India: CBDT Guidelines On Determination Place Of Effective Management

Introduction

On January 24, 2017, the Central Board for Direct Taxes (hereinafter referred to as "CBDT") issued a circular enumerating the Guidelines for Determining the Place of Effective Management (hereinafter referred to as "POEM Guidelines") of a company1. Section 6(3) of The Income Tax Act, 1961 (hereinafter referred to as the "IT Act") was amended by the Finance Act, 2015 and defines the term "Place of effective management" 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 amended definition was scheduled to come into effect from April 1, 2016 but The Finance Act, 2016, changed the effectiveness of the amendment to April 1, 2017 and hence, will apply to Assessment Year 2017-18 and subsequent assessment years.

Situation Prior to Amendment

Prior to the amendment, the situation was a bit different, as under Section 6(3) of the IT Act, a Company was said to be resident in India if –

  1. it was an Indian Company; or
  2. during the previous year the control and management of its affairs was situated wholly in India.

The Bombay High Court in Narottam and Pereira Ltd. Vs Commissioner of Income Tax (1953 23 CompCas 185 Bom) had observed that while construing the expression "control and management" it was necessary to bear in mind the distinction between doing of business and control and management of business. The Court observed that the entirety of business activities by a Company may be conducted outside India, while the control and management of that business may be wholly within India. Therefore, it did not matter where business activities were conducted and income has been earned. The relevant factor was where the controlling and directing power or the seat of head and the brain of the company lay.

However, under the old definition, the expression 'control and management' resulted in ambiguities and loopholes which led to tax avoidance and double taxation.

To address these concerns the Ministry of Finance, amended Section 6(3) of the IT Act to provide greater clarity in the Taxation Process.

Place of Effective Management in Tax Treaties-

The "place of effective management approach" is known to be an effective approach for avoiding tax evasion by foreign companies in India. Many other jurisdictions have adopted this approach in their tax laws such as China, Russia, South Africa, and Australia2 and most of the tax treaties entered into by India recognizes the concept of "place of effective management" for determination of residence of a company as a tie-breaker rule for avoidance of double taxation.

Important Provisions of the POEM Guidelines

  1. The POEM guidelines shall not apply to Companies whose turnover is INR Fifty Crore or less during a Financial Year.
  2. Some Factors that determine Place of Effective Management

    Identification or ascertaining the person or persons who actually make the key management and commercial decisions for conduct of the Company's operations and the determination of place where these decisions are in fact being taken. The following factors may be taken into account in the determination:

    1. The location where a company's Board regularly meets and makes decisions may be the company's place of effective management. If the Place of Effective Management of a Company engaged in active business outside India shall be presumed to be outside India, if the majority of meetings of the Board of the company are held outside India.
    2. The location of a Company's Head Office will be a very important factor in the determination of the Company's Place of Effective Management as the Head Office represents the place where decisions are made.
    3. In case of delegation of duties by the Board to an executive committee, the location where the members of the committee are resident and where their meetings are conducted will be taken into account.
    4. The place where the Directors or the Persons taking the decisions or the majority of them usually reside may also be a relevant factor.
    5. Other factors that may be considered include the place where main and substantial activity of the company is carried out; or place where the accounting records of the company are kept.
    For the purpose of determining the Place of Effective Management, the average of the data of the previous year and two years prior to that shall be taken into account. In cases where a Company has been in existence for a shorter period, the data of such period shall be taken into account. It is pertinent to note that no single principle will be decisive in itself and such determination will done based on the facts and circumstances of each case.
  3. Active Business Outside India

    A company is said to be engaged in 'active business outside India' if-

    1. Passive income is not more that 50% of its total income; and
    2. Less than 50% of its total assets are situated in India; and
    3. Less than 50% of total number of employees are situated in India or are resident in India; and
    4. The payroll expenses incurred on such employees is less than 50% of the total payroll expenditure.
    'Passive income' in this context means any income from the transaction purchase and sale to or from subsidiary or associated companies which shall also include income by way of royalty, dividend, capital gains, interest or rental income. (Income by interest as passive income is excluded in case of companies engaged in business of banking or is a public financial institution.)

    If any of the above conditions that are mentioned above are not met, then the income of such a Company will be presumed to be domestic income and shall be taxable in India. The CBDT has further clarified that this test has been provided to target shell companies and the companies which are created for retaining income outside India although real control and management is located in India.3
  4. For the purpose the average of the data of the previous year and two years prior to that shall be taken into account. In case of a company in existence for a shorter period the data of such period shall be taken into account.
  5. Factors not considered to be conclusive evidence-

    1. A foreign subsidiary of an Indian Company will not be considered to have its Place of Effective Management in India simply due to its status as a subsidiary.
    2. It is pertinent to note that having a permanent establishment of a Foreign Company in India is different from 'Place of Effective Management in India'. Having a Permanent Establishment means that income related to permanent establishment is taxable in India but having Place of Effective Management in India means that the worldwide income of Foreign Company is taxable in India.4 Therefore, a Foreign Company having a Permanent Establishment in India will not mean that the Company's management occurs in India.
    3. Residence of one or more directors of the Foreign Company in India or the existence of auxiliary support functions being situated in India will not be conclusive evidence for establishing POEM in India.

Observations-

The POEM Guidelines have been formulated keeping in view the increasing role of technology in carrying out business activities. The Guidelines take into account use of modern technology such as video conferencing and telecommunications which allow Companies to hold meetings with members without requiring them to be physically present in a conference room for a particular meeting.

It is reiterated that the principles are for guidance only and none of the principles are decisive in itself. Any determination of the Place of Effective Management will depend upon the facts and circumstances of each case. It may be noted that an entity may have more than one place of management, but it can have only one Place of Effective Management at any point of time for the determination of residential status as per the guidelines. Since tax is to be paid on a yearly basis a Company's Place of Effective Management will be determined on a year-to-year basis.

Footnotes

1. http://www.incometaxindia.gov.in/News/Circular06_2017.pdf

2. https://www.sircoficai.org/downloads/cpe-materials/PoEM-Training-1.pdf

3. http://www.incometaxindia.gov.in/Lists/Press%20Releases/Attachments/588/CBDT-Guiding-Principles-determination-Effective-Management-POEM-Company-24-1-2017.pdf

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

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