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Will PoEM Affect the Singapore Subsidiary Companies Formed by the Indians?

Last modified: June 6, 2018
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The corporate income tax rates in Singapore range from 0% – 17% which is lower than the corporate tax range of 0% – 30% in India. In addition, there are no taxes on the dividends and inheritance. On the other hand, Indian tax kicks in when the foreign income derived as the dividends are transmitted to India.

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Loophole: Tax Residency for Companies in India

It is easy to see that incorporating a company in Singapore is beneficial to entrepreneurs. Some of the Indian entrepreneurs and the businesses did more than that for avoiding taxes. By earlier definition, the foreign companies and foreign subsidiaries of Indian companies were considered as tax residents of India if their control and management during the assessment year were wholly in India.

These entities took advantage of a loophole in the requirements of tax residency for companies in India. They established shell corporations. They primarily managed and controlled business activities of these entities from India.

By holding a token number general and board meetings outside India, these entities successfully overcame tax residency requirements and saved huge amounts in taxes. The response from the Indian Tax authorities is harsh, and may have far-reaching effects.

First, they updated the definition of the tax residency for the companies. The new definition of tax residency of companies, as per the Indian budget 2015, covers so much ground that, unless clarified further, it is going to affect the working of the genuine Indian as well as foreign businesses operating in India.

Note: The primary aim for the tax residency upgrade was to reign in the Indian corporate that registered shell companies in the low tax jurisdiction in order to avoid Indian corporate tax.

Place of Effective Management (PoEM)

The tax authorities did it by bringing in the Place of Effective Management (PoEM) concept within the scope of the definition. According to Finance Bill 2015, a company will be tax resident of India, if it is:

  • An Indian Company or,
  • The Place of Effective Management (PoEM) is in India, at any time during the year.

The amended definition of tax residency of companies is not easy to digest and it is going to affect many business entities that were not a party to the tax avoidance activities.

Note: The PoEM is a reference to a place from where decisions facilitating smooth conduct of the business are taken.

Now the foreign subsidiaries of Indian companies and foreign companies will have to show that they held their general and board meetings and took their decisions outside India, to unburden themselves of any potential Indian tax liabilities.

Is Implementing PoEM a Step Forward to Curb Tax Avoidance?

Does it bring simplicity and clarity to the Indian tax regime?

Unfortunately, the answer is no. However, PoEM comes in the ambit of the Avoidance of Double Taxation Agreements (DTAs) and is applied where an organization is a resident of both the treaty countries it needs to be refined. It needs to be crystal-clear, which will help the establishment of a simple tax regime.

The inherent ambiguity in the PoEM leads to several international interpretations. It is going to make life difficult for several businesses. The global businesses have complex structures and it is not always possible to isolate management’s activities. The most affected business entities are as follows.

  • Foreign companies that have branches or subsidiaries in India
  • Foreign subsidiaries incorporated by Indian companies
  • Special Purpose business entities established by Indian companies
  • Foreign companies that have established regional headquarters in India

The Government of India and Singapore have signed a DTAA to streamline the trade. The PoEM test is a part of it. However, the addition of the phrase ‘any time of the year’ is going to confuse many businesses when it comes to determining their residency and their tax liability.

The following are a few precautions that these entities must follow.

  • It is necessary for these companies to have separate Board of Directors.
  • They must maintain accurate documentation regarding decisions taken during the meetings
  • Wherever necessary, the board, especially in the case of MNCs, should make important decisions out of India.
  • The foreign subsidiaries of Indian companies need to maintain a registered office out of India housing company’s books of accounts and registers. If it is a Singapore company, then it is prudent to have a Subsidiary Company, which can act independently and as a separate legal entity than its parent company.

The decision taken by the Indian tax authorities have sent shockwaves in the business community that have an interest in India. It is waiting for further clarification from the authorities.

Note: Singapore subsidiaries of Indian companies may find some respite due to the provisions in the DTAA between Singapore and India.

The PoEM changes are going to increase the cost of compliance for these entities and some of them may have to face litigations. The whole episode has become an antithesis of Simple Tax Regime. Now the question that is worth million dollars is, “Will it affect the foreign investment in India?”

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