CA Mehul Saboo
 BACKGROUND/ERSTWHILE POSITION (prior to the amendment in section 6(3) of the Income Tax Act, 1961, vide the Finance Act, 2015):
1.1 Under the provisions of the Income Tax Act, 1961 (hereinafter for the sake of brevity referred as “the Act”) to determine the quantum of tax liability of “persons” it is essential to determine the residential status u/s 6 of the Act of every such person for every previous year. As the subject matter of this article/paper is focused only on the residential status of companies (being a person defined u/s 2(31) of the Act) provisions of erstwhile sub-section 3 of section 6 of the Act are enshrined upon for determining the residential status of companies. Section 6(3) of the Act reads as under:
“6. For the purposes of this Act, —
(3) A Company is said to be resident in India in any previous year, if—
(i) It is an Indian Company; or
(ii) During that year, the control and management of its affairs is situated wholly in India.”(Emphasis supplied)
1.2 From the above, it is aptly evident that there are two alternative test to determine the residential status of a Company i.e. (a) If it is an Indian Company defined under sub-section 26 of section 2 of the Act (b) If the control and management of its affairs is situated wholly in India during the previous year. Thus, every Indian Company, being defined under section 2(26) of the Act, is a resident in India even if the control and management of its affairs is partly or wholly situated abroad; while a foreign Company is deemed to be resident in India only if, its control and management is situated wholly in India during that year.  However, on a plain reading of the above clauses, there appears to be a lacuna in the drafting of the provisions of the Act, which was being misused and exploited by numerous companies, explained in the subsequent paragraph.
1.3 The provisions of clause (ii) of sub-section (3) of section 6 of the Act uses the words “control and management of its affairs is situated wholly in India during that previous year”. The words wholly in India provided an option to numerous foreign companies which are substantially and effectively controlled from India, to shift its residential status by exploiting the lacuna created on using the words “wholly in India” with the primary intention to evade taxes. This position can be demonstrated with the help of an illustration.
E.g. Say Company ‘X’ a foreign Company is a 100% subsidiary of Company ‘Y’ an Indian Company. Majority of the substantial decisions in relation to the control and management of the affairs of Company ‘X’ are taken effectively by Company ‘Y’ in India. However, few isolated decision substantial to the control and management of Company ‘X’ are taken outside India where Company X is incorporated by holding a board meeting. Prima facie, since the majority of the decision-making related to the control and management of the affairs of Company ‘X’ is being taken in India during the previous year, Company X should become a resident in India in accordance with the provision of section 6(3)(ii) of the Act. However, due to few isolated decisions/events/transactions of Company X being taken outside India, Company ‘X’ will become a non-resident in India during the previous year, as the language used in section 6(3)(ii) of the Act states that the control and management of the affairs of the Company should be wholly in India during that previous year.
1.4 The repercussion of this being; even when the affairs of certain foreign companies are substantially controlled and managed from India, still by undertaking or executing few isolated decision/events related to the affairs of the Company outside India (see example in para 1.3) it outruns the residential status in India due to the lacuna in the language of section 6(3)(ii) of the Act i.e. the control and management of the affairs of the Company should be wholly in India during that previous year. Many companies have exploited this lacuna in the provision of section 6(3) of the Act by creating shell companies outside India which even though are substantially controlled and managed from India, however due to few isolated decisions/events related to the affairs of the Company being taken outside India, does not satisfy the residential status parameter laid down under section 6(3)(ii) of the Act.
 TRANSITION IN THE ACT (Post amendment to section 6(3) of the Act, vide Finance Act, 2015):
2.1 In order to curb the erstwhile lacuna in the language of the Act and to prevent formations of various foreign shell companies, which are eventually controlled and managed from India, the Government of India amended the provision of clause (ii) of sub-section 3 of section 6 of the Act vide Finance Act, 2015 to avoid future revenue losses and prevent tax abuse. The amended provisions of section 6(3) stand as under having legal force w.e.f. 01.04.2016 
“6. For the purposes of this Act, —
(3) A Company is said to be resident in India in any previous year, if—
(i) It is an Indian Company; 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 the business of an entity as a whole, are in substance made.” (Emphasis supplied)
2.2 The erstwhile parameters for determining the residential status of companies being “control and management of its affairs wholly in India during the previous year” stands replaced with the words “place of effective management in that year in India”. The logic behind introducing POEM is; it is an internationally recognized concept for determining the residential status of companies incorporated in foreign jurisdiction. Further, most of the tax treaties (DTAA) entered into by India recognizes the concept of ‘place of effective management’ for determination of residence of a Company as a tie-breaker rule while determining the residential status of companies for avoidance of double taxation.Therefore, POEM is an additional tool bestowed by the government in the hands of the revenue authorities to curb the formation of foreign shell companies and prevent future revenue losses.
2.3 So what exactly is place of effective management (POEM) and how to determine it?
POEM as stated in the explanation to the amended section 6(3)(ii) of the Act 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. In order to provide further clarification on the ambiguous meaning of POEM in the aforementioned explanation, the explanatory memorandum to Finance Bill, 2015 states that, a set of guiding principles will be issued that will need to be followed by foreign companies in determination of POEM. These guiding principles would be issued with the primary intention to ease the taxpayers as well as tax authorities efforts in determination of POEM for foreign companies in every previous year. In lieu with the explanatory memorandum to the Finance Bill, 2015, The Central Board of Direct Taxes (CBDT) vide F.No. 142/11/2015-TPL dated 23.12.2015 issued “Draft guiding principles for determination of POEM of a Company”.
 IMPLICATIONS AND POTENTIAL OUTCOMES OF THE “DRAFT GUIDING PRINCIPLES”
3.1 The draft guideline’s broadly conceptualizes two aspects in determination of POEM, i.e. (A) Companies engaged in active business outside India (B) Companies other than those classified in point (A) above. i.e. companies not engaged in active business outside India.
3.2 (A) Companies engaged in active business outside India:
A Company will be said to be engaged in active business outside India, if:
(a) Its passive income is not more that 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 are less than 50% of its total payroll expenditure.
3.2.1 The point of focus is that, all the above-mentioned points i.e. (a) – (d) are to be read in conjunction with each other and not isolation, since the word “and” is used at the end of each and every condition and not “or”. Each condition is in addition to the previous one and is not mutually exclusive to each other. The implication of this being, that even if the Company satisfies one or more of the above mentioned condition but does not satisfy all of the above conditions then, it will fail the test laid down for it to be considered as a Company actively engaged outside India.
3.2.2 Another point, which requires attention, are the words “passive income” being mentioned in condition (a) of para 3.2. The draft guidelines provide the definition of passive income, which is as follows: (i) Income from transaction where both the purchase and sale of goods is from/to its associated enterprise. (ii) Income by way of royalty, dividend, capital gains, interest on capital or rental income. Therefore, if the Company has passive income from the above-mentioned clauses (i) and (ii) and the aggregate of such income comprises more than 50% of its total income then, the Company will not be considered as Company actively engaged outside India.
3.2.3 Reiterating, for a Company to be actively engaged outside India it has to satisfy all the conditions mentioned in para 3.2. However, the plausible question, which arises, is for what time period the data is to be considered while determining the parameters (a) – (d) in Para 3.2 above. Whether, only the data for the current year is to be considered or even previous years data is to be considered in determination of POEM. The draft guidelines has taken into account this issue and explained that the “average of the data of the previous year and two years prior to that year shall be taken into consideration while determining POEM. However, for companies which are in existence for a shorter duration i.e. incorporated recently, then data of such short duration shall be considered in determination of POEM”.
3.2.4 One of the possible repercussion of taking the average data of the current year and two previous year would be that, every Company will be able to determine whether it is actively engaged in business outside India or not, only at the end of the current year, when the books of accounts (BOA) of the Company are finalized and adopted by the shareholders. This is so because, the data for the current year cannot be considered while determining POEM unless they are finalized, which usually happens by the end of accounting year say by 31st March XXXX. This could provide possible opportunity to the companies to modify its current year data by the end of the year, which would then show different data in comparison with the data/position held by the Company during the year. Since, POEM is to be considered for the entire year and not for a given point in time of a year, many companies could exploit the option of manipulating their books of accounts i.e. BOA maintained by them, by the end of the year showing manipulated results.
3.2.5 Another implication, which needs to be needs to be understood, is taking the average data for three years i.e. current year and two previous years. Since, POEM for a Company is to be determined on a year-to-year basis, by implementing the concept of averaging the three years data of the Company, there will always be an unintentional influence of the data of the previous two years in determination of POEM for the current year. To exemplify, the data for the previous two years could dilute the data of current year while taking the average, thereby not revealing the legitimate position of the Company for the current year in determination of POEM. In my view, averaging the three year data of Company, does not contemplate the modus operandi behind introducing POEM as POEM is to be determined on a year-to-year basis and only the data or facts of the current year should be the sole determinative factor for POEM of a Company.
3.2.6 Yet, another issue that could arise is, by using the words “employees” in condition (c) and (d) of para 3.2 (A). Many companies could exploit the use of the term employee by appointing “consultants” instead of employees. A consultant would not bear the employer-employee relationship like an employee and would be paid professional fees instead of salary. By doing so, many foreign companies may have several consultants in India but not employees wherein, it could lead to a possible outrun from the POEM implication. Therefore, this issue also needs to be given due consideration as the word “employee” could get replaced by the words work force/ man power or other akin terminologies in the final guidelines for determination of POEM.
3.2.7 The whole idea behind identifying whether a Company is actively engaged outside India or not is that, POEM shall be presumed to be outside India for all the companies actively engaged outside India, assuming the majority of the meetings of the Board of directors (BOD), where substantial decision for the Company is being taken are held outside India. In other words, for all foreign companies actively engaged in business outside India and also holding board meeting outside India will generally have a POEM outside India and should not be considered as a resident in India for that previous year. However, if on the basis of facts and circumstances, it is established that the BOD of the Company 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(s) resident in India, then the inherent presumption, of having POEM outside India will be rebutted and the POEM for such companies shall be considered in India.
3.3 (B) Companies other than those classified in point (A) of Para 3.2:
3.3.1 For companies falling within the purview of this category, POEM will be determined by recognizing two significant factors i.e. (i) Identification or ascertainment of person(s) actually undertaking the key management and commercial decisions for the conduct of the Company as whole (ii) Determination of the place where these key managerial and commercial decisions of the Company as a whole are in fact being taken. One of the significant factors influencing in determination of POEM is the place where key managerial and commercial decisions are being taken for the Company and . therefore, it is of utmost importance to determine the place/location where the key decisions for the Company are taken.
3.3.2 The plausible question, which arises, is how to determine the place and the person(s) undertaking the key managerial and commercial decision for the Company as a whole. It is a settled position of law that the Company is a separate legal entity and an artificial person created in the eyes of the law. Since, the Company is abstract in nature and cannot act or take decision on its own; usually the BOD are the person(s) responsible for taking the key commercial and managerial decisions for the conduct of the Company. However, if the Company follows a decentralized structure of hierarchy and the powers of taking key substantial decisions lie with the senior management then, such senior management will be considered as the responsible person(s) for the Company as a whole. The draft guidelines defines senior management as “the person(s) who are generally responsible for developing and formulating key strategies and policies for the Company and also ensuring the executions of those strategies on a regular and on-going basis”. (Emphasis supplied)
3.3.3 In light of para 3.3.1 and 3.3.2 it can be stated that, POEM of a Company will be that place/location where the BOD or the senior management, as the case may be, decides, executes and formulates core strategies, commercial and managerial decisions for the Company. However, this will hold true only when the BOD or the senior management retains and actually exercises the powers/authority and does in substance formulate key managerial and commercial decisions for the conduct of the Company. By merely holding a board meeting or by simply ratifying the decisions taken by some other person(s) in regards to the conduct of the undertaking at a different place will not reallocate the companies POEM to that different place.
E.g. Say, the BOD of Company X (a foreign Company) has de facto delegated their decision making powers/authority to person(s) in India, which indeed makes key decisions for Company X as a whole, in India. Subsequently the BOD of Company X by holding board meetings in the foreign country merely ratifies the key decisions taken by the person(s) in India for Company X. Under such situations, the POEM of the Company will not be in that foreign country but will be considered in India, as the key decisions for the Company as a whole are being undertaken in India.
3.3.4 In a plain vanilla structure, where the Company follows a decentralized structure of hierarchy and the key decisions for the Company has a whole are being taken by the senior management or an executive committee from a single location/place, then POEM would be comparatively easier to determine as compared to a situation where the individual members of the senior management or an executive committee executes decisions for the Company from various locations/places. Since, the entire emphasis of POEM is on the basis of place where the key commercial and managerial decisions are being taken, such a situation could lead to possible confusion in determination of POEM.
3.3.5 In order to avoid the possible confusion, the draft guidelines resorts to the definition of “head office” of a Company, as under normal circumstances the head office of the Company is the place/location where the key commercial and managerial decisions for the Company as a whole are being taken. “Head office,” means a place where the Company’s senior management and their direct support staff are located or, if they are located at more than one location, then the place where they are primarily or predominately located”. However, in a situation where the senior management or the members of the executive committee take decisions for the Company as a whole from various places then, the head office would be that place/location where these senior managers:
(i) Are primarily or predominantly based; or
(ii) Normally return to following travel to other locations; or
(iii) Meet when formulating or deciding key strategies and policies for the Company as a whole.
3.3.6 In my view, the aforesaid conditions i.e. (i) – (iii) in para 3.3.5 are mutually exclusive to each other and the failure of one condition would shift the determination of head office to the next condition until that condition, which is best suited from all the aforesaid three conditions while determining POEM is identified. A Company may have many persons classified as senior management however, the draft guidelines are silent on the quantum of personnel required to be analyzed while evaluating conditions (i) – (iii) in Para 3.3.5. In my view, the majority from the total personnel considered as senior management of the Company should be taken in account while assessing for each and every condition as these conditions are mutually exclusive of each other. This position can be better explained with the aid of an illustration.
E.g. Suppose X (a Company incorporated in country 1) poses a decentralized structure of hierarchy having 10 persons classified as senior management. Only couple of the members of the senior management are primarily or predominately based in say country 1 with other senior members scattered in various countries. Majority of the members return to different countries following their travel however, all the senior managers meet a single location, say country 2, for formulating or deciding key strategies and policies for the Company as whole. Under such situation, while determining head office of the Company X, the best-suited answer emerges on fulfilling condition (iii) in para 3.3.5 as, all the senior managers meet at a single location (country 2 in the above e.g.) for formulating or deciding key strategies and policies for the Company. Therefore, the head office of Company X in the above example would be country 2.
3.3.7 It is now clear that POEM is a place-oriented concept. However, the use of modern technology impacts the place of key decisions for the Company in many ways. It is no longer necessary for the person(s) taking decisions to be physically present at a particular location. Therefore, physical location of a board meeting or the executive committee meeting or the meeting of the senior management may not be where the key decisions are in substance being made. The person(s) responsible for taking decisions for the Company as a whole may also do so via telephones or video conferencing rather than being physically present at that place/location. The benefit of taking decision over the phone or through video conferencing is that it saves substantial time, money and efforts of the person(s) responsible for taking decisions; on the contrary it complicates the determination of POEM. Therefore, in such cases POEM would be determined on the basis of the place/location where the majority of the highest levels of management of the Company say, the Managing Director or the Chairman and their direct support staffs are located.
3.3.8 It needs to be appreciated that, the draft guidelines have attempted to cover many possible scenarios in determination of POEM, leaving with, the scope of improvements in determination of POEM of Company in certain aspects, which could be incorporated in the final guidelines to be issued by the CBDT. However, there is always a possibility of a certain situation emerging for a Company that due to its complete decentralized hierarchy, it may not be able to determine its POEM in accordance with the varied factors mentioned in the aforementioned. Under such situations, there will be no other alternative for the Company but to resort to the secondary factors in determination of POEM for that year. These secondary factors are as follows: (i) Place where the main and substantial activity of the Company is carried out (ii) Place where the accounting records of the Company are kept. However, at this stage it is difficult to comprehend the logic behind incorporating point no. (ii) (above) in the draft guidelines, as the place of the accounting records can be easily changed and manipulated by all the companies.
 ROAD TO CLIMAX BY COMPREHENDING CERTAIN ADDITIONAL CHARACTERISTICS/FACTORS:
4.1 The definition of POEM uses terminologies such as key management and commercial decisions that are necessary for the conduct of the business of a Company. What are key managerial and commercial decisions for the Company as a whole is a subjective concept and will be different for each and every Company. Key managerial and commercial decisions would generally mean decisions which are concerned with broader strategic and policy decisions and are made and executed by the BOD or senior management or executive for the Company as a whole. No definite set of parameters can be determined in general for identification of the key decisions for a Company. Therefore, POEM is a very subjective concept and every Company will have to undertake its own analysis of key commercial and managerial decisions in determination of POEM. However, a point to be highlighted here is that only key managerial and commercial decisions taken by BOD or senior management or executive committee should be taken into account while determining POEM for a Company. The operational, day to day routine, ancillary support decisions undertaken by the junior and middle level hierarchy of the Company will under no circumstance influence the POEM of a Company.
4.2 Yet another important aspect, which the Company will need to adhere, is the maintenance of proper and various documents for justifying its POEM. Without proper documentation such as minutes of board meetings, documents evidencing the place/location where the key decisions are taken etc. the Company will not be in a position to successfully justify its POEM before the revenue authorities and could expose itself to taxation in India.
4.3 POEM is an effective tool given by the Government of India in the hands of the revenue authorities, it is of utmost importance to take into consideration that the revenue authorities do not misuse it as this will cause unnecessary increase in the number of litigation and will be troublesome for the taxpayers. Therefore, in order to protect the interest of the taxpayers and to avoid unnecessary litigations, the Assessing Officers (AO) who proposes to hold a Company incorporated outside India on the basis of POEM as being resident in India will have to produce proper reasons, findings and also mandatorily seek prior approval of the Principle Commissioner or the Commissioner of Income Tax (I.T), as the case may be in this regards. However, an opportunity of being heard will be given to the foreign Company by the Principle Commissioner or the Commissioner (I.T) as the case may before adjudicating the matter.
4.4 Further, it needs to be emphasized that the determination of POEM would be based on all relevant facts and circumstances of the Company as a whole and will not be determined merely on the basis of isolated facts and circumstances. It should be kept in mind that the primary intention of introducing POEM vide the Finance Act, 2015 is to curb or prevent the incorporation of shell companies outside India, which are effectively controlled and managed from India. Therefore, the revenue authorities merely relying on the basis of isolated facts and circumstances cannot determine the POEM of a Company to be in India. Few examples of such isolated events are specified in the draft guidelines itself which are as follows:
(i) The fact that the foreign Company is completely owned by an Indian Company will not be conclusive evidence in determination of POEM of such foreign Company in India.
(ii) The mere fact that, one or some of the director of a foreign Company resides in India will not a conclusive evidence for determination of POEM in India. Etc.
4.5 Another possible outcome with the advent of POEM in the Act is the risk of double taxation. There could arise a situation where a Company becomes a resident in two countries. E.g. Company X is incorporated in United States of America (USA) and on the basis of it being incorporated over there, it becomes a resident in USA. However, The Income Tax authorities in India, on the basis of facts and circumstances, determine the POEM of Company X in India. Therefore, Company X becomes resident in two countries; firstly in USA on the basis on incorporation and secondly in India on the basis of POEM. Since, there is no guarantee that the other country (USA in the above e.g.) would accept the determination of POEM for Company X made by the Indian Income Tax Authorities, there should be more comprehensive rules and conventions laid down to avoid such situations in the final guiding principles to be issued by the CBDT.
5.1 POEM is a substance over form concept and no definitive set of rules can be documented for companies. All the aforementioned principles of POEM are to be used only as guidance and not as decisive factors in determination of POEM. The factors essential for the determination of POEM are not to be seen with reference to a particular moment in time, rather the activities performed by the Company as whole in the previous year will be considered in determination of POEM. The determination of POEM will be on a case-to-case basis and the same set of parameters cannot be applied to all the companies. Even though various factors/characteristic have been identified (see earlier paragraphs) in determination of POEM still there may be certain other additional factors, which the Company may resort to while justifying in determination of POEM. Further, there were considerably less litigation with regards to section 6 of the Act, but with the concept of POEM kicking in; in my view this position would definitely change in the coming years.
5.2 This article is based on the draft guiding principles for determination of POEM of a Company issued by the CBDT. All the view/opinions/ /explanations and other akin terminologies in all the aforementioned paragraphs are subject to changes made by the CBDT in the final guiding principles for determination of POEM of a Company.
 CA, LLB
 Section 2(31) of the Income Tax Act, 1961.
 Section 3 read with section 2(9) of the Income Tax Act, 1961 for previous year definition
 Kanga & Palkhivala’s (Volume I) “The Law and Practice of Income Tax”- Pg No. 318
http://indiabudget.nic.in/ub2015-16/memo/mem1.pdf- Pg No. 32
 Para 5 of the “Draft guiding principles for determination of POEM of a Company”
 Point (c) of para 5 of “Draft guiding principles for determination of POEM of a Company”
 See section 92A of the Income Tax Act, 1961 – definition “Associated Enterprise”.
 Solomon v/s Solomon.
 Para 5, Point (d) of “Draft guiding principles for determination of POEM of a Company”
 Para 8.2 of “Draft guiding principles for determination of POEM of a Company
 Para 5, Point (b) of “Draft guiding principles for determination of POEM of a Company
 Para 8.2, Point (c) of “Draft guiding principles for determination of POEM of a Company
 Para 8.2, Point (e) of “Draft guiding principles for determination of POEM of a Company
 Para 8.2, Point (f) of “Draft guiding principles for determination of POEM of a Company
 Para 8.2, Point (d) of “Draft guiding principles for determination of POEM of a Company
 Para 11 of “Draft guiding principles for determination of POEM of a Company
 Para 9 of “Draft guiding principles for determination of POEM of a Company