Draft rules tighten tax norms for MNCs

Such firms to pay tax in India if decision-makers hold most meets in the country

Business Standard Dec 24, 2015

Multinational companies (MNC) will be liable to pay in India if those who take key decisions conduct most of their meetings in India, even if the decisions are implemented in another tax jurisdiction, according to the draft guidelines of the finance ministry.

The proposed rules might force MNCs to locate their regional controller offices outside India, say experts.

With a view to tightening loopholes to deter tax evasion by multinational companies — Indian or foreign — the government on Wednesday released guidelines on (PoEM). The rules will affect Indian companies that take most decisions about their foreign subsidiaries from India and also foreign multinational companies with shell divisions.

The rules will come into effect from 2016-17 assessment year, which means this financial year.

PoEM has been defined as “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.”

Businesses will be liable to be taxed in India if most meetings of the board of directors of the company are held within India. In cases where the board of directors does not exercise its powers of management and such powers are exercised by either the holding company or any other person resident in India, it would be assessed where the decisions are taken.

Basically, the authorities will apply a two-stage test to determine if companies are to be taxed in India. The first stage would be identification of persons who take important decisions in these companies. These could be managing director, CEO, financial director, chief financial officer, chief operating officer, heads of various divisions or departments such as chief information, technology officer, or director for sales or marketing.

The second stage is to determine the place where these decisions are made. If these are made in India, the company would be liable to be taxed in the country.

The rules will also apply a test of active company in India to tax them. An active company in India is one whose passive income —  royalty, dividend, capital gains, interest or rental besides income from sale and purchase from associated companies — is more than 50 per cent of the total income and more than half its assets and total employees are situated in India or are resident of India.

The average of the data of the previous year and two years prior to that will be taken into account to determine PoEM.

PLACE OF BIZ GUIDELINES
Govt tightens loopholes to deter tax evasion by MNCs, either Indian or foreign
IT DEFINES ‘ACTIVE BUSINESS’ WHERE

  • Passive income is more than 50% of total income
  • More than half of its assets and total employees are situated in India or are resident of India
  • Payroll expenses incurred on such employees is more than 50% of its total payroll expenditure

THESE ACTIVE COMPANIES WOULD BE LIABLE TO PAY TAX IN INDIA, IF

  • Majority meetings of the board of directors of the company are held within India
  • Established that the board of directors do not exercise their powers of management and such powers exercised by either the holding company or any other person resident in India
  • Average of the data of the previous year and two years prior to that are taken into account to determine PoEM

The Central Board of Direct Taxes would apply POEM rules as substance over form and would take them jointly rather than separately. The draft guidelines said. “It needs to be emphasised the determination of PoEM is to be based on all relevant facts related to the management and control of the company, and is not to be determined on the basis of isolated facts that by itself do not establish effective management,” the guidelines said.

The guidelines will force companies to restructure their decision-making procedure to ensure key decision-making is done outside the country. Companies will also have to show their decision-makers were out of the country at the time of decision-making to ensure compliance with PoEM and avoid paying tax.

According to the existing rules, a company is liable to tax in India if it is an Indian company or if during that year, the control and management of its affairs is situated wholly in the country. However, these rules allowed tax avoidance opportunities for companies to escape the residential status by shifting insignificant or isolated events related with control and management outside India.

The draft PoEM provisions essentially seek to plug these tax avoidance loopholes for companies.

Central Board of Direct Taxes has invited comments and suggestion of stakeholders as well as the general public on the draft guidance by January 2, 2016.

This could result in more companies restructuring operations by way of moving employees, residences of senior management, delegation of authorities and assets, among others, to avoid getting entangled in the tax liabilities.

“The new wave of India becoming a jurisdiction as regional controller offices of MNCs might get a setback with respect to the active business rules of PoEM,” said Rahul Garg of PwC in India. He said the active income factors to be considered are “unreasonably strict” as “some of them have little relationship with control and management of entity as a whole”.

The head office of a company will be the place where the company’s senior management and direct support staff are located.

Amit Maheshwari, managing partner of Ashok Maheshwary & Associates, said the ‘active business outside’ test will be the key and is bound to impact the existing structures, especially those which were set up in jurisdictions that didn’t have very stringent substance requirements.

An entity might have more than one place of management, but it can have only one place of effective management at any point of time. Since ‘residence’ is to be determined for each year, PoEM will also be required to be determined on year-to-year basis, the guidelines said.

The government introduced PoEM in Budget 2015-16, where it modified the condition of residence in respect of company by including the concept of effective management as a measure to deal with cases of creation of shell companies outside India, but being controlled and managed from India.

Girish Vanvari, national head of tax at KPMG in India, argued against the applicability of these guidelines retrospectively from April 1, 2015. “We are already nine months down the line for this to be finalised and many clauses in the guidelines are directional rather than being conclusive. Tightening of some of these issues will be required,” he said.

“In order to safeguard the taxpayers, the guidelines propose for prior approval of principal commissioner or the commissioner as the case may be before holding a foreign company to be resident of India,” said Parikshit Datta, senior director, Deloitte in India.

Most tax treaties entered into by India recognise the concept of ‘place of effective management’ for determination of residence of a company for avoidance of double taxation.

Earlier, the government had withdrawn a provision in the Budget where companies holding even a board meeting once in a year would have been liable to pay tax in India.

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