The term “Place of Effective Management’ (POEM) had already been in existence in the Income Tax Act, 1961 (‘The Act’) for the purpose of application of special provisions for taxing shipping companies based on their POEM. However, the usage of the concept for the purpose of determination of residence of a foreign company was first introduced in Direct Tax Code 2010. The said concept also found its place in the revised draft of Direct Tax Code, 2013.
Introduction of POEM in Income Tax Act, 1961
The Finance Bill, 2015 introduced the concept of POEM for determination of residence of companies by way of amending Section 6 of the Act replacing the words ‘control and management’ by ‘POEM’ as follows:
Section 6(3) of the Income Tax Act, 1961 prior to the Finance Bill 2015
Sec 6(3) of the Income Tax Act stated as follows:
‘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.’
Section 6(3) of the Income Tax Act, 1961 as per Finance Bill 2015
Sec 6(3) of the Income Tax Act to be stated as follows:
‘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, at any time in that year, is in India.’
Thus, initially, a company would have been considered as a resident in India provided the control and management of its affairs were wholly situated in India. But, in respect of the amendment, a company would be treated as resident if, at any time of the year, its place of effective management is in India.
However, the insertion of the wordings ‘at any time‘ in Sec 6(3) of the Act was highly criticized on the grounds that such an amendment would attract the applicability of POEM even in non-substantial cases. For instance, POEM would be attracted where even a single Board meeting would be held in India. Hence, the said wordings were removed as mentioned below in the Finance Act, 2015.
Section 6 of the Income Tax Act, 1961 amended as per Finance Act, 2015
As amended by the Finance Act, 2015 and w.e.f. April 1, 2017,
Sec 6(3) of the Income Tax Act, 1960 states as follows:
‘A company is said to be a 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.’
Need for the amendment
The need for the above-mentioned amendment was felt due to the following reasons:
1. The initial provisions required a corporate to have its entire control & management in India. Thus, it provided an opportunity for the companies to avoid tax by shifting insignificant or isolated events related to control & management outside India.
For instance, since the initial provision provided for the entire control & management to be outside India and that too for the entire year, the companies would often hold a few meetings outside India in order to escape the applicability of the residence rule, thus eluding the taxation in India.
2. The initial provision facilitated the creation of shell companies outside India which in reality were controlled from India. This was evident from the decision of the Delhi Tribunal in the case of Radha Rani Holdings vs. ACIT  110 TTJ Delhi 920. The amendment, thus, brings such shell companies into the tax bracket using the concept of POEM.
3. The concept of POEM has been used by various countries for determining the residential status and also is well recognized and accepted by the Organisation of Economic Cooperation and Development (OECD). Thus, in order to align the domestic laws with international standards, such an amendment would be beneficial to incorporate the concept in Indian tax laws.
However, due to the non-clarity regarding the applicability of guidelines for determining a POEM, certain issues arose regarding the payment of advance tax, the applicability of TDS, etc. Therefore, Finance Act, 2016 deferred the applicability of POEM to April 1, 2017, i.e. to be made applicable from Assessment Year 2017-18 and onwards. Accordingly, various circulars were issued by Central Board of Direct Taxes [CBDT] providing the guidelines for the determination of POEM as well as on the transition mechanism for taxing the foreign companies treated as residents in India for the first time.
This Article will deal with the following aspects of POEM:
1. Meaning of POEM and its applicability
2. Aids for Determination of POEM
3. As per Domestic laws
4. As per International laws
5. Administrative Safeguards
5. Transition Mechanism
6. Importance of POEM
7. Implications of POEM
1. MEANING OF POEM AND ITS APPLICABILITY
The Finance Bill, 2015 also provided an Explanation under Section 6(3) of the Act for POEM to mean any place where key management and commercial decisions that are necessary for the conduct of a business of the entity as a whole are, in substance made.
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 key management and commercial decisions or the meaning for the same not being specifically defined in The Act would be a prime matter of litigation.
The CBDT issued POEM guidelines by way of CIRCULAR NO. 6 OF 2017 [F.NO.142/11/2015-TPL] dated January 24, 2017, for the purpose of determination of POEM. The concept of POEM would be made applicable from the financial year 2016-17 i.e. AY 2017-18 onwards. However, POEM guidelines shall not apply to companies having a turnover or gross receipts of Rs. Fifty crores or less in a financial year.
2. AIDS FOR DETERMINATION OF POEM
A. AS PER DOMESTIC LAWS
Determination of POEM as per the guidelines
The process of determination of POEM
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 (ABOI).
(i) If a company is engaged in ABOI.
POEM of such company would be presumed to be outside India if the majority meetings of the board of directors (BOD’s) of the company are held outside India. However, whether such reference to the majority meetings pertains to the majority of the meetings where key decisions are taken or a majority of overall meetings would need clarification.
However, if BOD’s are standing aside and not exercising their power of management and such power is actually exercised by either the holding company or any other person(s) resident in India, then POEM 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 way of CBDT Circular No.25 Of 2017 [F.No.142/11/2015-Tpl (Part-I)], dated October 23, 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).
(ii) If a company is not engaged in ABOI.
In this case, the determination of POEM would be done in two stages:
(i) Identify the person/s who actually make the key management and commercial decision for the conduct of the company’s business as a whole.
(ii) Determination of place where these decisions are de facto made. The manner of determination of such location has been discussed in detail below.
The concept of Active Business Outside India
Rationale Behind the Concept
The intention of applying the ABOI test for determining POEM is not to bring under the residence bracket Indian multinational companies engaged in business activities outside India but shell companies and such other companies created for retaining income outside India although real control and management of affairs are located in India.
Provision for Determination Whether a Company Is Engaged in Active Business Outside India (ABOI)
A company shall be said to be engaged in “active business outside India” if
(i) its passive income is not more than 50% of its total income; and
(ii) less than 50% of its total assets are situated in India; and
(iii) less than 50% of the total number of employees are situated in India or are resident in India; and
(iv) the payroll expenses incurred on such employees is less than 50% of its total payroll expenditure.
For the purpose of such determination, the following meanings would be given to the below-mentioned terms:
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.
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.
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.
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.
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.
Period to be considered for the purpose of determination of ABOI
The following scenarios give an insight into the determination of POEM:
A Co., incorporated in country X, is a wholly owned subsidiary of Indian company B. Details of Co. A include the following:
(i) 30% – Purchases from non-associated enterprise & sales to associated enterprise.
(ii) 30% – Both purchases and sales from/to associated enterprise
(iii) 30% – Purchases from associated enterprise & sales to non-associated enterprise.
(iv) 10% – Interest Income.
Finding: In this case, since the passive income is 40% i.e. not more than 50%, taking into consideration points (ii) & (iv), Co. A is engaged in ABOI.
Finding: In this case, though A Co. satisfies the first 3 conditions relating to income, assets, and employees, the condition relating to payroll is not being satisfied as the payroll expenditure incurred for the employee’s resident in India is more than 50% i.e. 60%. Thus, Co. A cannot be considered as a company engaged in ABOI.
(i) 2 meetings – held in India.
(ii) 2 meetings – held in Country X.
(iii) 1 meeting – held in Country Y.
Finding: Since the company is engaged in ABOI (as per Case 1 finding) and the majority of meetings i.e. 3 out of 5 are held outside India, POEM of Co. A would be presumed to be outside India.
Finding: In this case, POEM cannot be held to be outside India as the power of decision making is actually exercised by the Indian holding company.
In this case, an Indian parent company A has 3 wholly owned subsidiaries as follows:
(i) Co. B and Co. C incorporated in Country X.
(ii) Co. D incorporated in Country Y.
Findings: Merely because of the POEM of the holding company is in India, the POEM of all of its subsidiaries cannot be taken to be in India. Since the subsidiaries are engaged in ABOI and also the majority of the board meetings are held in their respective countries, POEM shall be presumed to be outside India.
Determination of the location where the decisions are made
(i) Primary Factors
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.
Thus, the mere holding of a meeting cannot be a conclusive criterion to determine POEM if the key decisions are taken place at any other place. Also, the place where the decisions are made is more important than the place where such decisions are implemented.
(ii) Secondary Factors
(i) Place where the main and substantial activity of the company is carried out; or
(ii) Place where the accounting records of the company are kept.
The activities that would really constitute as main and substantial activities would again be a vague discussion which would unfold with time.
Isolated facts not amounting to POEM
The following mentioned isolated facts by itself would not establish a POEM:
(i) A wholly owned foreign subsidiary of an Indian company.
(ii) Permanent establishment of a foreign entity in India.
(iii) Director/s of a foreign company residing in India.
(iv) Local management situated in India in respect of the activities carried out by a foreign company in India.
(v) The existence of support functions in India that are preparatory or auxiliary in character.
Determination for the location of the Head Office
Though the location of a head office is not a decisive factor, it is one of the important factors to be considered while determining the POEM. A company’s head office is not necessarily the same as the place where the majority of its employees work or where it’s board typically meets. The meaning of the term can be derived as follows:
Head Office of a company would be the place where:
(i) the company’s senior management and their direct support staff are located or,
(ii) if they are located at more than one location, the place where they are primarily or predominantly located.
Senior Management in respect of a company would mean the person or persons who are generally responsible for developing and formulating key strategies and policies for the company and for ensuring or overseeing the execution and implementation of those strategies on a regular and ongoing basis. While designation may vary, these persons may include:
(i) Managing Director or Chief Executive Officer;
(ii) Financial Director or Chief Financial Officer;
(iii) Chief Operating Officer; and
(iv) The heads of various divisions or departments (for example, Chief Information or Technology Officer, Director for Sales or Marketing).
The following points are to be considered for the determination of the location of Head office of the company:
(i) Single Location
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 or headquarters, then such location is the place where the company’s head office is located.
a. Temporary Basis
If the members of the senior management operate from offices located in various countries at times, then the company’s head office would be the location where such senior managers:
b. Permanent Basis
If the participation of the members of the senior management from various locations is more or less on a permanent basis, then the head office of the company would normally be the location, if any, where the highest level of management and their direct support are located.
However, where the extent of decentralization of the senior management is so high that it is not possible to determine the company’s head office with a reasonable degree of certainty, then the location of the head office would not be considered as relevant in determining POEM.
B. AS PER INTERNATIONAL LAWS
One of the major reasons for shifting the focus of POEM to economic nexus was to align the domestic law with international conventions. The concept of POEM has been well recognized by the following international conventions:
(i) OECD Model Tax Convention
(ii) UN Model Tax Convention
(iii) Multilateral Instrument
However, the term ‘POEM’ has not been specifically defined in any of the International Conventions.
The domestic laws of different countries may have different factors for the purpose of determination of residency and thus, there can be instances when an enterprise would be considered as a resident in more than one country. As per the International tax laws, POEM is used as a tie-breaker rule in case of an enterprise attracting residency of more than one nation.
However, CIRCULAR NO. 6 OF 2017 [F.NO.142/11/2015-TPL] states that in case of an enterprise having POEM in India as well as outside India, POEM of such enterprise would be presumed to be in India provided POEM has been mainly/predominantly in India. The term ‘mainly/predominantly’ has not been given any explicit meaning. Also, whether such a provision would override the treaty provisions is also quite uncertain.
3. ADMINISTRATIVE SAFEGUARDS
4. TRANSITION MECHANISM
Special provisions for taxing foreign companies treated as residents in India u/s 6(3) of the Act for the first time were introduced by way of Chapter XII-BC consisting of Sec 115JH through Finance Act, 2016. A draft notification [F No 370142/19/2017-TPL dated June 15, 2017] was issued by CBDT in order to clarify the following points:
(i) Computation of total income.
(ii) Treatment of unabsorbed depreciation.
(iii) Set off or carry forward and set off of losses.
(iv) Collection and recovery and special provisions relating to avoidance of tax.
In respect of the above-said notification, CBDT issued a final notification [Notification No. 29/2018 dated June 22, 2018] with some amendments in the draft notification. The said final notification would be applicable from the financial year 2016-17. The notification states the following points:
Calculation of Depreciation
Since the foreign company is treated as a resident for the first time in India, issues may arise regarding the asset value to be considered for calculating the depreciation. The same would be considered as follows:
(i) If the foreign company is assessed to tax in the foreign jurisdiction
(a) Where depreciation is considered for computation of total income
The written down value (WDV) as appearing in the tax records on the 1st day of the previous year should be considered as opening WDV for the purpose of calculating depreciation as per the Act.
(b) Where depreciation is not considered for computation of total income
In this case, the depreciation would be calculated as though the asset was installed, utilized and depreciation was allowed on the same in accordance with the foreign laws and the WDV so arrived on as on the 1st day of the previous year would be considered as the opening WDV for the purpose of calculating depreciation as per the Act.
(ii) If the foreign company is not assessed to tax in the foreign jurisdiction
The written down value (WDV) as appearing in the books of accounts of the foreign companies on the 1st day of the previous year should be considered as opening WDV for the purpose of calculating depreciation as per the Act.
Set Off and Carry Forward of Losses and Unabsorbed Depreciation
(i) If the foreign company is assessed to tax in the foreign jurisdiction
The brought forward loss and unabsorbed depreciation shall be determined year wise as per the tax records of the foreign company as on the 1st day of the previous year.
(ii) If the foreign company is not assessed to tax in the foreign jurisdiction
The brought forward loss and unabsorbed depreciation shall be determined year wise as per the books of accounts prepared as per the foreign laws on the 1st day of the previous year.
Such determined foreign losses and unabsorbed depreciation as calculated on the 1st day of the previous year would be allowed to be set off and carried forward for the remaining period as per the Indian tax laws. Such remaining period would be computed taking into consideration the period in which the loss was incurred for the first time.
For instance, A is a foreign company which has incurred a business loss of Rs. 1,00,000 in the financial year 2013-14. The foreign company is treated as a resident for the first time in India in FY 2016-17 and the business loss remaining to be set off as on April 1, 2016, is Rs. 30,000. Such amount of 30,000 would be eligible to be set off over a period of next 5 years i.e. till the financial year 2018-19. This is because as per Indian tax laws, business loss can be carried forward for a period of 8 years and 3 years have already lapsed.
Note: Unabsorbed depreciation can be carried forward for an unlimited period.
Also, such losses are to be set off only against income of the foreign company which is chargeable to tax on account of it’s becoming an Indian resident. Thus, any set off of losses or unabsorbed depreciation cannot be made from the income of the foreign company which would have been chargeable to tax irrespective of its POEM. For instance, such set-off cannot be made against any income of the foreign company chargeable to tax on account of its having a Permanent Establishment in India.
Global income of the foreign company would be taxable. However, this provision will require bifurcation of the global income of the foreign company into two categories:
(i) Income of the foreign company chargeable to tax in India even though the POEM would not have existed
(ii) Other residual income apart from the income mentioned in Point (i). The set-off and carry forward would be allowed only against the income mentioned in Point (ii).
Any revision or modification in the treatment of losses and unabsorbed depreciation in the foreign jurisdiction would lead to simultaneous revision or modification in the treatment as per Indian laws. This would be a cumbersome procedure, for a revision in any one particular year would have rippling effects in the subsequent years. Moreover, the process followed by the Income Tax department to keep a tab on all such revisions made in the foreign jurisdiction will be a matter of question.
In case of differing accounting periods as per the foreign laws and Indian laws, then the period for the purpose of treatment of losses would be as follows:
If the period starting from the accounting period of the foreign company and ending on the 31st March of the year immediately preceding the preceding previous year during which the foreign company has been treated as a resident is
(i) less than 6 months, such period shall be included in the accounting year.
(ii) equal to or more than 6 months – such a period shall be treated as a separate accounting year.
(i) The accounting year followed by a foreign company is calendar year i.e. January 2017 to December 2017 and the foreign company is held to be resident in India for FY 2018-19. In this case, the accounting year for the purpose of setting off of losses would be from January 2018 to March 2019 i.e. to be increased by 3 months.
(ii) The accounting year followed by a foreign company is from July 1, 2017, to June 30, 2018, and the foreign company is held to be resident in India for FY 2018-19. In this case, the accounting year for the purpose of setting off of losses would be July 1, 2017, to March 31, 2018.
Thus, the loss and unabsorbed depreciation shall be allocated on a proportionate basis.
Preparation of Books – Different Accounting Periods
If the accounting period as followed by the foreign company is not corresponding to the accounting period followed in India, then the foreign company needs to prepare additional books of accounts starting from the end of its accounting period to 31st March of the year immediately preceding the previous year during which the foreign company has been treated as a resident.
Such books are to be prepared in addition to the books maintained for the financial year in which the foreign company is treated to be resident in India on account of its POEM.
For instance, a foreign company follows the calendar year as its accounting year. Such a foreign company is considered as a resident in India for FY 2016-17. In this case, the foreign company would be required to maintain books for FY 2016-17 as well as additional books of accounts for the period January 1, 2016, to March 31, 2016.
Tax Deduction at Source
Where one provision applies to the foreign company treated as a resident while a different provision applies to the foreign company, then the provision as applicable to the foreign company must be considered for such an application. For instance, on making any payment to a foreign company, if TDS is deductible u/s 194J as applicable to the foreign company treated as a resident as well as u/s 195 as applicable to the foreign company, then TDS has to be deducted u/s 195.
Also, a foreign company is required to comply only with such provisions of Chapter XVII-B relating to TDS as applicable to the foreign company and no further excess compliance to be made on it being treated as a resident.
These provisions reveal how a foreign company though treated as a resident for the purpose of taxation is not at par with the resident Indian companies.
The provisions of Sec 195(2) of the Act shall apply in such a manner so as to include payment to the foreign company.
Benefits of DTAA
The foreign company would be eligible to take unilateral relief u/s 91 as well as bilateral relief u/s 90 of the Act.
Foreign Tax Credit
Transfer Pricing Provisions
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.
Applicability of provisions of Indian Tax laws
Subject to the above, the foreign company resident in India shall be treated to be a foreign company for the purpose of applicability of all the other provisions even if it is said to be resident in India. Thus, the applicability of provisions of the Act to the foreign company would be as follows:
(i) the provisions specifically applicable to a foreign company shall apply to it.
(ii) the provisions applicable to a non-resident company shall not apply to it.
(iii) the provisions specifically applicable to a resident company shall apply to it.
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.
5. IMPORTANCE OF POEM
Internationally Recognised Test
Tie Breaker Rule
6. IMPLICATIONS OF THE POEM
If any foreign company is found to have a POEM in India, the same would lead to the following consequences:
POEM is a dual purpose concept. From the perspective of domestic laws, it is used as a factor for determining the residency of a foreign company whereas, from an international laws perspective, POEM is used as a tiebreaker rule for restricting the dual residency to one nation.
The major POEM amendment would have a crucial impact on the multinational groups wherein the decisions for the foreign entities are not merely ratified but majorly taken by the officials’ in India. Moreover, multinational groups having any common directors on the board of foreign as well Indian enterprises would be susceptible to the applicability of POEM in India. Thus, entities planning to set up enterprises abroad should undertake adequate tax planning.
The principles established by the CIRCULAR NO. 6 OF 2017 [F.NO.142/11/2015-TPL] for determination of POEM are not decisive in itself but in the nature of guiding principles. The guidelines as provided by the CBDT are vague as regards to a number of terms mentioned therein. Thus, the lack of any definite established legal factors for the purpose of determination of POEM would lead to several tax disputes and the existence of POEM in India would be a subject matter of litigation in various cases.
– Sneha Lad
The above analysis is based on the personal view of the author. The contents of this document are only for information purpose. It does not constitute professional advice or a formal recommendation. While due care has been taken in preparing this document, the existence of mistakes and omissions herein is not ruled out. Comments and suggestions are most welcome at email@example.com.
|ABOI||Active Business Outside India|
|BOD||Board of Director|
|BEPS||Basic Erosion and Profit Shifting|
|CBDT||Central Board of Direct Tax|
|MLI||Multilateral Convention to Implement Tax Treaty related measures to prevent BEPS|
|OECD MTC||Organization for Economic Co-operation and Development Model Tax Convention|
|POEM||Place of Effective Management|
|TDS||Tax Deduction at Source|
|The Act||The Income Act, 1961|
|UN MTC||United Nations Model Tax Convention|