The “Place of Effective Management” (PoEM) regime was introduced in The Finance Act, 2016 for determining the residential status of companies incorporated in foreign jurisdiction.
PoEM provisions have replaced the conventional methodology of determining tax residency based on control and management of the company.
Understanding this is a very important from the view point of International Taxation.
What is Place of Effective Management?
Place of Effective Management is an internationally recognized test for determination of residence of a company incorporated in a foreign jurisdiction.
Applicability of PoEM:
The amended provisions of PoEM are applicable from financial year 2016-17.
Reason that influenced Place of Effective Management evaluation:
Companies other than the Indian companies had a wider prospect to escape tax in India, by establishing wholly owned subsidiaries in a foreign country but the key management decisions being taken from India.
To cover those companies that have tax base in India for all purposes but have business established in foreign country (tax heavens) only for the purpose of tax avoidance, the concept of “PoEM” was introduced which brings a wider range of companies under the tax regime in India.
Earlier Provisions for Place of Effective Management:
Up to the year 2015, section 6(3) of the Indian Income Tax Act was as follows:
“A company is said to be resident in India in any previous year, if –
- It is an Indian company; or
- During that year, the control and management of its affairs is situated wholly in India”
Thus, a foreign company shall be resident in India only if it has control and management situated wholly in India. Hence, companies used this aspect and arranged the circumstances in such a manner that the control and management would be situated partly outside India though major operations were carried on in India leading to a situation where the company would be regarded as non-resident.
Amended provisions of Place of Effective Management:
The following provisions are applicable with prospective effect from 1st April, 2016:
“A Company is said to be resident in India in any previous year, if –
- It is an Indian Company; or
- Its place of effective management, in that year, is in India.
Explanation- For the purposes of this clause, “place of effective management” means 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.”
Explanation of amended PoEM provisions:
The following are the important points to be noted for determining the PoEM test:
- The decisions made should be key and very important for the business.
- The place of making the decision should be decided on the basis of substance over form, i.e., the place where the decisions are actually made is important rather than who made the decision.
CBDT Guidelines on PoEM:
As the term “place of effective management” is very vaguely defined in the Indian Income Tax Act, CBDT came up with guidelines on PoEM to extend clarity.
Applicability of CBDT guidelines:
CBDT guidelines shall apply only to those companies having turnover or gross receipts of more than ₹50Crores in a financial year.
The implication of the same is that the definition of PoEM as mentioned in the Indian Income Tax Act shall apply for companies having turnover or gross receipts of ₹50Crores or less. However, PoEM guidelines shall not apply to companies having turnover or gross receipts of ₹50Crores or less.
Process of PoEM determination:
Test for determination of PoEM:
Test No. 1 – Active Business Out-side India test
Test No. 2 – Place of actual decision test
Test No. 3 – Residuary test
Tests for PoEM determination as per CBDT guidelines:
Test No. 1: Active Business Out-side India test (ABOI):
The first test in determination of POEM is whether or not the company is engaged in active business outside India. The place of effective management 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.
Exception: If suppose the directors are not exercising the powers but it is exercised by a holding company or any person resident in India, then the place of effective management is presumed to be in India, as the POEM is to be determined based on “SUBSTANCE OVER FORM”.
A company is said to be having ABOI if all the below conditions are satisfied:
- Passive income not more than 50% of its total income.
- Less than 50% of its total assets are situated in India.
- Less than 50% of total number of employees are situated in India or are resident in India.
- Payroll expenses incurred on such employees is less than 50% of its total payroll expenditure.
Passive income shall be aggregate of, –
- Income from the transactions where both the purchase and sale of goods is from/to its associated enterprises; and
- Income by way of royalty, dividend, capital gains, interest or rental income;
Other aspects in Test No. 1
- Average data of the current previous year and two preceding previous years shall be considered while determining the ABOI of a company.
- Where the company has accounting year that is different from the previous year as per the Indian Income Tax Act, data of the accounting year that ends during the relevant previous year and two accounting years preceding it shall be considered.
Test No. 2: Place of actual decision test
In case of companies other than companies engaged in active business outside India, place of effective management shall be determined on the basis of the following two stage process:
- First stage is identification of the persons who actually make the key management and commercial decision for conduct of the company’s business as a whole.
- Second stage would be determination of place where these decisions are in fact being made.
In case, the persons actually making the decisions are making the decision in India, the POEM shall be presumed to be in India and vice versa.
The principle enshrined above is again SUBSTANCE OVER FORM whereby the persons who are actually making the decision and the place where the decisions are actually made are important. The decision making authority legally may be with some person but what is to be seen is the person who is in fact making the decision.
The below are the guidance given by CBDT guidelines:
|If board retains the decision making authority and in fact makes the decision.||Place where board regularly meets and makes decisions. If important are made in a place other than the place where the meetings are held, then such place shall be the POEM.|
|If the powers of board of directors is delegated to shareholder, promoter, strategic or legal or financial advisor etc.||Place where these senior managers or the other person make those decisions.|
|Where board delegates some powers to committee such as executive committee.||Location of such committee and where the decisions are made by them.|
|Location of company’s head office||Head office may at many times be the place where the POEM is located. For determining where the Head Office is located, see table below.|
Principles for determination of location of Head Office:
|Location of Head Office|
|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.||Such principal place of business.|
|Company is more decentralized (for example where various members of senior management may operate, from time to time, at offices located in the various countries)||Location where these senior managers,-
|Where members of the senior management may operate from different locations on a more or less permanent basis and the members may participate in various meetings via telephone or video conferencing rather than by being physically present at meetings in a particular location.||Place where the highest level of management (for example, the Managing Director and Financial Director) and their direct support staff are located.|
|Where the senior management is so decentralised that it is not possible to determine the company’s head office with a reasonable degree of certainty.||Location of head office will not be relevant for POEM.|
Other aspects to be considered in Test No. 2
- In cases where modern technology is prevalent and the meetings are not held in physical locations place where the directors or the persons taking the decisions or majority of them usually reside may also be a relevant factor.
- In case of circular resolution or round voting the factors like, the frequency with which it is used, the type of decisions made in that manner and where the parties involved in those decisions are located etc. are to be considered. Accordingly, the place where the key decisions are made would be relevant.
- If by the Indian Companies Act, certain important and key decisions are to be made by shareholders, location of shareholders would not be relevant for determination of place of effective management.
If however, the authority of the board of directors is taken away by the shareholders and they exercise authority which actually results in effective management more than as contemplated in the Indian Companies Act, then the location if shareholders would become relevant.
- Day to day operational decisions shall not be relevant for determination of place of effective management. The decisions shall be key and important decisions which would affect the business as a whole.
- If however, the person making the operational decisions and the person making key decisions is the same person, there is a need to distinguish both and consider the location where the key decisions are made as being relevant for determination of place of effective management.
Test No. 3: Residuary Test
In case the above two tests do not help us in arriving at the poem, the residuary test shall be applied. Accordingly, the following factors shall become relevant for determination of place of effective management:
- Place where main and substantial activity of the company is carried out; or
- Place where the accounting records of the company are kept.
Where the above activities and accounting records are kept in India, place of effective management shall be presumed to be in India and vice versa.
The residuary test states that in case the POEM can’t be determined by the first two tests, the place where the major activities are carried out or the place or maintenance of books of accounts shall be the POEM.
Caution points to be exercised while determining PoEM
- Fact that foreign company is completely owned by an Indian company will not be conclusive evidence that the POEM is in India. Similarly, just because, PE (Permanent Establishment) of a non-resident is in India, POEM shall not be said to be in India.
- Fact that one or some of the Directors of a foreign company reside in India is not conclusive evidence that PoEM is in India.
- The fact of, local management being situated in India in respect of activities carried out by a foreign company in India will not be conclusive evidence that the POEM is India.
- The existence in India of support functions that are preparatory and auxiliary in character will not be conclusive evidence of POEM in India.
- POEM principles are for guidance only. No single principle shall be based on activities carried out over a period of time.
- Snapshot approach shall be avoided and determination of POEM shall be based on activities carried out over a period of time.
- Determination of POEM depends upon the facts and circumstances of each case.
- An entity may have more than one place of management but only one effective management.
Place of Effective Management in the OECD model convention
Article-4 of the OECD Model Convention on residence provides for a tie-breaker rule for determining residence where an entity (other than individual) is resident in two different countries. The residence of such a dual resident entity is determined to be in the country in which its POEM is situated.
OECD commentary mentions that place of effective management is the place where key management and commercial decisions that are necessary for the conduct of the entity’s business as a whole are in substance made.
In relation to POEM, the OECD Commentary further provides that, –
- All relevant facts and circumstances must be examined to determine the place of effective management;
- An entity may have more than one place of management, but it can have only one place of effective management at any one time.
- With respect to determining the POEM of a company, OECD provides various factors to be considered:
- Place where meetings of the Board of Directors or equivalent body of the company are usually held;
- Place where the chief executive officer and other senior executives usually carry on their activities;
- Place where the senior day-to-day management of the person is carried on;
- Place where the person’s headquarters are located;
- Place of which country’s laws govern the legal status of the person;
- Place where its accounting records are kept.