Place of Effective Management – Decoding UK’s Development Securities decision in the Indian context

mea_raju_kumar_LThumbDetermination of tax residence based on the Place of Effective Management (PoEM) has been in force in India since April 2016, with guidance and clarification from tax authorities issued in January 2017. The guidance[1] has shed more light on cases that the Government intends to cover within the ambit of the PoEM regulations. However, as is seen globally, in the context of PoEM, it is quite difficult to comprehensively and descriptively define what could be considered as the place from where a business is effectively managed.

The actual application becomes a question of facts and circumstance, which is why PoEM has seen significant jurisprudence in certain countries, especially the UK, with one of the first decisions going all the way back to 1876[2]. The most recent judicial development in the area came earlier this year in the case of Development Securities (No 9) Ltd. and others v HMRC[3], wherein an order was passed by the First Tier Tribunal (FTT) in the UK to hold that three Jersey-incorporated companies always had their control and management and, consequently, tax residence in the UK.

An examination of this judgment is relevant from an Indian standpoint for the following reasons:

  • It is likely for tax authorities to draw from international principles and experience as PoEM is a recent introduction in Indian law.
  • Given the current global tax landscape, especially in the backdrop of OECD’s Base Erosion and Profit Shifting (BEPS) project, countries want to be aligned and consistent in their approaches. They are keen to adopt best practices, more so for anti-avoidance legislation.

Overview of the judgment

In the case under consideration, the Jersey companies were set up to acquire certain assets from related parties at a value that significantly exceeded the market price. As per the judgment, the taxpayer intended to make the Jersey companies UK tax residents after the acquisition of assets such that on disposal of the assets, capital losses would be generated in the UK.

The conclusion that the central management and control (CMC) of the Jersey companies was always in the UK was based on the following factors:

  • The only transaction proposed to be undertaken by the Jersey companies was an uncommercial one, which was to acquire assets at a price much greater than their market value.
  • The transaction was justifiable only because the UK parent had funded the Jersey companies adequately — The Jersey companies did not have any real discretion.
  • The Jersey directors were merely agreeing to implement what the parent had already, in effect, decided to do.
  • The existence of the Jersey companies as Jersey tax residents was intended to be very brief — As per facts, this was fewer than six weeks.

However, in the course of implementation, all board meetings took place in Jersey, the board was comprised of experienced professionals who were Jersey residents and key decisions were taken after consideration at the meetings. This is important to note as based on a literal consideration of these facts, it could be contended that there was some background to support the position that the Jersey companies were tax residents of Jersey.

As per the judgment passed, this could not counter the fact that the boards of the Jersey companies only agreed to undertake the steps the parent company wanted to take; the steps themselves were not commercially sound but rather uncommercial. Therefore, the parent company had crossed the line of influence and had actually usurped the CMC of the Jersey companies. In conclusion, the CMC of Jersey companies was always in the UK with the parent.

Accordingly, the scheme was disregarded and the taxpayer was unable to take the benefit of offsetting capital losses in the UK.

What companies should consider in light of the judgment

This case is interesting in the Indian context. PoEM regulations in India contain the active business outside India (ABOI) test, wherein a higher threshold for the trigger of PoEM provisions is given and there is a favorable presumption for companies satisfying this test. While the exception to this test is where the board of directors is standing aside and the powers are being exercised by the parent, the Development Securities decision gives an illustration of when it really could be considered so.

Therefore, in the context of Indian outbound multi-nationals, the commercial rationale behind a structure must be clearly demonstrated. Merely meeting certain objective tests, such as ABOI, may not be enough if it could be looked through as a structure lacking substance.

The inclusion of the principal purpose test (PPT) in treaties as a minimum standard under the BEPS project also reinforces the direction in which cross-border tax is evolving and ties in with the conclusion in the aforementioned decision. Substance is now one of the key drivers.

Countries such as the UK have judicial history on CMC and PoEM extending over 100 years and the subject still continues to evolve. This should serve as an indicator of the complexities in making a factual determination of a company’s PoEM. The manner of enforcement of PoEM regulations in India is yet to be seen, but Indian business groups should remain well prepared for questions about their overseas operations.

 

The author of the blog is Raju Kumar, Tax Partner, EY India

Co-contributor:   Amish Behl, Senior Tax Professional, EY India

 

 

[1] Circular No. 06 of 2017 dated 24 January 2017

[2] Calcutta Jute Mills v Nicholson (1876) 1 TC 83

[3] [2017] UKFTT 565


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