The Central Board of Direct Taxes (CBDT) issued guidelines on the ‘place of effective management’

The Central Board of Direct Taxes (CBDT) issued guidelines on the ‘place of effective management’, or POEM, of a company to determine its tax liability. POEM rules target companies that were set up abroad to retain income outside India but are controlled from India.
Highlights:

• The company will considered to be engaged in active business outside India if the majority of its income, assets, employees and employee expense is from outside India.
• If the company directors are not exercising their powers of management and such powers are being exercised by either the holding company or any other person resident in India, then the place of effective management shall be considered to be in India.
• In case a firm is not classified as active outside India, a two-stage process will be followed, where the person making key management decisions and the location where such decisions will be taken will be looked at.
• For determining whether a firm is engaged in active business outside India, the average of the past three years’ data will be taken into account.
• In case a company’s board delegates some of its authority to one or more committees such as an executive panel consisting of key members of senior management, the location where the members of the executive panel formulate the key strategies will be considered as the firm’s place of effective management.
• It is no longer necessary for the persons taking decision to be physically present at a particular location, in such a case, the place of residency of the directors may also be important.
• These rules will not be applicable to firms with annual turnover of less than RS 50 crore.
• Assessing officer (AO), before initiating an inquiry for POEM in a case of a taxpayer, will seek approval from Principal Commissioner or Commissioner of Income-Tax. The AO shall also obtain approval from a Collegium of Principal Commissioners of Income-Tax before holding that POEM of a non-resident company is in India,” it said.
• In cases of “companies other than those that are engaged in active business outside India”, the determination of POEM will be a two-stage process.
• The first stage would be identification or ascertaining the persons who actually make the key management and commercial decision for conduct of the company’s business as a whole. The second stage would be determination of place where these decisions are in fact being made.
• The concept of POEM to decide the residential status of a company was introduced by the Finance Act, 2015.

Analysis:

• The modification to the existing norms was necessary as several companies skip tax liability by misusing the guidelines. This will protect the business interests of both global companies having business connection with India or presence here, and Indian multinationals having active business abroad.
• These guidelines are not intended to cover foreign companies or to tax their global income, merely on the ground of presence of permanent establishment or business connection in India.
• However, this could expose some Indian MNCs to double taxation, and increase litigation, as applicability is proposed from the current financial year, based on the average of the past three years' data.
• This will be very relevant for information technology companies, as they normally have an offshore subsidiary for onsite work, and also for the pharmaceutical industry.

By: Vishal