ABSTRACT

Place of Effective Management more

commonly known as POEM is the test for
determining the residential status of foreign
companies which earlier on account of the
lacuna in the law, particularly Section 6 of the
IT Act, 1961 were in a position to evade taxes.
Realizing it to be the need of the hour the
Finance Act was amended and thereby a
change was brought about under the IT Act,

PLACE OF 1961. It can be said that it was a much

needed change as such lacunas in law would
expose the Indian economy to grave threats.
EFFECTIVE Aakshay Amesur – A066 & Neel
Narsinghani – A059, IV year BBA LLB
MANAGEMENT (Hons), SVKM’s NMIMS KPM School
of Law
POEM
 Place of Effective Management

NMIMS SCHOOL OF LAW

AN ARTICLE SUBMITTED ON;

PLACE OF EFFECTIVE MANAGEMENT

IN COMPLIANCE TO PARTIAL FULFILLMENT OF THE MARKING SCHEME, FOR

TRIMESTER XI OF 2017-2018, IN THE SUBJECT OF TAX LAW – I

SUBMITTED TO FACULTY:

PROF. SOHINI SHRIVASTAV

FOR EVALUATION

SUBMITTED BY:

AAKSHAY AMESUR – A 066

NEEL NARSINGHANI – A 059

RECEIVED BY: ____________________________

ON DATE: 22/12/2017 TIME: ______

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 Place of Effective Management

Index of Abbreviations

Sr.No Abbreviation Full Form

1. ABOI Active Business Outside India
2. BOD Board of Directors
3. CBDT Central Board of Direct Taxes
4. CEO Chief Executive Officer
5. CFO Chief Financial Officer
6. COO Chief Operating Officer
7. DTC Direct Tax Code
8. Ho Head office
9. IT Income Tax
10. M&A Mergers and Amalgamations
11. No. Number
12. POEM Place of Effective Management
13. Sec./S. Section
14. w.r.t With respect to

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 Place of Effective Management

Introduction

The concept of POEM was introduced by the an amendment in the Finance Act, 2015 to bring
about a change in determining the residential status of foreign companies, who by setting up shell
companies in India and shifting their isolated events to India were avoiding taxes. Realizing the
need of the hour the Finance Act was amended, and thereby a change was introduced so as to
effectively determine and lay a concrete test for determining the residential status of foreign
companies in India. However the implementation of POEM was deferred by a year and the same
was then applicable to assessment years 2017-2018, as the amendment as it stood before failed to
establish a criteria to determine the place of effective management of a business. It therefore is
necessary to understand Sec. 6 as it stood before the amendment.

Prior to the amendment 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. The criteria to determine the residential status as it stood before is
highlighted hereunder:

Prior to the amendment

if it is an Indian
Company

Residential Status
during that year,
control and
management of its
affairs is situated
wholly in India

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 Place of Effective Management

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 Sec. 2(26) of the Income Tax Act, 1961 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. The provision as it stood
before suffered a loophole which was often exploited by foreign companies that enabled them to
avoid taxes by shifting their insignificant events related to control and management outside India.

The SC has time and again reinstated the rationale laid down for taxing a foreign company in the
case of De Beers vs Howe1, ‘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.

Control & Management Test

While interpreting the expression ‘control & management’ it is necessary to bear in mind the
distinction between the doing of business and the control and management of business. The
expression ‘control and management’ does not refer to carrying on day to day business activities
by servants, employees or agents. The real test to be applied is to check where the controlling
and directing power is or where the controlling and directing power function. In other words it is
the head & brain of the company which was to be determined while applying the test of control
and management.

1
De beers v. Howe [1906] Tax Cas 198

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 Place of Effective Management

Place of Effective Management

Initially a company was considered a resident for tax purposes if the control and management of
its affairs was situated wholly in India. However the law relating to residential status has now been
changed and a more stringent approach has been adopted. The section now provides for a provision
whereby a foreign company will be considered a resident in India if its Place of Effective
Management (POEM) in the assessment year is in India. The said change has been brought about
by an amendment in the Finance Act and Section 6 of the Income Tax Act, 1961 and the CBDT
has via Circular No. 06 of 20172 has not only implemented the following change but also laid
down the criteria or the test to determine the POEM of a company.

Section 6 of the Income Tax Act, 19613

Prior Amendment

• If it is an Indian Company
• its control and managment is situated wholly in India during
the accounting year

Post Amendment

• If it is an Indian Company
• Its place of effective management in that year is in India

2
http://www.incometaxindia.gov.in/News/Circular06_2017.pdf
3
http://www.incometaxindia.gov.in/_layouts/15/dit/mobile/viewer.aspx?path=http://www.incometaxindia.gov.in/acts
/income-tax%20act,%201961/2016/102120000000058020.htm&k=

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 Place of Effective Management

POEM: A tie – breaker rule for avoidance of Double Taxation

“Place of Effective Management”4 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.

The rationale behind introducing the concept of POEM was to ensure that the companies
incorporated outside India, but controlled and managed from India do not escape taxation in India.
It also brings in the concept of residency of corporates in line with internationally accepted
principles. The concept of POEM has been accepted and recognized by the OECD in its model tax
treaties along with “tie breaker” clauses in the case of a country being a tax resident in more than
one country. In the Indian context, POEM provisions were due to be introduced as part of the DTC.
As things stand the code has been shelved, however key elements from the proposed code have
been incorporated into the existing tax strictures.

Analysis of the definition of POEM

The test of POEM as has been defined by the lawmakers can be said to be an inclusive one as it
covers all the aspects of a business and then aids in reaching a consensus as to determine whether
the company is a resident or not. The key parts of the definition which indicate the same are
highlighted hereunder:

Key managerial and commercial decisions – the terms ‘key’, ‘managerial’ and ‘commercial
decisions’ are to be interpreted together and cannot be seen in isolation. Examples of
managerial decisions may include M&A and company restructuring decisions; on the other
hand commercial decisions may refer to borrowings, debt financing, capital structuring etc5.

In substance are made – the concept of POEM is of substance over form in the sense that the
decision being taken must be w.r.t any material or essential part of a thing. It is also necessary
that as a result of the decision taken some material change w.r.t the business has come into
existence.

4
Supra 2
5
https://www.bcasonline.org/ContentType/ITF%20Material/ITF-Pinakin%20Desai.pdf

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Applicability of POEM provisions

According to the guiding principles issued by the CBDT, for a company to fall outside the scope
of POEM, it must be engaged in active business outside India which means that its passive income
shall not be more than 50% of its total income. The board further has further laid down the criteria’s
to determine the same.

The circular issued by the CBDT provides a comprehensive test for determining whether the
company for the relevant accounting year is engaged in ABOI and at the same time provides a
definition for the expression passive income and lays down in detail as to what can be considered
to be passive income. It further has to be noted that a company is engaged in ABOI if majority of
the meetings of BODs is held outside India then the company can be said to be engaged in ABOI,
this provision however is subject to an exception that if it is witnessed that the BOD is standing
aside and key decisions are being taken by persons who are resident in India then the place of
effective management of the company is deemed to be in India.

Test for determining ABOI

Payroll expenses
of the company
•payroll expenses
Number of incurred on such
employees of the employees is less
company than 50% of total
Assets of the •less than 50% of expenses
company thte total
•less than 50% of emplpoyees are
Income of the the total are situated in India
company situated outside or are resident in
India India
•Passive income
not more than
50% of total
income

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 Place of Effective Management

There may be situations wherein it might be difficult to determine whether the company is engaged
in ABOI or not thereby creating difficulties for the tax authorities to determine whether the POEM
of that particular business assessee is India or no. Having regards to the same, the circular has
provided for a two stage process to determine POEM of such companies.

Stage I– Identification of persons who actually make key management and commercial
decision for conduct of the company’s business as whole.

Stage II – Determination of the place where these decisions are in fact being made.

Both the above factors are to be considered while determining the POEM of such companies who
are not engaged in Active Business outside India.

Determination of POEM: Not satisfying the ABOI test

Some of the factors that are to be taken into consideration for determining the POEM of companies
which do not satisfy the ABOI test as have been inculcated in the CBDT circular are:

Location of the Company – location of the HO of the company proves to be an important element
because it determines the place where the key decisions are made. Determination of POEM will
depend upon the structure of company which might give rise to the following specific situations:

Location of Single Location- place where senior management and

Company's
HO direct support staf are located

Multiple locations - where senior management is

predomminantly based

Decentralized - in such cases the HO is not relevant

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 Place of Effective Management

The expression senior management have been defined to include the following viz; (i) Managing
director or CEO (ii) Financial Director or CFO (iii) COO and (iv) the heads of various divisions
or departments as for instance Chief Information or technology officer, Director for Sales or
Marketing.

In cases where the company is decentralized the location of the HO of the company is not a relevant
and generally the following three factors w.r.t the senior management of the company are to be
taken into consideration viz:

 Where the senior management of the company is predominantly based

 Where the senior management of the company normally return to following travel to other
locations
 Where the senior management of the company meet for formulating or deciding key
strategies and policies for the company’s as a whole.

Delegation of Authority

Delegation of authority to make decisions is possible and the following situations might be
considered.

 Where the BOD delegates the authority to senior management or shareholder then the place
where these persons make the decision and

 If the same has been delegated to one or more committees then the place where these
committees develop key strategies for approval by the Board. Delegation may be de jure
or de – facto.

If in a case the following primary factors cannot be ascertained and further do not lead to a clear
identification of POEM then the following secondary factors are to be considered viz:

 Place where the main or substantial activity of the company is carried

 Place were accounting records of the company are kept.

POEM: Targeting Passive – Income Companies

The CBDT has stated that the intent of POEM is to not target Indian multi-nationals which are
engaged in business activity outside India. But the intent is to target shell companies created for

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 Place of Effective Management

retaining income outside India although real control and management of affairs is located in India.
The expression passive income has further been defined by the CBDT circular and while defining
the same, it was been specifically stated that any income earned by the way of interest is not passive
income if the same is earned by a business engaged in the business of banking. Accordingly the
circular includes the following within the scope of the expression passive income; (i) income from
transactions where both purchase and sale of goods is from/ to its associated enterprises and (ii)
any income earned by the way of royalty, dividend, capital gains, interest or rental income. 6

Consequences of POEM in India

The consequence of this provision, unless amended or clarified is going to be a large uptick in tax
disputes, where the department will invariably look at a foreign entity owned by Indians and tax it
at the maximum marginal rates. That there is no established jurisprudence on this matter in India
also means that litigation on this matter will only increase. Start-ups and established Indian players
have few options by way of recourse, one option would be to decouple ownership and
management/Control and ensure that such management is situated only outside of India and no
overlaps exist. This is easier said than done and will certainly be a challenge for all businesses
looking to go global.

6
Supra 2

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 Place of Effective Management

Conclusion

It can be said that the introduction of the concept of POEM brought out by amending the Finance
Act and Section 6 of the Income Tax Act was a much needed move. For long companies have been
avoiding taxes on account of the loopholes which earlier existed before the section was amended.
Earlier the residential status of a company was determined by the ‘control and management test’
in the sense that these companies often shifted their insignificant or isolated events relating to the
conduct of the business in India and on the other hand all the significant decisions relating to the
conduct of the business were though implemented in India but always were made outside India
which indirectly routed a way for such companies to avoid the burden of taxes in India.

It was the need of the hour to adopt a stringent approach and tax these shell companies and realizing
the same, the Finance Act was amended in 2015 which post amendment provided for a provision
whereby such companies were taxed based on their POEM i.e. the place of effective management.
Though the Amendment was brought about in 2015, its actual implementation was deferred by a
year on account of lack of guiding principles which later were issued by the CBT via Circular No.
06 of 2017. It can be concluded that the said circular is a well written law and as such due care has
been taken to cover all the measures relating to determination of POEM and the circular further
has been drafted carefully and each and every key word and test has been defined. Thus it can be
said that there is no ambiguity. On the whole it will be justified to say that the concept of POEM
was the much needed change and should have been brought into implementation long ago, the
same however being a new concept will give rise to a number of complications and litigations. It
is only the time that can tell whether the universally acknowledged concept will be successful in
India.

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Bibliography

Websites referred

https://www.google.co.in/url?sa=t&rct=j&q=&esrc=s&source=web&cd=6&cad=rja&uact=8&ve
d=0ahUKEwjB3_CcjprYAhXMqY8KHebjDaEQFghDMAU&url=http%3A%2F%2Fwww.inco
metaxindia.gov.in%2FNews%2FCircular06_2017.pdf&usg=AOvVaw3us1-DRS-
3fdX1OLAepeml

http://www.arkayandarkay.com/place-of-effective-management-concept-and-impact/

https://www.bloombergquint.com/union-budget-india/2017/01/24/tax-department-issues-place-
of-effective-management-rules-to-stop-evasion-by-foreign-companies

https://neerajbhagat.com/pdf/PoEM.pdf

Books referred

 Tax Law – I, Girjesh Shukla & Mahima V. Tiwari

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