At last, Govt targets shell firms with new set of stringent tax guidelines

Targeting shell companies, the government on Tuesday issued new tax rules requiring foreign firms to pay taxes in India if the effective control of business, management decisions and majority of board meetings take place within the country.

The long awaited Place of Effective Management (POEM) rules, to be effective from the current fiscal (April 2016), will not apply to companies having a turnover or gross receipts of Rs 50 crore or less in a financial year. 

The rules require foreign companies in India and Indian firms with overseas subsidiaries to pay local taxes based on where the business if effectively controlled. "The intent is 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," CBDT said. 

The rules require company's residency to be determined by persons exercising effective control over decision making and the place where such control is exercised from, according to the guidelines issued by CBDT on Tuesday.

This would help target shell companies, or holding companies, incorporated overseas to evade taxes by showing their residency as a tax haven even though the management and effective decision making takes place in India. "The place where these management decisions are taken would be more important than the place where such decisions are implemented. For the purpose of determination of POEM it is the substance which would be conclusive rather than the form," the CBDT said. 

As per the Guiding Principles, "place of effective management" is defined as 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.

The guidelines provide for an Active Business Outside India (ABOI) test, so as not to cover companies outside India which are engaged in active business. "The intent is not to target Indian multi-nationals which are engaged in business activity outside India," CBDT said. EY Tax Partner Rajendra Nayak said the guidelines strikes the right balance between providing certainty to taxpayers as well as ensuring that offshore companies with no substance or activities, which are controlled from India, are subject to Indian tax jurisdiction. 

The guidelines attempt to differentiate between shareholder control, management control and routine decisions, said KPMG in India National Head of Tax Girish Vanvari.

The place of effective management in case of a company engaged in active business outside India shall be presumed to be so if the majority meetings of its board of directors are held outside India.

"However, if on the basis of facts and circumstances, it is established that the board of directors of the company are standing aside and not exercising their powers of management and such powers are being exercised by either the holding company or any other person(s) resident in India, then the place of effective management shall be considered to be in India," the guidelines said.

For the purpose of determining whether the company is engaged in active business outside India, the average of the data of the previous year and two years prior to that shall be taken into account.

In cases of companies which do not have active business outside India, there will be a two-stage process for determining the place of effective management to assess their tax liability.

The first stage would be identification of the persons who make the key management and commercial decision for the company and secondly the determination of the place where these decisions are made.