POEM - a poetry without pattern, rhythm and rhyme
Tax Partner, EY India
The tax policies of the ruling NDA Government have largely found support from India Inc. The Government has always stated that it is committed to create a non-adversarial and predictable tax regime, without an element of nasty surprises later viz., retrospective amendments to the tax laws. While the Government has lived up to this promise and there have not been instances of retroactive tax provisions, the POEM provisions unfortunately stand out as an exception.
The Government in its Union Budget 2015, had modified the condition for determination of residential status of a foreign company with the introduction of the concept of Place of Effective Management (‘POEM’) with effect from FY 2015-16. The budgetary documents explaining the rationale of introducing the POEM provisions specifically mentioned that “in due course, a set of guiding principles to be followed in determination of POEM would be issued for the benefit of the taxpayers as well as, tax administration”. However, it was only after a span of almost 10 months, i.e., in December 2015 that a draft set of guidelines were released for determination of POEM, for comments from various stakeholders.
The POEM provisions read with the draft guidelines opened a Pandora’s box, had a host of ambiguities which had the potential of spawning significant litigation. Taking cognizance of this, the implementation of POEM was deferred by one year i.e., to 1 April 2016 so as to provide clarity on various issues. Thereafter, in January 2017, just a week before Union Budget 2017, the final guiding principles for determination of POEM of a foreign company (‘Guidelines’) were released to determine tax residency of foreign companies from FY 2016-17 – accordingly, the Guidelines would have retrospective applicability from 1 April 2016 onwards.
Although, the Guidelines provide the much needed clarity on various aspects for determination of POEM, since the same had only been issued towards the end of FY 2016-17, sufficient time should have been provided to all stakeholders to familiarize themselves on the nuances and potential implications of POEM.
The Government is yet to draft legislation (and then get it approved by both houses of Parliament) on various aspects pertaining to implementation of the POEM provisions i.e., computation of total income, set off or carry forward and set off of losses, treatment of unabsorbed depreciation, collection and recovery of taxes, etc., (Section 115JH). Accordingly, it is necessary that the date of applicability of POEM should be aligned to the date of applicability of this pending legislation.
It is pertinent to note that the Government has introduced ‘General Anti-Avoidance Rules’ (‘GAAR’) as a separate set of rules to target tax avoidance transactions. One of the consequences of invocation and application of GAAR to a taxpayer is that the residential status of the taxpayer may be changed. Since both POEM and GAAR are in the nature of anti-avoidance legislations (encompassing residential status of a taxpayer), both these provisions should be aligned and implemented together. Accordingly, since GAAR is proposed to be implemented from 1 April 2017, the POEM provisions should also be made applicable from the said date.
Another aspect which requires consideration by the Government is that the final Guidelines are still broad and ambiguous in certain areas (e.g., lack of clarity on classification of income for investment holding companies, no guidance on the weightage to be given to various factors for determination of POEM, etc.) The Government should consider these outstanding points and to ensure that undue hardship to taxpayers/ investors is avoided, POEM should be made applicable only after these aspects are appropriately clarified.
The Government should also take into consideration that the OECD’s BEPS Action Plan 3 (which is targeted towards avoidance of tax by creating shell companies outside the country of residence) has proposed that passive income earned by an overseas subsidiary company should be taxable in the parent company’s country of residency. Considering this and the fact that India is an active member of the BEPS project and is expected to implement the various BEPS recommendations, the Government should examine the overlap / interplay between Action Plan 3 and the POEM provision to avoid unnecessary complications.
It is evident that the uncertainty given the retrospective nature of the POEM provisions outweigh its envisaged benefits. While there is no doubt on the intention of the Government to create a non-adversarial and predictable tax regime, the Government should ensure that tax reforms are undertaken in a manner that investor confidence is not impacted and India continues to be a beacon of economic growth in an otherwise gloomy environment. Accordingly, the Government should seriously consider deferment of POEM provisions pending clarifications on the various issues plaguing this legislation.
(Anand Jain, senior tax professional, EY also contributed to this article)
(Views expressed are personal)