On 24 January, the Central Board of Direct Taxes released the final guidelines to determine the place of effective management (POEM) of foreign companies.
POEM is relevant in deciding the residential status of a company. The concept of POEM was introduced by the Finance Act, 2015, became effective from 1 April 2016, and is applicable from the 2016-17 financial year onwards.
Among other things, the POEM guidelines prescribe a test to determine whether a foreign company is engaged in an “active business outside India”. According to the guidelines, a company is engaged in active business outside India if: (a) its passive income is not more than 50% of its total income; and (b) less than 50% of its total assets are situated in India; and (c) less than 50% of its employees are situated in India or are resident in India; and (d) the payroll expenses incurred on such employees are less than 50% of its total payroll expenditure.
For companies engaged in active business outside India, the POEM is presumed to be outside India if the majority of meetings of the company’s board of directors are held outside India. However, if on the basis of facts and circumstances it is established that the board of directors is standing aside and not exercising its powers of management and such powers are being exercised by persons resident in India, the POEM shall be considered to be in India.
For companies other than those engaged in an active business outside India, the determination of POEM would be a two-stage process, namely: (a) identifying or ascertaining the persons who make the key management and commercial decisions for conduct of the company’s business as a whole; and (b) determining the place where these decisions are being made.
The POEM guidelines set out certain principles to consider when determining POEM and state that it is a concept of substance over form.
Adequate administrative safeguards have been incorporated in the POEM guidelines by mandating that the assessing officer (AO), before initiating a POEM inquiry in the case of a taxpayer, must seek approval from the principal commissioner of income tax or the commissioner of income tax. The AO is also required to obtain the approval of a collegium of principal commissioners of income tax before holding that the POEM of a foreign company is in India.
The POEM guidelines also contain illustrations to clarify some situations where the POEM of a foreign company may or may not be deemed to be in India.