Understanding the PoEM effect

The PoEM tests involve assessing evidence on where the effective management is located

The test of Place of Effective Management (PoEM) of an offshore company came into effect on April 1 last year. However, the provisions of the guiding principles came in the last quarter of 2016-17. This makes it challenging for companies whose management, operational structures and functioning are not aligned with the new rules. “The greatest impact shall be upon entities set up outside India, shell or otherwise, by Indian residents,” says Pallav Pradyumn Narang of chartered accountancy firm Arkay & Arkay. 

Tax experts say business groups that have to restructure their operations might face challenges in passing the PoEM tests if the tax department is of the view that the place of effective management of an overseas entity was situated predominantly in India for a major part of the year. The PoEM tests, being substance-driven, involve assessing evidence on where the effective management is located. These include checking the responsibility matrix in an organisation, studying key managerial and commercial decisions, trailing the documents and information flow between divisions and departments and the key managerial persons, among other things. 

“Groups that have not been preparing such robust documentation will have to catch up soon,” says Jiger Saiya, partner, direct tax, BDO India. The businesses that have been impacted will have to either move their decision makers and management outside India, or be prepared to be classified as tax residents of India and pay taxes on global incomes in India, tax experts say. 

According to Shefali Goradia, partner, BMR & Associates, PoEM determination is case-specific and depends on a holistic evaluation of factors rather than on satisfying defined tenets. “The thrust is to demonstrate the substance of effective management, in both documentation and actual conduct,” says Goradia.

The final guidelines require a foreign company crosses an active business threshold with predominant employees and assets situated outside India. A company is regarded as having an active business if less than 50 per cent of its income is derived from passive sources (namely, interest, royalties, rents, dividends or capital gains) or from related-party trading activities. In case a foreign company fails the active business threshold, a two-step determination follows. The first step would be to identify who comprise the senior management, which maked the key decisions to control the company. The second involves determining the place in which they take the decisions.

Tax experts say in the past few years many Indian businesses of various sizes have ventured outside the country and set up foreign subsidiaries for business or tax purposes. These subsidiaries are likely to be directly impacted by the PoEM guidelines. “The maximum impact of PoEM will be on investment-holding companies or intellectual property-holding (IP-holding) companies owned by Indian residents. Any income parked in these companies will now be taxable in India,” says Goradia. Setting up of a shell or intermediary company in a low-tax jurisdiction that retains a slice of the foreign profits may no longer be an option, says Rohinton Sidhwa, partner, Deloitte Haskins & Sells. These companies will be taxed in India. 

Despite safeguards, the guidelines are still subjective in many places and leave room for interpretation by the assessing officer, say tax experts. “The fact that these guidelines are being introduced only for the sake of guidance, and not as enshrined principles gives rise to the concern that an overzealous officer may choose to sidestep them when needed,” points out Narang. Further, the secondary process of determining the place of effective management is going to be a challenge in a cloud-centric world in which substantial activity and accounting records are located online.