ANALYSIS OF POEM - Place of Effective Management & EQUALISATION LEVY SAMPATH RAGHUNATHAN., HYDERABAD

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1 ANALYSIS OF POEM - Place of Effective Management & EQUALISATION LEVY SAMPATH RAGHUNATHAN., HYDERABAD

2 RESIDENTIAL STATUS OF COMPANIES hitherto and as amended Sec. 6 (3) A company is said to be resident in India in any previous year, if (i) it is an Indian company ; or (ii) duri g that year, the o trol and management of its affairs is situated wholly in India. above clause (3) shall be substituted for the existing clause (3) of section 6 by the Finance Act, 2016, w.e.f : (3) A company is said to be a resident in India in any previous year, if (i) it is an Indian company; or (ii) its place of effective management, i that year, is in India. Explanation. For the purposes of this clause "place of effective management" means a place where key management and commercial decisions that are necessary for the conduct of business of an entity as a whole are, in substance made.

3 co trol a d a age e t Supreme Court in Subbayya Chettiar v. Commissioner of Income-tax, Madras referred to the four principles as decided by Swedish & Central Railway Company Ltd. v. Thompson 1."Control and management signifies, in the present context the controlling and directive power, the head and brain " 2. the mere activity by the company in a place does not create residence. 3. the central management and control of a company may be divided and it may keep house and do business in more than one place. 4. in case of dual residence, there may be two centres of management. But the important principle which applies to the present case is the one that has been first set out and which emphasises the fact that what we have to consider in order to determine the residence of a company is as to where its head and brain is and the head and brain of the company will be where its controlling and directive power functions.

4 affairs wholly situated i I dia duri g affairs the word 'affairs' must mean affairs which are relevant for the purpose of the Act and which have some relation to income." holly would seem to recognise the possibility of the seat of such power being divided between two distinct and separated places. duri g Not more than mere indication of previous year situated implies the functioning of such power at a particular place with some degree of permanence && that the conception of residence in the case of a fictitious " person" such 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'.

5 POEM as per Section 6 of Income Tax Actamended As Per Se tio 6 of the I o e Ta A t 96 As A e ded - (3) A company is said to be resident in India in any previous year, if (i) it is an Indian company; or (ii) its pla e of effective a age e t, i that year, is in India. Explanation. For the purposes of this clause "place of effective management" means (1) a pla e where (2) key management and commercial de isio s that are (3) e essary (4) for the conduct of the usi ess of (5) a entity as a whole, are (6) i su sta e made.

6 PLACE OF EFFECTIVE MANAGEMENToecd commentary OECD model commentary provides- The place of effective management is the place where key management and commercial decisions that are necessary for the o du t of the e tit s usi ess as a hole are i su sta e ade. 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.

7 KLAUS VOGEL A Place of Management is a place where the business of the whole or part of the enterprises is conducted. If the business of an enterprise is conducted from various places, for example, if the enterprise has one management for its commercial inters and a separate one for its technical interests, there may be ore tha o e pla e of a age e t

8 PLACE OF EFFECTIVE MANAGEMENT High court in South Africa- OCIANIC - relying on SMALL WOOD case- held 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 are in substance made; The place of effective management will ordinarily be the place where the most senior group of persons (e.g. a board of directors) makes its decision, where the actions to be taken by the entity as a whole are determined; No definite rule can be given and all relevant facts and circumstances must be considered to determine the place of effective management of an entity; and Although there may be more than one place of management, there may only be one place of effective management at any one time.

9 Guidi g Pri ciples - CBDT Notification 23 rd Dec POEM is a fact dependent exercise. is a o ept of su sta e o er for. Deter i atio of POEM depe ds o hether or ot the o pa is e gaged i Active Business Outside I dia ABOI POEM considered outside India in the case of ABOI if majority of meetings of Board of Directors (BOD) are held outside Inida Where BOD assigned their powers of management and such powers are exercised by either a holding company or any other person resident in India, then the POEM will be considered in India For determining ABOI status data of current year and previous two years will be considered if existing for shorter period, such period will be considered. 4.A company has an ABOI- Its passi e i o e is not more than 50% of its total income and Less than 50% of its total assets are situated in India and Less than 50% of total number of employees are situated in India or are resident in India and The payroll expenses incurred on such employees is less than 50% of its total payroll expenditure 5. passi e i o e shall e aggregate of- Income from transactions where both purchase and sale of goods is from / to its associated enterprises and Income from royalty, dividend, capital gains, interest or rental income

10 Guidi g Pri ciples - CBDT Notification 23 rd Dec Companies not having ABOI- two stages of determination 1 st stage- identify persons who actually make the key management and commercial de isio s for the o du t of the o pa s usi ess as a hole 2 nd stage- determination of place where these decisions are in fact being made 7. Where a Board regularly meets and makes decisions may be the POEM provided the Board retains and exercises its authority to govern the company and in substance takes key management and commercial decisons 8. Where the Board delegates authority ( de jure or de facto) to Head Office or some executive committee or key members of senior management, the location of such Head Office or executive committee or senior management could be regarded POEM 9. In case of decentralized HO, such HO Senior most management are located 10. Where there is no clear POEM, the place where main and substantial activity of the company is located or where accounting records of the company are kept are relevant factors 11. Ownership of the company, place of residence of the directors, place of local and middle management or existence of support functions ARE IRRELAVANT.

11 Guidi g Pri ciples - CBDT Notification 23 rd Dec2015- Shortcomings Ambiguity in determining location of POEM Extra legislative concepts such as ABOI Apparent conflict in substantive provisions of DOUBLE TAXATION AVOIDANCE AGREEMENT Transfer Pricing implications

12 Conflicts with DOUBLE TAXATION AVOIDANCE AGREEMENTS- Definition of resident OECD MODEL TREATY: Article 4 RESIDENT 1. For the purposes of this Convention, the term "resident of a Contracting State" means any person who, under the laws of that State, is liable to tax therein by reason of his domicile, residence, place of management or any other criterion of a similar nature, and also includes that State and any political subdivision or local authority thereof. This term, however, does not include any person who is liable to tax in that State in respect only of income from sources in that State or capital situated therein.

13 Conflicts with DOUBLE TAXATION AVOIDANCE AGREEMENTS- Definition of resident INDIA USA DTAA ARTICLE Reside e. For the purposes of this Co e tio, the reside t of a Co tra ti g State means any person who, under the laws of that State, is liable to tax therein by reason of his domicile, residence, citizenship, place of management, place of incorporation, or any other criterion of a similar nature, provided, however, that (a) this term does not include any person who is liable to tax in that State in respect only of income from sources in that State; and (b) in the case of income derived or paid by a partnership, estate, or trust, this term applies only to the extent that the income derived by such partnership, estate, or trust is subject to tax in that State as the income of a resident, either in its hands or in the hands of its partners or beneficiaries.

14 Conflicts with DOUBLE TAXATION AVOIDANCE AGREEMENTS- Definition of resident INDIA MAURITIUS DTAA ARTICLE 4 RESIDENTS 1. For the purposes of this Convention, the term "resident of a Contracting State" means any person who, under the laws of that State, is liable to taxation therein by reason of his domicile, residence, place of management or any other criterion of similar nature. The terms "resident of India" and "resident of Mauritius" shall be construed accordingly.

15 Conflicts with DOUBLE TAXATION AVOIDANCE AGREEMENTS- Place of management vs POEM Are they one and the same? By determining the residence status of a company be reference to POEM is the law lost its effectiveness vis a vis definition in DTAA? Does POEM subsume POM in itself? Does POEM ea a other riteria of si ilar ature How this interpretation would work with DTAAs which provide POM i the ai part of Reside t defi itio a d POEM u der the tie- reaker rule UK case, Smallwood v Revenue and Customs Commissioners- the two concepts are completely different-

16 Conflicts with DOUBLE TAXATION AVOIDANCE AGREEMENTS- DTAAs DTAAs which do not have concept of POEM- DTAAs with Afghanistan, Canada, China, Greece, Japan, USA INDIA- US TREATY- TIE BREAKER CLAUSE: 4(4). Where, by reason of the provisions of paragraph 1, a person other than an individual or a company is a resident of both Contracting States, the competent authorities of the Contracting States shall settle the question by mutual agreement and determine the mode of application of the Convention to such person. INDIA- GREECE: 2(f) a company shall be regarded as resident in Greece if it is incorporated in Greece or its business is wholly managed and controlled in Greece; a company shall be regarded as resident in India if it is incorporated in India or its business is wholly managed and controlled in India ;

17 Conflicts with DOUBLE TAXATION AVOIDANCE AGREEMENTS- Definition of resident DTAAs where any determination under tie breaker clause shall be by mutual agreement by authorities of two states based on POEM- Finland, Indonesia, United Mexican States- India Finland DTAA- 4(3). Where by reason of the provisions of paragraph 1 of this Article, a person other than an individual is a resident of both Contracting States, the competent authorities of the Contracting States shall determine by mutual agreement the State of which the person shall be deemed to be a resident for the purposes of this Agreement having regard to the person's place of incorporation, the place of effective management and any other relevant factors.

18 Conflicts with DOUBLE TAXATION AVOIDANCE AGREEMENTS- DTAAs that provide POEM in TIE BREAKER RULE with a tag condition of competent authorities- DTAAs with Austria, Newzeland, South Africa, Sweden, Philippines, Luxembourg- DTAA between INDIA LUXEMBOURG- 4(3). 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. If the State in which its place of effective management is situated cannot be determined, then the competent authorities of the Contracting States shall endeavour to settle the question by mutual agreement.

19 Conflicts with DOUBLE TAXATION AVOIDANCE AGREEMENTS- DTAAs that provide POEM in Tie Breaker rule with no tag condition- Australia, Belgium, Brazil, Bangladesh, Cyprus, France, Germany, Italy, Kenya, Mauritius, Netherland, Poland, Russia, Singapore, Ukraine, Saudi Arabia INDIA SINGAPORE DTAA ARTICLE 4(3)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 of the State in which its place of effective management is situated.

20 Conflicts with DOUBLE TAXATION AVOIDANCE AGREEMENTS- DTAAs providing for some common criteria based on POEM in respect of income from shipping and air-transport- BRAZIL, CYPRUS, UAE, ITALY, GERMANY, FRANCE, SWISS, NETHERLAND, MAURITIUS, SRI LANKA, KUWAIT India Brazil DTAA ARTICLE 8 SHIPPING AND AIR TRANSPORT 1. Profits from the operation of ships or aircraft in international traffic shall be taxable only in the Contracting State in which the place of effective management of the enterprise is situated. 2. If the place of effective management of a shipping enterprise is aboard a ship, then it shall be deemed to be situated in the Contracting State in which the home harbour of the ship is situated, or, if there is no such home harbour, in the Contracting State of which the operator of the ship is a resident.

21 Adverse Consequences of POEM Impact on Indian MNCs The power will have to be entirely delegated to an independent BOD abroad. The BOD abroad should only be associated with the foreign entity. This will increase the compliance cost for Indian companies. If it is determined that the key decisions of the foreign subsidiary are taken in India or if the key management personal like a director on the board resides in India then the foreign subsidiary will need to pay back tax to the Indian authorities. Subsidiaries which do not have any operations of their own will be especially impacted by the proposed amendment to the law.

22 Impact on Foreign MNCs Foreign companies with legitimate business outside India would end up being treated as an Indian Resident and may be subject to taxes in India on the global income if any of the directors participates in decision making process from India only in that single meeting. Other Areas of Litigation in determining Poem Mobile places of effective management Place of effective management in multi-jurisdiction Videoconferencing

23 POEM Safeguards to be adopted Independent BOD for the foreign entity The BOD should be an independent body and autonomous body. The decisions of the BOD should be well informed and duly deliberated. The deliberations should be well documented and recorded in the minutes of the meeting. The BOD meetings should be held only in the Foreign country. All strategic and major decisions should be taken in the board meetings held outside India. Preferably all directors should attend the meetings outside India.

24 POEM Safeguards to be adopted In case the meeting is considered through video conference or teleconferencing, the host ou tr s orporate la is rele a t for deter i i g pla e of eeti g i such cases. There should be absolute clarity on the business role and activities of the foreign subsidiaries and the same should be evidenced in the corporate documents. The corporate documents should provide all powers to the subsidiary the run the business activities on its own. All corporate documents such as minutes, registers, secretarial records etc. should be maintained in the registered office of the foreign subsidiary.

25 POEM Safeguards to be adopted Pare t o pa s i flue e o the su sidiar should o l e restri ted to providing visionary direction. Parent company should not look to drive or steer the key activities of the subsidiary company. Parent company must exercise its powers in the capacity of majority shareholder to protect its interest but should not take control and run the subsidiary. The AGM should preferably be held in the country of incorporation of the subsidiary. The decision of appointing the directors in the subsidiary company should not be taken in India however, recommendations can be made by the BOD of the parent company.

26 POEM Safeguards to be adopted Executive Directors, COOs, CEOs, CFOs and other key management personnel of the subsidiary should not be in India. The information about the international subsidiaries posted on the websites of the Indian company should be regularly reviewed. The powers of the Executive Directors and officers about taking any strategic decisions should be subject to approval BOD approval and should be well documented. All communications regarding management decisions and functions should be appropriately documented.

27 Equalization Levy

28 Equalization levy- finance act 2016 Digitized transactions taxability- BEPS provision objective is to impose tax on the consideration received by the non-resident- the same escapes the source country taxation, because payee does not have a permanent establishment in India operating on an India based server not owned by the Non Resident Section 165 deals with the charge of the equalization on consideration for providing specified services. The other conditions are: a) The service provider has to be non- resident and b) It should receive consideration for the services from i) a person resident in India who is carrying on business or profession or ii) a non resident having a permanent establishment (PE) in India spe ified perso s or assessee

29 Equalization Levy Section 166 provides for the collection and recovery of the equalization levy- designates the specified persons as assessee and cast an obligation on them to deduct the amount of equalization levy from the amount of consideration paid or payable to the non resident towards the provision of the specified services. equalization levy will not be charged: when the non resident providing the specified services has a permanent establishment in India and such services are effectively connected to the permanent establishment

30 Specified services traditional rules of a brick and mortar economy posed challenges to levy source-based taxation EQL is currently applicable on online advertisement, provision of digital advertising space and other facilities/services for the purpose of online advertisement. Committee has already identified most of the other digital services- which include online marketing and advertisements; cloud computing; website designing, hosting and maintenance; provision of digital space; digital platforms; advertising on radio/television; services relating to online sale of goods and services, online use or download of software and applications.

31 deficiencies POEM as a concept is not attempted No charge of tax has been found created on the Non Resident No similar collection on Indian Residents hence can be questioned under Non discrimination clause of DTAA Whether any new tax be introduced in the absence of modification to Article 7 on Business Profits and Permanent Establishment in DTAA(s) Whether other i o e lause i DTAA s e applied? Glo al shift possi le to ou tries here other i o e is ot ta a le in India on account of DTAA(s)

32 Thank you

CONCEPT OF RESIDENCE. Seminar on Basics of International Taxation. Date : 5 th September 2014

CONCEPT OF RESIDENCE. Seminar on Basics of International Taxation. Date : 5 th September 2014 CONCEPT OF RESIDENCE Seminar on Basics of International Taxation SIRC of ICAI Date : 5 th September 2014 1 Particulars Section Resident RNOR Non- Resident Income received in India Sect 5 IncomeAccruing