tier subsidiary of such a subsidiary may be tested for POEM evaluation.

The most important impact of a foreign company triggering residency is that it results into global taxation of the company in India regardless of the situs of accrual or receipt of income.

Transactions between a resident and non-resident AE are subject to Indian transfer pricing regulations. Also, once the entity is regarded as resident, it may trigger applicability of specified domestic transactions (SDT) under s.92BA (unless one succeeds on non-discrimination argument applicable in the treaty context). Difficulty in maintaining documentation, report filing etc., may arise if residency change is alleged during the course of tax assessment proceedings.

Under tie-breaker rule, the entity may also be resolved to be a treaty resident of India. As a result, India may get right to taxation even in terms of treaty.

5. On global income

6. On foreign sourced income



For a dual resident entity, treaty benefit may itself be denied. For instance, a US incorporated company triggering residency in India, due to POEM, will be a resident of both US and India and hence, it may no longer have access to the India-USA DTAA by virtue of Article 4(3) of the DTAA. Does it mean that the company pays taxes in both the countries at the comprehensive tax rate?

Such a company paying taxes on its global income in both the countries may find it difficult to claim credit of such taxes in either country. Can the Taxpayer claim credit of foreign taxes under s. 91 of the ITA in case of countries like US, wherein DTAA benefit is denied in case of dual residency. If the answer is no, taxpayers may end up paying huge taxes in both the jurisdictions without any tax credits.

Foreign companies will lose the option of adopting presumptive taxation provisions for business income for certain sectors which apply only to NRs e.g. income from business of exploration of mineral oils or operation of aircrafts (s.44BB, s.BBA) in the year they trigger residency.

The company may not be able to get benefit of carry forward or set off of past losses, since ROI may not have been furnished in the past.

Different tax withholding provisions apply to residents and NRs. Default in withholding leads to disallowance of expense, when income is computed in ITA. Further, withholding in respect of payments to NRs including foreign companies is subject to a wider base – on every payment which is chargeable to tax such as trading transactions, property sale, guarantee fees, etc. For an Indian company, every such chargeable payment would not be covered within the net of tax withholding.

The participants may discuss applicability of MAT provisions to the foreign company which triggers residency in India. The participants may evaluate if the view may differ if such foreign company has no presence in India vis-à-vis a situation where the foreign company may have outsourced some of its functions to an entity in India.

Also, basis discussion in Vodafone ruling, can FCo with no presence in India claim that there is no TDS obligation triggered under Indian provisions – particularly for sections other than S.195?

10. Overseas LLP – A Company? Under s. 2(17) of the ITA, a company includes any body corporate incorporated outside

India. There may be different forms of overseas entities, for instance, LLC structure in USA / UK, GmBH form in Germany, and BV in Netherlands which are likely to be considered as ‘company’ under the ITA having regard to features such as perpetual existence or separate legal entity status, etc. LLP registered in India alone is regarded as a firm by fiction of ITA. Overseas LLP is not covered by the fiction. Nor will overseas LLP be akin to a partnership as defined in the Indian Partnership Act., 1932.

An entity which does not answer to the definition of a ‘company’ may be classified as a firm or an AOP and may have a very low threshold of triggering residency in India



having regard to the provisions of s.6(2) whereunder even part control for a short period of time may trigger residency in India. It is unlikely that a foreign LLP will fall within the scope of the LLP Act, 2008 so as to qualify as a ‘firm’ for the purpose of ITA. Such LLP may be treated as a corporate body for ITA. If such is the case, then POEM may be applicable to a foreign LLP, equally.

11. Indian Judicial Precedents on C&M or on POEM as tie-breaker11.1. The view point of the Indian Courts on the concept of C&M has been succinctly

summarized in the Commentary by Kanga & Palkhiwala titled ‘The Law and Practice of Income Tax’ (Tenth Edition, Page 319)

“As a rule, the direction, management and control, “the head and seat and directing power” of a company’s affairs is situated at the place where the directors meetings are held and consequently a company would be resident in this country if the meetings of directors who manage and control the business are held here.”

11.2. Judicial precedents in India have consistently held that C&M of an entity is situated at the place where the direction, management and control, “the head and seat and directing power” of the entity’s affairs is situated. In the context of companies, this may conventionally be the place where the directors meetings are held and consequently, it may be said that a company would be resident in this country if the meetings of directors who manage and control the business are held here. The following rulings, in the context of C&M are noteworthy in this regard:

• Subbayya Chettaiar (HUF) vs. CIT (19 ITR 168) (SC): C&M signifies the controlling and directive power, the head and brain and “situated” implies the functioning of such power at a particular place with some degree of permanence.

SC relied on the following principles from English rulings:

• The conception of residence in the case of a fictitious “person”, such as a company, is as artificial as the company itself, and the locality of the residence can only be determined by analogy, by asking where is the head and seat and directing power of the affairs of the company. What these words mean have been explained by Patanjali Sastri, J., with very great clarity in the following passage where he deals with the meaning of s. 4A(b) of the IT Act :

“Control and management signifies in the present context, the controlling and directive power, the head and brain as it is sometimes called, and situated implies the functioning of such power at a particular place with some degree of permanence, while wholly would seem to recognize the possibility of the seat of such power being divided between two distinct and separated places.”

• As a general rule, the control and management of a business remains in the hand of a person or a group of persons, and the question to be asked is wherefrom the person or group of persons controls or directs the business. But, mere activity by the company in a place does not create residence, with the result that a company may be ‘residing” in one place and doing a great deal of business in another.



• Nandlal Gandalal (40 ITR 1) (SC) (relying on Chettiar’s case): The expression “control and management” signifies controlling and directive power, “the head and brain” as it is sometimes called. Furthermore, the expression “control and management” means de facto control and management and not merely the right or power to control and manage.

• Erin Estate, Galah, Ceylon v CIT (1958)(34 ITR 1)(SC): What is relevant is de facto control and power actually exercised in the course of the conduct and management of the affairs of the firm is relevant, and not the de jure control. Control and management evidently refers to the controlling and directing power. Often enough, this power has been described in judicial decisions as the “head and brain”; the affairs of the firm which are subject to the said control and management refer to the affairs which are relevant for the purpose of taxation and so they must have some relation to the income of the firm.

• Narottam & Pereira Ltd. (23 ITR 454): C&M signifies the controlling and directive power, the head and brain of the company. Bombay HC equated C&M with directive power situated in India with some degree of permanence. It distinguished between doing of business and C&M of business. HC disregarded presence of strong manager overseas in favour of controlling directors being situated in India. The following extracts may be noted:

“It is perfectly true that these two managers do all the business of the company in Ceylon and in doing that business naturally a large amount of discretion is given to them and a considerable amount of authority. But the mere doing of business does not constitute these managers the controlling and directing power. Their power-of-attorney can be cancelled at any moment, they must carry out any orders given to them from Bombay, they must submit to Bombay an explanation of what they have been doing, and throughout the time that they are working in Ceylon a vigilant eye is kept over their work from the directors’ board room in Bombay.”

• Reference may also be made to the cases of Sri Raja K V (18 ITR 181) (Mad.) and Radha Rani Holdings (P) Ltd. vs. ACIT (2007)(110 TTJ 920) in this regard.

11.3. In the Indian context, there are certain decisions which have dealt with the concept of tie-breaker rule under Article 4(3) or in the context of Art. 8 and in the process dealt with the concept of POEM. BOD

• Saraswati Holding vs. DDIT (2007)(111 TTJ 334) (Del.): The US investors who floated Mauritian entity had given POA to India residents who were also the directors of Mauritius company. The Tribunal held that tie-breaker test may be relevant provided Mauritius company may be found to be resident in India. Since the total control of MauCo was not in India, MauCo was not regarded as resident in India, it was no more necessary to apply the test of POEM. In the course of the judgment, the Tribunal held that the control and management of affairs does not mean the day-to-day affairs of the business but it refers to the head and brain which deals with vital policies.

• X Ltd., In re (1996) 220 ITR 377 (AAR) and DLJMB Mauritius Investment Co (1997) 228 ITR 268 (AAR): AAR was concerned with the controversy whether the POEM of MauCo should be regarded as located in UK, despite Board meetings



being in Mauritius. The court rejected the situs of parental control as place of effective management of a company whose affairs were in Mauritius.

• Integrated Container Feeder Service vs. JCIT (96 ITD 371)(Mum.): The controversy was whether POEM of MauCo was in Mauritius or in UAE. On facts and evidence, it was demonstrated that all the operational decisions as also day-to-day operations were carried out in or controlled from UAE and hence there was no effective management of a shipping enterprise in Mauritius so as to qualify for the benefit of Article 8 of India-Mauritius DTAA.

• P No. 10 of 1996, In re (1996) 224 ITR 473 (AAR): The circumstance that the BOD had the benefit of advice and recommendations from professionals and consultants in India was not regarded as sufficient to dilute the decision making power of BOD. The AAR held that the assistance from advisory bodies can in no way control the decisions of the BOD.

• Reference may also be made to Shaan Marine Services Pvt. Ltd. vs. DDIT (2014) 165 TTJ 952 (Pune) wherein ITAT placed reliance on OECD MC and took note that POEM requires that decisions of the conduct of entity’s business as a whole are in substance made.

11.4. One will need to wait for responses from the Indian Courts on interpretation of the new definition.

11.5. Though, as a concept, POEM has some haziness, it sounds similar to the erstwhile concept of Control and Management (C&M) and the principles thereof may be useful in understanding POEM too.

12. POEM represents appraisal of conduct over a duration12.1. To evaluate whether a foreign company’s POEM is in India during a tax year, an

important question is that, at what point of time during the year, the POEM of the company should be in India. The provision or the definition does not throw light on the point of time POEM evaluation may be checked.

12.2. In this regard, it is relevant to look at the provision as introduced by Finance Bill, 2015.

“(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.”

12.3. At the pre-enactment stage, a company was said to be resident in India if its POEM was in India, at any time in the year. This test was of very wide amplitude and had no limitation to the test of POEM. It meant that POEM was to be tested on a continuous, real-time basis and a single spark of shift of key decision making power in India would automatically trigger the POEM of the foreign company in India for that tax year. Various representations were made to the Government over the unintended consequences and hardships which could have entailed – for instance the risk of a single Board meeting of the foreign company in India making that company a tax resident of India. Fortunately, the term was deleted at the enactment stage and the definition of POEM.



12.4. Even post deletion, there is no clarity on the duration or timing when POEM of a company is to be tested. The deletion suggests that intent was not to cover a stray case of decision making in India. POEM by nature needs to be tested over a period of time: long drawn basis. Courts, at the time of explaining the concept of ‘C&M’ have held that there should be some degree of permanence and durability with the place where controlling and directive power is situated. Refer, for instance, Bombay HC ruling in the case of Narottam & Pereira Ltd. vs. CIT (23 ITR 454):

“Control and management signifies in the present context, the controlling and directive power, the “head and brain” as it is sometimes called, and situated implies the functioning of such power at a particular place with some degree of permanence, while wholly would seem to recognize the possibility of the seat of such power being divided between two distinct and separated places.”

In the English case of Atkinson [2006] STC 732, the Special Commissioners of UK have laid some significance on the factor of continuity or durability of conduct as a factor of relevance in determining the place of C&M. They noted that,

“C&M carries with it connotations of continuity because of the use of phrases such as ‘actually abides’, ‘carries on business’, ‘keeping house’. It is necessary to consider the overall pattern of conduct established over a period of time residence does not change on every occasion where there is short-term change in the location of board meetings”.

As stated above, the UN Commentary (1979) also states that,

“It may therefore be inferred that in the OECD Model Convention the term “place of effective management” is to be interpreted as meaning the place where the business of a body corporate is managed and controlled, that is, for example, where the business has offices in which the regular managerial activities are carried out on a permanent basis.”

13. ‘Entity as a whole’13.1. POEM refers to control over the ‘entity as a whole’. The reference is to the

comprehensive control over the entity as a whole during the year, and is not the same thing as a part of the control of the entity residing in India for the whole of the year.

13.2. One has to look at POEM and decision making for the business activity as a whole together with certain degree of permanence, durability implicit into the requirement of the section. For example, location of one segment head in India – say IT head who takes all IT related decisions may not be equated with control of the business of the entity as a whole.

13.3. Needless to say, a company establishing PE in India is not equivalent to a company having effective place of management in India. While a place of management (which requires a low threshold of management functions in India) “may” be good enough to ignite PE in India, the company may still not be regarded as establishing presence of effective management in India.

13.4. At the threshold, one will need to list out the scope of key commercial and management decisions as are relevant to the nature of business activity of the concerned company in order to eventually evaluate the place of effective management.



For instance, in the context of a company which has only one line of business - say, for example, single hotel or single mine or single factory in FC, the singular activity may itself represent interest of the entity as a whole.

14. Decision making: What matters is ‘de facto’ and not ‘de jure’ decisions14.1. Actual conduct is of relevance and implicit in the evaluation of POEM, i.e. to say, what

analysis of POEM has always emphasized is the ‘reality’, ‘actual state of affairs’. The ‘puppet directors / dummy directors’ have always been disregarded. Not only the OECD and UN MCs, but also the SC7 has emphasized that it is not the power or the capacity to manage and control, but the actual control and management that is relevant, or, in other words, not the de jure C&M but the de facto C&M which is relevant.

Refer also the following extracts from SC ruling in the case of Vodafone:

“Where the subsidiary’s executive directors’ competencies are transferred to other persons/bodies or where the subsidiary’s executive directors’ decision making has become fully subordinate to the Holding Company with the consequence that the subsidiary’s executive directors are no more than puppets then the turning point in respect of the subsidiary’s place of residence comes about.”

14.2. ‘De facto’ decision making has been stressed also by UK Courts. Refer, in this regard, the following illustrative cases:

• Laerstate BV vs. Revenue Customs and Commissioners [2009] SFTD 551

In the case of Laerstate BV vs. Revenue Customs and Commissioners [2009] SFTD 551, it was noticed that Mr. B (a promoter and a shareholder) who ceased to be a director continued to control the decisions at the Board. The Board was perceived to be acting in accordance with instructions of Mr. B. The evidence, including travel records and other relevant documentation, were relied upon to reach the conclusion that the other continuing director of the Board was in fact acting as a shadow director and all decisions were, in reality, taken by Mr. B whether or not he was a part of the Board. The company was regarded as centrally managed and controlled in UK where Mr. B resided.

• Todd vs. Egyptian Land and Investment Co. Ltd. (1928) [14 TC 119](HL)

The House of Lords concluded that a company incorporated in UK and maintaining address with UK professional for corporate compliance need not be regarded as a company controlled and managed in UK. The professional was found to be having name plates of multiple companies hanging on his office door and the professional had no independent position or power to do anything. Compliance with minimum and occasional formalities required by the Act was not regarded as a test of ordinary residence.

7. Narottam & Pereira Ltd. vs. CIT (23 ITR 454) and in the case of Erin Estate, Galah, Ceylon vs. CIT (1958)(34 ITR 1) (SC)



• Wensleydale’s Settlement Trustees vs. Revenue Commissioners, 14 March 1996

In a case before the Commissioners of HMRC, the Taxpayers who sought to avoid CG tax on sale of properties in the UK, set up a trust in Ireland to devise the sale transaction. The settlor was a UK resident while the trustees were in Ireland and England. A trustees’ meeting was held in Ireland wherein certain routine/ administrative decisions were taken, for instance opening of bank accounts, etc. The Irish trustee took no active part in the management of the Trust. The Taxpayer claimed Irish residency and hence CG tax exemption from UK in terms of the DTAA.

Issue before the Commissioners was whether under Article 4(3) of the DTAA, POEM of the Taxpayer would fall in UK or in Ireland.

The Tax Authority described the transaction as a tax avoidance / sham scheme. The Commissioner noted that there was no reported decision (in 1996) on the meaning of POEM. The Commissioner referred to Professor Vogel’s Commentary and noted that it was said that the “place of management” was very similar to the “place of effective management” since the former also depended on factual conditions. He also noted that German case laws established that the place of management was the center of top level management, that is where the management’s important policies were actually made, and that both parties agreed that the center of top level management was a good description of the place of effective management. To be “effective”. It was not sufficient that some sort of management was carried on in Ireland such as operating a bank account in the name of the trustees. “Effective” implied realistic, positive management. The place of effective management was where the shots were called, to adopt a vivid transatlantic colloquialism. There was no “input” on the decisions from the Republic of Ireland. The Special Commissioner therefore found that the place of effective management of the trust was the UK.

14.3. In an outbound scenario, if directors of a foreign subsidiary of an Indian MNE take decisions which are always subject to approval by the Indian heads, or, are as per directions of Indian Head, the Tax Authority may contend that the decision making takes place in India.

14.4. All in all, what seems relevant is to examine who in actuality evaluates and finally makes the decisions. A case of stray ratification by the BOD of the decision made by some third person in good faith in case of some emergencies needs to be distinguished from a ‘repetitive’ or ‘routine’ approval of such decisions by the BOD.

15. Decision making – Role of directors and other Key Managerial Personnel (KMPs): Significance of Corporate Law

15.1. Generally, determination of POEM begins with identification of place of decision making and in the context of company, the start point is determination of the decisions making by the BOD. In an outbound structure, the corporate law of the concerned jurisdiction may be relevant. From an Indian perspective, under s.179 of the Companies Act, 2013 (CA 2013), the BOD of the company is entitled to exercise all such powers and do all such acts, as the company itself is entitled to do. Under s.179, certain decisions are



to be taken only at the Board meeting. This may mean that the other powers can be delegated by BOD to a director. The list of powers which shall be exercised by the BOD include powers to issue shares, borrow moneys, invest funds, diversify business, sanction of amalgamation or merger, takeover a company, etc. These are wide powers at entity level. Thus, the place of the BOD meetings could appropriately be regarded as the place of management of the company.

15.2. A director is a person who is entrusted with the responsibility of controlling and managing the company in his fiduciary capacity and by his very position, a director creates a fiduciary relationship vis-à-vis shareholders of the company who actually own the company. Under the CA 2013, a director has certain duties and responsibilities, has to act in good faith and work in the best interest of the company8.

15.3. The MD of a company executes the decisions taken by the BOD and is not actually the final decision making authority. Furthermore, though the MD is vested with substantial powers of management, such management is essentially in relation to the day-to-day affairs of the company under the supervision of BOD. Thus, the MD may not be regarded as the determinative factor, unless facts suggest to the contrary.

15.4. Similarly, a manager or any KMP is expected to work within the delegated authority as provided to them by the BOD. The powers of such personnel will be subject to control, superintendence and direction of the BOD, unless there has been undue delegation and the facts suggest that BOD is virtually docile. Charter documents of the company, employment agreements, PoAs and other management service agreements may be relevant to determine the authority and functions vested in the respective personnel.

15.5. Countries having a two-tier Board: In India, we are used to functioning of a single tier board. In certain civil countries (like Italy, France, Germany, China, Austria, etc.), there could be a two-tier board. One of them is supervisory board appointed by the general body and comprised also of independent members. The other one is a board of management which is appointed by the supervisory board. The main difference between a one-tier BOD system and a two-tier BOD system is that, with regard to the former, there is single BOD (which can be comprised of non-executive directors and/or executive directors). A two tier BOD system employs a separate supervisory BOD that has a controlling function, as well as a management board BOD that is entrusted with the management of the company.

From the literature available in public domain, there is no universal identification of the roles that are played by these two boards. If the supervisory board is in the nature of advisory board and performing more of the shareholder functions, the control and management may be regarded as located with the management board. However, there are jurisdictions where the supervisory board has a legal duty to participate and supervise in a more active manner, i.e. supervise the policy of the board of management; right to enter into offices and inspect records; suspend members of the board of management; approving certain decisions and functions; form audit committee;

8. Sections 166, 179 read with Schedule 4



in the event of failure, they may also be liable for damages etc. In such cases, role of supervisory may be considered as more ‘effective’ while POEM determination is de facto exercise, the applicable statutory provisions of corporate law will also be relevant factors.

15.6. In India, under CA 2013, the BOD has wide powers which may be subject to the Memorandum and Articles of Association and certain control imposed by that Act. In a case where, under the memorandum or articles, wide powers of management and decisions making are controlled by the shareholder or the parent, it is possible that BOD may not be necessarily considered as seat of power but a rubber-stamping authority.

16. Parental Control in decision making16.1. Generally, parental control is not considered as a determinative factor. Even under

Companies Act, 2013, certain matters require shareholders’ approval by way of resolutions. These are shareholder functions to protect their interest. While the directors are appointed by the shareholders, the corporate structure is an evidence of split of ‘ownership’ and ‘management’. Even 99% shareholding in a company may not empower the shareholder to take decisions regarding the management of the company9.

16.2. SC in the case of Vodafone had dealt with the separate legal existence of a subsidiary from its parent. It, however, noted as under:

“67. It is generally accepted that the group parent company is involved in giving principal guidance to group companies by providing general policy guidelines to group subsidiaries. However, the fact that a parent company exercises shareholder’s influence on its subsidiaries does not generally imply that the subsidiaries are to be deemed residents of the State in which the parent company resides. Further, if a company is a parent company, that company’s executive director(s) should lead the group and the company’s shareholder’s influence will generally be employed to that end. This obviously implies a restriction on the autonomy of the subsidiary’s executive directors. Such a restriction, which is the inevitable consequences of any group structure, is generally accepted, both in corporate and tax laws. However, where the subsidiary’s executive directors’ competences are transferred to other persons/ bodies or where the subsidiary’s executive directors’ decision making has become fully subordinate to the Holding Company with the consequence that the subsidiary’s executive directors are no more than puppets then the turning point in respect of the subsidiary’s place of residence comes about.”

16.3. Certain group policies are, by custom, formulated at Group HQ and circulated to the group companies for ensuring compliance, – say, for example, policy on bribery, IT system usage, gift or hospitality, mobility of employees, etc. In the context of outbound investment, these policies are likely to be formulated and circulated by Indian Flagship Company. Also, as a good ethical practice, parent may ensure that a whistle blower in a jurisdiction cannot be dismissed by the subsidiary without the consent of the parent

9. Radha Rani Holdings (P) Ltd. vs. ACIT (2007)(110 TTJ 920)



company. These, in themselves, may reflect shareholder function and not be decisive in triggering POEM of such entity in India.

16.4. The parent company may provide general policy guidelines or draw up the vision statement of the group. The parent company may also perform stewardship activities like general group management, administration of investments, internal auditing and coordinating, ensuring quality and confidentiality, etc.

16.5. There may be certain other functions, management or commercial decisions which the parent company may undertake for its subsidiaries to protect its own interest as a shareholder which may be considered as stewardship activities. They are carried out for self-benefit. The benefit to group company may be remote. They are not the services for which a subsidiary may pay as per ALP. The examples may be: internal audit / check to monitor adherence to operating procedures, or cost of IT for monitoring subsidiaries.

16.6. It is possible that the overseas entity may have entered into IP user or brand user or know-how support agreement with an enterprise in India. It is also possible that in terms of such commercial agreement, the grantor may have imposed certain restrictions and may have also provided for certain right of participation in the decisions which may directly or indirectly influence the underlying subject matter of the IP. It is possible that the grantor may be an affiliate or parent. If the licence is granted at arm’s length and if the restrictions or conditions put on the grantee are commensurate with the terms which are customary in such arrangement, it may be a strong case to support that the restrictions or right of participation of the grantor will have no influence on POEM analysis of the overseas entity.

16.7. One may need to do a fact sensitive analysis to ascertain if the BOD of subsidiary takes decisions within the parameters of group policy or, is it that group policy leaves no scope for the subsidiary / group entities to have any meaningful independence of its own.

17. Investment Companies / SPVs17.1. Determination of POEM may be critical in outbound cases of investment companies/

SPVs. For a variety of commercial reasons – in particular, in case of outbound investment, there are certain Special Purpose Vehicle (SPV) companies which are incorporated in strategic locations or in the locations of the operating joint ventures or subsidiaries.

17.2. These SPVs have very limited role to play. In case of such a company, the decision making may be limited to a few areas relating to investments, divestments, reviewing investee performance etc. On principles, the circumstance of limited arena of activity does not dilute the concept of POEM. What one needs to examine is whether the key decisions which are germane to the role of SPV are or are not performed by management of SPV. Indeed, the area of activity of SPV will be far limited as compared to the requirements of a fully operating company.

17.3. In all likelihood, in relation to SPV which holds investments, prior to setting up of the SPV, the parent company may make decisions regarding formation of the SPV, selection of its jurisdiction, amount of investments and other decisions pertaining to formation



of the SPV pre-incorporation of SPV. The circumstance that pre-set up decisions were taken by the parent company cannot mean that, going forward, POEM is located in the jurisdiction of parent company. The correct approach is to examine the place from where the SPV conducts itself after the date of its formation.

17.4. However, there may be an adverse situation if the parent company, at the time of establishment, lays down strict parameters within which alone the subsidiary is to operate (or, refrain from acting) and thus effectively prevents the directors of the subsidiary from achieving, at any time, any independence or flexibility worth its name, in the decisions which they may subsequently take. The reality / facts may corroborate that all the major decisions post-incorporation of SPV will therefore have been taken at the time when the subsidiary was established; its role and the way in which it will perform it are predetermined, and any subsequent discretionary action by the subsidiary directors is effectively excluded. In such a case, the BOD of the subsidiary investment company may be held to be obedient to the parent company’s directions without having effective right management.

18. Captive Subsidiaries18.1. In overseas jurisdiction, the entity may be a captive subsidiary for the parent company

or other group companies. Such a circumstance, in itself should trigger evaluation of TP implications and in itself may be considered as irrelevant in the determination of POEM of such subsidiary.

18.2. Factors of POEM will need to be applied in the context of business of the overseas company which is set up by Indian company. It is possible that a subsidiary which is set up as a distributor company (often, an area linked distribution company) or as a research company may not have flexibility beyond the work which is assigned to it. Such company may not be able to take up any activity other than the outsourced activity. The inability to commence new venture, or, inability to cater to any company outside the group, may not in itself be decisive, consideration in examining POEM of such captive subsidiary. The correct approach is to ascertain POEM in the backdrop of the business which is the main object of the subsidiaries. One needs to find out whether the key management and business decisions relevant to the business model applicable to the subsidiary are being taken by BOD of the company.

18.3. Implicit in the definition of POEM is evaluation of management and commercial decisions which are relevant for the business of the entity. It is therefore necessary to comprehend the decision making matrix based on business model of the entity. It is possible that the entity is acting as an outsourced / risk mitigated entity for the group/the parent. In such situations, the ALP remuneration which the entity may expect will be commensurate with risk and functions which the entity carries. The decision making matrix of such entity also will be circumscribed by the business model which it has. The rights which service recipient entity has in terms of the service agreement may not be relied upon by tax authority to support that the service provider entity’s decisions are taken by the service recipient. As against that, from the perspective of the service recipient, the place where the decision to outsource and the terms on which outsourcing be done, may be regarded as the place of taking strategic decision



18.4. As a matter of principle, for a low risk routine function subsidiary in an overseas jurisdiction (which is normally captive to the group and which hardly has any major strategic decision making opportunity), the factor of conduct of operations in the overseas jurisdiction/s coupled with evidences of key decisions relevant targets being taken by the board may be considered as sufficient evidence to establish its POEM outside India.

19. Support Service companies19.1. It is not uncommon for a multinational company to centralize certain support functions

such as data management, human resources, customer support or accounting, and to locate those services in countries that offer advantages such as superior infrastructure, lower costs or a highly skilled workforce. A group of companies may house these services in the group’s ultimate holding company or in a separate ‘specialist entity’ which provides the services to all members of the group.

19.2. This phenomenon may be of relevance to India. MNE group operating outside India may set up certain outsourcing units in India. The Indian company may be rendering services under a master agreement to all the companies in MNE group. The business operations of Indian company may have significant impact on the profitability of other overseas companies in the group. Thereby, can a question be raised that the overseas companies which are dependent on Indian company in terms of the quality of their performance in relation to outsourced activities or their profitability can be considered to have POEM in India?

19.3. Although such support services may be essential to an overseas company, the managers in charge of such a service company will be concerned only with the issues concerning the support service company. They will have no role to peruse the internals of other overseas companies. They will hardly be involved in making key management and commercial decisions that affect the conduct of overseas company’s business as a whole. Consequently, the location where such support services may be located may generally be of limited relevance to the determination of overseas company’s place of effective management.

19.4. On principles, the discussion is as relevant to the case of an outbound structure where one of the group companies in India may be extending support services on an arm’s length basis to the other overseas companies.

20. Factors of relevance while appraising actual place of de facto management and control

20.1. In the course of assessment, the AO may like to inquire into the factual analysis. He may, having regard to the business model, try to formulate the aspects which may be considered as key management or commercial aspects relevant to the business model. He may try to list the issues which may have fallen for decisions of the BOD of the company during a relevant year or may be over a period of time. Alternatively, he may try to collect information about the key business and commercial decisions as have been taken by the company during the year and then attempt to verify the manner in which and the place at which these decisions were taken. In the paragraphs hereunder, we have highlighted the factors of evidences which may weigh with the AO and taxpayer in establishing the place where decisions were taken.



20.2. To recollect, there is a difference between the place at which key decisions are, in substance, made as compared to the place where the decision may be implemented. To illustrate, a decision taken by Ministry of Education may need implementation at all the schools and colleges. Still, undisputedly, the decision making authority (including the debit and credit associated with the decision) can be linked to the Ministry. What is relevant for POEM is the evaluation of decision making authority and process.

i. Proper documentation to be maintained for agenda, discussion, records, appraisal• AO may examine the trail of documents in the form of agenda papers or in

the form of proposals leading to preparation of agenda papers for the Board meetings.

• It is possible that, the preparation may not be in the same jurisdiction in which the directors normally meet. It is also possible that professional advice may have been sought in the preparation of proposals or agenda papers. What is of greater relevance is the record of debate by the BOD before arriving at a positive or negative conclusion on a matter involving policy decision. The better the quality of the debate, the better are the chances to establish that the decision making was at the place of BOD meeting.

• When a company has a BOD comprised of persons who have strong knowledge and understanding of the subject which is being debated or evaluated, it is a strong prima facie evidence that the de facto management is by the BOD – particularly in a case where the agenda papers and minutes offer a support that there was in-depth discussion on the views and proposals which were put forth before the BOD.

ii. Independence of Directors• Apart from being competent, the BOD may need to be independent too.

Independence of directors is a free state of mind. In absence of any evidence to the contrary, a BOD acting in a fiduciary capacity would be regarded as acting independent and not under parental/ shareholders’ influence.

• So long as the BOD is competent and independent, it is not relevant that the BOD seeks opinion or views of the professionals or the advisors or the employees of the company. Seeking advice for decision making is different compared to surrendering oneself to the decisions which are ‘dictated’.

• Presence of independent directors on the BOD is a prima facie evidence of independence. They should be presumed to be acting independently. At times, the independent director of the holding company is nominated on the board of subsidiary. Mere nomination should not interfere with the state of independence. The presumption should be that the independent director is acting as independently on the Board of the subsidiary, such that, while on that Board, he is acting in the interest of the subsidiary without the influence of his seat on the holding company.



• It may be an adverse feature if the directors of a company are indemnified by the company or the parent company.

iii. Residence of Board members and situs of Board meeting• The circumstance that majority of the directors of an overseas company

are non-residents of India as also the circumstance that the meetings of the BOD are predominantly held outside India could be circumstance of comfort, except in a case where the evidence support that BOD acted as rubber stamp to decisions taken outside of board meeting.

iv. Video Conferencing and Circular Resolutions• In case of Board or Committee Meetings held through video conferencing,

it may become imperative to identify the place where the Board Meeting is held depending on the relevant corporate laws of the jurisdiction to which the entity is subject to.

• Participation of India Directors through video conferencing may not be fatal to determination of the situs of Board meeting. Indeed, it would be a matter of comfort if majority of the directors participating at the meeting are outside India.

• It may be relevant to note that CA 1956, vide a Circular, advised that the situs of such meeting was deemed to be at a place where the secretary or chairman is sitting during the board meeting. Under CA 2013 Act, the place of board meeting is deemed to be at the place of the meeting which is set forth in the notice which is issued to convene the meeting.

v. Collateral Evidences• The Tax Authority may also examine witnesses and passports of

the directors to verify presence of directors at a particular location. Correspondence with key customers or affiliates, call details and call duration timings may also be examined. There have been instances in India as well as in UK of the Tax Authority resorting to such practices. In addition, the following may be relevant:

• Social Media (e.g. LinkedIn) profiles of key employees or their description on the company’s website.

• Visiting Cards of employees showing their designation and location.

• Inquiries by other regulatory bodies or laws, for example, under SEBI disclosure, corporate governance disclosure or peer review requirements, Competition Law, etc.

• The attendance record of the meeting may be consulted by the Tax Authority. If the proceedings are recorded, the proceedings may be regarded as constituting evidence which can be perused by the authority.

• A company may have freedom to pass circular resolution which can be passed if the draft resolution, along with necessary supporting papers, is



circulated to all the directors at their respective registered addresses with the company. Location of the directors and their registered addresses may be relevant in this regard.

21. Onus of proof21.1. Since the level of tax implications and liability is prone to vary substantially depending

on the residential status, the onus of establishing residence can be considered to be on Tax Authority. However, when the onus is to be discharged in the light of facts, it is the duty of taxpayer to establish the facts, when called upon to do so. For example, the taxpayer may have to lead evidence as to where BOD meetings are held, how meetings are conducted, what decisions are taken in India, evidences of exercise of authority outside India, etc. in case of a fact based enquiry, the onus can keep on fluctuating in the course of assessment. One may also need to keep in mind that the provisions have been introduced as an anti-avoidant provisions to deal with ‘shell structures’.

22. POEM and BEPS22.1. The report on PECD BEPS Action 6 titled ‘Prevent Treaty Abuse’ identifies treaty

abuse (in particular treaty shopping) as one of the most important sources of BEPS concerns. The Report includes proposed changes to the OECD MC and Comm. to ensure prevention of treaty abuse. The Report proposes to replace Article 4(3) of OECD MC (POEM) by “Competent Authority Rule”. The Report also provides for “POEM” Rule as an alternative, but however, prefers “Competent Authority Rule” over “POEM” Rule. What this means is that the different competent authorities may, under the influence of domestic culture and thoughts, may introduce different tests and yardsticks.

23. Digitalization, e-Commerce activities and modern practices23.1. E-commerce business is beyond any boundary and hence, a question may arise whether

a requirement which is tied to a place of business or management has failed to keep pace with e-Commerce development. The dilemma could, therefore be the same as the dilemma one has in determining fixed place PE for e-commerce business. Focus may still be on the place where majority directors make strategic decisions for the entity.

23.2. In February, 2001, the OECD’s Technical Advisory Group (TAG) issued a draft discussion paper, titled “The Impact of the Communications Revolution on the Application of “Place of Effective Management” as a Tie-Breaker Rule” (Draft Discussion Paper). The Draft Discussion Paper summarized the issues of concern as follows:

“The communications and technological revolution is fundamentally changing the way people run their business. Due to sophisticated telecommunication technology and fast, efficient and relatively cheap transportation, it is no longer necessary for a person or a group of persons to be physically located or meet in any one particular place to run a business. This increased mobility and functional decentralisation may have a significant impact on the incidence of dual resident companies, and the application of the place of effective management tie-breaker rules”.

23.3. These factors may, however, need some specific perusal, on a fact sensitive basis, in context of automated e-commerce activities. If the business of overseas companies is e-driven in the sense of being driven by interactive software and if the activity of



development of software as also the activity of operating software is monitored by a support service company in India, interesting results may follow. If the structure is such that the overseas company may not need any meaningful employee and/or that is fully dependent on the competence of Indian company in terms of software and its adaptability and/or the control over software is wholly with Indian company and/or where the accounting records are also generated by the software, there may be scope for serious difference of opinions on the posture on POEM.

23.4. In the context of e-commerce also, one may need to draw a distinction between pure digital businesses vis-a-vis a situation where the digital model facilitates conduct of the business.

24. Health check for relative comfort10 • Check whether the charter documents recognize the authority of BOD, without

diluting it

• Directors of the company should be competent (in terms of qualification, or experience) and should be independent by status and in terms of their approach. It may be a plus point if majority directors are based out of country of residence of the company.

The Committee contributed by directors should work in accordance with mandate and subject to surveillance of the Board.

• One may keep track on powers delegated to MD / ED or other managers.

• Place of Board Meetings may be physically in country of residence. Discussions, debates, background justification documents and minutes should be well documented. The overall conduct should bring out that the BOD has the ability and appetite to cater or contribute to business needs and business development of the company.

• Parental control may be limited to statutory matters and as a shareholder or to comply with ‘Group vision’ and code of conduct. Also, transactions between parent and subsidiary or group companies should be strictly at ALP.

• In case of outbound investment, presence of senior level employee in the operating jurisdiction on BOD could be a good support – though, not conclusive.

• In case of outbound structure, it helps if there are business assets and operations in the jurisdiction.

• Company may obtain TRC from jurisdiction of residence.

• Secretarial, accounting and corporate records should be available in the country of residence. Mail trail or documents from HO (say, found in the course of survey or search) should not contradict the claim.

10. Await, however, the guidelines and one should advisedly adapt oneself to the guidelines though, it may be arguable that in absence of specific statutory power, the Guidelines may not be able to dilute scope of the defined term.



25. Conclusion As it presently seems, POEM can be considered as located where the head and

brain of the company is. The historical evolution seems to suggest that the authority which controls the management and commerce of a company is usually the BOD of the company. The challenge lies in establishing: how exactly does BOD of overseas company perform; is it that the BOD of Indian company or KMP in India who virtually control BOD of overseas company either by virtue of imposing personality of KMP or because BOD of overseas company has virtually delegated its functions to Indian KMPs.

Also, considering that different countries have adopted varying norms for their own domestic law, it is possible that the India tax authorities may also like to ‘cherry pick’ certain factors of advantage which may conflict with the general understanding. For example, if the factor of business operations or the factor of day to day management is considered as relevant, the operating companies in outbound structure may have greater comfort. But, the inbound companies may face difficulty if the operations are largely India centric.

One hopes that the Guidelines are pragmatic enough to allow for ease of doing business. They ought to hopefully factor the realities of group headquarters control over subsidiaries in an outbound structure. One also hopes that POEM is not used as a weapon of revenue generation; that, its applicability is limited to cases of shell structure; that India incorporate is given time to adjust its affairs and that, the power is used only when there is evidence of blatant non-compliance rather than making roving inquiries.



CASE STUDIES

Case Study 1: Dividend distribution by Step Down Subsidiary triggering POEM in India and onward distribution by subsidiary to Indian parentThe group structure is as follows:

ICo

India

TFJ

FCo1 (InvCo)

Operating Jurisdiction

FCo2 (OpCo)

Background Factsi. In the year 2010, ICo group acquired OpCo from the existing promoters. OpCo is a

profitable entity and till its acquisition by ICo group, it was controlled and managed by promoters situated in the jurisdiction of OpCo.

ii. The acquisition was a leveraged acquisition. At the insistence of the financial institutions, shares of OpCo were acquired through SPV set up in a jurisdiction acceptable to the lenders.

iii. ICo has provided guarantee / letter of comfort to the financiers of FCo1.

iv. OpCo has continued to operate as before, though the CEO of OpCo reports on a regular basis to the Chairman of ICo who is also the Chairman on the board of FCo2.

v. OpCo has paid dividends regularly so as to enable FCo1 to service its interest and repayment obligation.

vi. During FY 2015-16, OpCo is likely to pay huge dividends to FCo1. After meeting its interest and administrative cost, FCo1 is to upstream dividend to ICo.

vii. In the jurisdiction of FCo1, dividend income from OpCo is claimed exempt on account of participation exemption provisions.

viii. ICo is contemplating further distribution of dividend received from FCo1 in favour of its own shareholders and to claim relief in respect of roll over credit as contemplated by s.115-O.



ix. During FY 2015-16, FCo2 is also contemplating buy-back of part of its capital to ensure accelerated remittance of surplus in favour of FCo1. The buy-back is also tax exempt in the jurisdiction of FCo1. Also, in terms of the treaty between FCo1 jurisdiction and OpCo jurisdiction, the right to tax buy-back is allocated to the jurisdiction of FCo1.

AssumptionsAssume that, on a review of the factors which are relevant to POEM, FCo1 and FCo2 are regarded as residents of India under s.6(3) of ITA and, even for the purpose of tie-breaker, POEM is considered to be in India.

Questions which fall for determination in the backdrop of assumptionsi. Rate of tax at which FCo1 and FCo2 will trigger tax liability in respect of income

sourced outside India?

ii. Can FCo1 claim benefit of concessional rate of S.115BBD in respect of dividend income received from FCo2?

iii. Can FCo1 / FCo2 claim deduction in respect of interest cost given the representation that no TDS has been withheld in respect of such interest under s.195 of ITL?

iv. Can ICo claim benefit of S.115BBD as also benefit of S.115-O (1A)(i)(b) of the Act, in respect of dividend which is received from FCo1?

v. Will the buy-back transaction between FCo1 and FCo2 get covered within the scope of transfer pricing provision of India? How will the transaction get taxed in India?

vi. Can the benefit of treaty between FCo1 and FCo2 be denied in the jurisdiction of FCo2 in respect of buy-back transaction merely because FCo1 is regarded as resident in India by virtue of S.6(3) including by virtue of tie-breaker rule of the treaty between India and FCo1 jurisdiction?

vii. Can there be any notional addition in respect of guarantee fee in respect of letter of guarantee / letter of comfort provided by ICo?

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Case Study 2: POEM in case of Investment SPV (outbound structure)

USCo (pooling vehicles

Promoted by NRIs)

USA

MauCo (IT SPV)

MauCo Infra SPV

Mauritius

India

IT Cos Infra Cos

Fact Patterni. US investor group from US (primarily technocrats and high net worth NRIs) have come

together for making India centric investments. They floated a pooling vehicle in USA to make an investment in the ventures in India. It has since made several investments. It has also exited from some investments – including on a premature basis.

ii. The pooling fund has identified professionals in India who have deep experience of acting as investment advisors with niche mutual fund or comparable entities. The professionals have agreed to provide umbrella services of identifying the start-ups/ investment opportunities, deciding the terms of investment, advising on terms of shareholders agreement, advice on rights as a shareholder, exit timing, etc. etc. The professionals have agreed to act on success fee basis whereby the remuneration is linked to the performance of the investment portfolio.

iii. As per the advice of the investment advisors, the fund has incorporated two Mauritian entities as the IT SPV entity and Infra SPV entity. The professionals have privity of relationship with SPV.

iv. In certain limited circumstances, the SPV has a right to terminate the services of the professionals. The professionals also have a right to terminate the contract by giving 3 months’ advance notice.

v. The investment advisors have identified information technology and infrastructure as two business laterals for deploying the funds. For this purpose they identify targets and do also finalize the terms of investment.

vi. The funds for investment in both the entities have flown from USA investors.

vii. BOD of both the Mauritian entities comprise of 2 directors from USA, 1 from Mauritius and 3 from India. All the Directors are independent and are duly qualified. The 3 Indian directors are the nominees / executives of the advisor entity from India. The nominee directors will cease to be directors upon termination of the service contract.



viii. The facts of the case support that the BOD at Mauritius has almost always implemented advice of professionals in as much as that in almost all cases, decisions of investment, exit and dividend extraction were as per advice of the investment advisors. There are, however, evidences where the US investors and BOD were wholly in disagreement with the advice of professionals.

ix. One of the 3 directors (nominated by investor) is the permanent Chairman at Board meeting. In his absence, the designated nominee of advisor, chairs the meeting. The Chairman has no casting vote.

x. During the year, for 2 months, one of the investor directors ceased to be a director due to regulatory reasons. In the middle of the year, one of the investor advisor’s nominee directors resigned as a director. The vacancy of nominee director remained unfulfilled for almost 6 months before another nominee director was appointed.

xi. During the year, there were 6 Board meetings. 3 of them were in Mauritius; one was in India and one was in US. One more Board meeting was through video conferencing where the the Chairman participated from India. Each physical meeting lasted more than 2 days and as it appears from the minutes, all issues were considered threadbare before acceptance or rejection.

xii. The agenda papers and proposals for the meeting are prepared by the professionals in India. They are approved by the Chairman prior to circulation.

Apprehensionsi. Whether Mauritian company may be considered to have its POEM in India on the basis

that:

• Negotiations which preceded formation of SPV took place largely / predominantly in India.

• Business of SPV is India centric

• The accounting entries recorded by SPV reflect that beyond corporate compliance, Board meetings and routing of funds, there are no other transactions or activities in Mauritius.

• BOD of SPV has members who are from India. BOD is entitled to rely on advice received from Indian advisors. In any case, conduct shows that BOD has not deviated from recommendations of the Indian advisor in most cases either in terms of making investment, divestment, dividend extraction, voting on Indian companies’ matters, etc.

• For some part of the year, the majority of the directors were resident in India.

• Or, for any other reason

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Case Study 3: Overseas holding company for investment in downstream operating entities by Indian Group (Outbound structure) Facts

XYZ Group (ICo)

India

MauCo

Mauritius

Europe/USA

JV Partner

EUCos USCo (JVCo)

• XYZ is a progressive and a profitable Indian headquartered group. The group decided to expand and have a global market presence, where it was earlier exporting goods.

• It set up or acquired certain of the operating companies in various jurisdictions and for this purpose formed an SPV in Mauritius.

• Amongst operating subdidiaries, one of the prominent and profitable companies (USCo) is a joint venture company based in US. It has its own assets and infrastructure, including employees. There are 8 directors of the company – 4 having been nominated by each group. India nominated directors are India residents. There are matters on which decision cannot be taken without affirmative vote of at least one Board member of the other group. In terms of division of responsibilities, there are certain matters on which CEO and CFO of USCo have to report to CEO of India or CEO of US joint venture partner, depending upon the subject involved.

• The meetings of the USCo are held in the USA. Usually, all important business heads of USCo are invited to the meeting for their presentation and views. Each joint venture partner has its own vision statement and it is agreed that USCo (JvCo) will remain compliant with both the vision statements.

• The right to exit from the company or the right to raise any dispute with the joint venture shareholder or the right to refer such dispute to arbitration is with the respective group headquarter company.

• Having regard to considerations of economy, some of the functions of USCo have been outsourced an Indian group company of XYZ group on commercial and ALP terms.



• Other OpCos in EU are wholly owned step down subsidiaries of ICo. Each company has well experienced CEO and CFO. Each of them reports to the CEO of India. The reporting is in the nature of presentations which are made at the Board meeting where CEO of India is normally present as the Chairman of ICo as also the Chairman of OpCo. The decisions taken at the Board meetings are implemented by OpCos. The majority of the directors of OpCos are residents in India. The directors are either the employees of ICO or of concerned OpCo, or, are the employees of some other group company outside India. There is one independent director on each OpCo who is also an independent director of the Board of ICo.

• With regard to Mauritius company, the conclusion seems to be that it is, till date, almost wholly managed in India. It is felt that it may be considered as resident of India.

Apprehensions and questions• Assuming Mauritius company is considered as a resident of India, can it have any

impact on residential status of step down companies, if regard be had to the facts of the case?

• Can Mauritius company be considered as resident of India if it is holding TRC issued by Mauritian authority? Can it be suggested that Circular No. 789 will be decisive in determining residency of MauCo?

• What are the chances that the operating companies may be considered to be resident of India?

• Would you have any suggestions for the group in case litigation is to be avoided in India?

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Case Study 4: Indian operations of foreign company with strong management personnel in India (Inbound structure)

USA

USA

Group Management Co (UAE)

Area KMPs

UAE

Various SPVs (HK)

West Asia & Middle East countries

HK (I) Co.

India

Various SPVs (HK)

Far East

POs / BOs POs / BOs

HK

India

POs / BOsIndia KMPs

Facts• The group is in the business of undertaking diverse EPC contracts and turnkey projects

many of which are relatable to power projects. The group is headquartered in USA.

• The group is structured such that the responsibility of overseeing Asian market segment is with Management Company at UAE.

• The Group also has policy of undertaking projects in a given country through a country specific SPV formed as subsidiary of the area management company. The country specific SPV for India (other Asian markets) are in Hong Kong. Indian operations are housed in HK(I)Co.

• The group entered Indian market in the year 1995 and has a huge market share. For past some years, Indian operations have contributed >80% of group turnover in Asia. Annual turnover of HK(I)Co has been in the range of USD 150-200M.

• Various offices in India employ many of the key management personnel (KMPs).



• Mr. A is CEO for India operations. He has strong technical experience and his technical ability has helped the company win many contracts. His presence gives comfort to the client on timely completion of the projects. Apart from Mr. A, there are various KMPs like segment line heads, finance head, HR head, etc. in India for looking after the Indian operations.

• Various lateral heads for Asia region (e.g. Finance head, Operational head, HR head, etc.) are based out of UAE. Mr. A, and other KMPs of India are appraised and evaluated by the respective heads of Management Company.

• The Area Chairman at UAE formulates the annual strategy (budget, allocation, pricing, minimum IRR calculations for bids submission, etc.) and financial targets for India operations. Within the framework of these parameters, all key decisions for Indian operations are taken by Mr. A in consultation with KMPs located in India. Whether or not to bid for particular contract or tender, determining and negotiating the price and terms of contract, managing the equipment and finances for the project and other such issues are evaluated and decided by the Indian KMPs in consultation with Mr. A in India. However, where asset acquisition value exceeds USD 1 million individually or the contact value exceeds USD 10 million the Area Chairman and Area KMPs located in UAE are expected to be involved in the decision making.

• E-mail correspondence may show that almost all suggestions made by Mr. A or the Indian KMPs are approved by the UAE heads.

• There are two directors on the BOD of HK (I) Co who are privy to routine compliances in HK. There are no other personnel at Hong Kong Co. Any surplus in Bank account of HK(I)Co is transferred to treasury division of the group in Singapore. The Singapore treasury division works under guidance of Management Company at UAE.

• Almost all banking transactions of India project are through bank account in India operated by Mr. A.

• All books of account, corporate seal and other records of HK(I)Co are kept outside India at UAE.

• Recently, Mr. A of India has been assigned responsibility of overseeing Far East markets for 2 years on rotation basis. The operational heads of Far East projects report to Mr. A for all their technical and marketing performances.

Questions(i) Is HK(I)Co likely to have challenge of residency under new Rule? Should the exercise

be limited to evaluation of situs of POEM as between India and Hong Kong?

(ii) What are the cautions which HK(I)Co should take into account to mitigate the risk of residency in India?

(iii) What are the risks / challenges for the Far East entities which report to Mr. A?

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ANNEXURE – A

Explanatory Memorandum to Finance Bill, 2015 on POEM:

Amendment to the conditions for determining residency status in respect of CompaniesThe existing provisions of S.6 of the Act provides for the conditions under which a person can be said to be resident in India for a previous year. In respect of a person being a company the conditions are contained in clause (3) of S.6 of the Act. Under the said clause, a company is said to be resident in India in any previous year, if-


(ii) during that year, the C&M of its affairs is situated wholly in India.

Due to the requirement that whole of C&M should be situated in India and that too for whole of the year, the condition has been rendered to be practically inapplicable. A company can easily avoid becoming a resident by simply holding a BOD meeting outside India. This facilitates creation of shell companies which are incorporated outside but controlled from India. ‘Place of effective management’ (POEM) is an internationally recognized concept for determination of residence of a company incorporated in a foreign jurisdiction. Most of the tax treaties entered into by India recognise the concept of ‘place of effective management’ for determination of residence of a company as a tie-breaker rule for avoidance of double taxation. Many countries prefer the POEM test to be appropriate test for determination of residence of a company. The principle of POEM is recognized and accepted by Organisation of Economic Cooperation and Development (OECD) also. The OECD commentary on model convention provides definition of place of effective management to mean the place where key management and commercial decisions that are necessary for the conduct of the entity’s business as a whole, are, in substance, made.

The modification in the condition of residence in respect of company by including the concept of effective management would align the provisions of the Act with the Double Taxation Avoidance Agreements (DTAAs) entered into by India with other countries and would also be in line with international standards. It would also be a measure to deal with cases of creation of shell companies outside India but being controlled and managed from India.

In view of the above, it is proposed to amend the provisions of S.6 to provide that a person being a company shall be said to be resident in India in any previous year, if–


(ii) its place of effective management, at any time in that year, is in India.

Further, it is proposed to define the place of effective management to mean 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.

Since POEM is an internationally well-accepted concept, there are well-recognised guiding principles for determination of POEM although it is a fact dependent exercise. However, it is proposed that in due course, a set of guiding principles to be followed in determination of POEM would be issued for the benefit of the taxpayers as well as, tax administration.

These amendments will take effect from 1st April, 2016 and will, accordingly, apply in relation to the assessment year 2016-17 and subsequent assessment years.

mmm

place of effective management – redefining corporate residency material/itf-pinakin de… · 2.7....

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