SEBI’s amended Listing & Disclosure Requirements - POEM impact
Simachal Mohanty (Chartered Accountant)
The doctrine of ‘Place of Management’ (POEM) found its way into Indian Income Tax law with effect from FY 2016-17 by way of an amendment to Sec. 6(3) of Income Tax Act. A foreign company is said to be resident in India only if its place of effective management in that year, is in India.
\"Place of effective management\" is defined in the Act to mean a place where key management and commercial decisions that are necessary for the conduct of the business of an entity as a whole are, in substance, made.
The guidelines were issued by Central Board of Direct Taxes enumerating the guiding principles for determining POEM.
Simplistically stating, there are two tests in relation to POEM determination. If a company successfully satisfies one of the tests, then such company comes out of ambit of POEM. In other words, a company must satisfy criteria of one of the tests to avoid POEM, thereby avoiding Indian tax residency.
- Primary Test : Comprises of (i) Active Business Test (ii) Board Meeting Test.
- Secondary Test : Requires to identify the persons who actually make the key management and commercial decisions for the conduct of the company\'s business as a whole & the place where such decisions are made.
Active Business test requires that the foreign company must have passive income not more than 50% of its total income; and (i) less than 50% of its total assets are situated in India; and (ii) less than 50% of total number of employees are situated in India or are resident in India; and (iii) the payroll expenses incurred on such employees is less than 50%.
The Board meeting test stipulates that POEM exists at a place where the Board of Directors (BOD) meets and makes decisions.
A foreign company, in order to pass the Board meeting test, usually demonstrates that majority of the directors are non-residents and the Board meetings are held periodically outside India. These parameters, although not part of the statute in verbatim, still are qualitative indicators for passing the Board meeting test.
Now, Securities and Exchange Board of India (SEBI) has amended the Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations with effect from 9th May 2018 incorporating various additional corporate governance parameters.
Such criteria and parameters, in its original form and also the amendment, may have implication on determining POEM under Income Tax law.
a) Significant Transactions
As per Listing Obligations and Disclosure Requirements (LODR), the management of the unlisted subsidiary shall periodically bring to the notice of the BOD of the listed entity, a statement of all significant transactions and arrangements entered into by the unlisted subsidiary.
Significant transactions denote at least 10% of total revenue or total expenses or total assets or total liabilities of the unlisted material subsidiary for the immediately preceding accounting year.
In this context, the management of the unlisted subsidiary (say “foreign subsidiary”) must bring to notice all the significant transactions, of the BOD of the listed entity (say “Indian parent entity”).
If the BOD of Indian parent entity is involved in decision making with regard to such significant transactions in India, then it would constitute POEM in India. However, if the BOD only takes note of such transaction, then POEM will not trigger in India.
[This requirement is in existence as part of LODR since the year 2015 applicable to material unlisted subsidiary, however, it is amended now to be applicable to all unlisted subsidiary companies effective from April 1, 2019. Material subsidiary means a subsidiary whose income or net worth exceeds 20% of the consolidated income or net worth in the previous accounting year.].
Example: I Co , is a company listed in India. F Co is a foreign subsidiary of I Co. F Co 2 is a foreign subsidiary of F Co. F Co contemplates to carry out a significant restructuring i.e. (i) to divest the holding in F Co 2 & (2) invest the same fund in acquisition of certain valuable IPs.
I Co passes a resolution in its Board meeting approving such transaction. F Co Board accordingly seconded the restructuring and the restructuring was carried out.
In such a situation, POEM is likely to trigger in India for F Co due to the fact that I Co Board approved the decision of restructuring in India.
The practical way of carrying out this restructuring is that (i) First the Management of the F Co places the proposal before the Board of F Co (ii) Secondly, Board of F Co 2 approves the transaction (iii) Management of F Co brings the transaction to the notice of Board of I Co which takes note of the transaction.
In such a case, the POEM will not be attracted for F Co in India.
b) Review of Utilization of Loans & Advances
LODR has added a new requirement, effective from April 1,2019, obligating a holding company to review the utilization of loans/advances/investments by the holding company in the subsidiary exceeding Rs.100 Crs or 10% of asset of the subsidiary whichever is lower (emphasis supplied).
In case an Indian Parent company has invested in a foreign subsidiary company by way of loan or equity, then it is obligated to review the utilization of the funds. The word ‘review’ is different from the word ‘bringing to the notice’ and may sometimes be intrusive in nature. In such a case, if the Indian parent company, while reviewing the utilization of loans/advances/investments funds, gets involved in making some key commercial decisions, then it may trigger POEM in India.
c) Independent Directorship
LODR regulation requires that at least one independent director on the Board of the listed entity shall be the director on the Board of Directors of the unlisted material entity, whether incorporated in India or not. This amended requirement is effective from April 1, 2019.
In order to comply with this condition, foreign subsidiary of an Indian listed parent company would have to appoint an independent director in its Board who is also a director in the Board of such parent company.
Such independent director may be an Indian national or may be a foreign national. If such director is an Indian national, the foreign subsidiary of the Indian listed company must ensure cautiously that the key commercial decisions by such director or BOD including such directors are taken in foreign soil and not in India. That will help avoid POEM and consequently tax residency in India.
Example: I Co is a listed Company in India. F Co is a foreign subsidiary of I Co. I Co Board has three independent directors (Mr.A, Mr.B, Mr.C) who are national/resident of India. F Co Board has appointed Mr.A and Mr.B as directors in its Board, apart from another director Mr.D who is a foreign national. Board of F Co comprises of three directors i.e. Mr.A (Independent/Indian National) , Mr.B (Independent/Indian National) and Mr.D (Executive/Foreign National). The Board meeting is held in the foreign country. However, in order to save the time, Mr.A and Mr.B met in India, discussed and agreed on a key commercial decision which was likely to be placed in the Board of F Co. Later, in a Board Meeting of F Co held in the foreign country, such decision which was approved in India was adopted by the Board of F Co.
In such a case, the POEM is likely to trigger in India since the decision was effectively taken in India.
d) Group Governance Committee
As per the requirement of a specified Circular issued by SEBI for recommendation of the Committee on Corporate Governance, where a listed entity has a large number of unlisted subsidiaries, such listed entity may monitor their governance through a dedicated group governance unit or Governance Committee comprising the members of its BOD [ Effective from the circular dated 10th May 2018]
If an Indian parent company is having large number of unlisted subsidiaries, including foreign subsidiaries, then it may monitor their governance through a dedicated group governance unit or Governance Committee comprising of the BOD of the Indian parent company.
This requirement seems suggestive in nature and not a compulsory requirement since the word ‘may’ is used. In case, the Indian company chooses to implement the above, it must ensure that it is not involved in key decision making of the foreign subsidiary in order to avoid POEM.
Conclusion:
POEM was introduced to bring the shell companies into the Indian tax net, if such companies are effectively managed from India. Further SEBI’s LODR is a step in identical direction to propel best corporate governance practices in India.
Endeavour must be made on the part of the foreign companies to ensure that its management and Board in substance, take independent and effective decisions (in the foreign soil) to avoid attracting POEM and thereby tax residency status in India.
The views expressed by the author are personal in nature.