By Mayur B. Nayak, Tarunkumar G. Singhal, Anil D. Doshi, Chartered Accountants
Readers may be aware that the
Finance Act, 2015 had inserted the concept of Place of Effective Management
(POEM) for determining the residential status of a company by amending section
6(3) w.e.f. 1-4-2016. The said section 6(3) was substituted by the Finance Act,
2016 with effect from 1st April
2016 (i.e. the current Financial Year) and accordingly shall apply from the
Assessment Year 2017-18 onwards. Although the term “POEM” was defined in the
Income-tax Act, 1961 (“Act”), the definition was short and crisp. Subsequently,
the Government issued draft guidelines for determination of POEM. After
considering comments and suggestions from various stakeholders and general
public, these guidelines have been finalised in the form of “Guiding
Principles” for determination of POEM. This write-up covers detailed analysis
of these guiding principles and issues arising out of them and/or unresolved
grey areas which may lead to litigation.
1.0 Introduction
Section 6(3) of the Act, prior to
its amendment vide Finance Act, 2015, provided that a company would be
considered as resident of India under two circumstances, namely, (i) if it is
incorporated in India or (ii) control and management of its affairs is situated
wholly in India. This definition was prone to misuse. A foreign company
owned and controlled by Indian residents could shift its insignificant part of
control or management outside India to claim its status as non-resident. There
have been cases where foreign companies, though controlled and managed by Indian
residents, were held to be non-resident as their one or two board meetings were
held outside India. In order to address these concerns, the requirement of POEM
was introduced in the Act.
The concept of POEM is not new to
the constituents of international taxation. Essentially it refers to a place
where head and brain of an organisation is located or operates from.
Section 6 (3) as amended with
effect from 1st April 2016, reads as follows:
A company is said to be a
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.
Explanation.— For the purposes
of this clause “place of effective management” means a place where
key management and commercial decisions that are necessary for the conduct of
business of an entity as a whole are, in substance made.
In the backdrop of the above
amendment, CBDT issued the draft guidelines for determination of POEM on 23rd
December 2015 inviting suggestions and feedback from public at large.
After a year of issuance of the draft guidelines the CBDT has now issued
Circular No. 6 of 2017 dated 24th January 2017 containing the
“guiding principles” for determination of POEM. (Hereinafter referred to as
“Circular”)
2.0 Determining
Criteria
The Circular prescribes various
tests to determine the POEM. They can be broadly classified into:
(i) Active Business Test having sub
sets of
(a) Passive Income/Total Income Test
(b) Assets Test
(c) Employees Test
(d) Payroll Test
(ii) Control and Management Test
(iii) Location of Head Office and Senior Management Test
(iv) Location of Board of Directors’ Meeting Test and
(v) Secondary Factors Test.
Any foreign company has to be
evaluated based on these tests to determine whether it has a place of effective
management in India or not. Though the objective seems to be to apply these
tests to foreign companies owned or controlled by Indian residents, technically
it applies to any foreign company.
Let us go through them in detail.
2.1 Active Business
Test
The Circular requires determining
an “active business outside India” with the help of various tests. The POEM of
a foreign company having an “active business outside India” shall be presumed
to be outside India if its majority of Board meetings are held outside India.
(It may be held at a place other than the country of incorporation).
It may be noted here that 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.
Where the accounting year for tax
purposes, in accordance with laws of country of incorporation of the company,
is different from the previous year, then, data of the accounting year that
ends during the relevant previous year and two accounting years preceding it
shall be considered. For example, for a foreign company following calendar year
(CY) for the previous year 2016-17 (April-March) the data of the foreign
company to be examined are CY 2016, CY 2015 and CY 2014.
The Circular provides that for the
purposes of these guidelines, –
(a) A company shall be said to be
engaged in “active business outside India”
(i) if 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;
All the above tests are cumulative
in nature, meaning in order for a company to qualify as doing an active
business outside India, all the above tests need to be satisfied. However, as
reiterated by the Circular the determination of the POEM is a fact based
exercise with the underlying principle of substance over form and therefore,
failure to satisfy any single test by the foreign company per se, should
not be held against it. Much would depend upon the actual conduct of the
business and exercise of the control and management of its affairs.
2.1.1 Income Test
The income test to be fulfilled by
a foreign company for being considered as engaged in active business outside India is:
“the passive income is
not more than 50% of its total income”.
The Circular defines both total
income as well as passive income.
Total Income
The income for this purpose is
explained to be (a) as computed for tax purpose in accordance with the laws of
the country of incorporation; or (b) as per books of account, where the laws of
the country of incorporation does not require such a computation.
It is not clear as to whether such
books of account need to be audited or not. However, looking at the spirit of
the Circular, one would be guided by the laws of the host country. If audit is
not mandatory in the host country then even self-certified accounts should be
good enough.
Passive Income
“Passive income” of a company
shall be 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.
However, any income by way of
interest shall not be considered to be passive income in case of a company
which is engaged in the business of banking or is a public financial
institution, and its activities are regulated as such under the applicable laws
of the country of incorporation.
Inclusion of trading transactions
between two associated enterprises may cause genuine hardships to some foreign
companies owned by Indian residents which may be dealing within its global AEs
without any t ransaction with any AE
situated in India.
2.1.2 Assets Test
The assets test to be fulfilled by
a foreign company for an active business outside India is:
“less than 50% of its total
assets are situated in India”.
The value of assets :
(a) In case of an individually
depreciable asset, shall be the average of its value for tax purposes in the
country of incorporation of the company at the beginning and at end of the
previous year; and
(b) In case of pool of a fixed
assets being treated as a block for depreciation, shall be the average of its
value for tax purposes in the country of incorporation of the company at the
beginning and at end of the year;
(c) In case of any other asset,
shall be its value as per books of account;
With world accounting converging
to International Financial Reporting Standards (IFRS), valuation of assets
should not be an issue unless the foreign company is situated in a jurisdiction
which does not follow IFRS or no audit requirements are prescribed.
2.1.3 Employees Test
The employees test to be fulfilled
by a foreign company for an active business outside India is:
“less than 50% of total number
of employees are situated in India or are resident in India”.
The Circular provides that the
number of employees shall be the average of the number of employees as at the
beginning and at the end of the year and shall include persons, who though not
employed directly by the company, perform tasks similar to those performed by
the employees;
A question may arise as to
payments made to a retainer be included in the list of employees. Here, one may
be guided by the terms of the engagement, the nature of job profile and actual
conduct of the person etc.
2.1.4 Payroll Test
The test to be fulfilled by a
foreign company for an active business outside India is:
“the payroll expenses
incurred on such employees is less than 50% of its total payroll expenditure”.
The Circular provides that “the
term “payroll” shall include the cost of salaries, wages, bonus and all other
employee compensation including related pension and social costs borne by the
employer.
2.2 Control and Management Test
This test is useful in determining
where exactly head and brain of the company resides.
The Circular provides that in
cases of companies other than those that are engaged in active business outside
India, the determination of POEM would be a two stage process, namely:
(i) 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.
(ii) Second stage would be
determination of place where these decisions are in fact being made.
It is also provided that the place
where the management decisions are taken would be more important than the place
where they are executed. Day to day routine operational decisions taken by the
junior and middle level management shall not be relevant for the purposes of
determination of POEM. It is also provided that where by operation of law certain
key decisions are left to the shareholders such as dissolution, liquidation or
deregistration of the company etc. which may typically affect the
existence of company rather than the conduct of the company from management and
commercial perspective etc. would generally be not relevant in
determination of the POEM.
2.3 Location
of Head Office and Senior Management Test
The Circular provides that
location of Head Office (HO) will be an important factor in determining the
POEM as often key decisions are taken there.
The term HO is defined to mean the
place where the company’s senior management and their direct support staff are
located or, if they are located at more than one location, the place where they
are primarily or predominantly located. A company’s head office is not
necessarily the same as the place where the majority of its employees work or
where its board typically meets.
Location of senior management and
their support staff may play a key role in determination of the place of HO.
According to the Circular the
“Senior Management” in respect of a company means the person or 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: (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
(for example, Chief Information or Technology Officer, Director for Sales or
Marketing).
Generally the locale of senior
management or the highest level of management personnel (such as the Managing Director
or the Finance Director) shall determine the location of HO. However, if the
company’s senior management is so highly decentralized that it is difficult to
determine its HO, then HO will not be of much relevance in determining the
POEM.
In case of decisions by video
conferencing, telecommunication etc. the location of maximum number of persons
taking such decision would be relevant in determination of the POEM. In case of
circular resolution or round robin voting etc. the location of the
person who has the authority and who exercises the authority to take decisions
would be a relevant factor in determination of the POEM.
2.4 Location of Board of Directors’ Meeting
Test
The Circular provides that the
location where a company’s Board regularly meets and makes decisions may be the
company’s place of effective management provided, the Board- (i) retains and
exercises its authority to govern the company; and (ii) does, in substance,
make the key management and commercial decisions necessary for the conduct of
the company’s business as a whole.
In deciding the place of board
meetings as the POEM, one must look at the actual conduct of business at the
board meetings, whether key decisions are taken or not. Therefore, merely a
formal board meeting at a particular place by itself would not result in the
POEM.
If the board has delegated its
power or authority to take key decisions to senior management, executive
committee or any other person including a shareholder, promoter, a strategic,
legal or financial advisor etc. then the POEM would at the place of
location of such decision maker/s.
2.5 Secondary Factors for determination of
the POEM
The Circular provides that if the
primary factors (as mentioned above) do not lead to clear identification of POEM
then the following secondary factors can be considered:
(i) Place where main and
substantial activity of the company is carried out; or
(ii) Place where the accounting
records of the company are kept.
2.6 Summary of the POEM Tests
Based on the various tests
prescribed by the Circular, the POEM of a company can be determined based on
following criteria:
It may be noted that there is no
fixed hierarchy of the above tests.
3.0 Exceptions and Assurances
After elaborately prescribing
various guidelines to determine the POEM in paragraphs 1 to 8, the Circular in
paragraphs 9 and 10 provides certain exceptions, clarifications and assurances
in determining the POEM. The Circular reiterates that the guiding principles
are only for the purpose of guidance and that no single principle in itself
will be decisive. One needs to take a holistic view of the matter. The
principles need to be applied over a period of time in a given previous year
and not at a particular moment. “Snapshot” approach is not to be adopted.
Following clarifications are
provided in the Circular with regard to determination of the POEM in India:
Following isolated facts in
themselves will not be conclusive evidences that the conditions for establishing
a POEM in India have been satisfied:
(i) Foreign company is a wholly
owned subsidiary of an Indian company;
(ii) Foreign company has a Permanent
Establishment in India;
(iii) One or more directors of a
foreign company reside in India;
(iv) Local management of a foreign
company being situated in India in respect of activities carried out by a
foreign company in India;
(v) The existence in India of
support functions those are preparatory and auxiliary in character.
4.0 Summary
of various tests in determination of POEM as listed above
4.1 Determination of POEM
is a fact based exercise.
4.2 No single factor can be
considered as final. One needs to take a holistic view of the matter.
Determination of the POEM cannot be based on isolated facts.
4.3 In determination of
POEM, one needs to look at substance over form; only substance will prevail in
the end.
4.4 There can be more than
one place of management but there can be only one POEM at a given point of
time.
4.5 If during the previous
year a company is found to be having POEM, both in India and abroad then it
would be deemed to be at a place where it is mainly or predominantly located.
4.6 POEM is to be
considered over a period of time during the previous year and not at a
particular point in time. One should not take a “snapshot view” of the matter.
4.7 POEM should be
determined on a yearly basis. The existence or otherwise of the POEM should be
examined on year to year basis by applying various tests enumerated in the
Circular.
4.8 Just because an
intermediary holding company (say a first level subsidiary abroad of an Indian
Company) has a POEM in India, its downstream subsidiary/Joint venture companies
per se would not be regarded as having their POEMs in India. In other words,
the tests of determination of the POEM shall be applied to every overseas
entity separately and independently.
4.9 Actual conduct of the
Board of Directors or Senior Management Team or an Executive Council is
important rather than formal delegation of powers.
5.0 Threshold Limit
The Press Release issued by the
Ministry of Finance on 24th January 2017 citing issuance of the CBDT
Circular mentioned and discussed above, provides that the POEM guidelines shall
not apply to companies having turnover or gross receipts of Rs. Fifty (50) Crore or less in a financial year.
It appears that the threshold has
been prescribed for the applicability of the guiding principles only and not of
the POEM of a company itself u/s. 6 (3) of the Act. However, this does not seem
to be the intent of the CBDT. A clarification to this effect should be
issued.
6.0 Invocation of POEM
The Circular contains certain
administrative safe guards by mandating that the Assessing Officer (AO) will
have to obtain a prior approval of the Principal CIT/CIT for initiating an
inquiry of the POEM. The AO also need to obtain an approval from the Collegium
of 3 Principal CITs/CITs before holding that POEM of a non-resident company is
in India.
One hopes that provisions of the
POEM are invoked in rare cases and used as a deterrent than as a revenue raiser
tool. In this context, highest amount of restraint is called for on the part of
the tax administration so as to strike a balance between genuine cases of
overseas ventures and shell companies.
7.0 Summation/Conclusion
The Circular at paragraph 12
contains certain illustrations as to which situations would constitute a POEM
and which would not. Readers are well advised to go through the same.
The sum and substance of these
guiding principles for determination of the POEM is that the facts are supreme.
No one particular criteria can determine the existence or otherwise of a POEM.
One needs to take a holistic view of the matter and that too over a period of
time and not in isolation. In the ultimate, one needs to look at the substance
over form in establishment of the POEM.
The way these guidelines are
drafted, a question arises as to whether the era of Special Purpose Vehicle
(SPV) at an overseas location, for various commercial reasons, is over? All
SPVs by design will have passive income only and may not have substantial or
any business activities except for holding investments in downstream companies.
It appears that only holding cum operating companies which would fulfill the
conditions of active business outside India will be able to establish their
POEMs outside India.
With the release of the final
guidelines for POEM determination, one has to wait and watch the position with
respect to introduction of Controlled Foreign Corporation [CFC] rules as stated
in the BEPS action reports. However, taking a cue from the CFC regulations
worldwide and in the interest of the Indian entrepreneurship it would be better
if the overseas listed companies are kept outside the scrutiny of the POEM.
The Finance Act, 2016 had also
introduced section 115JH in the Act to enable the Government to notify rules in
relation to computation of income, carry forward and set-off of losses,
treatment of unabsorbed depreciation and applicability of transfer pricing in
relation to foreign companies which are treated as being resident in India.
Rules in this regard are still awaited.
The compliance with these final guidelines which
are issued only now especially since POEM is effective from 1-4-2016 (AY
2017-18) and we are already 10 months down the line. This certainly merits
deferment of the provisions of POEM by a year to 1-4-2017 (AY 2018-19).
Otherwise, this retrospective application of Final guidelines for AY 2017-18
could lead to confusion and unwarranted problems for assessees.
