Place of Effective Management (POEM)
 

Under Income Tax Act (ITA)
 

‘Place of Effective Management’ (‘POEM’) is an internationally recognised test for determination of residence of a company incorporated in a foreign jurisdiction.
 

Most of the Double Tax Avoidance Agreements (‘DTAA / Tax Treaties’) entered into by India recognises the concept of POEM for determination of residence of a company as a tie-breaker rule for avoidance of double taxation. As per the Tax Treaties, a company would be deemed as a resident of the country where its POEM is situated. Most of the tax treaties provide mutual agreement as an alternative method to determine the residency.
 

The Finance Bill, 2015 introduced the concept of POEM for determination of residence of companies by way of amending Section 6 of the Act.
 

Resident Criteria for a Company under – The Income Tax Act (‘ITA / the Act’)–
 

Section 6(3)(ii)1 – Relevant extract of the same is as under –
“Residence in India – Section 6 – For the purposes of this Act, –

(1) …………………………
(2) …………………………
(3) A company is said to be a resident in India in any previous year, if—
(i) ……………..; or
(ii) its place of effective management, in that year, is in India.
 

Explanation.—For the purposes of this clause “place of effective management” means a place where key management and commercial decisions that are necessary for the conduct of business of an entity as a whole are, in substance made.”
 

NOTE: The meaning of ‘key management and commercial decisions’ would be derived from the facts and circumstances of each case and thus, is very subjective. The exact scope or definition of the terms ‘key management and commercial decisions’ or the meaning for the same are not specifically defined in the Act and hence, would lead to litigation.
 

The Central Board of Direct Taxes (‘CBDT’) has further issued final guidelines2, for determination of POEM of a company as per Section 6(3) of the ITA, by way of Circular No. 63 of 2017 [F.NO.142/11/2015-TPL] dated 24 January, 2017. Also a Press Note4 was released on 24 January, 2017 accompanying the final POEM guidelines stating that POEM guidelines shall not apply to companies having turnover or gross receipts of INR 50 Crores (i.e., INR 500 million) or less in a financial year.
 

1. As amended by the Finance Act, 2015 and w.e.f. April 1, 2017
2. The principles established in the CBDT Circular for determination of POEM are not decisive in itself but in the
nature of guiding principles.
3. https://www.incometaxindia.gov.in/news/circular06_2017.pdf
4. https://www.incometaxindia.gov.in/lists/press%20releases/attachments/588/cbdt-guiding-principlesdetermination-effective-management-poem-company-24-1-2017.pdf
 

Further, CBDT issued clarification vide Circular No. 85 of 2017 dated 23 February, 2017 providing relief from applicability of of Section 6(3) of the ITA to companies having turnover or gross receipts of of INR 50 Crores (i.e., INR 500 million) or less in a financial year.
 

Based on the above, criteria for residency test of a company, under the Act, it is important to analyse where the effective management and control of the company in substance exists.

Implications of POEM
 

If any foreign company is found to have POEM in India, the same would lead to the following consequences:
 

1. The foreign company would be termed as a resident u/s 6(3) of the ITA.
2. The entire global income of such foreign company would be subjected to tax in India as per Sec. 5(1) of the Act.
3. The rate of tax applicable would be 40% i.e., the rate which is applicable to foreign companies in India, plus applicable surcharge and cess. Even though such foreign company is treated as a resident in India, the rate as applicable to resident Indian companies is not made applicable to a foreign company treated as a resident in India.
4. Other implications are applicable as mentioned in Section 115JH of the ITA read with notification6 issued by CBDT.
5. In case of any conflict of provisions as applicable to the foreign company as a resident and those applicable to the foreign company, the provisions as applicable to a foreign company would prevail.
6. Any transaction of the foreign company with any other person or entity under the Act shall not be altered only on the ground that the foreign company has become an Indian resident. Hence, Transfer Pricing provisions would be applicable to all the international transactions entered into with Associated Enterprises as per the ITA.
7. Foreign Tax Credit – In case of an income of the Foreign company, deemed to be resident in India, on which foreign tax has been paid or deducted, is offered to tax in more than one year in India, credit of such foreign tax would be allowed for all those years in the same proportion in which the income is offered to tax or assessed to tax in India in respect of the income to which it relates. The foreign tax credit would be provided in accordance with the provisions of Rule 128 of the Income Tax Rules, 1962.
 

POEM determination under the ITA:-
 

Determination of POEM is absolutely fact-based, fact-centric and fact specific on case to case basis and year to year basis. There are no fixed yardsticks for POEM determination.
 

The process of determination of POEM under the ITA is driven based on the fact test as to whether or not the company is engaged in Active Business Outside India (ABOI).
 

5. https://www.incometaxindia.gov.in/News/circular-8-2017-clarification-on-place-of-effective-management.pdf
6. CBDT has issued notification dated 22 June, 2018 providing POEM based tax consequences for foreign companies – https://www.incometaxindia.gov.in/news/notification29_2018.pdf
 

The intention of applying the ABOI test for determining POEM is to deem shell companies and such other foreign companies, created for retaining income outside India, although real control and management of affairs are located in India, to be resident of India for tax purposes.
 

ABOI Concept:-
 

A company shall be said to be engaged in ‘Active Business Outside India’ if:-
 

a. its passive income is not more than 50% of its total income; and
b. less than 50% of its total assets are situated in India; and
c. less than 50% of the total number of employees are situated in India or are resident in India; and
d. the payroll expenses incurred on such employees is less than 50% of its total payroll expenditure.
 

Further, for the purpose of determination of whether an entity is engaged in ABOI, the average of the data of the previous three financial years should be considered.
 

Further, for the purpose of ABOI determination, it would be important to note the meaning of the terms – ‘Income’, ‘Value of Assets’, ‘Number of Employees’, ‘Payroll’, ‘Passive Income’. Kindly refer to Appendix ‘A’
 

Whether ABOI exists or not:-
 

1. If a company is engaged in ABOI –
 

As to the company engaged in ABOI, circular guides that POEM would be assumed to be out of India if majority of meetings of the Board of Directors (‘BOD’) of the company are held outside India. However, if the facts indicate that BOD are standing aside and not exercising their powers of management but such powers are being exercised by the holding company or any other person(s) resident in India, then, POEM of such company even if it is engaged in ABOI, would be considered to be in India.
 

This would not include in its purview BOD of any foreign company merely following the general and objective principles of global policy of the group laid down by its parent entity in the field of Payroll functions, Accounting functions, Human resource (HR) functions, IT infrastructure and network platforms, Supply chain functions, Routine banking operational procedures, and such other functions not being specific to any entity or group of entities. Thus, any foreign subsidiary of an Indian holding company merely complying with its global policy as laid down for the entire group would, by itself, not attract applicability of POEM. This has also been clarified by CBDT vide Circular No.25 of 2017, dated 23 October, 2017. However, use of such clarification for the purpose of abusive or aggressive tax planning may attract the applicability of General Anti Avoidance Rule (GAAR).
 

2. If a company is NOT engaged in ABOI –
 

In case of a company other than ABOI company, then the determination of POEM would be two stage process involving the following criteria’s:-
Identification of the persons making the key management and commercial decisions for conduct of the company’s business as a whole; and
b. Determining the place where these decisions are made.
 

Thus, based on above discussion, the ITA and the POEM guidelines prescribed by the CBDT seek to provide both quantitative and qualitative tests for detailed objective determination of POEM.
 

Recommendations / Guidelines and Safeguards in relation to POEM concept
 

This Note attempts to provide recommendations and/or guidelines for interpreting and application of POEM in determining the tax residency status of a foreign company.
 

The following guiding principles would be considered while determining POEM of a company:
 

1. Location – where the Board of Director’s (BOD) regularly meets, provided it retains and exercises governing authority over the company and in substance takes key management and commercial decisions.
2. Decision making – The place where key decisions are in fact taken would have more relevance than where formal Board meetings are held.
3. If the Board routinely ratifies decisions made by senior management, executive committee or any other person, the place where such person takes decisions will be considered as POEM.
4. The location of a company’s head office is an important factor and the following facts have to be considered in this regard:
(i) Location where the company’s senior management and support staff are based and which is held out to the public as its headquarters.
(ii) In a more decentralised company, the head office would be the place where the senior management is predominantly based, normally return to after travel, or meet when formulating key strategies or policies for the company as a whole.
(iii) If senior management permanently operate from different locations, and participate in meetings via telephone or video conferencing, the location of the highest level of management such as the managing or financial director will be considered as the head office.
(iv) The head office would not be of much relevance in a highly decentralised company where it is not possible to determine its location with reasonable certainty.
5. Day to day routine operational activities of junior or middle management are not relevant for determining POEM.
6. With the use of modern technology, physical location of meetings may not be where the key decisions are in substance made. In such situations, place of residence of majority of directors or decision making persons may also be a relevant factor.
7. As secondary factors, place of main and substantial activity of the company and place where accounting records are kept may be considered if the primary factors are inconclusive.
8. Ownership of a foreign company by an Indian company or person(s), residence of some of the directors of the foreign company in India, location of local management of a foreign company in India and existence of support functions of preparatory or auxiliary character in India will not be conclusive of POEM in India.
9. The above principles are only for guidance and no single principle will be conclusive. Activities performed over a period of time during a financial year should be considered rather than a ‘snap shot’ approach. If POEM is found to be in India as well as outside, it will be presumed to be in India if it has been predominantly in India.
10. The tax officer will require prior approval from the Principal Commissioner or the Commissioner while treating a foreign company as a resident based on POEM, after providing an opportunity of being heard.
 

POEM – Safeguards to be adopted
 

1. Control and management would imply the controlling and directive power, i.e., where the head and brain of the company lie.
2. Independent BOD for the foreign entity – The BOD should be an independent body and autonomous body.
3. The decisions of the BOD should be well informed and duly deliberated.
4. The deliberations should be well documented and recorded in the minutes of the meeting.
5. The BOD meetings should be held only in the Foreign country.
6. All strategic and major decisions should be taken in the board meetings held outside India.
7. Preferably all directors should attend the meetings outside India.
8. In case the meeting is considered through video conference or teleconferencing, the host country’s corporate law is relevant for determining place of meeting in such cases.
9. There should be absolute clarity on the business role and activities of the foreign subsidiaries and the same should be evidenced in the corporate documents.
10. The corporate documents should provide all powers to the subsidiary the run the business activities on its own.
11. All corporate documents such as minutes, registers, secretarial records etc. should be maintained in the registered office of the foreign subsidiary.
12. Parent company’s influence on the subsidiary should only be restricted to providing visionary direction.
13. Parent company should not look to drive or steer the key activities of the subsidiary company.
14. Parent company must exercise its powers in the capacity of majority shareholder to protect its interest but should not take control and run the subsidiary.
15. The AGM should preferably be held in the country of incorporation of the subsidiary.
16. The decision of appointing the directors in the subsidiary company should not be taken in India however, recommendations can be made by the BOD of the parent company.
17. Executive Directors, COOs, CEOs, CFOs and other key management personnel of the subsidiary should not be in India.
18. The information about the international subsidiaries posted on the websites of the Indian company should be regularly reviewed.
19. The powers of the Executive Directors and officers about taking any strategic decisions should be subject to approval BOD approval and should be well documented.
20. All communications regarding management decisions and functions should be appropriately documented.
 

Disclaimer :-
This Note relates only to the Income Tax law as in force at the date hereof. This Note including any opinion set out herein is privileged and may solely be relied upon by the recipient. Without our prior written consent, this Note cannot be relied upon by any third party and must not be quoted or referred to in any public filing or submission to any government agency, regulatory or other authority. Our Note is a matter of our professional judgment and there is no assurance that the views expressed herein must be accepted by any court, tribunal, statutory authority or regulatory agency.
 

Appendix – ‘A’
 

For the purpose of ABOI determination, it would be important to note the meaning of the below-mentioned terms –
 

1. Income – shall be,
(i) as computed for tax purpose in accordance with the laws of the country of incorporation; or
(ii) as per books of account, where the laws of the country of incorporation do not require such a computation.
 

2. Value of assets –
(i) In case of an individually depreciable asset, it shall be the average of its value for tax purposes in the country of incorporation of the company at the beginning and at the end of the previous year; and
(ii) In case of a pool of a fixed asset being treated as a block for depreciation, it shall be the average of its value for tax purposes in the country of incorporation of the company at the beginning and at end of the year;
(iii) In case of any other asset, it shall be its value as per books of account.
 

3. Number of employees
The number of employees shall be the average of the number of employees as at the beginning and at the end of the year and shall include persons, who though not employed directly by the company, perform tasks similar to those performed by the employees.
 

4. Payroll
The term “payroll” shall include the cost of salaries, wages, bonus and all other employee compensation including related pension and social costs borne by the employer.
 

5. Passive Income – of a company shall be aggregate of,
(i) income from the transactions where both the purchase and sale of goods is from/to its associated enterprises; and
(ii) income by way of royalty, dividend, capital gains, interest or rental income.
However, any income by way of interest shall not be considered to be passive income in case of a company which is engaged in the business of banking or is a public financial institution, and its activities are regulated as such under the applicable laws of the country of incorporation.