A misdirected tax missile

This will discourage MNCs from locating their headquarters or regional functions in India

Source: The Financial Express

Ace jurist Nani A Palkhivala once described the legendary British prime minister Winston Churchill’s art of persuasion as thus: “For some thing to be convincing, it must, in the first place, be simple.” That is how one can possibly sum up the reaction to the draft Place of Effective Management (PoEM) guidelines.

The draft guidance, issued for public comments, is in pursuance of what the law makers describe as an anti-avoidance measure passed in the budget of 2015 to bring under the tax net (a portion) of passive income of foreign subsidiaries of Indian companies and Indian subsidiaries of foreign companies using the PoEM test. It reinforces the strictest form of source-based rules and is often used by tax regimes of sophisticated jurisdictions to curb the practice of shifting profits. In the context of India, it shall override existing regulation on taxability of income based on residency principles. Under the present law, foreign companies (whether subsidiaries of Indian companies or holding companies of Indian subsidiaries) are not taxable unless the entire management of that foreign company is situated in India. To bring to tax such income, definition as to what constitutes PoEM assumes significance.

A case in point is the first principle under the draft guidance: “…the PoEM in case of a company engaged in an active business outside India shall be presumed to be outside India if majority of meetings of the Board is held outside India”. The guidance has defined what is active business outside India based on tests laid down by way of assets, employees, payroll expenses, etc. Most, if not all, tests are subjective and, despite the intended precision to address the concept of PoEM in the context of tax-payers using modern technology, lot has been left to discretion. The final three conclusions (listed here) are the most subjective seen in any form of tax law:

• The guidance says that if the primary tests for determining PoEM doesn’t lead to clear identification, it shall be the location where the main and substantial activity is located or where the accounting records of the company are kept.
• It doesn’t stop here and further says that if it is determined that PoEM is in India and outside India, it would be presumed to be in India if it is predominantly in India.
• And finally, it concludes by saying that all the principles articulated are for guidance only.

First, that the law is effective from April 2015 and the guidance has not been finalised, raises a question on its retrospective applicability. Second, from the “ease of doing business” perspective, we would be subjecting overseas subsidiaries of Indian companies to burdensome compliance with a presumption that if such businesses retain income in overseas jurisdiction, they are avoiding tax. We will be discouraging MNCs from locating their headquarters or regional functions in India or holding board meetings in India. Even if it is eventually concluded that no income arises out of PoEM, tax-payers would be subjected to onerous compliance, besides of course planning their affairs to avoid tax under PoEM.

My question is, have we done any kind of impact analysis on how much tax is evaded presently or how much tax would we collect by introduction of PoEM? Have we done a cost-benefit analysis of costs associated with administering the law, burden of compliance, impact on ease of doing business index which is on top of the mind of the senior-most functionary in the government, and have these costs been weighed against the tax that the exchequer shall collect? To me, it seems like another case of rushed legislation, without assessing its consequences.

I don’t think that the intended economic rational to arrest tax avoidance can be addressed—instead, it will result in litigation and, more importantly, runs the risk of being a road-block for ease of doing business, particularly for Indian companies having overseas subsidiaries with part of their management located in India. It would lead to disputes with treaty partners in situations of double taxation. The government should give it a serious thought and consider postponing PoEM’s implementation if not totally doing away with this law. In summary, I don’t see either the tax-payer or the tax-gatherer benefitting—the only constituency that would benefit would be lawyers and tax accountants.