POEM - A harmony of business affairs and taxation!

WITH the Indian economy promising dynamic growth, it has become an international hot spot for business houses to set or expand their operations. While historically, the companies have structured their operations to stay outside the tax radar in India, the scenario is likely to change with introduction of Place of Effective Management (POEM).

In order to curb such practices, POEM was introduced by the Finance Act, 2015. The amended provisions of POEM are applicable from Assessment Year 2017-18. While no guidance was available on how to determine POEM, Circular no. 6 of 2017 by the Central Board of Direct Taxes (CBDT) provides the much needed clarification on various aspects for determination of POEM.

Certain key guidance on POEM have been discussed and summarized in the ensuing paragraphs:

Concept of Residency

Traditionally, it was provided that a company is considered to be an Indian company only if the control and management of its affairs are wholly situated in India. As mentioned earlier, the concept of POEM for determining the Residential Status of a company was introduced by the Finance Act, 2015.

The amended provisions state that, a company is said to be a resident of India for a particular previous year if,

i) It is an Indian Company; or

ii) Its place of effective management in that year is in India

What is POEM?

POEM is 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. Thus, determination of POEM in a simplified manner is a two-step process which involves identification of key personnel and place where decisions are taken by them.

The guiding principles as laid down by the CBDT for determination of POEM are briefly discussed in the succeeding paragraphs:

(a) A company will be considered to be engaged in "active business outside India" if

i) the passive income is not more than 50% of its total income; and

ii) less than 50% of its total assets are situated in India; and

iii) less than 50% of total number of employees are situated in India or are resident in India; and

iv) the payroll expenses incurred on such employees is less than 50% of its total payroll expenditure.

(b) "Head Office" of a company refers to the place where the company's senior management and their direct support staff are located. In case they are located at more than one location, the place where they are primarily or predominantly located.

(c) "Passive income" of a company is considered to be an aggregate of

i) income from the transactions where both the purchase and sale of goods is from / to its associated enterprises; and

ii) income by way of royalty, dividend, capital gains, interest or rental income;

(d) "Senior Management" in respect of a company means the person or persons who are generally responsible for developing, formulating and overseeing the execution of key strategies and policies. The circular states an illustrative list of designations which includes the following:

i) Managing Director or Chief Executive Officer;

ii) Financial Director or Chief Financial Officer;

iii) Chief Operating Officer; and

iv) The heads of various divisions or departments

Key Factors

a) Substance over form:

i) Determination of POEM depends on the facts and circumstances. If for a company, majority of meetings of the Board are held outside India, then the company will be considered to have active business outside India. For this, the average of the data for previous year and two years prior to that shall be taken into account.

ii) Certain decisions are made by the shareholders of a company. In such cases, emphasis is to be given to the nature of decisions taken from a management or commercial perspective and the relevancy for determining the place of effective management.

iii) Certain authority may be delegated by the key management to other senior members of a company or legal advisers, promoters, etc. When the key management solely plays a role of ratifying these decisions rather than participating, the place of effective management will be determined based on the location where such decisions are taken by the authorized person.

b) Significance of location:

i) The place where management decisions are taken is more important than the place where these decisions are implemented.

ii) Location of the head office is one of the key determinants as key decisions are usually made there.

iii) In a scenario where the senior management operate from various locations, consideration may be given to the location of highest level of management.

c) Annual requirement:

As residential status is to be determined on an annual basis, the same principle applies to POEM. Thus POEM will have to be determined every year and the process of determination will have to be carried out annually.

Conclusion

OECD model commentary mentions POEM for determining residency of an entity which is resident in two different countries. This concept has also been considered in several tax treaties. The introduction of POEM by the CBDT ensures alignment of Indian regulations to these global practices, however, the practical implications and impact on Indian companies having outbound operations are yet to be assessed.

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