A company’s POEM cannot determine its ownership and control status

Under Indian foreign exchange regulations, Indian companies having foreign investment participation are generally categorised either as Indian owned and controlled company (IOCC), or foreign owned or controlled company (FOCC).

An Indian company in such cases is considered as IOCC where they are owned and controlled by resident Indian citizens and/or Indian companies that are in turn owned and controlled by resident Indian citizens. If not, they are considered as FOCC.

The status of IOCC or FOCC becomes relevant from the perspective of calculation of foreign direct investment in a company and for other matters such as further downstream investments/sectoral restrictions. The terms ‘owned’ and ‘control’ are defined under the foreign exchange regulations. The term ‘control’ inter-alia includes the right to control the management or policy decisions of a company. It may be noted that the control test concerns itself primarily with who exercises control and not really where it is exercised from.

Unconnected with the foregoing, it may be noted that the domestic taxation laws of several countries treat not only companies domiciled within their territories as tax resident but also companies incorporated outside their territories as tax resident if such companies are effectively managed/controlled from such countries.

This sometimes leads to the anomaly of double taxation in cases where a company is domiciled in one country but being managed/ controlled from some other country and considered as tax resident in both such countries, as per the domestic taxation laws .

To prevent this anomaly and to aid in the determination of tax residency as a tie-breaker rule, taxation treaties between two contracting countries, in most cases, provide that a company shall be considered tax resident of such contracting country where the place of effective management (POEM) lies irrespective of its domicile.

POEM test is widely accepted and means the place where the key management and commercial decisions that are necessary for the conduct of the business of an entity as a whole, are in substance made.

Although the two aforesaid concepts are relatively unconnected, one may wonder whether determination of POEM of an Indian company that has foreign investment participation would have any deeming impact on its status as an IOCC or FOCC. The answer should typically be in the negative.

It may be noted that while for determination of POEM, the emphasis is generally on ‘where’ the key management and commercial decisions are in substance made, the determination of whether an Indian entity is FOCC or IOCC, largely depends on ‘who’ owns and controls the said Indian entity.

Let us take, for example, an investment company in South Africa and its non-subsidiary investee company in India. The said Indian investee company will be considered a tax resident in India owing to its domicile. Independently, if various board meetings of the Indian investee company are on a consistent basis held in South Africa as well as key management decisions made at such meetings, the Indian investee company would also be considered a tax resident in South Africa by virtue of its place of effective management (POEM) being in South Africa, as per the South African tax regime.

In such a case, one would have to look at the Double Taxation Avoidance Agreement (DTAA) between India and South Africa to find truce regarding tax residency. As per the DTAA between the two countries, if a company is considered a resident of both contracting States, then it shall be deemed to be a resident of the State in which its POEM is situated.

Therefore, in the given example, the Indian investee company will be considered a tax resident in South Africa. However, the determination that the said Indian investee company is being effectively managed from South Africa and a tax resident thereof per the taxation treaty cannot per se deem the said Indian company as being foreign controlled, thus FOCC. As long as the Indian investee company is ‘owned and controlled’ from a foreign exchange regulatory perspective, that is, ownership of more than 50 per cent of the share capital, right to appoint majority of directors and right to control management and policy decisions are with resident Indian citizens and/or Indian Companies that are owned and controlled by resident Indian citizens, it should be construed only as an IOCC, irrespective of its POEM being in South Africa.

To conclude, it is important that the test for determination of FOCC or IOCC status of an Indian company, having foreign investment participation/interest, be undertaken independently under the foreign exchange regulatory framework without reference to where its POEM is located.