Tax Implications of the COVID-19 Response: Corporate Residency and POEM

[Manjri Singh and Vijayaditya Reddy are IV year students at NALSAR University of Law]

The public health emergency caused by the corona virus pandemic has plunged the world into uncertain times. In order to ensure continuation of business in such an environment, video conferencing and other remote options are the only possibilities for conducting corporate meetings. For example, the Ministry of Corporate Affairs released different notices and circulars that would guide companies during these times. This includes a notification on board meetings, which provides that the requirement of physical presence of directors under section 173(2) of the Companies Act, 2013 read with rule 4 of the Companies (Meetings of Board and its Powers) Rules, 2014 would be relaxed, and video-conferencing and audio visual means could be employed for key commercial decision making. Although this would not apply to foreign companies, it is representative of the new mode of undertaking business management.

Due to the reliance placed on virtual means, there is an inadvertent impact of the tax residency status of corporations, which is to be assessed on a yearly basis. Section 6(3) of the Income Tax Act, 1961 provides that a company is a resident in India if it is an Indian company (i.e. incorporated in India), or its place of effective management (POEM) in that year, is India. The explanation to the sub-section states that POEM refers to the place where key management and commercial decisions that are necessary for the conduct of the business are made. The implication of being a resident of India is that global income becomes chargeable to tax in India by virtue of section 5(1) of the Income Tax Act. This test is used to determine the residency of a company that has not been incorporated in India.

The Ministry of Finance on 24 January 2017 issued a Circular on the Guiding Principles for determining the POEM of a Company. The working of the test is as follows. Companies incorporated in a foreign jurisdiction are classified as having active business outside India (ABOI) or not having active business outside India. The Circular provides the criteria for such determination. Relevant to this post, it is important to note that for companies that have active business outside India, the POEM is presumed to be outside India if majority of the meetings of the board of directors is held outside India (Guideline 7). There is no further guidance if the location of the meetings is not ascertainable, but the presumption may still operate.

For companies not engaged in active business outside India, the identification of people taking the key commercial decisions and the place where these decisions are being made assume significance (Guideline 8). It also provides that the place of taking decisions weighs over the place where these decisions are implemented. In the case of both companies engaged in active business in India, and not in India, it is evident that the physical place of commercial decision making is the most pertinent factor. It is this physical conducting of decision making that is rendered difficult by the pandemic and will have an impact on the determination of residency.

However, for companies not engaged in active business outside of India, the POEM test refers to decentralised means of holding meetings such as video conferencing. In such a case, the place where the majority of the directors reside become the guiding criteria (Guideline 8.2(d)). The head office of the company may also become relevant (Guideline 8.2(c)).

Illustratively, take a foreign company that is not engaged in active business outside India, and a majority of the directors are Indian residents. During the previous year, there were five board meetings, all of which were held outside India. At these board meetings, key decisions relating to the business were made. In such a scenario, ordinarily, the POEM would not be India, and the company would not be a resident of India for tax purposes. Taxation of this company would be limited to taxation on source-based principles. However, if the board were to conduct meetings virtually, and the place of meeting is now not ascertainable, the location or residence of the directors or even the head office would become the determinative factor. In case the location or residence of the directors that is considered, this company would now have its POEM in India.

Overall, the POEM test is still largely in unchartered territory, and evaluations are made on a case-by-case basis.  The POEM Circular is only meant to contain guidelines, and further these are used for domestic law purposes. If a corporation is a tax resident of India, and some other country (by virtue of the application of their domestic law), then a tiebreaker rule in the relevant tax treaty between these two nations may be applicable for dual residency. However, several solutions may be implemented such that the dual residency problem is avoided.

As a matter of policy, the relevant authorities may determine that the implications of change in the POEM as a result of COVID-19 is a temporary situation and will be overlooked in favour of the ordinary place of effective management. This has been implemented in Ireland where presence may be disregarded if owing to travel restriction.

In a similar vein, the HM Revenue and Custom in the United Kingdom (UK) published a guidance to state it was sympathetic to the disruption of business caused by the pandemic, and occasional participation of meetings from the UK on a temporary will not necessarily lead to a change to the resident status. A holistic view will be taken and determined on a case-by-case basis. The likelihood of this course of action being adopted in India is uncertain as the impact of the pandemic on revenues and tax may result in more aggressive taxation policies concerning foreign companies.

Other solutions would include having a minimum number of meetings during the period of travel restrictions. Even if such meetings are necessary, changing the composition of the board of directors, or ensuring a majority of the directors participating in the meeting are in the preferred place of management is adopted. In any case, it will be necessary for companies to re-evaluate and plan in advance their tax liabilities.

Manjri Singh & Vijayaditya Reddy

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