The Doctrine of Place of Effective Management (POEM)

Introduction

The place of effective management (POEM) is an established test for determining whether an organization registered in a foreign state is resident in India. The place where a firm is really operated and managed, or the region where the most significant policies for a company’s management are decided at the highest level, is called the place of effective management (POEM). The objective is to go after shell companies and corporations that are set up to keep money out of India but have their true administration and monitoring in India. The amount of income that is taxed is determined by a taxpayer’s residency status. Every country’s national tax legislation specifies resident criteria. In general, a company’s resident status is determined by its place of incorporation. Corporate residency is significant because it has the potential to bring foreign enterprises under the scope of another jurisdiction’s comprehensive income taxes. However, in most cases, a country maintains the power to tax revenue that originates in that country. According to Section 6 of Income Tax Act, a company incorporated in India is always a resident company. A foreign firm, on the flip side, may be considered an Indian resident if it has a POEM in the country. The Finance Act 2015 changed the criterion of residency for foreign firms, replacing the words ‘control and management’ by ‘POEM’, which means if a company’s “place of effective management” (POEM) in the preceding year was in India, it would be considered a resident in India. Prior to the amendment, Section 6 of the Act stipulated the criteria under which a company might be considered to have resided in India for the preceding year. The requirements for a person who is a company are set forth in clause (3) of section 6 of the Act. According to the previous clause, an organization is stated to be resident in India in any prior year if it is an Indian company, or if the control and administration of its operations are entirely based in India during that year.

Elaborating POEM

Finance Act 2015 ^[1]added the provision of POEM to the Income Tax Act, which went into effect from April 1, 2017. With the introduction of the “Place of Effective Management” (POEM) regulation, the Finance Act, 2015 ushered in new standards of how foreign corporations in India are assessed. POEM has been defined as “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”. POEM is a concept which is recognized throughout the world.

The Financial Act of 2015 added the POEM test to section 6(3) of the Act. The processes for determining a foreign business’s residential status have been changed as a result of the amendment.

Section 6(3^[2]), as amended, reads as under:

“(3) A company is said to be resident in India in any previous year, if—

(i) It is an Indian company; or

(ii) Its place of effective management, in that year, is in India.”

We can analyze the key words to obtain a better grasp of POEM by breaking down the definition, which is “Key management and commercial decisions that are necessary for the conduct of the business of an entity as a whole are, in substance, made.”

Key management and commercial decisions: POEM is the location where essential management policies are formulated and where the management directions are delivered from, not the location where they take effect. A firm’s ‘centre of management’ operations are the place where the individual authorized to represent the company conducts his business management activities. A location where the business is just overseen would not be considered. The location of commercial management is given priority if the commercial and noncommercial sides of the firm are managed at different places. 

Necessary for the conduct of business: The emphasis is to be placed on executive management decisions, which will include decisions about the general conduct of the business in accordance with the board of directors’ broad plans and policies.

Of an entity as a whole: The day-to-day activities may be unimportant since they are not included in “key” decisions.

In substance made: Based on the “Substance over Form” principle, POEM would be determined. Accordingly, when determining POEM, it appears that substance would take precedence over form, as is the intention of covering shell companies under this provision.

Determination of POEM

The determination of POEM is a fact-specific process. The determination must be made using the Central Board of Direct Taxes’ [CBDT] guidelines. POEM must be determined each year because it is based on residency status, which must also be assessed each year. Even if an entity has several management locations, it can only have one effective management location at any given time. The principle of substance over form should be used to make the decision. The following two categories are used to determine POEM:

1. Companies engaged in Active Business Outside India (ABOI): To understand this, first we should understand what ABOI is. A company is said to be involved in ABOI, if:
2. The passive income of the company does not exceed 50% of the company’s total income; and
3. The percentage of its total assets located in India is less than 50%; and
4. Less than half of the total number of employees are based in India or reside in India; and
5. The payroll expense on such employees is less than 50% of total payroll expenditures.

When most of the board meetings (BOD) of the company are held outside of India, the POEM for that company would be presumed to be outside India. The question of whether the term “majority of the meetings” is used in the context of all the meetings where important decisions are made or as most of the meetings generally needs more clarity. However, if the de-facto ^[3]decision-making authority is not the Board of Directors but a resident of India, POEM is considered to be in India. The simple fact that a foreign subsidiary of an Indian holding company complies with its global policy as outlined for the entire group would not qualify for the application of POEM.

• Companies other than those engaged in ABOI: Here there are 2 stages of determination:
• Determine who is involved in making the key commercial and management decisions for the overall operation of the company.
• It’s more crucial to figure out where these judgments are actually made than where they’re implemented.

Period to be considered for purpose of determination of ABOI

The averages of the data from the three previous years must be examined in order to determine ABOI. If a company has been in existence for less than three years, the data for the whole time period since its establishment should be taken into account. If the tax accounting year differs from the previous year, it should be determined which accounting year finishes during the relevant preceding year, and that, together with the two accounting years before it, should be taken into account.

Consequences of having POEM in India for a company

• As per section 6(3) of the Income Tax Act of 1961, the foreign corporation would be considered a resident.
• As per Section 5(1) ^[4]of the Act, such a foreign company’s whole worldwide income will be taxed in India.
• Though the foreign company is considered a resident company, it will not be considered equivalent to a resident Indian company. Therefore, it will be taxed at 40% (including Surcharge and Cess), which is the same as for foreign companies.
• The company will have to abide by the tax regulation of India.
• Section 115JH ^[5]sets forward all other implications.

Conclusion

POEM is a fact-based assessment. Since POEM is a globally recognized concept, there are well-established guiding principles for determining POEM. Many countries consider the POEM criterion to be an adequate test for determining a company’s residence. Organization of Economic Cooperation and Development (OECD) has also accepted the doctrine of POEM. Previously, foreign companies were considered tax residents of India if their control and management were “wholly” located in India at all times during the relevant financial year. Therefore, if even a part of a foreign firm’s control and management is situated outside of India, the firm was considered to be a non-resident. POEM was enacted by the government of India to ensure that some businesses did not set up shell corporations in tax avoidance schemes or other foreign countries to avoid having to pay domestic taxes. The organizations are also required to have board meetings in India and keep records of those sessions. Unfortunately, due to the ongoing pandemic, there have been reports of difficulties in the same by many companies and they are relying on video calls or telephonic calls. This also amounts to POEM in India. The purpose of using the ABOI test to determine POEM is not to bring Indian multinationals engaged in business operations outside India into the residence tax band, but rather to bring shell companies and other entities created for the purpose of preserving income outside India, despite the fact that actual control and management of affairs are located in India, into the residence bracket. The CBDT’s guidelines contain ambiguity in various terms. This could lead to a slew of tax-related disputes.

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References:

[1] FINANCE ACT 2015, , https://www.cbic.gov.in/resources/htdocs-cbec/finact2015.pdf (last visited Dec 12, 2021).

[2] Section 6(3) in the income- tax act, 1995, , https://indiankanoon.org/doc/448708/ (last visited Dec 11, 2021).

[3] De facto, Cambridge Dictionary, https://dictionary.cambridge.org/dictionary/english/de-facto (last visited Dec 12, 2021).

[4] Section 5(1) iIncome Tax Act, Income Tax Department, https://www.incometaxindia.gov.in/_layouts/15/dit/mobile/viewer.aspx?path=https%3A%2F%2Fwww.incometaxindia.gov.in%2Facts%2Fincome-tax+act%2C+1961%2F2017%2F102120000000063745.htm&k=#:~:text=%E2%80%94For%20the%20removal%20of%20doubts,received%20by%20him%20in%20India. (last visited Dec 12, 2021).

[5] Name: Taxwink Team Qualification: Bio: The article has been contributed by t et al., Section 115JH- taxation of a foreign company having poem in India Taxwink, https://www.taxwink.com/blog/section-115jh-income-tax (last visited Dec 12, 2021).

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