Guiding Principles for determination of Place of Effective Management (POEM) of a Company

The concept of “Place of Effective Management” (POEM) was introduced for deciding the residency status of a non-Indian company, by Finance Act, 2015 which is applicable from 1st April, 2017. Further it shall be applicable to a company having turnover or gross receipts of more than Rs. 50 cr. in a financial year. Any determination of the POEM will depend upon the facts and circumstances of a given case. Since “residence” is to be determined for each year, POEM will also be required to be determined on year to year basis.

Prior to its amendment a company was said to be resident in India only if it is an Indian company or during that year, the control and management of its affairs is situated wholly in India. Through which companies were creating tax avoidance opportunities to artificially escape the residential status by shifting insignificant or isolated events related to control and management outside India.

POEM is an internationally recognised test for determination of residence of a company incorporated in a foreign jurisdiction and 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. Most of the tax treaties entered into though India recognises the concept of POEM for determination of residence of a company.

For determining the POEM, we need to perform “ACTIVE BUSINESS OUTSIDE INDIA” (ABOI) test alongwith the guiding principles, namely:

  • Companies fulfilling ABOI test
  • Companies not fulfilling ABOI test
  • The POEM of a company engaged in ABOI shall be presumed to be outside India if the majority of board meetings of the company are held outside India. However, if it is established that the Board of directors (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 resident in India, then the POEM shall be considered to be in India.

For this purpose, merely because the BoD follows general and objective principles of global policy of the group laid down by the parent entity and not being specific to any entity or group of entities per se; would not constitute a case of BoD of companies standing aside.

Guiding Principle:

  • A company will be deemed to be engaged in ABOI if
  • the passive income is 50% or less of its total income; and
  • less than 50% of its total assets are situated in India; and
  • less than 50% of total number of employees including the persons, who are not directly employed by the company, 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.
  • Income to be computed as per the tax laws of the country of incorporation and if that law doesn’t require such computation then as per books of account.
  • An average of value of assets & number of employees for previous three years or a shorter period for which company has been in existence must be taken into account for ABOI test.
  • “Passive income” of a company shall be aggregate of, –
  • income from the transactions where both the purchase and sale of goods is to/from its associated enterprises; and
  • income by way of royalty, dividend, capital gains, interest or rental income;

However in case of a company engaged in business of banking or public financial institution, income by way of interest will not be considered to be passive income.

  • In case companies other than those engaged in ABOI, the determination of POEM would be a two stage process, namely:-
  • 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.
  • Determination of place where these decisions are in fact being made.

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.

Guiding Principle:

♣ The location where BoD regularly meets and makes decisions may be the company’s POEM provided, the Board retains and exercises its authority to govern the company and, in substance, make the key management and commercial decisions necessary for the conduct of the company’s business as a whole.

♣ A company’s board may delegate* some or all of its authority to one or more committees like executive committee, consisting of senior management or any other person including a shareholder, promoter, strategic, legal or financial advisor. POEM shall be deemed to be the place where

  • the members of the executive committee are based and
  • the committee develops and formulates the key decision for mere formal approval by the Board.

*The delegation of authority may be either de jure or de facto.

  • “Head Office” (HO) of a company would be the place where the company’s senior management and their direct support staff are primarily or predominantly located.

Location of HO is a very important factor in determining the POEM because it represents the place where the key decisions are made.

If the company’s senior management and their support staff are based in a single location and that location is held out to the public as the company’s principal place of business then POEM will be the place where HO is located.

  • With the use of technology such as video conferencing, physical presence is not so necessary for decision making. Therefore physical location of various meetings will the place where the majority of directors or the KMPs usually reside instead where the key decisions in substance are being made.
  • In case of circular resolution or round robin voting it would be required to determine the person who has the authority and who exercises the authority to take decisions. The place of location of such person would be of more important.
  • Some matters like dissolution, liquidation, sale of major part of undertaking etc. under companies law are reserved for shareholders, and decision on those matters are not relevant for determination of company’s POEM. These matters typically relate either to the existence of the company or to the rights of the shareholders, and not to the conduct of the business from a management or commercial perspective and therefore are not relevant for the determination of a company’s POEM.

But in certain situations the shareholder’s involvement can turn into that of effective management. For example, if shareholders restrict the authority of board and senior managers to make decision then the shareholders guidance transforms into usurpation and such undue influence may result into effective management.

If the above factors do not lead to clear identification of POEM then the following Secondary Factors can be considered:-

  • Place where main and substantial activity of the company is carried out; or
  • Place where the accounting records of the company are kept.

The determination of POEM is based on all relevant facts related to the management and control of the company, and is not determined on the basis of isolated facts illustrated below:

  • Foreign company is wholly owned by an Indian company.
  • Foreign company has a Permanent Establishment in India.
  • One or more directors of a foreign company reside in India.
  • Local management situated in India is responsible for activities carried out by a foreign company in India.
  • Support functions that are preparatory and auxiliary in character in India.

Administrative Safeguard:

Prior approval of senior tax officers is necessary before the Assessing Officer (AO) determines a foreign company’s POEM residency.

The three-member board’s approval, consisting of Principal Commissioners or the Commissioners must be obtained before holding that foreign company is a POEM resident. The collegium so constituted will grant the taxpayer opportunity of being heard before issuing directions to the tax officer.

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June 2021