PoEM

Draft guiding principles for determination of PoEM

Background

The Finance Act, 2015 amended Section 6(3) of the Income-tax Act, 1961 (‘The Act’) to provide that a company is said to be resident in India in any previous year, if its place of effective management in that year is India. This diluted the requirement of control and management to be situated wholly in India for a company incorporated outside of India (‘foreign company’) to be treated as a resident in India. The Explanatory Memorandum to the Finance Bill, 2015 has stated that a set of guiding principles to be followed in the determination of PoEM would be issued for the benefit of the taxpayers as well as the tax administration. Accordingly, the guiding principles on the following lines are proposed to be issued. Public comments have been sought on these principles before a final circular is released.

Summary

The draft acknowledges that PoEM is an internationally recognised test for determination of residence of a company. It further reiterates some of the well accepted principles that determination of PoEM is a factual exercise, where substance would prevail over form of the transaction.

The guideline links the determination of PoEM of a foreign company to the nature of business carried by such company. The draft guidelines prescribe different determination criterion for company engaged in active business or otherwise. It further provides that in case of active business, PoEM shall be presumed to be outside India if the majority meetings of the board of directors of the company are held outside India.

The guidance prescribes criterion such as location of board, senior management, executive committee, head office etc as primary tests and place of substantial activity or place of maintenance of accounts as secondary test for determination of PoEM. It also clarifies that PoEM determination would not be based on isolated fact of location of shareholder, director, management or support function in India and in case during a year PoEM has been mainly/predominantly in India, it would be presumed to be in India, even if it was outside India for a part of year.

Salient features of PoEM determination

  • Determination of the PoEM will depend upon the facts and circumstances of a given case
  • Substance would prevail over form of the transaction
  • Determination of PoEM will be an annual exercise as residency needs to be tested independently for each year
  • The place where these management decisions are taken would be more important than the place where such decisions are implemented
  • 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

Criterion for determination of PoEM

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. In this regard, following process has been laid out.

Company engaged in active business outside IndiaCompany not engaged in active business outside India

PoEM shall be presumed to be outside India if the majority meetings of the board of directors of the company are held outside India.

If on the basis of facts and circumstances it is established that the Board of directors of the company are standing aside and powers of management are being exercised by either the holding company or any other person resident in India, then PoEM shall be considered to be in India.

The determination of POEM would be a two stage process, namely:

  • First stage would be identification or ascertaining the person or persons who actually make the key management and commercial decision for conduct of the company’s business as a whole
  • Second stage would be determination of place where these decisions are in fact being made

A company shall be said to be engaged in “active business outside India” if the passive income (which has been defined as aggregate of royalty, dividend, capital gains, interest or rental income and income from the transactions where both the purchase and sale of goods is with associated enterprises) 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 total number of employees are situated in India or are resident in India; and
  • the payroll expenses incurred on such employees is less than 50% of its total payroll expenditure

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.

Key guiding principles for determination of PoEM

Location of PoEMBasis of consideration
Location of Board Meetings

The location where a company’s board regularly meets and makes decisions may be the company’s place of effective management 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

It has been clarified that mere formal holding of board meetings in a location would not be conclusive for determination of PoEM.

Location of Senior Management

If the board has de facto delegated the authority to make the key management and commercial decisions for the company to the senior management or any other person including a shareholder and does nothing more than routinely ratifying the decisions that have been made, the company’s PoEM will ordinarily be the place where these senior managers or the other person make those decisions. “Senior Management” has been defined as the persons who are generally responsible for developing and formulating key strategies and policies for the company and for ensuring or overseeing the execution and implementation of those strategies on a regular and on-going basis. While designation may vary, these persons may include:

  • Managing Director or Chief Executive Officer;
  • Financial Director or Chief Financial Officer;
  • Chief Operating Officer; and
  • The heads of various divisions or departments (for example, Chief Information or Technology Officer, Director for Sales or Marketing)
Location of executive committee

If the board has de facto delegated some or all of its authority to one or more committees such as an executive committee consisting of key members of senior management. In these situations, the location where the members of the executive committee are based and where that committee develops and formulates the key strategies and policies for mere formal approval by the full board will often be considered to be the company’s PoEM.

Location of a Company’s Head Office

The location of a company’s head office will be a very important factor in the determination of the company’s PoEM because it often represents the place where key company decisions are made.

Determination of the location of the head office of a company:


Prescribed criterionLocation of Head Office

Where company’s senior management and their support staff are based in a single location; and that location is held out to the public as the company’s principal place of business or headquarters

The location where senior management is based

Where various members of senior management operate, from time to time, at offices located in the various countries

The location where the senior managers:

  • are primarily or predominantly based; or
  • normally return to following travel to other locations; or
  • meet for deciding key strategies and policies for the company as a whole.

Where various members of senior management operate from different countries and participate in various meetings via telephone or video conferencing

The location where the highest level of management (for example, the Managing Director and Financial Director) are located.


Note: In situations where the senior management is so decentralised that 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.

Note: Where decisions are taken via telephone or video conferencing, place of residence of director or person taking decisions would be considered

Secondary Factors

If the above factors do not lead to clear identification of PoEM then the following secondary factors can be considered :-

  • Place where main and substantial activity of the company is carried out; or
  • Place where the accounting records of the company are kept.

Location of shareholder, director, management or support function in India, in isolation, not relevant

PoEM should not to be determined on the basis of isolated facts that by itself do not establish effective management, such as:

  • Shareholder of the foreign company is in India;
  • One or some of the Directors of a foreign company reside in India;
  • Local management in respect of activities carried out by a foreign company in India, is situated in India; or
  • Support functions that are preparatory and auxiliary in character are situated in in India.

PoEM to be tested for a year not at a point of time

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. In other words a “snapshot” approach is not to be adopted.

Predominance test to be applied, if PoEM is partly in India during a year

Where 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.

Persuasive value of the guidance

It is reiterated that the above principles for determining the PoEM are for guidance only. No single principle will be decisive in itself.

Procedure to be adopted by tax officer

The tax officer would seek prior approval of the Principal Commissioner or the Commissioner, before proposing to hold PoEM of a foreign company in India. The Principal Commissioner or the Commissioner shall provide an opportunity of being heard to the company before deciding the matter.

Our View

The guidelines provide an insight to the approach of tax authorities regarding implementation of PoEM regulations, which borrow certain international best practices and also introduce the novel concept of prescribing different criterion for active and passive businesses. The guidelines are focused on location aspect, but are silent on what constitutes ‘key management and commercial decisions’. Since, determination of PoEM is an annual exercise, determination of whether a company is engaged in active business should also be done for the relevant year, rather than deciding on the basis of average of three year(s) period as is currently prescribed. Also, certain safe harbour provisions (i.e. PoEM provisions should not apply to companies situated in jurisdictions having headline tax rate of 20% or more) should be introduced.

To download a copy of the guidance, please click here.