Determination of place of effective management– ABOI & other principles

Determination of place of effective management (POEM) – ABOI and other principles

1.    Introduction to POEM:-

Section 6(3) of the Income-tax Act, 1961 (the Act), prior to its amendment by the Finance Act, 2015, provided that a company is said to be resident in India in any previous year, if it is an Indian company or if during that year, the control and management of its affairs is situated wholly in India. This allowed tax avoidance opportunities for companies to artificially escape the residential status under these provisions by shifting insignificant or isolated events related with control and management outside India. To address these concerns, the existing provisions of section 6(3) of the Act were amended vide Finance Act, 2015, with effect from 1st April, 2016 to provide that a company is said to be resident in India in any previous year, if-

1. It is an Indian company; or
2. 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 Finance Act, 2016 has changed the effectivity of the said amendment to section 6(3) of the Act. Therefore, the amended provision would now be effective from 1 st April 2017 and will apply to Assessment Year 2017-18 and subsequent assessment years.

2.  General guidance for determination of POEM:-

The process of determination of POEM would generally be: −

1. Based on facts and circumstances;
2. Driven by substance over form;
3. Based on the place where decisions are taken, rather than the place of implementation of the decisions.
   

Note:-

• Day-to-day routine operational decisions shall not be relevant for the determination of POEM.
• An entity may have more than one place of management, but it can have only one POEM at any point of time. The POEM will be required to be determined on a year-to year basis.

3.  Guidance for Companies engaged in Active Business outside India (ABOI):- 

A company shall be said to be engaged in “active business outside India” if the passive income is not more than 50% of its total income; and

1. Less than 50% of its total assets are situated in India; and
2. Less than 50% of total number of employees are situated in India or are resident in India; and

• The payroll expenses incurred on such employees is less than 50% of its total payroll expenditure.

Definitions of Important Terms:-

1. The Income shall be, –

(a) As computed for tax purpose in accordance with the laws of the country of incorporation; or

(b) As per books of account, where the laws of the country of incorporation does not require such a computation.

“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.

2. The value of assets, –

(a) In case of an individually depreciable asset, 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 previous year; and

(b) In case of pool of a fixed assets being treated as a block for depreciation, 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;

(c) In case of any other asset, shall be its value as per books of account;

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

POEM guidelines for “active business outside India”  

For a company engaged in active business outside India, the POEM will be presumed to be outside India if a majority of the meetings of the board of directors of the company are held outside India.

However, if it is established that the board of directors are standing aside and not exercising their powers of management, and such powers are being exercised by either the holding company or any other person resident in India, then the POEM shall be considered to be in India.

For the purpose of determining whether the company is engaged in active business outside India, the average of the data of the previous year and two years prior to that shall be taken into account.

In case the company has been in existence for a shorter period, then data of such period shall be considered.

Where the accounting year for tax purposes, in accordance with laws of country of incorporation of the company, is different from the previous year, then, data of the accounting year that ends during the relevant previous year and two accounting years preceding it shall be considered.

4.  Guidance for Companies NOT engaged in Active Business outside India:-

For companies not engaged in active business outside India, a two-stage process for the determination of POEM is provided as follows:

1. Identifying or ascertaining the person or persons who actually make the key management and commercial decisions for the conduct of the company’s business as a whole.
2. Determination of the place where these decisions are being taken.
   

The following guiding principles are provided in this context, none of which could unilaterally decide the POEM but will have to be considered on a holistic basis. 

• Location of meeting of the company’s board:- The place where the company’s board regularly meets and makes decisions can be considered as the POEM, provided that the company’s board: retains and exercises its authority to govern the company; and · does, in substance, make the key management and commercial decisions necessary for the conduct of the company’s business as a whole. If the key decisions by the directors are being taken in a place other than the place where the formal meetings are being held, then such other place would be relevant for the determination of POEM.

• If the board has de facto delegated the authority to make key management and commercial decisions for the company to the senior management or any other person, including a shareholder, promoter, strategic/ legal/ financial advisor, and does nothing more than ratify such decisions, then the POEM would be the place where such senior management or other persons make those decisions.

The term ‘senior management’ has been defined and it includes key managerial personnel such as managing directors, CEOs, CFOs and heads of various divisions/ departments, such as sales or marketing.

• Location of the head office of a company:-
  

• Factors that do not by itself establish POEM:-
  

The determination of POEM is to be based on all relevant facts related to the management and control of the company and not on the basis of isolated facts, which do not establish effective management, as illustrated below.

1. A foreign company is completely owned by an Indian company.
2. Foreign company has a permanent establishment in India.

• One or some of the directors of a foreign company reside in India.

1. Local management being situated in India, in respect of activities carried out by a foreign company in India.
2. The existence in India of support functions that are preparatory and auxiliary in character.

5.  Concluding Remarks:-

It is reiterated that the above principles for determining the POEM are for guidance only. No single principle will be decisive in itself. The above principles are not to be seen with reference to any particular moment in time rather activities performed over a period of time, during the previous year, need to be considered. In other words a “snapshot” approach is not to be adopted. Further, based on the facts and circumstances if it is determined that during the previous year the POEM is in India and also outside India then POEM shall be presumed to be in India if it has been mainly /predominantly in India.