Tax guidelines to target shell companies notified

The Finance Ministry made public the final guidelines on the Place of Effective Management (POEM), underlining the government’s intent to target shell companies created to keep income out of India even when real management is taking place within the country.

The Place of Effective Management is defined in the Income Tax Act to mean “a 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.”

According to the guidelines, a company will be deemed to be engaged in active business outside India if the passive income is not more than 50% of its total income and less than 50% of its total assets are situated in India, less than 50% of the total number of employees are situated in India or are resident in India, and the payroll expenses on such employees is less than 50% of the total payroll expenditure.

These norms emphasise substance over form, said Girish Vanvari, national head of tax for KPMG in India. “It attempts to differentiate between shareholder control, management control and routine decisions. Whilst the guidelines are comprehensive, it subjective on substance and can be challenged for interpretation in many places,” he said.

He also asked how one would comply with guidelines issued ten months after the effective date for POEM — April 1, 2016. “This certainly merits deferment of POEM by a year to April 1, 2017 else this retrospective application could lead to confusion,” Mr Vanvari said.

Following the definition of a company engaged in active business outside India, the guidelines also defined the various components of that definition. ‘Passive income’, for example is “income from the transactions where both the purchase and sale of goods is from/to its associated enterprises and income by way of royalty, dividend, capital gains, interest or rental income”.

This definition, however, will not apply in the case of a banking company or public financial institution.

“This clarifies that the intent is not to target Indian multinationals which are engaged in business activity outside India, but to target shell companies and companies which are created for retaining income outside India although real control and management of affairs is located in India,” Amit Maheshwari, Managing Partner, Ashok Maheshwary & Associates said.

“‘Head Office’ of a company would be the place where the company's senior management and their direct support staff are located or, if they are located at more than one location, the place where they are primarily or predominantly located,” the guidelines added. “A company’s head office is not necessarily the same as the place where the majority of its employees work or where its board typically meets.”

“In the final guidelines, the CBDT has provided adequate safeguards to ensure that the POEM guidelines do not become an oppressive tool in the hands of revenue to harass genuine assesses,” Rakesh Bhargava, Director of Taxmann said. “Now the assessing officer can ascertain the residential status of foreign company on basis of POEM guidelines only after taking two-stage approval. First approval is required before initiating any proceedings and second approval is required before giving any final finding on residential status of foreign company.”

According to the guidelines, the first stage would involve the identification of the person or persons who actually make the key management and commercial decision for the conduct of the company’s business as a whole. The second stage would be the determination of the place where these decisions are in fact being made.

“A passive income exception for interest income of banking and financial institutions has been made alleviating concerns from that industry,” Rohinton Sidhwa, Partner, Deloitte Haskins & Sells said.

“In addition, controls have been placed over a tax assessing officer triggering these rules. He will need approval of a three-member collegium of his senior officers prior to invoking these guidelines.”

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Printable version | Sep 25, 2020 3:59:41 PM |

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