Section 6(3) of the Income Tax Act, 1961 discuss the provision relating to residential status of a company, according to which:
“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.
where, ‘place of effective management’ 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.”
Further, the provision of above mentioned clause ii of sub-section 3 are only applicable on companies having a turnover of more than Rs.50 Crore in a financial year. (Circular No. 8/2017)
Determination of “Place of Effective Management”
The meaning of “key management and commercial decisions” is derived from the facts & circumstances of the case which is very subjective in nature. Thus, certain guiding principles are laid down by the CBDT in its circulars for determining, the Place of Effective Management (herewith after referred as ‘POEM’). (Circular No. 6/2017 & Circular No. 25/2017)
These Principles are only guiding in nature & POEM is to be determined according to facts & circumstances of the case, using the concept of substance over form. Since, residence is determined for each year separately, POEM is required to be determined on year-to-year basis.
For determination of POEM of a company incorporated outside India an important criterion is whether company is engaged in Active Business Outside India?
Active Business Outside India: A company shall be said to be engaged in “active business outside India”, if:
i. the 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 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.
Meaning of Certain Terms:
|Income||a) As computed for tax purpose in accordance with the laws of the country of incorporation; or
b) As per books of account, where the laws of the country of incorporation does not require such a computation.
|Value of assets||
|Number of Employees||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;|
|Pay Roll||This term includes the cost of salaries, wages, bonus and all other employee compensation including related pension and social costs borne by the employer|
|Passive Income||It is the 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.
For the purpose of determining whether the company is engaged in active business outside India, the average of the data of the previous year and two years prior to that shall be taken into account. In case the company has been in existence for a shorter period, then data of such period shall be considered.
a) POEM of a company engaged in active business shall be presumed to be outside India if the majority of board meetings are held outside India.
However, in case the Board is not exercising its power of management & such powers are exercised by either the holding company or any other person, resident in India, then POEM shall be considered to be in India.
For the purpose of this, merely because the BOD or regional headquarters follows general & objective principles of global policy laid down by the parent entity in field of certain activities, would not constitute that BOD/regional headquarters are not exercising power of management & such activities alone will not be the basis for establishment of POEM.
b) In cases of companies other than those that are engaged in active business outside India, the determination of POEM would be a two stage process, namely: –
i. First stage: Identifying the person(s) who actually make the key management and commercial decision for conduct of the company business as a whole.
ii. Second stage: Determine the place where these decisions are, in fact, being made.
The place where these management decisions are taken would be more important than the place where such decisions are implemented. For the purpose of determination of POEM, it is the substance which would be conclusive rather than the form.
Determination of place where decisions are made:
This would be an important factor in determining the POEM in both the cases ie. where the ABOI has been established (in determining the second test of place of BOD meetings) and where the ABOI has not been established
Some of the guiding principles which may be taken into account for determining the POEM are as follows:
A. 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.
The mere holding of a formal meeting cannot be a conclusive criterion to determine POEM if the key decisions are taken at any other place. An example of this may be the case where the board meetings are held in a location distinct from the place where head office of the company is located or such location is unconnected with the place where the predominant activity of the company is being carried out.
If the Board has delegated the authority to make key management and commercial decisions to senior management or to any other person which are merely ratified by the Board on a routine basis, then the place where such decisions are made by the senior management or such person would constitute POEM.
B. If the Board has delegated some or all of its authority to make decisions to an Executive committee consisting of key members of senior management, then the location of the members of such committee would constitute POEM.
The delegation of authority may be either de jure (by means of a formal resolution or Shareholder Agreement) or de facto (based upon the actual conduct of the board and the executive committee).
C. Determination of Location of the Head office:
The location of a company’s head office will be a very important factor in the determination of the company’s POEM because it often represents the place where key company decisions are made.
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.
Also, Head office is not necessarily the same as the place where the majority of its employees work or where its board typically meets
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:
• are primarily or predominantly based; or
• normally return to following travel to other locations; or
• meet when formulating or deciding key strategies and policies for the company as a whole.
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.
D. The use of modern technology impacts the POEM in many ways. It is now possible to take decisions virtually on a telephone or through video conferencing. In the case where the BOD members participate virtually in the meetings, then the place of decision making would be the place where the persons taking the decisions or a majority of them reside.
E. In case of circular resolution (a substitute for resolution passed at a meeting, whereby the documented/draft resolution is circulated otherwise than in a meeting for approval by the directors) or round robin voting (a resolution which can be passed by majority of the directors provided all the directors are provided by a notice of such proposed resolution), the place of the person who has the authority or who exercises the authority to make decisions would be more important in determining POEM.
F. The decisions made by the shareholders on matters which are reserved for shareholder decision, are not relevant in the determination of POEM as they affect the existence of the company itself or the rights of the shareholders as such, rather than the conduct of the company’s business from a management or commercial perspective.
However, in some cases, the shareholder’s involvement can be relevant for the determination of POEM such as where the shareholders limit or replaces the authority of the BOD to make decisions, thus resulting into usurpation of the decision making power or undue influence.
Therefore, whether the shareholder involvement is crossing the line into that of effective management is one of fact and has to be determined on case-to-case basis only.
G. The day to day routine operational decisions undertaken by junior and middle management shall not be relevant for the purpose of determination of POEM. Decisions by the plant manager appointed by senior management to run that facility, concerning repairs and maintenance, the implementation of company-wide quality controls and human resources policies, would be examples of routine operational decisions.
In case if the persons responsible for operational decisions are the same persons who are responsible for key management & commercial decisions, a bifurcation needs to be made between the two types of decisions and then the location where such key decisions are made should be determined
If the above factors do not lead to clear identification of POEM, then the following secondary factors can be considered:-
i. Place where main and substantial activity of the company is carried out; or
ii. Place where the accounting records of the company are kept.
Isolated Factors: (which shall not lead to POEM)
It needs to be emphasized that the determination of POEM is to be based on all relevant facts related to the management and control of the company, and is not to be determined on the basis of isolated facts that by itself do not establish effective management, as following examples would not be conclusive evidence for establishment of POEM:
(i) A foreign company is completely owned by an Indian company.
(ii) There exists a Permanent Establishment of a foreign entity in India.
(iii) One or some of the Directors of a foreign company reside in India.
(iv) Local management being situated in India in respect of activities carried out by a foreign company in India.
(v) The existence in India of support functions that are preparatory and auxiliary in character.
The Assessing Officer (AO) shall, before initiating any proceedings for holding a company incorporated outside India, on the basis of its POEM, as being resident in India, needs prior approval of the Principal Commissioner or the Commissioner.
The concept of POEM is a dual purpose concept that is used for determining residential status and being a tie-breaker rule in restricting the dual-residency. It has been widely used in many countries & brought up in India by the Finance Act, 2015, as prior to this insertion companies were escaping the applicability of residency provisions, just by holding few meetings outside India. From the above reading it is clear that the concept of POEM is based on two major tools i.e. Active Business Outside India & Location from where key decisions are made. Active Business Outside India is a tool to bring the shell companies & such other companies created for retaining income outside India although real control and management of affairs are located in India, whereas Location of key management decision in based on substance over form to tax companies just registered outside India but controlled & managed by person’s resident in India. However, even after the establishment of guiding principles, POEM is a very subjective matter based on the facts & circumstances of each case as these principles are only guiding in nature. The AO shall, before initiating any proceedings for holding company resident as per the POEM requires the approval of principal commissioner or commissioner. Further, AO before giving any such findings shall also require approval from a collegium consisting of three members being the PCIT or CIT, as the case may be of the region concerned.
However, having discussed the factors which shall determine POEM, the lack of definite legal provisions still make POEM a matter of tax dispute & litigation in India.
You can further read about other articles based on your preferences on Articles
For any query, please feel free to post your queries. We would be happy to respond.
You may also mail your queries at email@example.com