Why was the PoEM introduced?
As of right now, if a foreign company’s[1] operations and affairs are fully controlled and managed within India, it is recognised as an Indian resident. To regulate the tax of these companies incorporated outside India but controlled from India, the Finance Bill of 2015 introduced the “Place of Effective Management” (PoEM) concept to determine foreign companies’ residential status. This resulted in an amendment to the Income Tax Act, 1961; the word “control and management” was replaced with “PoEM” in Section 6 of the act as follows:
Section 6(3) of the Income Tax Act, 1961,[2] before the Finance Bill 2015 stated 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 are situated wholly in India.
This provision clearly mentioned controlling and managing the company’s affairs in India. But, with respect to the amendment, the above situation has been changed by introducing the Place of Effective Management (PoEM).
Section 6(3) of the Income Tax Act, 1961, is amended as per the Finance Act, 2015[3] as follows:
“A company is said to be a resident in India in any previous year if:
- It is an Indian company;
- Its place of effective management in that year is in India.”
The definition of the PoEM was attached in the annexure of this act as “PoEM refers to a place where the key management and commercial decisions necessary for conducting an entity’s business are made in substance. It is an internationally recognized concept that the Organization for Economic Co-operation and Development (OECD) accepts.”[4] After the incorporation of PoEM, a foreign company is considered a resident of India if its control and management of affairs are situated wholly in India. These companies often maintained superficial control over their international operations to avoid paying taxes on overseas earnings, thereby paying taxes solely on Indian operations. PoEM was established to curb such practices and prevent profit erosion from India, ensuring that companies with significant management and critical administration in India are taxed accordingly.
How to Determine the PoEM? In the case of Radha Rani Holdings (P) Ltd. v. DIT, [5] the Supreme Court found that an unwarranted implication of control and management was manifested. A company cannot beconsidered a resident of India for tax purposes merely because it has isolated instances of control outside India. However, the government criticised this criterion, arguing that it allows companies to evade taxes simply by holding a single board meeting outside the country. Only companies whose control was “wholly situated in India” were considered Indian residents, prompting the government to lower the threshold by introducing the POEM Test. The Ministry of Finance issued guidelines on PoEM to provide more clarity in this regard. The assessment is based on several factors:
- First, determine if the company is engaged in Active Business Outside India (ABOI) by checking that the passive income of the company is not more than 50% of its total
- Out of the company’s total assets, less than 50% are situated in India.
- Out of total employees, less than 50% of its employees are in India, and if the payroll expenses for Indian employees are less than 50% of total payroll expenditure,.
- Secondly, if a company is engaged in ABOI (American Board of Oral Implantology), it is not considered as resident of India. If not, the next steps are to identify the individuals making key managerial and commercial decisions.
These factors were further assessed based on guiding principles such as the location of regular board meetings, the delegation of executive committees, the head offices, the types of decisions made, and the people making them.[6]
CONCLUSION:
The PoEM is essential for establishing a company’s tax residency. If a company is deemed a tax resident in a specific jurisdiction, it might be liable for taxes on its global income in that location. Therefore, identifying PoEM aids in preventing tax evasion and guarantees that companies pay taxes in the regions where they conduct significant economic activities.
AUTHOR:
Thirisha S, 4th-year student of B.A., LL.B. (Hons.) from School Of Excellence in Law.