Koushik D C
We know that a new concept was introduced by the Finance Act, 2015 for determining the residential status of company incorporated in foreign jurisdiction [“Foreign company”], namely Place Of Effective Management [POEM] by substituting the section 6(3) of Income Tax Act, 1961[“Act”]. Accordingly a foreign company would be resident in India in any previous year if its POEM in that year is in India. There were no guidelines to determine the POEM under the Act. Hence, now CBDT has issued a circular No. 6 of 2017, dated 24.01.2017 under the subject Guiding Principles for determination of Place of Effective Management (POEM) of a Company [hereunder “Guidelines”]in this regard.
1. Objectives of the Amendment:
Prior to amendment by the Finance Act, 2015, a foreign company is said to be resident in India in any previous year if during that year, the control and management of its affairs is situated wholly in India. This allowed tax avoidance opportunities for such companies. To address these concerns, the existing provisions of section 6(3) of the Act were amended vide Finance Act, 2015.
2. Meaning of Place of effective management [POEM]:
POEM means 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.
‘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 tax treaties entered into by India recognises the concept of ‘place of effective management’ for determination of residence of a company as a tie-breaker rule for avoidance of double taxation.
Apply to A Y 2017-18 and subsequent assessment years.
4. How POEM is determined?
Determination of POEM is depended upon whether company is engaged in active business outside India or not, which are explained under the point 5 & 6 as follows:
5. Company engaged in active business outside India
5.1 The place of effective management in case of a company engaged in 1active business outside India shall be presumed to be outside India if the majority meetings of the board of directors of the company are held outside India.
5.2 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.
6. POEM in case of other companies
6.1 In cases of companies other than those that are engaged in active business outside India referred above, the determination of POEM would be a two stage process, namely:-
a) First stage would be identification or ascertaining the person or persons who actually make the key management and commercial decision for conduct of the company’s business as a whole.
b) Second stage would be determination of place where these decisions are in fact being made.
6.2 The place where these management decisions are taken would be more important than the place where such decisions are implemented. For the purpose of determination of POEM it is the substance which would be conclusive rather than the form.
6.3 Following are the guiding principles which may be taken into account for determining the POEM:
6.3.1 The location where a company’s Board regularly meets and makes decisions may be the company’s place of effective management provided, the Board-
(i) retains and exercises its authority to govern the company; and
(ii) does, in substance, make the key management and commercial decisions necessary for the conduct of the company’s business as a whole.
It may be mentioned that mere formal holding of board meetings at a place would by itself not be conclusive for determination of POEM being located at that place. If the key decisions by the directors are in fact being taken in a place other than the place where the formal meetings are held then such other place would be relevant for POEM.
6.3.2 A company’s board may delegate some or all of its authority to one or more committees such as an executive committee consisting of key members of senior management. In these situations, the location where the members of the executive committee are based and where that committee develops and formulates the key strategies and policies for mere formal approval by the full board will often be considered to be the company’s place of effective management.
6.3.3 The location of a company’s head office will be a very important factor in the determination of the company’s place of effective management because it often represents the place where key company decisions are made.
In situations where the senior management is so decentralised that it is not possible to determine the company’s head office with a reasonable degree of certainty, the location of a company’s head office would not be of much relevance in determining that company’s place of effective management.
6.3.4 The use of modern technology impacts the place of effective management in many ways. It is no longer necessary for the persons taking decision to be physically present at a particular location. Therefore physical location of board meeting or executive committee meeting or meeting of senior management may not be where the key decisions are in substance being made. In such cases the place where the directors or the persons taking the decisions or majority of them usually reside may also be a relevant factor.
6.3.5 In case of circular resolution or round robin voting the factors like, the frequency with which it is used, the type of decisions made in that manner and where the parties involved in those decisions are located etc. are to be considered.
6.3.6 The decisions made by shareholder on matters which are reserved for shareholder decision under the company laws are not relevant for determination of a company’s place of effective management.
However, the shareholder’s involvement can, in certain situations, turn into that of effective management. This may happen through a formal arrangement by way of shareholder agreement etc. or may also happen by way of actual conduct. As an example if the shareholders limit the authority of board and senior managers of a company and thereby remove the company’s real authority to make decision then the shareholder guidance transforms into usurpation and such undue influence may result in effective management being exercised by the shareholder.
6.3.7 It may be clarified that day to day routine operational decisions undertaken by junior and middle management shall not be relevant for the purpose of determination of POEM.
In certain situations it may happen that person responsible for operational decision is the same person who is responsible for the key management and commercial decision. In such cases it will be necessary to distinguish the two type of decisions and thereafter assess the location where the key management and commercial decisions are taken.
6.4 If the above factors do not lead to clear identification of POEM then the following secondary factors can be considered :-
(i) Place where main and substantial activity of the company is carried out; or
(ii) Place where the accounting records of the company are kept.
7. Other points to be noted:
1) Any determination of the POEM will depend upon the facts and circumstances of a given case. It may be noted that an entity may have more than one place of management, but it can have only one place of effective management at any point of time.
2) Since “residence” is to be determined for each year, POEM will also be required to be determined on year to year basis. The process of determination of POEM would be primarily based on the fact as to whether or not the company is engaged in active business outside India.
3) It needs to be emphasized that the determination of POEM is to be based on all relevant facts related to the management and control of the company, and is not to be determined on the basis of isolated facts that by itself do not establish effective management, as illustrated by the following examples:
(i) The fact that a foreign company is completely owned by an Indian company will not be conclusive evidence that the conditions for establishing POEM in India have been satisfied.
(ii) The fact that there exists a Permanent Establishment of a foreign entity in India would itself not be conclusive evidence that the conditions for establishing POEM in India have been satisfied.
4) 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. 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.
5) 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.
1A company shall be said to be engaged in “active business outside India” if the 2passive income is 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% of its total payroll expenditure.
2“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.
It is worth noting that the above principles for determining the POEM are for guidance only and no single principle will be decisive in itself. Since, POEM is to be determined on year to year basis considering the facts and circumstances of a given case, now it would a great deal for foreign companies to determine their POEM. Further, as POEM concept is one of substance over form, we can expect more clarity in the near future by ways of case laws, circulars etc.
Reference: CBDT Circular No. 06 of 2017 dated 24th January, 2017
Views expressed herein are not necessarily the views of any relevant statutes. Author is not responsible for the correctness or otherwise of the contents published herein.
Author is an Independent Accounting/Tax Professional and can also be reached at Koushik.firstname.lastname@example.org / www.linkedin.com/in/koushikdc