A. Background

Section 6 of the Income tax Act, 1961 provide for conditions in which residence in India is determined in case of different category of persons. Section 6(3) deals with conditions to be satisfied for a Company to be treated as resident in India in any previous year. Prior to the introduction of the concept of POEM, a Company was said to be resident in India in any previous year if it was an Indian company or during that year, the control and management of its affairs was situated wholly in India. The Finance Act, 2015 amended the above provision so as to provide that a Company would be resident in India in any previous year if it is an Indian company or its Place of Effective Management (POEM) in that year is in India. The POEM was defined 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. In order to bring clarity about the applicability criteria of certain Income tax provisions, the concept of POEM has been deferred for one year the same has been made applicable w.e.f. previous year 2016-17.

The concept of POEM is important to determine the residential status of a foreign company operating in India. For Example, a foreign company fulfilling the conditions of POEM will be deemed as Indian Resident and the global income of such foreign company is taxable in India.

B. Residential Status of Companies under the Income tax Act, 1961: 

Section 6(3) of the Income tax Act, 1961 provides that a Company is said to be resident in India in any previous year if:

  • The Company is an Indian Resident; OR
  • Its place of effective management, in that year, is in India.

Place of Effective Management (POEM) means a place where key management and commercial decisions that are necessary for the conduct of business of an entity as a whole are, in substance made. 

Analysis:

  • In case the Company is registered under the Companies Act, 2013 or any other previous Company law is termed as Indian Company and the principles of POEM are of no relevance for such Company since an Indian Company is always an Indian Resident.
  • Determination of whether the Place of Effective Management (POEM) is India for any Company is relevant for foreign company since the residential status will determine the vicinity of income which will be taxable in India. For Example, in case of a foreign company is having POEM in India, then the global income of such Company will be treated as “taxable in India”.
  • The percentage of tax rate will not be determined by the residential status but Company needs to check whether it is a Domestic Company or not. In case the Company is a Domestic Company (i.e. Indian Company or any other Company which has made prescribed arrangements for declaration and payment of dividend within India), then the lower rate of tax i.e. 30% or 29% or 25% (as the case may be will be levied) otherwise the income will be taxable at higher rate of 40%. Needless to mention that the tax is further increased by Surcharge and Cess as applicable.
  • The POEM is required to be determined each year since the residential status is required to be ascertained each year.
  • Circular 8/2017 dated February 23, 2017 issued by CBDT has clarified that the provisions of POEM will not be applicable to a Company having turnover of Rs. 50 crores or less in a financial year.

C. Guidelines determining POEM (whether in India):

General Principle:

The POEM in case of a Company engaged in active business outside India shall be presumed to be outside India if the majority meetings of the board of directors of the company are held outside India. 

Analysis:

  • Conditions when POEM in India is not applicable to a Company:
    • Company is engaged in active business outside India; and
    • Majority of Board Meeting are held Outside India.
  • Active Business Outside India:

A Company is said to be active business outside India if its passive income is not more than 50% of the total income of such Company and:

♦ Assets in India are < 50% of the total assets

(Assets will be taken as average of opening and closing);

♦ Employees in India < 50% of the total employees

(No. of employees will be taken as average of opening and closing);

♦ Payroll Expenses in India < 50% of the total payroll expenses.

Passive Income means Income in relation to transactions of purchase and sale with Associated Enterprises (AEs) or Income generated from Royalty, Dividend, Interest, Rental or Capital Gains. 

  • It is to clarify that merely because the Board of Directors (BOD) follows general and objective principles of global policy of the group laid down by the parent entity which may be in the field of Payroll functions, Accounting, Human resource (HR) functions, IT infrastructure and network platforms, Supply chain functions, Routine banking operational procedures, and not being specific to any entity or group of entities per se; would not constitute a case of BOD of companies standing aside and in such case also the BOD are considered to be effectively managing the business of the Company.
  • The Company needs to analyze the data of assets, no. of employees etc. in relation to the relevant previous year and two years prior to that year in order to determine that whether Company is having any active business outside India.

Specific Principles:

The Guidance further provides that in cases of Companies other than those that are engaged in active business outside India referred to in above, the determination of POEM would be a two stage process, namely:

Stage 1: First stage would be 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 (WHO TAKE THE DECISIONS).

Stage 2: Second stage would be determination of place where these decisions are in fact being made (WHERE THE DECISIONS ARE IMPLEMENTED). 

IN CASE THE DECISIONS UNDERTAKEN BY THE COMPANY ARE IN INDIA (NOT SUCH DECISIONS WHICH ARE OF ROUTINE NATURE TAKEN BY MIDDLE OR LOWER LEVEL MANAGEMENT) AND SUCH DECISIONS TAKEN BY THE BOD OR SENIOR MANAGEMENT HAVE ACTUALLY BEEN IMPLEMENTED IN INDIA, THEN THE POEM SHALL BE CONSIDERED AS IN INDIA AND THE COMPANY WILL BE DEEMED AS INDIAN RESIDENT. 

D. EXAMPLES:

Example: Company A Co. is a sourcing entity, for an Indian multinational group, incorporated in country X and is 100% subsidiary of Indian company (B Co.). The warehouses and stock in them are the only assets of the company and are located in country X. All the employees of the company are also in country X. The average income wise breakup of the company’s total income for three years is,

  • 30% of income is from transaction where purchases are made from parties which are non-associated enterprises and sold to associated enterprises;
  • 30% of income is from transaction where purchases are made from associated enterprises and sold to associated enterprises;
  • 30% of income is from transaction where purchases are made from associated enterprises and sold to non-associated enterprises; and
  • 10% of the income is by way of interest.

Solution: Since passive Income of the Company is less than 50% i.e. 40% of the total income of such entity and both the assets and employees are working in country X, therefore the Company is deemed to have active business outside India.

(The author can be reached at cayogesh21191@gmail.com)

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