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India DTC - Enhanced Scope of Residency Impacts Multinationals
The Direct Taxes Code Bill, 2010 ('DTC') proposes significant changes to the definition of tax residency when compared to the definition under the Income tax Act, 1961. For the determination of tax residency of a company, the DTC introduces the concept of Place of Effective Management ('POEM').
The introduction of POEM along with the General Anti-Avoidance Rules ('GAAR') and the Controlled Foreign Corporation ('CFC') regime reflects India's aspirations to incorporate developed country taxing concepts into its new tax law. Further, it attempts to substantially expand the available Indian tax base. Foreign companies with an Indian connection and those doing business with India would need to consider whether their Indian operations / presence could be regarded as a POEM for Indian tax residency purposes under the DTC regime.
Taxand India discusses the impact of the new tax residency rules, including, more specifically the concept of POEM as we countdown to the introduction of DTC.
Residency under the DTC
- Under the DTC, all persons have been classified into 'residents' or 'non-residents'.
The POEM concept
Under the DTC, POEM is defined to mean:
- the place where the board of directors of the company or its executive directors, as the case may be, make their decisions
- 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.
As an internationally recognised concept for determining residency, the Organisation for Economic Co-operation and Development ('OECD') describes POEM 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'.
Significant imperatives for Indian Multinational companies
By proposing legislation to tax overseas companies that are ultimately owned or controlled as well as managed from India, new ground has been broken with the proposed introduction of concepts such as CFC and POEM. While these concepts are in line with global standards, however, the manner of their proposed introduction has created uncertainty. The implications of these provisions are that profits of an overseas entity will be taxed in India at 30% in the year in which it is earned even if the same is not repatriated to India. If the overseas entity qualifies to be a CFC, then the income will be taxed under 'income from residuary sources' and in case the POEM is in India, then as resident under the relevant heads of income. It is therefore important that Indian MNCs undertake a comprehensive functional analysis of the group organisational structure considering these issues.
The DTC seeks to introduce tax concepts in line with internationally accepted practices. In this context, if one examines POEM as it has been enshrined within the DTC, it appears to be at variance with internationally accepted principles for the determination of POEM. Looking at the guidance issued by the OECD, POEM should be determined by taking into account factors such as where meetings of the board of directors are 'usually' held, where the headquarters are located, etc. The OECD places importance on 'key' management and commercial decisions. Further, the OECD looks at POEM holistically by taking into account decisions for the business as a whole rather than placing importance on isolated occurrences.
In comparison, POEM under the DTC is more broad ended and relies on whether at 'any time' in the year decisions are taken in India. It further broadens the scope by not relying on the place of 'key' management and commercial decisions but considers as relevant, the place where management and commercial decisions are taken. As per the DTC, even a single board meeting in India could constitute the POEM of the foreign company being in India. The DTC appears to have a transactional approach to POEM rather than a pragmatic over all approach.
POEM could impact multinationals with close managerial connections with India. Such companies may need to review their decision processes and their link to India, as well as the documentation and supporting evidence to confirm that they are in a position to establish that the POEM of the foreign company in question is actually not in India.
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