Place of Effective Management – Ensuing Imbroglio
Finance Act 2015 has ushered
in new model for determination of Residential status of Foreign Company,
Company registered outside India. Accordingly the Foreign Company is resident
in India under Income Tax Act, 1961, if its Place of effective Management
(POEM) is In India.
The concept of POEM may be
novel under domestic scenario but same has been ubiquitous in Double Taxation
avoidance agreement (Treaty). The concept of POEM in DTAA is used to act as
tie-breaker rule, where if a company/entity is resident of both contracting
states under domestic legislation of said states then, for Treaty purpose, a company/entity will be a resident of contracting
state, where there is place of effective management. Despite the POEM being prevalent in DTAA, no
guidelines are there either in OECD Model or UN Model to lay down concrete principles
for its determination.
In this critique, endeavor is
made to understand complications for foreign Company in two different scenarios
on account of POEM.
·
Ideal
Scenario – Where Foreign Company (Assessee), Assessing Officer (AO) & Foreign
Country (where Assessee is incorporated) under Treaty concur with a view that
POEM of Assessee is India.
Determination of Foreign Tax
Credit Available in India
1. Article
23B of UN/OECD Model reiterates as under:-
Where a resident of a Contracting State
derives income or owns capital which, in
accordance with the provisions of this Convention, may be taxed in the other
Contracting State, the first-mentioned State shall allow as a deduction
from the tax on the income of that resident, an amount equal to the income-tax
paid in that other State;_____
2. The
Highlighted text merits attention. Resident State will allow credit for taxes
levied in source state to the extent such levy is in accordance with treaty.
For example under DTAA, suppose source state right to levy tax on Interest is
at a rate not exceeding 15% on gross amount of Interest but actual tax paid in
source states comes to be at rate of 17% on gross amount. The resident state
will allow credit to the extent of 15% on Gross amount, since that rate is in
accordance with DTAA and to the extent of 2%, there is juridical double
taxation.
3. When
Assessee is resident in India, then its actual operation outside India will be
considered as Permanent Establishment (PE) under Treaty and there needs to
arrive at the profit attributable to PE as per Article 7 of UN/OECD Model.
Foreign Country has right to tax only on the profit attributable to PE and then
India will give credit for said tax.
4. Point of Contention – Allocation of
Profit between India and PE and consequent availability of foreign tax credit
in India.
5. Distinction
has to be drawn between the place where actual business operations, functions
& risk undertaken and place where key managerial and commercial decisions
for the conduct of the company as a whole are made.
6. As
per principles enunciated in Article 7 of Treaty, allocation of profit between
PE and Head office should be based on actual conduct of business operations.
Article 7 provides no special value to key managerial and commercial decisions
as basis for allocation of profit; rather quantity of operations not quality of
operation seems to be the basis for allocation of profit.
7. Thus
in case of Assessee, foreign country will try to allocate maximum profit to
itself, since all operations are carried in that locality and AO in India may
try to prove contrary. In this process, AO may dispute the allocation of profit
to foreign country and will allow the foreign Tax credit accordingly on reduced
profit attributable to PE in foreign Country.
8. Assessee
has to prove to the satisfaction of both the countries (Foreign Country and
India), the correct profit attributable to them, otherwise there will be double
taxation on the part of assessee, due to availability of less credit of taxes
in India, then paid in Foreign Country.
·
Adverse
Scenario – Where Foreign Company (Assessee), Assessing Officer (AO) concur with
a view that POEM of Assessee is India & Foreign Country under Treaty holds
other view i.e Assessee is resident of Foreign Country.
Double
Taxation on Assessee
Ø On
Profit in Foreign Country (Foreign Operations)
Ø On
Income earned from Third Country by Assessee
Ø On
Income in the nature of Royalty, Fees for Technical Services etc.
Foreign
Operations
1. Foreign
Country will treat the assessee as its resident and will levy tax accordingly.
2. India
will allow credit for taxes proportionate to profit attributable to foreign
operations under Article 7 and will not allow credit for entire amount of taxes
levied in Foreign Country.
3. Thus
there will be double Taxation to the extent assessee is unable to get credit of
foreign taxes in India.
On
Income from Third Country.
1. On
receipt of Income from Third Country by Assessee, Foreign Country will tax the
same in its jurisdiction and will allow credit for taxes, if any paid in third
country.
2. India
will also tax such income of assessee from third country, on the basis of
taxation of global income of resident. But it will not give credit for taxes
levied in foreign country, since that taxation from India perspective is not in
accordance with DTAA and to that extent there will be double taxation.
On
Income in the nature of Royalty & FTS
1. As
per DTAA, source state right to tax on income in the nature of royalty and FTS
is restricted to certain rate (say 15%) on gross amount. There is an exception,
whereby if right or services (which are basis for Royalty & Service income)
is effectively connected with PE in source state, then source state get right
to tax the same on net basis in normal manner, without any restrictions.
2. Suppose
assessee has income in the nature of Royalty and FTS in foreign Country. The
said country will tax the same on normal basis, as accordingly to it, assessee
is its resident. If such income is not effectively connected to foreign operations in foreign country,
India will not allow tax credit of entire taxes paid in Foreign Country but
will restrict the tax credit to the amount, which source state has right to
levy on Gross basis.
3. This
will result in double taxation of excess tax paid in foreign country.
In this scenario, Assessee has
to invoke the provision of Article 25 of Treaty, relating to Mutual Agreement
Procedure, to settle down upon its residential status under Treaty to avoid
above-stated juridical double taxation.
