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Tax Residency for Indian-Owned Companies Incorporated Outside India

How Indians can still set up an offshore company

About the Guiding Principles for determination of Place of Effective Management (POEM) of companies incorporated outside India

India has enjoyed an economic steady growth during last decade. Being a market with great opportunities that both international and local companies are taking advantage of. The favorable economic environment together with the Government’s liberal policies, have resulted in an increasing internationalization. Indians are investing in companies incorporated outside India or establishing associated entities and branches to access foreign markets. The most popular destinations have been the United States and especially Singapore.

companies incorporated outside india

For Indians wishing to expand their business abroad, it may be essential to incorporate a company outside India for several reasons. Access to finance and resources, the possibility of acquiring assets abroad and the diversification of investments, the access to international payment processors that are not available in India or simply because it is more suitable for the development of a business activity in operational terms. As we have said in countless occasions, establishing an offshore company opens a range of infinite possibilities to optimize business management and development. But, there may be legal issues if are not properly met the corresponding tax obligations.

Of these tax obligations is what I want to talk about. Companies incorporated outside India may be tax residents depending on its Place of Effective Management (POEM). A topic that generated much debate, controversy and confusion in recent times. Following the issuance of a circular by the Central Board of Direct Taxes of India (CBDT) on January 24, 2017 determining the Guiding Principles for determination of Place of Effective Management (POEM) of a Company, we will shed some light on this issue. What are the requirements for Indians own an offshore company and that legally it is not considered as a Tax Resident and its revenues are not subject to the Indian Corporation Tax. Keep reading.

 

What companies are Tax Resident in India?

The Income Tax Act of 1961 determined that it was a corporation tax resident, any (i) Indian company and (ii) any foreign company which, during that year, control and management of its affairs was located entirely in India.

The law was amended two years ago, via the Finance Act, 2015, to avoid, textual words from the circular, “tax avoidance opportunities for companies to artificially escape the residential status under these provisions by shifting insignificant or isolated events related with control and management outside India”. Modifying the criteria for determining the tax residence of an Indian-owned foreign company to the Place of Effective Management. The amendment of the Finance Act, 2015, states that any business is a tax resident in India if:

(i) it is an Indian company; or

(ii) its Place of Effective Management in that year is in India.

Although the Finance Act, 2015 entered into force on 1st April 2016, The Finance Act of 2016 has modified the validity of said amendment, which will come into force from April 1, 2017 and will apply from assessment year 2017-18 onwards.

The main difference between the 1961 Act and the recent amendment is that under the old law a foreign company was not tax-resident if the meetings of its board of directors were held outside Indian territory. Even with full Indian ownership and control and most of its management team Indian national. Now, with the amendment, tax residence is established by determining the place where management and commercial decision-making is carried out, bringing into play several factors, which we will discuss below.

It is important to note that according to the circular by the Central Board of Direct Taxes of India (CBDT) on January 24, 2017, Active Business Outside India (explained below) and Indian-owned companies incorporated outside India whose turnover does not exceed Rs 50 crore (≈ USD 7M) are excluded from the scope of the POEM guidelines. Therefore, they may not be considered as residents for tax purposes.

 

What is the POEM?

The amendment of the Finance Act, 2015, defines the Place of Effective Management (POEM) as “the 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”. This test, included in the OECD tax treaties models, makes possible to determine the tax residence of a company incorporated in a foreign jurisdiction. Serving as a tie-breaking rule to avoid double taxation. The POEM shall be determined on a case-by-case basis and year after year.

 

Who is subject to the POEM guidelines?

All companies incorporated outside India wholly or partly owned by natural or legal persons resident in India. Except those considered Active Business Outside India (ABOI). And I as mentioned above, POEM guidelines shall not apply to those companies whose turnover does not exceed Rs 50 crore (INR 500M ≈ USD 7M) in the previous tax year.

It will be considered as an Active Business Outside India (ABOI) if on the previous year or two previous years:

  • its average of passive income (income from the purchase and / or sale of assets from its associated entities and dividends, capital gains, interest or rental income) do not exceed 50% of total revenues.
  • less than 50% of their average total assets are located in India
  • less than 50% of total number of employees (including outsourcing) are situated in India or are resident in India
  • gross payroll and related expenses incurred on Indian employees account for less than 50% of the total.

ABOI companies will not be subject to the POEM guidelines, and therefore not taxed as resident.

 

How is the POEM of a company determined?

The CBDT determines that the Assessing Officer (AO) will evaluate the POEM of each of the separate subsidiaries of a parent company. Based on the place of meeting where the management of the subsidiary or associate companies incorporated outside India and its direct support staff, make key strategic and commercial decisions. The Assessment Officer (AO) before determining that a foreign company’s POEM is in India will require the approval of the Income Tax Commission, which will give the company the opportunity to file claims before issuing a verdict.

If the majority of meetings of the Board of Directors of the Company are held outside India, the POEM shall be presumed to be abroad. Authorities reserve the right to establish that the POEM is in India if they determine that the actual powers are exercised by the holding company or any person resident in India rather than by the Board of Directors. Such management powers do not include those which the Board of Directors does not exercise for compliance with the general principles and objectives of the overall policy of the Parent Entity. Such as payroll functions, accounting, human resource functions, IT infrastructure and network platforms, supply chain functions or routine banking operational procedures.

POEM Key factors

  • The Board of Directors’ (BOD) meeting and decision-making venue will be the POEM if the BOD retains and exercises its authority to govern the company and makes the key management and commercial decisions necessary for the conduct of the company’s business in its set.
  • The place where these management decisions are made is more important than the place where these decisions are implemented.
  • If the BOD delegates de facto or de jure the decision making and only ratifies those taken by a committee or the management of the parent company or any other person (shareholder, promoter, adviser … etc.). It will be determined as POEM the place where the committee or the management of the parent company or any other person makes these decisions.
  • The “Head Office” of the company could be an important factor for the determination of the POEM. Provided that the top management and its support staff are based in a single meeting place, or meet predominantly or when returning from the next trip to other places, or meet for strategic planning, in the same place.
    In the event that the BOD operates from different locations, but on a more or less permanent basis and members can participate via video conference or telephone. The head office will be where the highest level of management met. If decentralization does not allow the location of the head office to be assessed with a reasonable certainty, it will not matter in determining the POEM.
  • Consideration should be given to whether the use of modern technology means that decision-making is not carried out at board meetings. In this case the place of residence of the directors or decision-makers may become relevant.
  • The decisions of the shareholders exercising their rights over the company, such as the sale / dissolution / liquidation / cancellation … etc. are not relevant for evaluating the POEM. Unless such decisions become a usurpation of the actual BOD authority.
  • The operational decisions made by the middle management will not be considered.
  • If the POEM of an intermediate holding company is in India, it does not influence the determination of the POEM of its subsidiaries, each one will be examined separately.
  • In the event that a clear identification of the place of strategic and commercial decisions cannot be made. The POEM will be established at the place where the main and substantial economic activity is carried out or where the accounting records of the company are kept.

 

Conclusion

Despite the tightening of the conditions for companies incorporated outside India not to be considered as a tax resident. Indians may still set offshore companies, as long as the criterion of place of effective management (POEM) outside India is met, or is considered Active Business Outside India (ABOI) or company’s turnover is less than Rs 50 crore (≈USD 7M).

Flag Theory, as an international corporate structure consulting, provides effective solutions to incorporate offshore companies. Contact us, have a talk, explain your case and through an in-depth and detailed analysis of your situation, we will find the finest offshore solution for your business.
You can also compare jurisdictions to incorporate your offshore company at incorporations.io, join our Information center FT Intel Society or get started on your business internationalization.


This article should not be construed as legal or tax advice. Flag Theory has access to qualified attorneys and accountants in India who can give you the proper advice for your particular circumstances.  Contact us for further information.

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