What is Place of Effective Management (PoEM) in India

The Indian Income Tax System places the incidence of tax based on the residential status of the assessee. If the assessee is Individual, it’s residential status is based on the number of days of his residence in India. However, in case of Companies, residential status is decided on the basis of its place of Incorporation or place of effective management.

Before amendment to section 6(3) of Income Tax Act, 1961, wordings of the section were as follows: –

“A Company is said to be resident in India in any previous year, if-

  it is an Indian Company; or

  during that year, the control and management of its affairs is situated wholly in India.”

However, meaning of the wordings “Control and management of its affairs” was not clear and was based of some subjective assumptions.

That’s why, Finance Act, 2016, amended the wordings as follows:

“A Company is said to be resident in India in any previous year, if-

  it is an Indian Company; or

  its place of effective management, in that year, is in India.”

Also, Explanation to the section was added, that “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.”

Also, CBDT issues circular on 24th January, 2017 as guiding principles for determination of Place of Effective Management (POEM) of the Company

To view the circular,visit > https://www.incometaxindia.gov.in/news/circular06_2017.pdf

When the Place of Effective management is said to be outside India: –

Place of effective management is based on Active business of the company in India and many other aspects like consideration of shareholders’ decisions by the parent company, broader strategic and policy decisions, etc. If company’s active business is outside India, it is one major consideration for saying that the Company’s place of effective management is outside India and the Company will be Non-resident.

Conditions when POEM is considered as not in India: –

POEM is considered outside India if: –

  Company is engaged in active business outside India; and

  Majority of Board Meeting are held Outside India.

Lets understand what are the key considerations for Active business outside India: –

As per the guidelines, A company shall be said to be engaged in “active business outside India”

if the passive income is not more than 50% of its total income; and

  less than 50% of its total assets are situated in India; and

  less than 50% of total number of employees are situated in India or are resident in India; and

  the payroll expenses incurred on such employees is less than 50% of its total payroll expenditure.

Where Passive Income is 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.

Example for passive income: –

Company A Co. is a sourcing entity, for an Indian multinational group, incorporated in country X and is 100% subsidiary of Indian company (B Co.). The warehouses and stock in them are the only assets of the company and are located in country X. All the employees of the company are also in country X. The average income wise breakup of the company’s total income for three years is, –

  30% of income is from transaction where purchases are made from parties which are non-associated enterprises and sold to associated enterprises;

  30% of income is from transaction where purchases are made from associated enterprises and sold to associated enterprises;

  30% of income is from transaction where purchases are made from associated enterprises and sold to non-associated enterprises; and

  10% of the income is by way of interest.

Interpretation:

In this case passive income is 40% of the total income of the company. The passive income consists of, –

  ). 30% income from the transaction where both purchase and sale is from/to associated enterprises; and

  10% income from interest. The A Co. satisfies the first requirement of the test of active business outside India.

Income stated in point no. (i) in example i.e. purchase from non-associated enterprise and sale to associated enterprise is not passive income as, purchase and sale both should be with associated enterprise to call it as passive income.

Since no assets or employees of A Co. are in India the other requirements of the test are also satisfied. Therefore, company is engaged in active business outside India.

Note that Place of effective management is relevant for determining residential status
of the Company.

Status of the company i.e. Domestic Company and Foreign company is not affected by this concept. Tax rates applicable to the company will still be decided on the basis of status of the company i.e. domestic / foreign company and its residential status will not be relevant for thisApplicability: –

Circular 8/2017 dated February 23, 2017 issued by CBDT has clarified that the provisions of POEM will not be applicable to a company having turnover of Rs.50 Crores or less in the financial year.

To view the circular, visithttps://www.incometaxindia.gov.in/news/circular-8-2017-clarification-on-place-of-effective-management.pdf

Also, provisions relating to POEM are applicable from AY 2017-18 and onwards.