A sad POEM for shell companies based abroad

Global entities liable to pay tax on yearly income if their place of effective management is India even for a single day

Shell companies based abroad would have to pay taxes on their global income for a year if their place of effective management (POEM) is India even for a day.

According to the Union Budget, presented Saturday, shell companies would be considered tax resident of India if their POEM is the country for one day in a financial year.

“The explanation for POEM is riddled with and can lead to fresh litigation in India,” said a lawyer with BMR legal. “The key companies likely to be impacted are the Indian groups that have overseas subsidiaries that lack substance.”

Many Indian companies have subsidiaries in tax havens abroad which, in turn, do businesses in other countries. With this amendment — proposed to be made effective from the next financial year — all these companies will be bought under the local tax jurisdiction.

The POEM, a Khaitan & Co lawyer said, could lead to unintended consequences and result in a situation whereby foreign companies with legitimate business operations outside India would end up being treated as Indian tax residents and consequently be subjected to tax in India on their global income. This could occur if, for example, a board member of the foreign company is present in India and participates in the decision making process from India only in that single board meeting.  

The requirement of the POEM being in India at any time during the fiscal year defeats the very essence of the concept, since it is supposed to be determined after an evaluation of the affairs of the company throughout the year. This anomalous situation will result in double taxation of income which may not be mitigated by tax treaties as both countries — India and the country of incorporation — will seek to tax the global income of the foreign company.

“This would lead to litigation and will defeat the intention of the finance minister and the government to remove uncertainty and adversarial tax environment.” the lawyer said.   

Considering that POEM is a well-accepted concept under the Organisation for Economic Cooperation and Development (OECD), it will be interesting to see if the prescribed guidelines will be in line with the principles enunciated by OECD in its commentary.  Till now, the shell companies outside India, easily bypass the condition of “controlled and managed” as even holding one board meeting outside India puts it outside the purview of being resident in India.  

“The introduction of POEM test for residential status determination is a welcome move and would curtail the practice of opening of shell companies by Indian companies outside India and also would align the provisions of the Act with the Double Taxation Avoidance Agreements (DTAAs) entered into by India with other countries,” said tax expert Suresh Surana.