OVERVIEW
The Place of Effective Management (POEM) is a concept that has been introduced under the Income Tax Act, 1961. The primary objective of POEM provisions is to determine the residential status of a company. The concept of POEM is internationally recognized and is essential for all tax treaties entered into by India to avoid double taxation. There are instances where Indian taxpayers establish entities outside India to conduct business abroad. In such cases, it is possible that strategic and key business decisions are being made in India by Indian business owners or promoters. In such situations, determining the POEM of the foreign entity becomes crucial. The guiding principle for determining the POEM of a foreign entity is laid down under the Income-tax Act, 1961, read with the guidelines provided by the Central Board of Direct Taxes (CBDT). The POEM provisions were introduced in 2015 to bring clarity and uniformity in determining the tax liability of companies with a global presence.
MEANING OF PLACE OF EFFECTIVE MANAGEMENT
The Place of Effective Management (POEM) is the 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. The POEM is not necessarily the same as the place where the Board of Directors meet or where the shareholders are located. It is a broader concept that takes into account the entire decision-making process of the entity.
ACTIVE BUSINESS OUTSIDE INDIA (ABOI) TEST
The "Active Business Outside India" (ABOI) test states that if a company conducts active business outside India, its Place of Effective Management (PoEM) will be deemed to be outside India if the majority of its board of directors' meetings are held outside India. For a company to be considered as having an active business outside India, the following conditions must be met:
a) The passive income of the company must be less than or equal to 50% of its total income. Passive income refers to the sum of income received through the exchange of goods with associated enterprises, as well as any income earned from royalty, dividend, capital gains, interest, or rental income.
b) Less than 50% of the company's total assets must be located in India. If the assets are depreciable (either individually or in block), the total asset value will be the average of their value for tax purposes at the beginning and end of the financial year. However, if the assets' value is not required for tax purposes, their value shall be based on the company's books of account.
c) Less than 50% of the company's total number of employees must be situated in India or be residents of India. The total number of employees shall be the average of employees at the beginning and end of each year.
d) The payroll expenses incurred on such employees must be less than 50% of the company's total payroll expenditure. The term "payroll" shall include salaries, wages, bonus, and all other employee costs paid by the employer.
The above ratios shall be analyzed based on the average of the data of the previous year and two years prior to that.
KEY MANAGEMENT TEST
In cases where a company does not meet the criteria for ABOI being outside India, determining its Place of Effective Management (PoEM) would involve a two-stage process.
Identifying the person or persons who actually make key management and commercial decisions for the company as a whole.
Determining the place where these decisions are made. It is important to note that for determining a company's PoEM, the place where commercial decisions are taken holds more weightage than the place where these decisions are executed.
The key management decisions can be made by either the board of directors, an executive committee authorized by the board, or senior management as authorized by the board.
HEAD OFFICE TEST
The location of a company’s Head Office is an important factor in deciding its PoEM. Following points should be kept in mind while determining the location of a company’s head office:
(i) If the company’s senior management and support staff is based in a single location then that place shall be the head office of the company;
(ii) If the company is more decentralized i.e. various members of senior management are located in various locations then head office shall be the place where these members of senior management are primarily based or place where they normally return to after travelling to various locations or place where these members meet to formulate major decisions for the functioning of the company;
(iii) If the company’s senior management is located in various locations but they participate in various meetings via telephone or video conferencing rather than being physically present then head office shall be the place where highest level of management i.e. Managing Director or Financial Director are located;
(iv) If a company is so decentralized that it is not possible to determine the company’s head office then the location of such head office will not be relevant in determining the company’s PoEM.
A company can have multiple places of management but in any given case, it can have only one effective place of management. However, determination of PoEM shall depend on facts and circumstances of each case.
Miscellaneous Lastly, if the above factors do not lead to clear identification of POEM then the following secondary factors can be considered:-
(i) Place where main activity of the company is carried out; or
(ii) Place where the accounting records of the company are kept.
LEGAL PROVISIONS
The POEM provisions were introduced in the Income Tax Act, 1961 by the Finance Act, 2015. The provisions were applicable from the assessment year 2017-18 onwards.
As per section 6(3) of the Income-tax Act, 1961, a company will be considered to be a resident of India if: a) It is an Indian company, b) Its place of effective management is in India. Here, “Place of effective management” means a place where key management and commercial decisions that are required to be taken for functioning of the entity, as a whole, are taken. Examples of commercial decisions include- a decision to open a major new manufacturing facility or to discontinue a major product line. For Income Tax purposes, the residential status is to be checked every year and hence, these PoEM will also be required to be determined every year. However, these PoEM provisions shall not apply to any company having turnover or gross receipts of Rs 50 crore or less in a financial year. Section 6(3) of the Income Tax Act, 1961 defines the residential status of a company. According to this section, a company is said to be a resident in India if it is an Indian company or its place of control and management is situated wholly in India during the previous year.
Section 115JH of the Income Tax Act, 1961 provides for the determination of the POEM. According to this section, the POEM of a company shall be determined by taking into account the following factors:
The place where the board of directors of the company, or its executive director, makes its decisions.
The place where the key management and commercial decisions that are necessary for the conduct of the business of the company as a whole are, in substance, made.
The place where the chief executive officer of the company, or any other person, who holds the position of the CEO or the managing director of the company, makes his/her decisions.
The place where the majority of the directors of the company or its executive directors reside.
If any of the above factors are located outside India, the POEM of the company shall be considered to be outside India.
The Central Board of Direct Taxes (CBDT) has issued guidelines for determining the POEM of a company. These guidelines provide clarity on various aspects such as the meaning of key management and commercial decisions, the role of the board of directors, the importance of substance over form, and so on.
CASE LAW ANALYSIS
1. The first case that involved the POEM provisions was the case of Azadi Bachao Andolan v. Union of India Appeal (civil) 8163-8164 of 20023, In this case, the petitioner challenged the constitutional validity of the POEM provisions. However, the Supreme Court upheld the validity of the POEM provisions and stated that they were introduced to prevent tax evasion and to ensure that companies pay their fair share of taxes.
2. In the case of Centrica India Offshore Pvt. Ltd. v. Commissioner of Income Tax w.p.(c) No. 6087/2012 SC 567, the taxpayer was a UK-based company that had a subsidiary in India. The taxpayer argued that its POEM was in the UK and not in India, and hence, it should not be considered a resident in India. However, the tax authorities held that the POEM of the taxpayer was in India, and hence, it was a resident in India. The taxpayer appealed to the Income Tax Appellate Tribunal (ITAT), which upheld the decision of the tax authorities.
CONCLUSION
In conclusion, the concept of Place of Effective Management (POEM) is an important consideration for companies, particularly in the context of taxation. The POEM test determines the location where key management and commercial decisions are made and where the control and management of the company ultimately lies.
In recent years, many countries have introduced the POEM test as a way of preventing tax evasion and ensuring that companies pay taxes in the countries where they operate. It is important for companies to carefully consider their POEM and ensure that it aligns with their business operations and strategy. Failing to do so can result in tax penalties, reputational damage, and other legal consequences.
Overall, understanding and complying with POEM regulations is crucial for companies that operate across borders and want to maintain good relationships with tax authorities and stakeholders.
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