Central Board of Direct Taxes issues draft Guidelines for determination of Place of Effective Management for corporate residency

The test of residency for foreign companies in the Indian Tax Laws (ITL) was amended in 2015. As per the amended rule applicable from tax year commencing on 1 April 2015, a foreign company is treated as a resident of India if its Place of Effective Management (POEM), in a given year, is in India. Pursuant to this, the Central Board of Direct Taxes (CBDT) has, vide Press Release dated 23 December 2015, issued a draft of the guidelines (Guidelines) for determination of POEM of foreign companies in India. Comments and suggestions on the same are invited from stakeholders by 2 January 2016.

The Guidelines emphasize that the test of POEM is one of “substance over form” and is to be determined having regard to the facts and circumstances of each case on a yearly basis. The Guidelines provide that the determination of POEM is primarily based on whether or not a company has “Active Business Outside India” (ABOI). The ABOI test needs to be evaluated on the basis of: (i) Passive income of the taxpayer. (ii) The asset base, number of employees and payroll expenses deployed outside India. For such companies, the POEM is deemed to be outside India if majority Board meetings are held outside India, unless facts suggest that the Board of Directors (BOD) is not the de facto decision-making authority.

For companies other than those engaged in ABOI, the Guidelines prescribe a twin test: (a) Identification of persons who take key management and commercial decisions. (b) Determining the place where these decisions are, in fact, made. In this behalf, the Guidelines also provide relevant factors, such as determination of the location of Board meetings, or location of the Head Office (HO), who constitutes senior management etc. It is also stated that the place of implementation of decisions or the place where routine day-to-day decisions are taken are not relevant for determination of POEM. Furthermore, POEM is not to be determined by taking a “snapshot” view, but by considering activities performed over a period of time during the year for which POEM is determined. The Guidelines also deal with determination of POEM where participation in decision-making is by use of telephone or videoconferencing.

By way of a safeguard, the Guidelines require the tax officer to seek prior approval from a senior tax officer and also give an opportunity of hearing before deciding the issue of residency of the foreign company.

The Guidelines underscore the application of fact-based analysis and “substance over form” approach in determining residency. The ABOI test and the safeguard of seeking prior approval of senior tax officers are welcome steps. The consultative approach also reinforces commitment on the part of the GOI to work towards non-adversarial tax regimes. It may. however, be useful if certain aspects are further addressed.

Given that the stated object of introducing POEM is to target shell structures, it may be useful to keep entities in comparable tax jurisdictions outside the scrutiny of POEM or at par with entities fulfilling the ABOI test. An overarching statement that POEM is a deterrent measure, and not a revenue raiser, may also be of significance to taxpayers.

Furthermore, the ABOI test may be linked to commercial activity, rather than being linked to normative characterization of income. To illustrate, rent income earned by a logistics company or interest income earned by a finance company from active operations may not be regarded as passive income. Also, there are certain expressions such as “‘total assets”, “income” or “total income” which may need further guidance.
In respect of the companies which do not fulfil the ABOI test, the Guidelines rightly provide a two-stage process involving identification of key management and commercial decisions for the conduct of the business as a whole followed by the determination of place where such decisions are made. These criteria have listed multiple factors without defining the hierarchy of elimination and without guidance on the weightage of each factor. This is likely to make the exercise subjective and uncertain, on a year-to-year basis.

It may also help to specifically clarify that POEM is to be evaluated for the business of the company as a whole and that such determination is limited to ascertaining whether POEM is in India, while being irrelevant for India purposes to ascertain in which other specific country the decision-making process takes place.