Published Fri, 08 May 2020 | Updated Tue, 19 Jan 2021 Income Tax
Section 6(3) of Income Tax Act provides that a company is said to be a resident in India in any financial year, if its place of effective management, in that year, is in India. Further explanation to that section provides that "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.
‘Place of effective management’ (POEM) is an internationally recognised test for determination of residence of a company incorporated in a foreign jurisdiction. Most of the tax treaties entered into by India recognises the concept of ‘place of effective management’ for determination of residence of a company as a tie-breaker rule for avoidance of double taxation. The guiding principles to be followed for determination of POEM are enumerated in the following paragraphs.
Key Considerations while determining POEM:
- Any determination of POEM will depend upon the facts & circumstances of a given case
- While determining the POEM, the concept of substance over form should be used
- An entity may have more than one place of management, but it can have only one place of effective management at any point of time
- Since residence is determined on yearly basis, POEM will also be determined on year to year basis.
What is Active Business Outside India
The process of determination of POEM is primarily based on the fact as to whether or not the company is engaged in “active business outside India”.
A company shall be said to be engaged in “active business outside India” if:
- Its passive income is not more than 50% of its total income
- Less than 50% of its total assets are situated in India
- Less than 50% of its total number of employees are situated in India or resident in India.
- the payroll expenses incurred on such employees is less than 50% of its total payroll expenditure.
Here, Income shall be -
- as computed for tax purpose in accordance with the laws of the country of incorporation; or
- as per books of account, where the laws of the country of incorporation does not require such a computation.
Passive income shall be aggregate of:
- Income from the transactions where both the purchase and sale of goods is from/to its associated enterprises
- Income by way of royalty, dividend, capital gain, interest or rental income.
However, interest income would not be considered as passive income if the company 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.
Value of Assets shall be the aggregate of:
- In case of an individually depreciable assets, shall be the average of its value for tax purposes in the country of incorporation of the company at the beginning and end of the year
- In case of pool of a fixed assets being treated as a block for depreciation, 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
- In case of any other assets, shall be its value as per books of accounts.
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 shall include cost of salaries, wages, bonus and all other employee compensation including related pension and social costs borne by the employer.
Companies having 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. However if it is established that the board of directors are standing aside and not exercising their powers of management and such powers are being exercised by either the holding company or any other person resident in India, then the POEM shall be considered to be in India.
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 consideration. In case, Company having a short period of existence the data for such shorter period shall be considered.
Companies not having active business outside India
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:
- Identification/ascertaining the person/persons who actually make the key management and commercial decisions for conduct of Company’s business.
- Determination of place where these decisions are being made.
Key considerations while determining POEM for companies not having active business outside India:
- The place where these management decisions are taken would be more important than the place where these decisions are being implemented.
- The location where a company’s Board regularly meets and makes decisions may be the company’s place of effective management provided, the Board-
- retains and exercises its authority to govern the company; and
- does, in substance, make the key management and commercial decisions necessary for the conduct of the company’s business as a whole.
- In case the board delegates some or all of its authority to any committee consisting of key members of senior management, POEM will be the location where members of the committee are based and and where that committee develops and formulates the key strategies and policies for mere formal approval by the full board.
- The location of a Company’s head office will be a very important factor in the determination of Company’s place of effective management because it often represents the place where key company decisions are made. The following pointers need to be considered for determining the location of head office of the Company:
- Company’s senior management and their support staff are in a single location and that location is held out to the public as the Company’s principal place of business or headquarters then that location is the place where head office is located
- If the 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) then the company’s head office would be the location where these 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 whole
- 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. In such situation the head office would normally be the location, if any, where the highest level of management (for example, the Managing Director and Financial Director) and their direct support staff are located.
- In situations where the senior management is so decentralized that it is not possible to determine the company’s head office with a reasonable degree of certainty, the location of a company’s head office would not be of much relevance in determining that company’s place of effective management
- Due to use of modern technologies it is not necessary for the person taking decision to physically present at the place where decisions are being taken, hence for determining the POEM, the place where the persons/directors taking the decisions usually reside will be a relevant factor.
- In case of circular resolution or round robin voting the factors like, 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. In such case, place of person who has the authority and who exercises the authority to take decisions is more important.
- The decisions made by shareholder on matters which are reserved for shareholder decision under the company law are not relevant for determination of place of effective management, as these decision are typically 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 certain situations shareholders decision may turn into an effective management. For example if the shareholders limit the authority of board and senior managers of a company and thereby remove the company’s real authority to make decision then the shareholder guidance transforms into usurpation and such undue influence may result in effective management being exercised by the shareholder.
- It is also clarified that day to day operational decisions undertaken by junior & middle management shall not be relevant for the purpose of determination of POEM.
- If the above factors do not lead to clear identification of POEM then the following secondary factors can be considered:
- Place where main and substantial activity of the company is carried out
- Place where the accounting records of the company are kept.
Readers may note that the above principles for determining the P0EM are for guidance only and not decisive itself. Further based on the facts and circumstances if it is determined that during the previous year the POEM is in India and also outside India, then POEM shall be presumed to be in India if it has been mainly/predominantly in India.
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, seek prior approval of the Principal Commissioner or the Commissioner, as the case may be. Further, in case the AO proposes to hold a company incorporated outside India, on the basis of its POEM, as being resident in India then any such finding shall be given by the AO after seeking prior approval of the collegium of three members consisting of the Principal Commissioners or the Commissioners, as the case may be, to be constituted by the Principal Chief Commissioner of the region concerned, in this regard. The collegium so constituted shall provide an opportunity of being heard to the company before issuing any directions in the matter.