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22 Mar 2017

Redefining Corporate Tax Residence: Implementing POEM

The concept of Place of Effective Management (“POEM”) instead of “Place of Control and Management” (“POCM”) for determining the residential status of the companies was introduced by the Finance Act, 2015. POCM was based on place of incorporation or the place from where the company was ‘wholly’ controlled and managed. The reason for introducing the concept of “effective” management is that there may be cases where a company may have more than one place of management; however, there can only be one place of “effective” management at any point in time- and it is this place which will be used for determining the tax residency of a company.

 In order to determine the POEM, guidelines have recently been notified through the circular (“POEM Guidelines”) issued by the Central Board of Direct Taxes (“CBDT”)[1] and will become effective from 1st April, 2017. Foreign companies having turnover or gross receipts of less than INR 50 crores in a financial year have been exempted from application of the POEM Guidelines. [2]

To determine the resident status, POEM will be applicable in following manner:

  1. Determination if the place of Active Business is outside India (“ABOI”);
  2. If No, POEM shall be determined by the application of a two-tier test i.e.
    • Who takes the key management decisions; and
    • Where the key management decisions are taken.
  1. Determination of ABOI:

ABOI helps in targeting shell companies whose management and commercial decisions are taken in India, but income is retained outside India (probably with the intention of evading taxes in India). A company is said to be engaged in ABOI if:

  1. its passive income[3] is not more than 50% of its total income; and
  2. less than 50% of its total assets are situated in India; and
  3. less than 50% of total number of employees are situated/resident in India; and
  4. the payroll expenses incurred on such employees is less than 50% of its total payroll expenditure.

POEM Guidelines also prescribe definitions of value of assets, senior management, payroll, etc. and explanations regarding which country’s law is to be applied when computing the income. If a company’s place of Active Business is outside India, then its POEM is outside India, and therefore, it is not a tax resident of India.

  1. If Company is not engaged in ABOI:

In cases of companies whose Active Business is not outside India, the company’s POEM is to be determined by application of a two-tier test:

  1. Determination of who is making the key management and commercial decisions of the company as a whole (“Key Decisions”); and
  2. Determination of the place from where Key Decisions are made and taken.

However, it needs to be underscored that only Key Decisions are relevant to determine POEM, and not all decisions are Key Decisions. For example, routine operational decisions or decisions affecting the existence of the company are not key decisions; only key management and commercial decisions having broader strategic and policy impact are relevant. For example, a decision taken to diversify into different products or open a new facility would be a Key Decision since it affects the company’s business as a whole. However, a decision which would affect the day to day running of a company’s facility, such as appointment of labourers staffor repairing and maintenance of that facility will qualify as operational decisions.

In the process of applying the above tests, various factors (primary and secondary) are considered. Primarily, the persons making the Key Decisions (“Key Decision-makers”) are the Board members, although sometimes decision-making is delegated, either by its conduct or by means of resolution/agreement, to a shareholder, advisor or Executive Committee.

Once the Key Decision-makers are ascertained, the place from where the Key Decisions are made is determined. Primarily, the location where a company’s Decision-makers regularly meet to develop and formulate the Key Decisions proves decisive in determination of POEM.

Therefore, if the Key Decision-maker is the Board, the POEM will be the place where Board meetings are regularly held. Head Office (“HO”) of the company may be POEM, if the Senior Management (“SM”) are the Key Decision makers, i.e. Board merely ratifies their decisions, and are based in a single location. However, in case they are not in a single location, then HO shall be where:

  • Members of SM are primarily/predominantly based; or
  • SM members normally return to after travel to other locations;
  • SM members meet when formulating/deciding Key Decisions; or
  • The highest levels of management & support are in the event of e-meeting.

However, place of HO is irrelevant for determining POEM, if it cannot be ascertained with some degree of certainty. Further, the place where the Decision-makers usually reside is relevant in the event of e-meetings. In cases of circular resolutions/round robin voting, factors such as the types of decisions, frequency with which they are made and the parties involved are also considered in addition to the recognition of the Key Decision-makers, the place of the Key Decision-makers and Key decision making.

Further, if the aforementioned factors do not lead to a clear identification of the POEM of a company, then secondary factors such as the place of main and substantial activity of the company or safe keeping of accounting records can be used to determine the POEM of a company.

However, the aforementioned factors should not be considered at any one single point of time (as in a snapshot), but over a longer time period.  Therefore, not only place of the Board meetings, if Board is the key decision maker, but also the frequency of the meetings becomes relevant. A single occurrence cannot lead to the correct conclusion about a company’s POEM.

Further, POEM Guidelines require the Assessing Officers to seek the approval of the Principal Commissioner/Commissioner before analysing for POEM of any company.

The POEM Guidelines are comprehensive and well explained. The threshold for application of POEM guidelines coupled with the prior approval of Principal Commissioner/ commissioner before going for POEM analysis of the companies lead us to conclude that the POEM analysis is not to be resorted to in day to day affairs but only in specific cases that merit the effort.

[1] Circular No. 6/2017 dated 24th January, 2017.

[2] Circular No. 8/2017 dated 23rd February, 2017.

[3] Passive Income is defined under the POEM Guidelines as the aggregate of (i) income from transactions where both the purchase and sale of goods is from/ to the company’s associated enterprises; and (ii) income from royalty, dividend, capital gains, interest and rental income

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