Place of Effective Management (POEM) of a business

Finance minister had announced during budget 2016 that place of effective management (POEM) will determine if a company is resident in India or not. Accordingly, this was notified in Finance ACT 2016 as under.

Finance Bill

The details of what will determine the place of business rules was not decided in the Finance Act 2016. The POEM provisions was supposed to become effective from April 2017. The detailed guidelines of what rules and conditions will determine the POEM has been issued by CBDT on 24 January 2017.

Ever since the announcement in 2016 there were many apprehensions on POEM, especially in SaaS companies.

In order to clear this apprehension a PolicyHacks session of iSPIRT was conducted.

The video discussion on POEM attended by Girish Rowjee, Founder CEO of Greytrip; Mrigank, Mrigank Tripathi,  Founder CEO of Qustn Technologies; Sanjay Khan Nagra, of Khaitan and Co.; Avinash Raghava and Sudhir Singh, iSPIRT  is given below.

What does the above POEM ruling incorporate in finance bill imply?

In simple terms the place of effective management in above act means a place where key management or commercial decisions that are necessary for the conduct of the business of an entity are made, in substance. This implies Indian resident status on a company will apply even when the entity is incorporated outside India, if the place of effective management is proven to be in India.

The guidelines issued on 24th January 2017 by CBDT will be used to determine if a business of non-Indian entity or a subsidiary of Indian entity will fall under the place of business rules or not. The Guide lines can be accessed here.

POEM is an internationally recognised test for determination of residence of a company incorporated in a foreign jurisdiction.

Why this regulation has been brought in?

POEM require Indian firms with overseas subsidiaries or foreign companies in India to pay local taxes based on where the business is effectively controlled.

The main intention of this regulation is to capture the income in shell companies incorporated outside India that are held by resident Indians with a basic intention of retaining the income outside India.

The regulation is not intended to discourage valid Indian businesses to setup an entity outside India or operate in global markets.

Does it impact Software sector?

It is very common for the India Software companies to open an office in foreign geography, many times as a subsidiary of Indian company and sometimes a new entity with mixed local and Indian management. Hence, the POEM has been worrying entrepreneurs in this sector. For SaaS segment, it is very normal to have a foreign entity, either for reasons of funding or market penetration.

As mentioned above, for a valid global business the POEM will not be a hurdle. Businesses, having global operation but not retaining income in foreign companies (i.e repatriating profits to Indian company) through authorised route and after complying with other regulations, POEM will not be a a worrying factor.

There may be a very few Software Companies, who may need to be concerned, to pass the test of POEM. Any determination of the POEM will depend upon the facts and circumstances of a given case. The POEM concept is one of substance over form. If POEM is established to be in India for businesses operating outside India, they will be taxed in India.

It is not possible to generalize the impact of POEM on Software sector or illustrate few used cases. Whether a business operating outside India will get classified as POEM can only be ascertained after detailed examination.

Exemption for turnover less than 50 Crore

There is good news for startups as per the Press release accessible here, it has been decided that the POEM guidelines shall not apply to companies having turnover or gross receipts of Rs. 50 crore or less in a financial year.

This was not clear before video discussion and doubts were expressed during discussion, as this rule has not been described in the guideline circular of CBDT but has been mentioned in the press release of same date from CBDT.

Hence, we can expect that the rule of less than 50 crore income shall be embedded in income tax rules to be notified later.

Other salient features

  1. The provision would be effective from 1st April 2017 and will apply to Assessment Year 2017-18 and subsequent assessment years.
  2. The Assessing Officer (AO) shall, before initiating any proceedings for holding a company incorporated outside India, on the basis of its POEM, as being resident in India, seek prior approval of the Principal Commissioner or the Commissioner, as the case may be.
  3. Further, in case the AO proposes to hold a company incorporated outside India, on the basis of its POEM, as being resident in India then any such finding shall be given by the AO after seeking prior approval of the collegium of three members consisting of the Principal Commissioners or the Commissioners, as the case may be, to be constituted by the Principal Chief Commissioner of the region concerned, in this regard. The collegium so constituted shall provide an opportunity of being heard to the company before issuing any directions in the matter.

The point 2 and 3 mentioned above will ascertain that there is no arbitrary discretion exercised by Assessing officers on ground.

The Guidelines issued can be accessed here, also provides examples that explains when an active business outside India will be treated as Indian business based on POEM. These examples do not explain each and every case.

Also the exemption of 50 Crore is neither given in Finance Act or in the Guidelines but mentioned in press release.

CBDT may therefore issue further circulars to clarify these positions.

A budget for “Digital Economy” sake

Looking deeper in to the budget 2017.

[An immediate official iSPIRT response to the budget was issued as a Press release on 1st FEB 2017. It is placed in media section. You can access it here.]

Budget can’t be construed as main stream policy making exercise. Yet, the policy analysts and experts, track it with utmost seriousness, to understand Government’s thought process in economic policy. Similarly, industry looks in to budget for the sectoral emphasis, allocations that will influence the demand/ supply, reforms and special provisions in the sector. A reminiscent of this in recent period of history is 2012-13 budget speech of then finance minister Pranab Mukherjee, when analysts were counting how many times he used “inclusive growth” as a phrase.

This budget speech was unique in many sense and very tactical. The proposed GST regime, the rigours of demonization and skepticism of coming state elections have all effected this budget. The usual rigmarole by media of comparing prices of commodities and consumer goods from cigarettes, electronics to automobiles is missing.  GST being in pipeline, the indirect tax section, which was usually the largest section of finance bill is almost missing. Hence, allocation of resources and the direct taxes had all the share of FM’s mind in budget. The new item on the block is “Digital economy”.

We have been seeking attention of Government on:

  • increasing domestic demand,
  • promote innovation (Startups)
  • ease of doing business and
  • level playing field for Indian companies.

These four parameters impact our “product nation” focus. Let us briefly analyse how these have been taken care in the budget.

Influencing Domestic Demand function

The usual model of a demand stimulating economic policy has been based on consumption led demand relying mainly on sops and taxes for several years with doses of investment driven demand and growth from time to time.

Increased efficiency, transparency, formalization of economy and investment driven growth are four major thoughts embedded in this budget. The former three are additional determinants of demand function of emerging new economies and a means to achieving developmental agenda. Relying mainly on investment driven demand and growth is very need of the time of low sentiments.

A big measure towards increased efficiency is the change from plan and non-plan classification of expenditure. “This will give us a holistic view of allocations for sectors and ministries. This would facilitate optimal allocation of resources”, said the FM in speech.

The agriculture and rural sector of India cannot be ignored by any Govt. Hence, increased focus in budget on these two important sectors is about inclusive growth, and also in “Digital economy” perspective an attempt to avoid a digital divide.

Both continual emphasis on infrastructure investment and targeting doubling farmer income will provide an investment driven demand push and a consumption driven demand function at higher level.

What is most heartening on domestic demand side for ICT sector is the huge recognition of the “Digital Economy” in the budget. For past some years iSPIRT has been pursuing the “Digital economy” agenda at various forums. There was cautious optimism, but not full acceptability. Thanks to demonetization, “Digital” is now a mainstream concept.

Devoting a full section in his speech on “Digital economy” and dealing with it in ‘direct tax’ provisions speaks a volumes of the mind share this has taken at top in the present Govt. The finance minister stated in his speech, “Promotion of a digital economy is an integral part of Government’s strategy.”

Further, the finance minister said, “Government will consider and work with various stakeholders for early implementation of the interim recommendations of the Committee of Chief Ministers on digital transactions.” This is especially important for iSPIRT as Nandan Nilekani and Sharad Sharma of iSPIRT are special invitees on this committee.

The demand conditions for ICT  sector can best be boosted by increased adoption of the ICT by masses and the businesses, especially the SME businesses. This throws open a number of opportunities for many new startups to emerge and contribute to the development of an ecosystem, friendly to “Software product”.

Following are the notable announcements in the budget on “Digital economy” Steps:

  1. Stepped up the allocation for BharatNet Project to Rs. 10,000 crores in 2017-18.
  2. Targeting high speed broadband connectivity on optical fibre in more than 1,50,000 gram panchayats, with wi-fi hot spots and access to digital services
  3. A “DigiGaon” initiative will be launched to provide tele-medicine, education and skills through digital technology
  4. No transaction above 3 lakh should be permitted in cash.
  5. Limit the cash expenditure allowable as deduction, both for revenue as well as capital expenditure, to Rs. 10,000. Similarly, the limit of cash donation which can be received by a charitable trust is being reduced from Rs. 10,000 to Rs. 2000.
  6. All indirect tax/ duty exempted on miniaturised POS card reader for m-POS, micro ATM standards version 1.5.1, Finger Print Readers/Scanners and Iris Scanners. Also components for manufacture of such devices exempted.
  7. Increased digital transactions will enable small and micro enterprises to access formal credit. Government will encourage SIDBI to refinance credit institutions which provide unsecured loans, at reasonable interest rates, to borrowers based on their transaction history.
  8. To make MSME corporate tax with annual turnover up to 50 crores will be 25%
  9. Presumptive income tax for SME tax payers whose turnover is up to 2 crores reduced from 8% to 6%.
  10. BHIM app with cashback and referral schemes
  11. exemption of service charge on railway bookings,
  12. Aadhaar based smartcards for Senior citizens
  13. Create a Payments Regulatory Board in the Reserve Bank of India by replacing the existing Board for Regulation and Supervision of Payment and Settlement Systems.

Also Government has on mid the ‘indigenous’ in ICT sector. This is reflected by the proposal on metro rail policy for upcoming metro infrastructure across the country. The budget statement reads, “A new Metro Rail Policy will be announced with focus on innovative models of implementation and financing, as well as standardisation and indigenisation of hardware and software.”

Further in related electronic sector, the budget has exponentially increased the allocation for incentive schemes like M-SIPS and Electronic Development Fund (EDF) to 745 crores in 2017-18. The draft National Policy on Software Product already intends to have a synergy with the EDF in PPP model.

This is not enough on “Digital economy” if the Government itself does not implement the “Digital” in its own functions in pervasive manner. The thought process of the Government seems to be aligned in this direction also.

The Finance Minister has said in his speech, ”we are trying to bring in maximum use of Information Technology to remove human contact with assesses as well as to plug tax avoidance.” 

Innovation and Startups

Both innovation and Startups still occupy the thought process at top leadership level. There are signals and clear provisions indicating this.

The income tax exemption window slider for Startups, approved under DIPP, has been increased for 3 years in five years to 3 years in 7 years.

Another new measure is promoting innovation right at secondary education level and in backward areas. “An Innovation Fund for Secondary Education will be created to encourage local innovation for ensuring universal access, gender parity and quality improvement. This will include ICT enabled learning transformation. The focus will be on 3479 educationally backward blocks”, mentions the Finance minister, in budget speech.

Ease of doing business

Ease of doing business is an important topic in PART-B of the content list of budget document. Hence, its importance in thinking process of Government.

iSPIRT has pursued a Stay-in-India-checklist with the Department of Policy and Promotion (DIPP) with an intent to remove various frictions faced by industry in funding, company formation, corporate regulation and taxation issues. A number of steps have been taken up by Government in past one year to sort out these issues.

Announcements like abolition of FIPB, rationalization of taxation (on FPIs, convertible instruments, long term capital gains, etc), lower rate of taxation of 25% for companies with revenue of less than 50 crores, rationalization of labour laws, carry forward of MAT for 15 years, etc. are all in line with the philosophy of iSPIRT’s Stay-in-India checklist.

Among key issues from the Stay-in-India checklist which were expected to be addressed in the budget but have been missed out are angel tax and tax parity between listed and unlisted securities etc.

Level Playing Field

There many ‘level-playing field’ issues that iSPIRT has been taking up with the ministry of finance. Most in taxation domain. None of these issues have been addressed in this budget also e.g. TDS on sale of software, service tax on B2C sales of domestic products.

We hope the proposed National Policy on Software product will crystallize ground for taking up specific ‘Software product’ industry issues with Government in future.

Conclusion

Overall the budget is very encouraging. The main take away for iSPIRT is “Digital economy” recognition. We have to further leverage this in our policy initiatives with different departments in Government and most importantly with MeitY to realize the dream of “Product Nation”.

RBI allows convertible notes for Startups from foreign sources

As part of policy hacks, we covered the issue of Convertible notes being recognized by Ministry of Company affairs (MCA) in our earlier blog here.

For benefit of users to start, the convertible note has been explained below.

What is a convertible note?

Convertible notes are debt instruments that converts in to equity, at a later date. The lender initially gives a loan with an understanding that he can convert these in to equity. In most cases, this later date is the date of next valuation of the company. If there is no next round of valuation, the company should return the debt back to lender in a fixed time interval.

Convertible notes are quite popular in startup ecosystems like Silicon Valley in USA.

Earlier Ministry of corporate affairs has announced acceptance of the convertible note as a concept for startups through a circular no. G.S.R. 639(E) New Delhi, dated 29th June, 2016.

The announcement by RBI is a development further to the above given MCA circular.

How does new RBI provision help startups?

Foreign investors were allowed, foreign direct investment (FDI) by way of equity and other instruments that were at par with equity e.g. compulsorily convertible preference shares/debentures. Convertibles notes were not allowed till now.

Reserve Bank of India (RBI) notification of 10 January 2017 has amended the Foreign Exchange (Transfer or Issue of Security by a Person Resident outside India) Regulations, 2000, to allow ‘Startups’ to issue convertible notes to foreign investors.

This opens new avenues for ‘Startups’ to raise funding.

iSPIRT volunteer Sanjay Khan Nagra, covers the RBI announcement on Convertible Notes here in the video below.

The complete circular is given here  on RBI website.

Other provisions in the new RBI notification explained

Convertible note has been defined in the notification

‘Convertible note’ means an instrument issued by a startup company evidencing receipt of money initially as debt, which is repayable at the option of the holder, or which is convertible into such number of equity shares of such startup company, within a period not exceeding five years from the date of issue of the convertible note, upon occurrence of specified events as per the other terms and conditions agreed to and indicated in the instrument.

Who can invest and how much?

A person resident outside India (other than an individual who is citizen of Pakistan or Bangladesh or an entity which is registered / incorporated in Pakistan or Bangladesh), may purchase convertible notes issued by an Indian startup company for an amount of twenty-five lakh rupees or more in a single tranche.

NRIs may acquire convertible notes on non-repatriation basis in accordance with Schedule 4 of the Principal Regulations.

What is a Startup?

For the purpose of this Regulation, a ‘startup company’ means a private company incorporated under the Companies Act, 2013 or Companies Act, 1956 and recognised as such in accordance with notification number G.S.R. 180(E) dated February 17, 2016 issued by the Department of Industrial Policy and Promotion (DIPP) , Ministry of Commerce and Industry.

Govt. approval required for some sectors?

A startup company engaged in a sector where foreign investment requires Government approval may issue convertible notes to a non-resident only with approval of the Government.

Inwards remittance of amount?

A startup company issuing convertible notes to a person resident outside India shall receive the amount of consideration by inward remittance through banking channels or by debit to the NRE / FCNR (B) / Escrow account maintained by the person concerned in accordance with the Foreign Exchange Management (Deposit) Regulations, 2016, as amended from time to time.

Provided that an escrow account for the above purpose shall be closed immediately after the requirements are completed or within a period of six months, whichever is earlier. However, in no case continuance of such escrow account shall be permitted beyond a period of six months.

Convertible notes are transferable

A person resident outside India may acquire or transfer, by way of sale, convertible notes, from or to, a person resident in or outside India, provided the transfer takes place in accordance with the pricing guidelines as prescribed by RBI. Prior approval from the Government shall be obtained for such transfers in case the startup company is engaged in a sector which requires Government approval.

Compliance and reporting

The startup company issuing convertible notes shall be required to furnish reports as prescribed by Reserve Bank.