SKP Tax Alert
24 December 2015 | Volume 8 Issue 25
CBDT releases draft guiding principles for determining Place of Effective Management

The Finance Act, 2015 has amended the criteria for companies to be qualified as ‘resident in India’. According to the amended definition, a company would be resident in India if it is an Indian company or its ‘place of effective management’ (POEM), in that year, is in India.

POEM has been defined to mean 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.

Furthermore, the Memorandum Explaining the Provisions in The Finance Bill, 2015 had mentioned that the Central Board of Direct Taxes (CBDT) would release a set of guiding principles to determine the POEM, which would benefit taxpayers and the tax administration.

The CBDT released draft guiding principles on 23 December 2015; comments and suggestions thereon have been invited by 2 January 2016. A summary of the draft principles is as follows:
  • The POEM concept is one of substance over form.
  • The entity may have more than one place of management but it can have only one POEM at any point of time.
  • Since the ‘resident’ status has to be determined every year, the POEM has to be determined each year.
  • The process of determining the POEM would primarily be based on whether a company is engaged in ‘active business’ outside India or otherwise.
For this purpose, a company would be said to be engaged in ‘active business’ outside India if:
  • its passive income 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 residents in India; and
  • the payroll expense incurred on such employees is less than 50% of its total payroll expenditure.
For this purpose, an average of the data of the current financial year and two years prior shall be taken into account.
Passive income of a company shall be considered to be the aggregate of:
  • income from 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.
POEM guidelines for companies engaged in active business outside India
The POEM of a company engaged in active business outside India shall be presumed to be outside India if the majority of meetings of the company’s Board of Directors are held outside India.

However, in case the Board of Directors is not exercising its powers to make decisions and such decisions are taken by the holding company or by any other persons resident in India, the POEM would be considered to be in India.

POEM guidelines for companies other than those engaged in active business outside India
For companies other than those engaged in active business outside India, determining the POEM would be a two-stage process:
  • Firstly, identifying/ascertaining persons making the key management and commercial decisions for conducting the company’s business as a whole.
  • Secondly, determining the place where these decisions are being made.
Thus, the place where management decisions are taken would be more important than the place where the decisions are implemented. Some guiding principles for implementing the above two tests are as follows:
  • Location where the company’s Board regularly meets and makes decisions can be the POEM of the company, provided the Board:
    • retains and exercises its authority to govern the company; and
    • in substance, makes key management and commercial decisions – mere formal holding of a Board meeting would not be conclusive. If key decisions are taken at a place which is different from the location of the Board meetings, then such place would be considered.
  • A company may delegate (either through board resolution or by conduct) some or all of the authority to executive committee consisting of key senior management. In these situations location of the key members and the place where such committee members develop policies and plans will be considered the POEM.
  • The location of the head office will be very important in considering the POEM because it often reflects the place where key company decisions are taken. The following points need to be considered for determining the location of the head office:
    • The place where the company’s senior management (which may include the Managing Director, CEO, CFO, COO, etc.) and support staff are based and that which is considered as the company’s principal place of business or headquarters would be considered as the head office.
    • If the company is decentralised, then the company’s head office would be the location where these senior managers are predominantly based or normally return to following travel to other locations, or meet when formulating or deciding key strategies and polices for the company as a whole.
    • In cases where the senior management participates in meetings via telephone or video conferencing, the head office would be the location where the highest management and their direct support staff are located.
    • In cases where the company is so decentralised that it is not possible to determine its head office, then the same may not be considered for determining the POEM.
  • Day-to-day routine operational decisions undertaken by junior/middle management would not be relevant for determining the POEM.
  • In the present age, where physical presence is no longer required for taking key management decisions, the place where the majority of the directors/persons taking the decisions usually reside would be considered for the POEM.
  • If the above guidelines do not lead to clear identification of the POEM, then the place where the main and substantial activity of the company is carried out or place where accounting records of the company are kept would be considered.
POEM to be a fact-based exercise: examples of isolated instances would not necessarily lead to POEM.
The following illustrations merit consideration:
  • A foreign company being completely owned by an Indian company would not necessarily lead to POEM in India.
  • One or some of the directors of a foreign company residing in India would not necessarily lead to POEM in India.
  • Local management of the foreign company situated in India would not be conclusive evidence for establishing the POEM in India.
  • Mere existence in India of support functions that are preparatory or auxiliary in nature  would not be conclusive evidence for establishing the POEM in India.
Other key points
  • The above principles are only guidelines and no single principle will be decisive in itself.
  • POEM to be a fact-based exercise – a ‘snapshot’ approach cannot be adopted and activities are to be seen over a period of time and not at a particular time.
  • In case the POEM is in India as well as outside India, POEM shall be presumed to be in India if it is mainly/predominantly in India.
  • Prior approval of higher tax authorities would be required by the tax officer in case he proposes to hold a foreign company as resident in India based on its POEM. The taxpayer must be given the opportunity to be heard.
SKP's comments
The introduction of these guidelines is definitely a welcome move and provides much-needed clarity to Indian corporates wanting to set up companies outside India. The guidelines have brought in the concept of an ‘active business’ which is not provided in the OECD Commentaries. Indian business groups having presence outside India or proposing to establish presence outside India would have to consider these guidelines very carefully as they provide for some stringent conditions. Collective reading of the definition of active business and passive income may result in many foreign subsidiaries falling under POEM.

These guidelines could largely affect Indian groups that have set up trading companies outside India, which mainly deal with related parties. Board meetings, composition of the Board of Directors, the place where the effective decisions are being taken, and location of the company’s head office are some very important factors for determining the POEM. If due care is not exercised, it could lead to the company getting into deep trouble.

SKP
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