Place of Effective Management (PoEM) is an internationally recognized test for determining the residential status of a company incorporated in foreign jurisdiction. This concept is crucial for all the tax treaties entered into by India as it helps to avoid double taxation. There are various situations where Indian taxpayers form an entity outside India to tap the business abroad. In such cases, there might be instances where the entire strategic and key business decisions are being taken in India by the Indian business owners/promoters. In these situations, the concept of PoEM gains importance and one must determine the PoEM of the foreign entity based on the guiding principle laid down under the Income-tax Act, 1961 read with the CBDT circular.
As per section 6(3) of the Income-tax Act, 1961, a company will be considered to be a resident of India if:
a) It is an Indian company,
b) Its place of effective management is in India.
Here, “Place of effective management” means a place where key management and commercial decisions that are required to be taken for functioning of the entity, as a whole, are taken. Examples of commercial decisions include- a decision to open a major new manufacturing facility or to discontinue a major product line. For Income Tax purposes, the residential status is to be checked every year and hence, these PoEM will also be required to be determined every year. However, these PoEM provisions shall not apply to any company having turnover or gross receipts of Rs 50 crore or less in a financial year.
The Central Board of Direct Taxes (‘CBDT’) had issued detailed guidelines vide circular no.6 of 2017 dated 24 January 2017 for determination of PoEM. The guiding principles to determine the PoEM are as under:
1. Active business outside India (ABOI) test
In case a company has an active business outside India, its PoEM is assumed to be outside India if majority meetings of its board of directors are held outside India. A company is said to have an active business outside India, if:
a) Its passive income is less than or equal to 50% of its total income. ‘Passive income’ shall be aggregate of:
(i) Income received through exchange of goods with associated enterprises;
(ii) Any income earned by way of royalty, dividend, capital gains, interest or rental income.
b) Less than 50 % of its total assets are situated in India. In case of depreciable assets (either individually or in block), value of total assets will be average of its value for tax purpose at the beginning and end of the financial year. However in cases where there’s no requirement to compute value of assets for tax purposes, the value of these assets shall be as per books of account;
c) Less than 50 % of its total no. of employees are situated in India or are resident in India. Total no. of employees shall be the average of employees at the beginning and at the end of each year,
d) The payroll expenses incurred on such employees is less than 50 % of its total payroll expenditure. The term ‘payroll’ shall include salaries, wages, bonus and all other employee costs paid by the employer.
The above ratios is to be analysed based on the average of the data of the previous year and two years prior to that shall be taken into account.
2. Key management test
In cases where ABOI is not outside India, determination of PoEM would include a two stage process:
(i) Identifying person or persons who actually make the key management and commercial decisions for the company as a whole,
(ii) Determining the place where these decisions are made.
It is important to note that for determining a company’s PoEM, the place where commercial decisions are taken is more important than the place where these decisions are implemented. The key management decisions may be taken by (i) the board or (ii) executive committee authorised by the board or (iii) Senior management as authorised by the board.
3. Head office test
The location of a company’s Head Office is an important factor in deciding its PoEM. Following points should be kept in mind while determining the location of a company’s head office:
(i) If the company’s senior management and support staff is based in a single location then that place shall be the head office of the company;
(ii) If the company is more decentralized i.e. various members of senior management are located in various locations then head office shall be the place where these members of senior management are primarily based or place where they normally return to after travelling to various locations or place where these members meet to formulate major decisions for the functioning of the company;
(iii) If the company’s senior management is located in various locations but they participate in various meetings via telephone or video conferencing rather than being physically present then head office shall be the place where highest level of management i.e. Managing Director or Financial Director are located;
(iv) If a company is so decentralized that it is not possible to determine the company’s head office then the location of such head office will not be relevant in determining the company’s PoEM.
A company can have multiple places of management but in any given case, it can have only one effective place of management. However, determination of PoEM shall depend on facts and circumstances of each case.
4. Miscellaneous
Lastly, if the above factors do not lead to clear identification of POEM then the following secondary factors can be considered:-
(i) Place where main activity of the company is carried out; or
(ii) Place where the accounting records of the company are kept.
In order to better understand the determination of PoEM, consider the below given examples:
Example 1: ABC ltd has its head office situated in the USA while it conducts its board of directors meeting in London. However, the senior management of the company is situated in India from where the major decisions for the conduct of the company are taken. In such a case where would be the company’s PoEM?
In the given case, the company’s PoEM would be in India as it is the place where the senior management of the company takes decisions which are important for the functioning of the entity.
Example 2: In cases where the board of directors delegate the authority of taking major decisions of the company to one or more committees like executive committee consisting of key members of senior management or if shareholders restrict the right to make commercial decisions to themselves instead of letting the BOD formulate it, then the place where these key members or majority of shareholders are located shall be the PoEM of the company.
Example 3: ABC ltd engaged in manufacturing of product X has 2 branches, one in India and other in China. It has a total of 10 assets out of which, 6 assets are located in China and 4 assets are located at the Indian branch. It has a total of 100 employees out of which 45 employees are Indian residents and other 55 employees are located in China. However, the company’s CEO & MD are Indian residents. The payroll expenditure incurred on these employees amounts to Rs. 5 crores out of which 3 crores belong to employees located in India and 2 crores to employees located in China. Can ABC ltd be considered to be a resident of India?
In the given case, even though the company’s majority i.e. more than 50% of the assets and employees are located outside India, majority of its payroll expenditure i.e. more than 50% of the payroll expenditure pertain to employees located in India. Therefore, ABC ltd does not have an active business outside India and its Place of effective management is in India. Hence, ABC ltd is said to be a resident of India and its global income shall be taxable in India.
Example 4: Considering the same data regarding assets and employees given in the above example, if payroll expenditure of Rs. 3 crores was incurred in respect of employees located in China and 2 crores was incurred in respect of employees in India. The company has its head office in China and conducts its board of directors meeting in India. But the CEO & MD are still Indian residents and they formulate key decisions from India. Is ABC ltd said to have its PoEM in India?
In the given case, majority i.e. more than 50 % of ABC ltd’s assets and employees are situated outside India. Also the majority i.e. more than 50% of payroll expenditure is incurred in respect of employees that are situated outside India. However, its CEO & MD are located in India from where its key management decisions are made and hence ABC ltd is said to have a PoEM in India.
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Authors:
Karan Vakharia | Partner at MASD & Co | Email: [email protected]
Nishika Acharya | Associate at MASD & Co | Email: [email protected]
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