VIDYA VARDHINI

76/2024 – January

Relevance of Place of effective management [POEM]

for determination of residential status of companies
Introduction
In previous issues, we have dealt with the subject of Residential Status and determination of total
income based on such status. In the present issue, we take a subject which is very relevant for
companies.

Under the provisions of the Income Tax Act, 1961, in respect of every person, the scope of ‘Total
income’ chargeable to tax in India for every person, is dependent upon the residential status of
the person. Section 6 of the Income Tax Act contains provisions relating to the determination of
residential status of different categories of persons. As far as a company, which is not an Indian
company is concerned, the determination of the residential status is based on the Place of
Effective Management [POEM] of such company. Determination of the place of effective
management is a complex matter. The objective of this article is to provide the reader a basic
understanding of the concept of POEM and how the residential status of a company is determined
based on POEM.

What does section 6 of income Tax Act say about the residential status of a company?
A company is said to be a resident in India in any financial year, if -
1. It is an Indian company; or
2. Its place of effective management, in that year, is in India.

For this purpose, “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.

So, for an Indian company, the status is always- ‘Resident.’ For non- Indian companies, the status
is based on POEM. For every financial year, the POEM is to be independently determined.

What are the guiding factors for determining the 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 year 2017, Central Board of Direct Taxes [CBDT] has issued circular Numbers 6, 8 and 25in
relation to POEM. These circulars provide the guiding factors. The main guiding principles for
determination of POEM of a company are provided in the Circular No. 6, with clarification
regarding one factor provided under circular No. 25. Circular No.8 provides that the guidelines of
circular 6 shall not apply to a company having a turnover or gross receipts of Rs.50 crores or less
in a financial year. In other words, for those companies, determination of such place would be
based on the facts and circumstances.
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What is the significance of POEM?

POEM is an internationally recognized test for the determination of residence of a company
incorporated in a foreign jurisdiction.
Most of the tax treaties entered into by India recognize the concept of POEM for
determination of residential status of a company.
POEM concept is one of substance over form. An entity may have more than one place of
management but it can have only one POEM at any point of time. Since “residence” is to be
determined for each financial year, POEM also required to be determined on year-to-year
basis. The process of determination of POEM would be primarily based on the fact as to
whether or not the company is engaged in Active Business Outside India. (ABOI test)

When is a company said to be engaged in active business outside India?

A company is said to be engaged in active business outside India, if all the following conditions are
fulfilled -
Its ‘Passive income’ is not more than 50% of its total income;
Less than 50% of its total assets are situated in India.
Less than 50% of total no. of its employees are situated in India.
The payroll expenses incurred on such employees (i.e., those that are in India) is less than 50%
of its total payroll expenditure.

What is meant by ‘Passive income’?

Passive income of a company is the aggregate of the following
1. Income from transactions where both the purchase and sale of goods is from/ to its associated
enterprises.
2. Income by way of royalty, dividend, capital gains, interest or rental income.

However, interest is not considered to be passive income in case of a company which is engaged in
business of banking or is a public financial institution and its activities are regulated under
applicable laws of country of incorporation.

Where is the POEM?

The determination is to be for two categories of companies:
A. Companies engaged in ABOI.
B. Companies not engaged in ABOI.

A) POEM for companies engaged in ABOI:

It is presumed to be outside India if the majority of the meetings of board of directors [BOD] are
held outside India.

Exception - The exception applies if both the following conditions are fulfilled:
If based on facts and circumstances it is established that:
1. BOD is standing aside and not exercising the powers of management; and
2. Such powers are exercised by-

(a) holding company resident in India; or

(b) any other person/ persons resident in India.
In such case, POEM is considered to be in India.

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Clarification about BOD standing aside

Merely because BOD follows general and objective principles of global policy of the group laid
down by parent entity and not being specific to any entity or group of entities per se, would not
mean that it is standing aside.
Such global policy may be in the fields such as the following:
Payroll/ accounting/ HR functions;
I.T. infrastructure and network platforms;
Supply chain functions;
Routine banking operational procedures.

Circular No. 25 clarifies whether POEM is triggered when there is regional headquarter in India. It
clarifies that so long as the regional headquarter operates for subsidiary/ group companies in a
region, within the general and objective principles of global policy (referred to in Circular No.6), it
would not per se be a case of BOD standing aside. Such activities of Regional headquarter in India
alone will not be a basis for establishment of POEM for such subsidiaries/ group companies.

B) POEM for companies not engaged in ABOI

Determination of POEM is a two-stage process:

Identification of person/ persons who actually make the key management and commercial
decisions for the conduct of company’s business as a whole;
Determination of place where these decisions are in fact being made.

Place where these management decisions are taken would be more important than the place
where such decisions are implemented. For the purpose of determination of POEM, it is the
substance which would be conclusive rather than the form.

Other matters clarified

CBDT circular No. 6 clarifies other matters also such as the meaning of various terms used, e.g.,
income, assets, number of employees, payroll, senior management, data to be used for ABOI
test, Head-office etc.
The circular clarifies that the principles provided in the circular are for guidance only. No
single principle can be decisive in itself.
The principles are not to be seen with reference to any particular moment in time. Rather,
activities performed over a period of time during the financial year need to be considered. A
“snapshot” approach cannot be adopted.
Based on the facts and circumstances, if it is determined that during the financial 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.
Certain illustrations to highlight the applicability of the principles are also given in the circular.

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Concluding Remarks
Residential status is a vital concept in the matter of taxing the income. For multi-national
companies, the determination of residential status becomes a complex matter. Similar to the global
legislative provisions in respect of residential status based on POEM, Indian Government also has
legislated in respect of the same. These provisions are very significant as the residential status and
consequently the chargeability to tax of the income of multi- national companies is dependent
upon such provisions.

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Subhash Bhide
has contributed to this article.
If you wish to discuss this further, you can reach out to subhash.bhide@mmchitale.com

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non- commercial use. The views expressed are not our professional advice or opinion. Readers are requested to
take appropriate professional advice before taking any decision based on the information contained in this
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