This article is co-authored by Kunal Dey, a Fifth Year, BBA.,LL.B student from School of Law, University of Petroleum and Energy Studies, Dehradun and Sagarika Kapoor, a Fifth Year, BBA.,LL.B student from School of Law, University of Petroleum and Energy Studies, Dehradun.

PLACE OF EFFECTIVE MANAGEMENT (AMENDMENT UNDER SECTION 6(3) OF THE INCOME TAX ACT, 1961)

The Indian taxation system places the incidence of tax based on the residential status of a person. Prior to the amendment of Section 6(3) of the Income Tax Act, 1961 (hereinafter referred to as the ‘Act’) a company was regarded to be as a resident in India in any previous year, it is an Indian company or if during that year, the control and management of its affairs is situated wholly in India. The provisions of Section 6(3) was amended through the Finance Act of 2015,[i] with effect from April 1, 2016 to provide that a company is said to be resident in India in any previous year, if:-

1. It is an Indian Company
2. Or, its place of effective management (hereinafter referred to as ‘POEM’) in that year is in India.

The Central Board of Direct Tax (hereinafter referred to as ‘CBDT’), issued guiding principles for the determination of POEM of a company on January 24, 2017.[ii] These provisions have now come into effect from April 1, 2017 and is applicable for the Assessment year (hereinafter referred to as ‘AY’) 2017-18.

The final guidelines take forward the concept laid down in the draft guidelines for POEM determination,[iii] based upon the bifurcation of companies engaged in active business outside India and other companies providing clarifications on the following points:-

1. Computational aspects for the determination of ‘active business outside India’.
2. Exclusion of shareholder decisions by the parent company.
3. Adherence to global group policies on accounting, HR, IT, supply chain and routine banking operations shall not lead to POEM in India.
4. Broader strategic and policy decisions to be relevant in determining POEM, as against routine operational decisions for oversight of day-to-day business operations.
5. The Assessing Officer shall initiate POEM determination only after prior approval of the Principal Commissioner/Commissioner. The decision on upholding the determination of POEM needs to be approved by a collegium of three Principal Commissioners/Commissioners.
6. The POEM guidelines shall not apply to companies having turnover or gross receipts INR 500 million or less in a financial year.[iv]

Analysis Of The Salient Features Of the Guidelines

Determination of ‘Active Business outside India’

A company would be considered as engaged in an active business outside India if the passive income of the company is not more than 50 % of its total income, and

• less than 50% of its total assets are situated in India; and
• less than 50% of the total number of employees are situated in India or are resident in India; and
• The payroll expenses incurred by such employees is less than 50% of its payroll expenditure.

‘Passive income’ of a company is defined to mean the aggregate of

• Income from transactions where both purchase and sale of goods is from/to its associated enterprises; and
• Income by way of royalty, dividend, capital gains, interest or rental income.

The final guidelines have clarified that income by way of interest shall not be considered to be as passive income in case of a regulated company engaged in the business of banking or a public financial institution. The income for the above mentioned purpose shall be as computed for tax laws in the country of its incorporation, or in other cases, as per its books of accounts.

Guidance has also been given for the computation of value of assets, the number of employees and payroll expenses. It is significant in this case to note that ‘employee’ shall include persons who perform tasks similar to those performed by employees, though not employed directly by the company.[v]

For the above mentioned test to be fulfilled, the average data of the previous year and two years prior to that shall be considered. If the company has been in existence for a shorter period, the data of such short period shall be considered. The final guidelines also provides that where the accounting year for tax purposes is different from the previous year, then the data of the accounting year that ends during the relevant previous year and two accounting years preceding it shall be considered.[vi]

POEM Guidelines for ‘Active Business outside India’

For a company involved in active business outside India, the POEM will be presumed to be outside India if the majority of the meetings of the company are held outside India. However, if it is established that the Board of Directors are standing aside and not exercising their power 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.

The final guidelines has clarified the disputed position by stating that for the above mentioned purpose, merely because the Board of Directors follow the general and objective principles of the global policy of the group laid down by the parent entity, which may be in the field of payroll functions, accounting, human resource functions, IT infrastructure and network platforms, supply chain functions, routine banking operational procedures, and not being specific to any entity or group of entities per se, would not constitute a case of Board of Directors of the company standing aside.

Guidance for companies not engaged in active business outside India

For companies not involved in active business outside India, a two step process for the determination of POEM has been culminated. First, identifying or ascertaining the person or persons who actually make the key management and commercial decisions for the conduct of the company`s business as a whole. Second, is the determination of the place where these decisions would be taken.

The Location Criteria

The place where 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.[vii]

Some of the guiding principles which may be taken into account for determining POEM are as follows:-

• The location where a company`s board regularly meets and makes decisions may be the company`s POEM 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.
• Mere formal holding of board meetings at a place would by itself not be conclusive for determination of POEM being located at that place where the formal meetings are held then such other place would be relevant for POEM.[viii]
• Executive Committee: If the company’s board has delegated (De jure or de facto) some or complete authority to an executive committee which consists of members of the senior management, the location where such members are based and the place where such a committee develops and formulates the key strategies and policies for approval of the board, will be regarded as the POEM.[ix]
• Head Office of the Company: A company`s Head Office is a very important factor for the determination of POEM. The Head Office of a company has been defined as “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 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.[x]

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 situations, the Head Office would normally be the location, if any, where the highest level of management and their direct support staff are located. In cases where the management is decentralised and 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 POEM.

1. Shareholder’s decisions: Shareholder’s voting rights generally are not a relevant factor in determining the POEM, but in certain cases where the shareholders gain authority of the management of the company and its commercial business, then this will result into effective management exercised by the shareholders.
2. Secondary factors: If the above mentioned factors do not give a substantial conclusion with respect to place of effective management then the following two factors should be considered;
   • Place where the substantial activities of the company are carried out or
   • The place where the company’s books of accounts are kept.[xi]

Factors that do not essentially determine POEM

The basis for determination of POEM should be the relevant facts in relation to effective management and control of a company, isolated facts should not be considered while deciding the POEM of a company as illustrated below:

• The fact that a foreign company is completely owned by an Indian company, will not satisfy that the conditions required for establishing POEM have been fulfilled.
• The fact that there is a permanent establishment of an entity in India will not establish the fact that India is its POEM.[xii]
• If some of the directors are residents of India, will not be enough to fulfill the condition of POEM.
• The local management of a foreign company if, is situated in India, will not be enough to establish the POEM. [xiii]

CONCLUSION

The guidelines require a total factual analysis and should not be applied in isolation. There is ambiguity with respect to application of the various provisions of the Income Tax Act for foreign companies which are resident of India under the POEM guidelines. The effectiveness of the regulations will be determined only after the adoption of Controlled Foreign Company Rules and with time as the guidelines are used for analysis of facts and circumstances of each case.

[i] The Finance Act, 2015, May 14, 2015, http://www.cbec.gov.in/resources/htdocs-cbec/finact2015.pdf.

[ii] CBDT Circular No. 06/2017 dated January 24, 2017.

[iii] Draft Guiding Principles for Determination of Place of Effective Management, December 23, 2015, http://www.incometaxindia.gov.in/Documents/POEM-note-for-uploading.pdf.

[iv]Supra note 2.

[v] PwC, CBDT Issues final guidelines for determination of POEM, January 25, 2017, https://www.pwc.in/assets/pdfs/news-alert tax/2017/pwc_news_alert_25_january_2017_cbdt_issues_final_guidelines_for_determination_of_poem.pdf

[vi]Id.

[vii] KPMG, CBDT issues guiding principles for determination of the place of effective management, January 24, 2017, http://www.in.kpmg.com/taxflashnews/KPMG-Flash-News-POEM-Guidelines-3.pdf.

[viii] Id.

[ix] Supra note 5.

[x] Id.

[xi] Id.

[xii]Supra note 7.

[xiii] Supra note 5.