CA Anshika Singhal
WHAT IS POEM?
POEM is the place where the ‘key management and commercial decisions that are necessary for the conduct of business of an entity as a whole are, in substance made.
NEED: This concept is the test of residence for foreign companies to provide that a company would be treated as resident in India if its POEM in the previous year is in India for tax purposes.
APPLICABILITY:
Companies having turnover or gross receipts less than 50 crores will not come under the scrutiny of POEM (Circular 8/2017 of CBDT).
Before going into conceptual depth, it is most important to know that the concept of POEM (Place of Effective Management) originates from the Indian Income Tax Act, 1961 for taxing shipping companies based on their POEM. However, this concept, for the purpose of determination of residence of a foreign company was first introduced in Direct Tax Code 2010.
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 [2007] 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.
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 dated 24th January, 2017 for the purpose determining 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.
WAYS TO DETERMINE POEM
A. AS PER DOMESTIC LAWS
Determination of POEM as per the guidelines
- The determination of POEM depends on the facts and circumstances of each case i.e. it is fact specific. However, such determination should be done in light of the guidelines as prescribed by CBDT. The principles as stated in the guidelines would not be decisive in itself and should be used only for the purpose of guidance. Also, such principles should be considered with reference to activities not in a certain/particular moment but over a period of time.
- The determination of POEM is to be done each year as the residency is also analyzed on an annual basis
- While determining the POEM, the concept of substance over form should be used.
- Though an entity has more than one place of management, it can have only one place of effective management at a given point of time.
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, 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 made.
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
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.
Payroll
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
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
- For the purpose of determination of whether an entity is engaged in ABOI, the average of the data of the previous three years should be considered.
- For instance, if POEM is to be determined for AY 2019-20 i.e. PY 2018-19, the average of data of last 3 previous years i.e. PY 2017-18, PY 2016-17, and PY 2015-16 are to be considered.
- If in case the company has been in existence for less than 3 years, the data for the period that the company has been in existence should be considered.
- If the accounting year for the tax purpose is different from the previous year, then the data for accounting year that ends during the relevant previous year and 2 accounting years preceding it shall be considered.
- For instance, in case the accounting year is the calendar year and POEM to be determined for AY 2019-20 i.e. PY 2018-19, then the accounting year ending in the relevant previous year i.e. PY 2018-19 would be 2018. Thus, the average of data should be considered for the years 2018, 2017 & 2016.
IMPLICATIONS OF THE POEM
If any foreign company is found to have a POEM in India, the same would lead to the following consequences:
- The foreign company would be termed as a resident u/s 6(3) of the Income Tax Act, 1961.
- The entire global income of such foreign company would be subjected to tax in India as per Sec 5(1) of the Act.
- The rate of tax applicable would be 40% i.e. the rate which is applicable to foreign companies in India. Even though such foreign company is treated as a resident in India, the rate as applicable to resident Indian companies is not made applicable to a foreign company treated as a resident in India.
- Other implications are applicable as mentioned in Sec 115JH as mentioned in the transition mechanism which is discussed in detail earlier.
CONCLUSION
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 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.
Disclaimer: The analysis does not constitute professional advice or a formal recommendation but is purely based on personal view.
