POEM: Draft rules spark off double taxation fears

Critics point to risks on double taxation, litigation; suggest not applying with retrospective effect

The proposed guidelines to determine the 'Place of Effective Management (POEM)' for multinational companies (MNCs) have met with some criticism.

The phrase refers to the location determined as to where key decisions of the company are made, needed by tax authorities where a company is incorporated in another country. The concept was introduced in India in this year's Union Budget proposals, as a means to check tax avoidance. Feedback on the proposals have been invited for another 10 days.

Critics feel the draft language could expose some Indian MNCs to double taxation, and increase litigation, as applicability is proposed from the current financial year, based on the average of the past three years' data.

“This will be very relevant for information technology companies, as they normally have an offshore subsidiary for onsite work, and also for the pharmaceutical industry,” says Sanjay Sanghvi, tax partner at corporate law firm Khaitan & Co. Jayesh Sanghvi at Ernst & Young agrees these two sectors would be substantially impacted.  

That would cover Indian heavyweights such as Tata Consultancy Services and Sun Pharmaceutical Industries. It would also be applicable to a large number of fund managers and start-ups with foreign fund entities or holding companies.  

“There is significant risk of double taxation, especially in the case of US companies managed from India, since the India-US tax treaty does not recognize POEM, and such companies might not be able to claim treaty relief,” says Nishith Desai, founder,  Nishith Desai Associates.  

The draft says the place of effective management in a company engaged in active business outside India shall be presumed to be outside India if the majority of meetings of the board of directors are outside India. And, considered to be engaged in active business outside India if the majority of its income, assets, employees and employee expense are from abroad.

However, if the company directors are not exercising their powers of management and these are being exercised by either the holding company or any other person resident in India, the place of effective management shall be considered to be in India. For determining engagement in active business outside India, the average of the past three years’ data will be taken into account.

“Indian companies will need to ensure that in substance they are managed from outside India. Else, they will get to be tax residents in India and thereby taxable in India,” says Girish Vanvari,  partner at KPMG in India. “These guidelines should be made effective from April 2016. Making these retrospectively effective from April 2015 could lead to more ambiguity and litigation.”

Multinationals with significant operations in India in terms of revenue, employees and assets will also be considered residents in India if the majority of board meetings are here.

PROSE OF POEM

Not Taxed

• If the majority meetings of the board of directors of the company are held outside India
• If the majority of its income, assets, employees and employee expense is from outside India

Taxed

• If the power of company directors are being exercised by either the holding company or any other person resident in India

Contention

• Determination based on the average of the past three years’ data

Impact

• Largely Indian information tech and pharma companies that have been conducting their foreign operation, oblivious to new rules