PLACE OF EFFECTIVE MANAGEMENT (POEM) and the related provisions
Feb 20, 2023
In India, the system of direct taxation as it is known today has been in force in one form or another even from ancient times. There are references both in Manu Smriti and Arthasastra to a variety of tax measures. Collection of Income-tax was well organized and it constituted a major part of the revenue of the State.
The Income Tax Act, 1961, is an act to levy, administrate, collect & recover income tax in India. It came into force from 1 st April 1962. Income tax including surcharge (if any) & cess is charged for any person at the rate as prescribed by Central Act for that assessment year. The money collected by the direct tax route is used by the Government for infrastructural developments and also to pay the employees of central and state government bodies.
For the purpose of calculating the tax liability of a person under the Income Tax Act, 1961, determining the residential status of the respective person is an important process. In this regard, the Act has provided us with a few guidelines on determining the residential status of every person, be it an individual, a Partnership Firm, a Limited Liability Partnership, a Hindu Undivided Family, a Company, a Trust, or any other person covered under the provisions of The Income Tax Act, 1961.
An individual will be considered as a resident based on the number of days; he/she has stayed in India in the relevant Previous Year. And based on his number of days of stay in India in the preceding previous years, he will be termed as an Ordinary Resident or a Not-Ordinary Resident. Further, based on whether the individual is an Ordinary Resident, a Not-Ordinary Resident, or a Non-Resident, the taxable income and the tax liability on such income will be calculated.
The residential status of a Hindu Undivided Family (HUF) will be decided based on the residential status of the Kartha. ‘Kartha’ is the main person of the family who manages and runs the business of the Family. If the Kartha is a resident, the HUF will also be considered as a resident, and vice-versa.
Every other person is said to be resident in India in any previous year in every case, except where during that year the control and management of his affairs is situated wholly outside India
Now, let us talk about how the residential status of a company will be decided. Since a company has a recognition as an artificial person, it is covered under the purview of the Act as a person. The provisions of The Income Tax Act 1961, before the amendments by the Finance Act 2015, provided that, a company is said to be a resident in India if it is an Indian company, or if its control and management of affairs is situated wholly in India during the year. This made way for the companies to artificially escape residential status by shifting insignificant events related with control and management outside India. Therefore, the provisions of section 6(3) were amended vide Finance Act 2015, with effect from 1 st April 2016 to provide that 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.
Definition of ‘Place of Effective Management”:
‘Place of Effective Management’ is defined in the Act 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.
‘Place Of Effective Management’ (POEM) is an internationally recognized test for determination of residence of a company
incorporated in a foreign jurisdiction.
It may be noted that 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” has to be decided for each year, POEM will also have to be determined on a year-to-year basis. The process of determination of POEM would be primarily based on the fact as to whether or not the company is engaged in active business outside India.
The guiding principles to determine POEM are enumerated below:
I. A company shall be said to be engaged in “active business outside India” if the passive income is not more than 50% of its
total income; and
a. Less than 50% of its total assets are situated in India; and
b. Less than 50% of total number of employees are situated
in India or are resident in India; and
c. The payroll expenses incurred on such employees is less
than 50% of its total payroll expenditure.
For the aforesaid purpose;
1. The income shall be
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.
2. The 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;
3. The term ‘payroll’ shall include the cost of salaries, wages, bonus and all other employee compensation including related
pension and costs borne by the employer.
II. “Head Office” of a company would be the place where the company’s senior management and their direct support staff are
located or, if they are located at more than one location, the place where they are primarily or predominantly located. A company’s head office is not necessarily the same as the place where the majority of its employees work or where its board typically meets.
III. “Passive income” of a company shall be aggregate of
1. Income from the transactions where both the purchase and sale of goods is from/to its associated enterprises; and
2. Income by way of dividend, royalty, capital gains, interest or rental income
IV. “Senior Management” in respect of a company means the person or persons who are generally responsible for developing and formulating key strategies for the company. While designation may vary, these people may include:
a. Managing Director or Chief Executive Officer
b. Financial Director or Chief Financial Officer
c. Chief Operating Officer
d. The heads of various divisions or departments (for example, Chief Information or Technology Officer, Director for Sales or
Marketing).
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 (BOD) of the company are standing aside and are not exercising their powers of management and such powers are being exercised by either the holding company or any other person(s) resident in India, then the place of effective management shall be considered to be in India. For this purpose, merely because the BOD follows the general principles of global policy of the group laid down by the parent entity which may be in the specified fields, and not being specific to any entity or group of entities per se; would not constitute a case of BOD of companies standing aside.
The specified fields for the above purpose are:
a. Pay roll functions
b. Accounting
c. Human Resource functions
d. IT infrastructure and network platforms
e. Supply Chain Functions
f. Routine Banking Operational Procedures
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. Where the accounting year for tax purposes, in accordance with laws of country of incorporation of the company, is different from the previous, then, data of the accounting year that ends during the
relevant previous year and two accounting years preceding it will be considered.
With all the above legislations made, the following companies are
affected:
1. Subsidiary Companies/Joint Ventures of Indian parent companies established overseas
2. Software companies having parent companies in India & operate in various overseas jurisdiction
3. Investment companies established overseas by Indian companies to enjoy tax treaty shopping
4. Shell companies incorporated overseas but managed and operated from India
It is reiterated that the above principles for determining the POEM are for guidance only. The above principles are not to be seen with reference to any particular moment in time rather activities performed over a period of time, during the previous year, need to be considered. 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.
In case the Assessing Officer 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 Assessing Officer 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.
Srisamarth G Khasnis
Nitin J Shetty &Co
