Indian companies with foreign units likely to be impacted by POEM guidelines
MUMBAI: Many manufacturing and trading subsidiaries of Indian companies that are currently operating independently outside India may have to pay taxes in India as they could fail the new test set under the Place of Effective Management (POEM) guidelines.
Not just that, some of the companies could see complications with taking credit from other countries and may face a risk of double taxation, say industry trackers. Under draft guiding principles of POEM recently issued by the finance ministry, any subsidiary that has a passive income outside India would be taxed domestically. The guidelines define “active” and “passive” incomes.
Under these, many intermediaries or subsidiaries may be considered to be engaging in “active business outside India” and hence be liable to pay tax here. A company or subsidiary located outside India, whose passive income – purchase or sale of goods, royalty, dividend, capital gains, rental income and interest – is less than 50% of its total income would be deemed “active business outside India” and hence be taxed in India. Such income isn’t currently taxed in India.
“The distinction between active and passive income is helpful; however, the guidelines mention that trading between parent and foreign subsidiary will be considered as passive income, and this doesn’t appear to be justified,” said Ketan Dalal, managing partner (west), at PwC India.
Analysts point out that information technology and pharma subsidiaries could see most of the impact. Currently, many Indian companies have a foreign subsidiary which deals with their Indian parents at “arm’s length” but are essentially just trading arms or, in some cases, marketing units. Industry trackers say these companies could also see double taxation in some extreme cases. “POEM could give rise to double taxation and hence treaty (between two countries) has to be relied upon to avoid double taxation.
This may not be easy in many cases and may pose certain challenges,” said Amit Maheshwari, partner at Ashok Maheshwary & Associates. The tax treaty gets complicated as in some cases, like in the US, POEM is not recognised. “Indian companies having US subsidiaries or affiliates which are managed from India may not get relief under the India-USA treaty since the treaty does not recognise the concept of POEM. Certain other treaties like the Japanese treaty leave it up to the competent authorities to decide, which may be very time consuming,” said Maheshwari.
Currently, many Indian companies use subsidiaries registered in Europe and the US as trading arms. “Like an Indian pharma company sells a product which has a cost price of Rs 85 to its US subsidiary at Rs 100.
The US subsidiary, which incurs additional marketing cost of Rs 6, sells the product at Rs 110, and makes a Rs 4 profit,” said a tax expert, explaining how the system works.
Under the POEM guidelines, the subsidiary will be considered to have a passive income, as its total income will be less than 50% of the total profit. And, the Rs 4 profit could be taxed in India as well. Ideally, the subsidiary can take a credit on the tax paid in one place and seek a refund of that paid in the other country to avoid double taxation. However, it is not that simple.
Enforce new rules from FY 2016-17
The government wants to prevent curb tax planning. The draft rules — which stipulate the circumstances under which a foreign company’s place of effective management would be in India – target any sharp tax practices. What is clear is that companies must have proper documentary evidence to prove that a foreign company’s management is actually situated outside the country. However, these rules are not cast in stone, and the government should factor in industry’s concerns before finalising them. It also makes sense for the government to enforce these rules from April 1, 2016 to ensure that foreign companies understand the nuts and bolts of the new compliance regime.