November 7, 2023

Guiding principles to determine Place of Effective Management (POEM) for foreign companies| Income Tax Act, 1961

Place of effective management (POEM) determines the place where management of the company is actually situated to determine the correct residential status of the company for Income tax purposes. As per amended Section 6(3) of Income Tax Act, a company shall be considered as resident if:

It is an Indian Company; or
Its place of effective Management in that year is in India

Foreign companies are divided into Active Foreign Company and Passive Foreign Company to determine their POEM.

POEM is not something which can be defined by fixed guidelines. Facts of each case have to be checked to determine their POEM. The Income Tax department has specified certaining gilding principles to be considered while determining POEM. Therefore, While determining POEM, following points are to be kept in mind:

1. Principles to be considered for determine POEM

a. Location of Board Meeting

Location where the Board of the Company meets and makes decisions may be considered as the place of effective management.
However, the board must:
- Retains and exercises its authority to govern the company; and
- Make key management and commercial decisions at Board meeting which are necessary for the business as a whole.

Therefore, mere formal holding of board meetings at a place will not determine such a place as POEM. If the key decisions by the directors are taken at some place other than the place where formal meetings are held then such other place would be relevant for POEM.

b. Delegation of Authority to take decision

A company’s board may delegate some or all of its authority to one or the other person or committee. In such a case, the location where such other persons or committees are based and formulate the key strategies will be considered as POEM of the company.
E.g. A Board delegates the authority to make the key management and commercial decisions of the company to the senior management and the Board is merely involved in routinely ratifying the decisions taken by such senior Management. In this case, POEM of the company will be the place where these senior managers take the key decisions and not the location of where board meetings are held.

c. Location of Head office

The location of a company’s head office is an important factor because it often represents the place where key company decisions are made.
Location of the head office of the company can be determined by considering following points:

Company having single location: Location where the company’s senior management and their support staff are based and which is held out to the public as the company’s principal place of business or headquarters.
Company having more than one location: If company is having more than one locations, e.g., various members of senior management may operate at offices located in the various countries, then the company’s head office would be where these senior managers:
1. are primarily or predominantly based;
2. normally return to following travel to other locations; or
3. meet when formulating or deciding key strategies and policies for the company as a whole.

Company having more than one location permanently: If Senior management of a company operates from different locations on a permanent basis and the members participate through virtual mode rather than physically mode then the head office of the company will be the location where the highest level of management and their direct support staff are located.

If senior management is so decentralized that it is not possible to determine the company’s head office then Location of head office will not of any relevance in determining POEM. In such case, other factors may be considered in determining POEM.

d. Physical location of meeting is not relevant

In case, persons taking decision are no longer required to be physically present at a particular location due to modern technology then the physical location of board meetings will not be the place where key decisions are in substance being made.

In such cases, POEM will be the place where the directors or the persons taking the decisions or majority of them usually reside.

e. Decision through Circular Resolution

If a company takes decisions through circular resolution or round robin voting then POEM is to be determine by considering following factors:

frequency of such resolution;
Types of decisions made;
Where parties involved in such decisions are located

Location of the proposer of decision will not be the only important factor. Rather, it would be determined who has the authority and who exercises the authority to take decisions. The place of location of such person would be more important.

f. Decisions by Shareholders

Shareholder’s decisions not be considered for POEM

There are certain matters which are decided by shareholders only as per power given by Company law such as Sale of substantial assets of the company, Liquidation of the company etc.
These decisions affect the existence of the company or rights of the shareholders. These decisions are not made for conducting business or from a management or commercial perspective. Therefore, they are generally not relevant for the determination of a POEM.

Shareholder’s Decisions to be considered for POEM

However, in certain cases, shareholder’s involvement can turn into effective management such as through formal arrangement by way of shareholder agreement etc.
In such a case, shareholder guidance transforms into usurpation and may result in effective management being exercised by the shareholder.

Therefore, it has to be determined on a case to case basis whether the shareholder involvement is resulting in effective management or not.

g. Routine decisions are not relevant for POEM

The Circular has clarified that day to day routine operational decisions undertaken by junior and middle management are not relevant for determining POEM such as appointment of manager, senior manager, repair & maintenance, HR policies etc.
It is the key management and commercial decisions which are relevant for determining POEM such as opening a new manufacturing facility, discontinuation of a major product line etc.
If routine decisions and key management decisions are taken by same person then it will be necessary to distinguish the two type of decisions and thereafter assess the location where the key management and commercial decisions are taken.

h. Residuary Principles to determine POEM if above factors do not identify POEM

If POEM can’t be determined through above mentioned principles, 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.

2. How to apply guiding principles in determining POEM

It has been clarified that POEM is determined based on all relevant facts related to management or control of the company. None of the above mentioned principles can isolately determine the POEM.
E.g.
- If a foreign company is wholly owned by an Indian Company then mere this fact that its holding company is situated in India is not conclusive evidence to establish that POEM is in India.
- Similarly, if Permanent Establishment of a foreign entity is situated in India then it would itself not be conclusive evidence to determine that POEM is based in India;

Therefore, all above guiding principles have to be check collectively to determine POEM of any entity.

Also, these principles are not to be checked at a particular point of time. Rather, activities performed over a period of time need to be considered. Therefore, a “snapshot” approach is not to be adopted.
Further, if as per facts and circumstances, it is determined that 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.

3. Invoking POEM

If any Assessing officers wants to initiate a proceeding to hold a company incorporated outside India, on the basis of its POEM, as being resident in India, then is required to seek prior approval of the Principal Commissioner or the Commissioner.

Further, if AO proposes to hold a company incorporated outside India, on the basis of its POEM, as being resident in India then any such finding has to be prior approved by collegium of three members consisting of the Principal Commissioners or the Commissioners. Further, an opportunity of being heard shall be given to the company before issuing any directions in the matter.

4. Illustrations

The Circular has shared few illustrations to give an idea that how these guiding principles are to be used for determining POEM.
E.g.

Facts	Status
1. Company A is incorporated in Country X and is 100% subsidiary of Indian Company. 2. All assets of the company are located in Country X. 3. All employees are also based in Country X 4. 30% of the total income is from transactions where purchase is made from associate enterprises and sales are also made to associate enterprises. 5. 10% of total Income is from the royalty	1. Since less than 50% of the total income of the company is from “Passive Income” therefore, the company is engaged in “Active business outside India”
1. In Above mentioned facts, if 3 out of 50 employees are based out in India and their salary is INR 3 Crores out of total salary cost of INR 5 Crores.	1. Company A Co. is not engaged in active business outside India as more than 50% of the total payroll expenditure is pertaining to employees based out in India
1. If in First case, all directors are Indian residents and 3 Board meetings out of 5 are held outside India.	1. Since majority of Board meetings are held outside India then POEM shall be considered outside India

5. Conclusion

Change in principles of determining residential status from “Wholly control and Management” to “Effective Place of Management” has changed the residential status of most of the companies such as Investment companies established overseas by Indian Companies to avoid residential status.

Determination of POEM is completely based on Facts and circumstances of each case and every company is required to seek a professional opinion to determine its POEM as change in residential status can have major impact on tax liabilities.

DISCLAIMER: The views expressed are strictly of the author and VJM & Associates LLP. The contents of this article are solely for informational purpose. It does not constitute professional advice or recommendation of firm. Neither the author nor firm and its affiliates accepts any liabilities for any loss or damage of any kind arising out of any information in this article nor for any actions taken in reliance thereon.

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