To determine the residential status of foreign companies, the Finance Act 2015 introduced the concept of place of effective management (POEM). By definition in Indian Tax Laws “Place of effective management” means 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.
The Finance Act, 2016 has changed the effectivity of the said amendment to section 6(3) of the Act. These amended provisions came into effect from 1st April 2017 and are now applicable for Assessment Year 2017-18 and subsequent assessment years.
‘Place of effective management’ (POEM) is an internationally recognized test for determination of residence of a company incorporated in a foreign jurisdiction. Most of the tax treaties entered into by India recognizes the concept of ‘place of effective management’ for determination of residence of a company as a tie-breaker rule for avoidance of double taxation.
Prior to the 2015 amendment, a company was classified as an Indian resident:
- If company is incorporated in India; or
- If during that year, the control and management of its affairs is situated wholly in India
Classification as per these provisions provided tax avoidance opportunities to companies. Companies used to artificially escape the residential status by shifting insignificant or isolated events related with control and management outside India. Further, this liberal test resulted in shift of profits by incorporating shell companies outside India, which were substantially controlled from India.
General Principles of relevance for determining POEM
- It depends on the facts and circumstances of a given case for each year.
- Driven by the concept is one of substance over form.
- An entity may have more than one place of management but it can have only one POEM.
- The POEM will be required to be determined on a year-to year basis.
- Review and study of all facts related to the management and control of the company are necessary as the POEM determination cannot be based on isolated facts.
- If, during the tax year, the POEM is exists both in and out of India, the POEM is presumed to be in India.
Quantitatively, companies with turnover of INR 50 crore or less in a financial year will be exempt from the POEM provisions. Qualitatively, companies with active business outside India will be exempt from these provisions.
The CBDT has spelled out the criteria for the active business test:
- Passive income should not be more than 50% of total income;
- Less than 50% of total assets should be situated in India;
- Less than 50% of total employees should be situated in India; and
- Payroll expenses on such employees should be less than 50% of total payroll expenditure.
“Passive income” of a company shall be aggregate of:
- Income from the transactions where both the purchase and sale of goods is from / to its associated enterprises; and
- Income by way of royalty, dividend, capital gains, interest or rental income.
*Interest is not considered as passive income in case of banks and NBFCs
Once your active income is more than 50%, it will be presumed that your place of effective management is outside India, as long as you have majority of the board meetings outside India which is easy to satisfy but they’ve also said that you can’t misuse this rule.
For companies except those engaged in ABOI, determination of POEM is a two-stage process:
- Identifying or ascertaining the person or persons who actually make the key management and commercial decisions for conduct of the company’s business as a whole.
- Determination of place where these decisions are, in fact, being made.
The CBDT has stated that the intent of POEM is to tap shell companies trying to avoid tax compliances in India. The POEM cannot be established to be in India merely because one or more of the following conditions exist:
- Foreign company is wholly owned by an Indian company.
- Foreign company has a permanent establishment in India.
- One or some of the directors of a foreign company reside in India.
- Local management in India relates to activities carried out by a foreign company in India.
- Support functions that are preparatory and auxiliary in character in India
The foreign companies having POEM in India have to pay corporate tax at a rate of 40% instead of 25% payable by companies that have status “resident of India”.
As it may not be possible to provide a detailed list of all the factors that must be considered, we welcome you to clarify your queries regarding the same. Reach us here.