Tax Residency for Indian-Owned Companies Incorporated Outside India
How Indian citizens can set up an offshore company
A summary of the Guiding Principles for determination of Place of Effective Management (POEM) of companies incorporated outside India
India has enjoyed a period of steady economic growth over the last decade. The enormous Indian market provides a wide range of great opportunities for both international and local companies. Its favorable economic environment together with its government’s liberal economic policies, has resulted in an increasing internationalization of Indian companies. 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.
For Indians wishing to expand their business abroad, it may be essential to incorporate a company outside India for several reasons. Among these are access to finance and resources, the possibility of acquiring assets abroad and diversifying investments, gaining 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 outlined on countless occasions, establishing an offshore company opens a range of infinite possibilities to optimize business management and development. However, there may be legal issues if the corresponding tax obligations are not appropriately met.
These tax obligations are what will be discussed in this article. Companies incorporated outside India may be tax residents depending on their Place of Effective Management (POEM). This is a topic that has 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, it’s important to shed some light on the issue.
What are the requirements for Indians to own an offshore company? And how can such a company be legally not considered as a Tax Resident, and its revenues not subject to the Indian Corporation Tax? Keep reading to find out.
What companies are Tax Resident in India?
The Income Tax Act of 1961 determined that a corporate tax resident was any (i) Indian company and (ii) any foreign company which, during that year, control and management of its affairs were located entirely in India.
The law was amended in 2015, via the Finance Act, 2015, to avoid, in quoting 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”. The Act modified 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 modified the validity of the said amendment, and come into force on April 1, 2017, and began apply for the assessment year of 2017-18 onwards.
The main difference between the 1961 Act and the 2016 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 being Indian nationals. 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 are discussed below.
It is important to note that according to the circular issued by the Central Board of Direct Taxes of India (CBDT) on January 24, 2017, Active Businesses 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 OECD tax treaties models, makes possible the determination of the tax residence of a company incorporated in a foreign jurisdiction, and serves as a tie-breaking rule to avoid double taxation. POEM is determined on a case-by-case basis and year after year.
Who is subject to the POEM guidelines?
In short, all companies incorporated outside India wholly or partly owned by natural or legal persons resident in India, except those considered as an Active Business Outside India (ABOI). And as was mentioned above, POEM guidelines do not apply to companies whose turnover has not exceeded Rs 50 crore (INR 500M ≈ USD 7M) in the previous tax year.
A company 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) does not exceed 50% of total revenues.
- less than 50% of their average total assets are located in India
- less than 50% of the total number of employees (including outsourcing) are situated in India or are resident in India
- their 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 a 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. This will be based on the place of meeting of 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. These include 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 decision-making de facto or de jure, and only ratifies those taken by a committee or the management of the parent company or any other person (shareholder, promoter, adviser… etc.), the place where the committee or the management of the parent company or any other person makes these decisions will be determined as the POEM.
- The “Head Office” of the company could be an important factor in 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 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 relating to sale/dissolution/liquidation/cancellation… etc., are not relevant for evaluating the POEM, unless such decisions become a usurpation of the actual BOD’s authority.
- The operational decisions made by the middle management will not be considered.
- If the POEM of an intermediate holding company is in India, this will 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 in the place where the main and substantial economic activity is carried out, or where the accounting records of the company are kept.
Despite the tightening of the conditions for companies incorporated outside India to not be considered as tax resident, Indians may still establish offshore companies, as long as the criteria of place of effective management (POEM) outside India is met, the company in question is considered an Active Business Outside India (ABOI), or if the company’s turnover is less than Rs 50 crore (≈USD 7M).
Flag Theory, as an international corporate structure consultant, provides effective solutions for incorporating offshore companies. Contact us to have a conversation and explain your case; through an in-depth and detailed analysis of your situation, we will find the best offshore solution for your business.
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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.