Concept of Place of Effective Management ( POEM) for

determination of residence of artificial persons like companies

etc. ( Amendment to Section 6(2)(b) of the Income Tax Act.

Place of Effective Management (POEM)

Introduction
The Indian economy has been growing at a relatively fast pace over the past
decade or so, and is still growing resulting in a market that represents an
enormous opportunity for global businesses who have responded by making a
beeline to set up operations in the country. Local businesses too have grown and
have begun to aggressively expand their footprint across the world.
Thanks to the liberal policies of the Reserve Bank of India (RBI) Indian
nationals and Indian companies can invest in offshore companies through the
Overseas Direct Investment (ODI) route. As per the guidelines Indian nationals
can invest up to specified percentages of their net worth to acquire either a stake
in a Joint Venture company (JV) or set up a wholly owned subsidiary company
(WOS) outside of India under the automatic route without the need for any
permission from the RBI. Further, individual investors can invest up to a total of
USD 2,50,000 annually to set up companies abroad under the automatic route
without the need for any permission from the RBI!
This has resulted in many individuals and companies setting up offshore entities
using a variety of structures , for various reasons including, Investor
participation, Access to foreign markets and , importantly, Tax mitigation..
The United States of America and Singapore have proven themselves to be the
most popular investment destinations for Indian businesses the former on
account of the market and the investment opportunities available there. Whilst
Singapore finds favour as a gateway to South East Asia and as a low tax
jurisdiction. As mentioned earlier, access to new markets or global expansion
remain some of the key reasons for businesses to establish subsidiaries or
associated entities outside of India. There are legitimate business concerns that
push some of these businesses outside of India .

Residential concepts under the Income tax Act 1961

Traditionally under the income tax act, companies situated outside of India
would be considered non-residents and taxed only on incomes that accrue from
India or have a business connection with India, since as per the income tax act
( the act) a company was said to be a resident in India in any previous year if :
1. it is an Indian company; or
2. during that year, control and management of its affairs is situated
wholly in India
A company would be deemed to be a resident in India if it satisfied one of the
two alternative tests specified. Thus every Indian company as defined in section
2(26) of the act (being a company incorporated in India) was considered to be a
resident in India even if its control and management was situated wholly or
partially abroad. On the other hand a foreign company was liable for
reclassification as an Indian company if its management and control was
situated fully in India. As held in the cases of De Beers v Howe ” A company
cannot eat or sleep but it can keep house and do business, and for the purposes
of income tax a company resides where it really keeps house and does business,
i.e. where the control and management actually abides. Therefore, a company
registered abroad is a foreign company but a foreigner can reside in India and so
can a foreign company. Upon such reclassification the global income of such
foreign company would be subjected to tax in India .
Control and Management
The expression “Control and Management” is used in terms of the “affairs” of
the company this leads to the inference that the affairs of a company can lie in a
place which is separate and different from the “business” of the company, a
term which refers more to the activities that generate money for the company.
Making use of this expression, the management and control of the company are
situated in a place where the directors meetings are held. Therefore for a foreign
company whose owners are situated in India the company shall be deemed to be
resident in India if the meetings of directors who manage and control the
business are held here. While this may seem surprising reclassification of the
nationality of a company is very much a possibility and notoriously easy for a
taxman looking to tax greater revenue in his own jurisdiction.

Section 6 of the Income Tax Act ( As Amended) :

As Per Section 6 of the Income Tax Act’1961 (As Amended), It specifies that
the Company will be said to be resident in India, if it satisfies the following
condition:
1. It is an Indian Company or,
2. The Place of Effective management is in India, at any time during the
year.
After the amendment, India has become the unique country in the world
(other than Malaysia) which:
(a)Taxes the Global Income of Its Residents
(b)Company is treated as tax resident if it has Place of Effective
management in India
(c)Place of Effective Management, at Any TIME of the year situated in
India will make company tax resident in India.
Through introduction of POEM, the Government of India has launched attack
on “Tax Planning”. This is avoidance of Indian tax which is permitted under
the Law. Now the Government is changing the law and extending the net of
Indian Income-tax Act . 
 

Place of Effective Management (PoEM) Definition.

POEM has been defined in the finance bill to mean a place where the key
management and commercial decisions that are necessary for the conduct of the
business of an entity as a whole are made. As per the budget memorandum “The
modification in the condition of residence in respect of company by including
the concept of effective management would align the provisions of the Act with
the Double Taxation Avoidance Agreements (DTAAs) entered into by India
with other countries and would also be in line with international standards. It
would also be a measure to deal with cases of creation of shell companies
outside India but being controlled and managed from India”.
The provision effectively means that if at any point of time during the year the
decisions necessary for the conduct of the business as a whole are taken in India
then the entity would be classified as an Indian resident and taxable as such.
The ramifications for this shift in thresholds are immense, for example consider
the following situations:
 An American company holds a board meeting in India
 Two directors of a Singapore company take a significant decision
impacting the group companies, while on Holiday in India
 Indian company sets up a subsidiary unit in Mauritius with the same
directors as the parent unit and the management takes all decisions from
India
In all the above cases the foreign companies can be deemed by virtue of the new
provisions to be tax residents in India and their global incomes can be taxed in
India .

Meaning of Effective management:

The words Effective Management refer to actual management and not just
formal or ostensible management. For example, in some SPVs, the consultants
may be the directors. One consultant/ solicitor/ banker may be managing a
thousand companies. The clerical staff of this company may be on the board of
all the thousand companies. This is management for the sake of name. They
cannot be considered as effective directors. To establish effective management,
one will have to appoint directors who are competent to take business decisions.
Having just one or a minority of professional directors to comply with local
regulations would be ok. However, the Key Management should comprise of
genuine business managers. 
 
Meaning of Key Management:
(i) The term “Key Management” has significance. The definition does not use
the term “Board of Directors”. The Board may meet only once in a few
months. Actual management of the company on a regular basis may be
conducted by the managing or executive directors and CEO or similar other
important executives. Key persons who actually manage the company are to be
considered and not the Board of Directors. If the key managerial persons
conduct management from a specific place; that will be the POEM of the
company. 
 
(ii) A company may have several business functions. It may have a few
factories, several shops, different offices for purchase and administration, and
one head office where the directors and chief executive officers function. The
day-to-day operations and business transactions will take place at all the
factories, sales offices and purchase offices. However, those operations are not
important while determining the key management. Directors and CEOs take key
managerial decisions. Hence company’s POEM will be considered where the
key managers function. This group is referred to in this article as “Key
Management”. 

Impact
The parties most impacted by this amendment shall be Indian individuals and
companies which have set up foreign JV’s and routinely take decisions for such
entities from India, also affected will be groups where the executives of the
Indian entity are also on the board of the foreign subsidiary. These companies
shall soon see that their legitimate foreign companies are now deemed to be
Indian residents and are subject to taxation in India, this imposes a huge cost in
the form of taxes on such companies and the group as a whole.
And the place of effective management means the place where the key
commercial and management decisions are taken as a whole and this is taken in
substance i.e substantially the decisions are taken from that place for smooth
conduct of business.

POEM in other Countries- Corporate tax residency

China: A company is considered to be resident in the People’s Republic of
China (“PRC”) if it is established under PRC law, or is an enterprise that is
established under the laws of foreign countries (regions), but its place of
effective management is located in PRC. Tax residents are taxed on their global
income.It does not make foreign enterprise, tax resident using the concept of at
any time in the year
France: France has a territorial system of corporate income taxation.
Accordingly, French companies and French branches of foreign companies are
subject to corporate income tax for profits derived from businesses run in
France, i.e. companies, wherever resident, are only subject to corporate income
tax on income derived from French source.There is neither the concept of
POEM nor concept of global taxation of residents.
Brazil: A foreign company is resident if incorporated in Brazil. Taxable on
global income. Therefore there is no concept of POEM in Brazil
Australia: A company is a resident of Australia if :
a) it is incorporated in Australia; or
b) although not incorporated in Australia it carries on business in Australia and
has either i) its central management and control in Australia ii) its voting power
controlled by shareholders who are residents of Australia.
Therefore there is no concept of POEM at any time in the year in Australia as
well.
UK: companies are UK tax resident if they are incorporated or centrally
managed and controlled in the UK. UK also does not have concept of POEM
Germany: Corporations with a registered office or a German place of
management and control are deemed to be resident in Germany. Foreign
companies that have neither their legal seat nor a place of management and
control in Germany are deemed to be non-resident. Germany also does not have
concept of POEM.
Italy: Resident companies are those that, for the greater part of the tax year,
have had their legal headquarters, place of effective management or main
business purpose in Italy. The place of incorporation is not relevant. Resident
companies are subject to taxation on their worldwide income.
It is different from Indian rule in that it requires place of effective management
should be greater part of the tax year whereas india requires POEM at any time
of the tax year.
South Africa: A company is regarded as a South African resident if it is
incorporated in South Africa or if it has its place of effective management in
South Africa. Resident companies are subject to tax on their worldwide
income.It is different from Indian rule as it does not make a company tax
resident if place of effective management is situated in SA even for one time
during the year.
Malaysia: A company carrying on a trade or business is resident in Malaysia
for the basis year for a year of assessment if at any time during the basis year
the management and control of its business or of any one of its businesses are
exercised in Malaysia.It comes close to India , in respect of definition for
determining tax residency of companies.
Singapore: A company, whether incorporated in Singapore or otherwise, is
considered a resident of Singapore for tax purposes if the place of control and
management of its business is exercised in Singapore. Generally, a company is
treated as a resident of Singapore if, among other things, its directors’ meetings
are held in Singapore. Here also there is no concept of POEM at any time.
Russia: Russia has recently introduced in Nov 2014, the concept of Place of
Effective management for determining tax residency of companies, however it
also does not have concept of POEM at any time.
Therefore a comparative study makes it clear that only Malaysia has the
concept of corporate tax residency similar to new Indian position which will be
effective from April 1, 2016.
DTAAs and Concept of Corporate tax residency.
Though, most of the DTAAs have concept of Place of effective management for
determining residential status of companies, however, none of the DTAAs nor
the OECD model conventions have the concept of “Place of effective
management at any time in the year”.
Nowhere, it is found that a corporate is made a tax resident if, it has place of
effective management at any time in the year
Determination of Residence : OECD commentary on Article 4.
OECD commentary on Article 4 of model convention on Residence mentions as
under:
The place of effective management is the place where key management and
commercial decisions that are necessary for the conduct of the entity’s business
as a whole are in substance made. All relevant facts and circumstances must be
examined to determine the place of effective management. An entity may have
more than one place of management, but it can have only one place of effective
management at any one time.
Competent authorities having to apply such a provision to determine the
residence of a legal person for purposes of the Convention would be expected to
take account of various factors, such as where the meetings of its board of
directors or equivalent body are usually held, where the chief executive officer
and other senior executives usually carry on their activities, where the senior
day-to-day management of the person is carried on, where the person’s
headquarters are located, which country’s laws govern the legal status of the
person, where its accounting records are kept, whether determining that the
legal person is a resident of one of the Contracting States but not of the other for
the purpose of the Convention would carry the risk of an improper use of the
provisions of the Convention etc.
Countries that consider that the competent authorities should not be given the
discretion to solve such cases of dual residence without an indication of the
factors to be used for that purpose may want to supplement the provision to
refer to these or other factors that they consider relevant.
Reservations on Article 4
Japan and Korea reserve their position on the provisions in this and other
Articles in the Model Tax Convention which refer directly or indirectly to the
place of effective management. Instead of the term “place of effective
management“, these countries wish to use in their conventions the term “head or
main office”.
Turkey reserves the right to use the “registered office” criterion (legal head
office) as well as the “place of effective management” criterion for determining
the residence of a person, other than an individual, which is a resident of both
Contracting States .
The United States reserves the right to use a place of incorporation test for
determining the residence of a corporation, and, failing that, to deny dual
resident companies certain benefits under the Convention.

Adverse Consequences of POEM

The government believes the current conditions are practically inapplicable and
contends they can be easily subverted by simply holding a board meeting
outside India, leading to the creation of shell companies, which are incorporated
outside but controlled from India. However, the change also will involve
practical difficulties as under:
Consequences for Indian MNCs.
Many executives are associated with the Indian parent company function as
directors of its foreign subsidiaries. Now the power will have to be entirely
delegated to an independent board abroad, only associated with the foreign
entity. This may increase compliance cost for Indian companies
If an Indian company has a subsidiary in another country where it has certain
operations and pays taxes to the local authority there, it will have to pay tax
back home in India if key decisions with respect to the foreign business are
determined to have been taken in India, or if key management personnel like a
director on the board of the overseas firm resides in India.
Many overseas subsidiaries are created for the purpose of facilitating business
activities like fund-raising and did not have any operations of their own, and
these may be especially impacted as a consequence of the proposed amendment
law.
Consequences for Foreign MNCs
Foreign companies with legitimate business operations outside India would end
up being treated as Indian tax residents and consequently, be subjected to tax in
India on their global income. This could occur if, for example, a board member
of the foreign company is present in India and participates in the decision-
making process from India only in that single board meeting. This anomalous
situation will result in double taxation of income which may not be mitigated by
tax treaties as both countries (viz. India and the country of incorporation) will
seek to tax the global income of the foreign company.
Other Areas of litigation in determining POEM in India
Mobile places of effective management– It is not too difficult, for example, to
envisage a situation where the managing director of a company who is
responsible for the management of that company is constantly on the move. In
some extreme cases, that person may consistently be making the decisions while
flying over the ocean or while visiting various sites in different jurisdictions
where his business is conducted.
Similarly, a board of directors may arrange to meet in different places
throughout the year. For example, the board of a multinational enterprise may
agree to meet at the offices of the enterprise around the globe on a rotational
basis. This can also lead to an enterprise having a mobile place of effective
management.
Place of effective management in multi-jurisdictions: The characteristics of
effective management may exist in a number of jurisdictions and it may be said
to exist simultaneously in more than one jurisdiction without a specific single
jurisdiction being dominant. Thus to the extent that the place of effective
management test fails to provide a clear allocation of residence to one country,
albeit in a limited number of cases, it may be seen to be an ineffective rule.
Videoconferencing: If senior managers adopt conferencing through the Internet,
for example, as a key medium for making management and commercial
decisions and those managers are located throughout the world, it may be
difficult to determine a place of effective management. In such cases, a place of
management might be regarded as existing in each jurisdiction where a manager
is located at the time of making decisions, but it may be difficult (if not
impossible) to point to any particular location as being the one place of effective
management.

 
 

Annexure : – Definitions of “Residence”

1. Under the Income-tax Act, 1961, the definition is as under: 
 
Residence in India.
Section 6. For the purposes of this Act, - 
 
(1) An individual is said …..
(2) A Hindu undivided family …..
(3) A company is said to be resident in Indian in any previous year, if –
(i) it is an Indian company; or
(ii) during that year, the control and management of its affairs is situated wholly
in India.
2. Direct Taxes Code Bill 2010 proposed a definition as under:

Section 4 (b): its place of effective management, at any time in the year, is in

India.

Section 314 (192) “place of effective management” means –

(i) the place where the board of directors of the company or its executive
directors, as the case may be, make their decisions; or
(ii) in a case where the board of directors routinely approve the commercial and
strategic decisions made by the executive directors or officers of the company,
the place where such executive directors or officers of the company perform
their functions.

3. Finance Bill 2015 – as moved on 30th April, 2015 proposed as under:

Section 6 (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.

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 the business of an entity as a whole are in
substance made.