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POEM Impacts Foreign Companies

Place of Effective Management (POEM) Impacts Foreign Companies 

Setting Context 

(Place of Effective Management) POEM Impacts Foreign Companies those may be trying to evade taxes by merely having incorporation or a set of directors operating from outside India while in substance it is carrying our activities in India and earning income which should be subject to tax in India.

What is POEM?

POEM is the concept related to the determination of residential status of a Company in India. As per Section-6(3) of Indian Income Tax Act, a company is said to be Resident in India in any previous year, if:

I) it is an Indian company; or

II) Its place of effective management (POEM), in that year, is in India.

To know the definition of Indian Company, we need to know:

  1. Foreign Company: S-2(23A) means a Company which is not a domestic company.
  2. Domestic Company: S-2(22A) means an Indian company or any other company which, in respect of its total income liable to tax under ITA, has made arrangements for the declaration and payment, within India, of the dividends payable out of such income.
  3. Indian Company: S-2(26) of ITA means a company formed and registered under Indian Companies Act and including statutory corporations, any institutions, association or body which is declared by the board to be a company.

So, the companies incorporated in India or declared to be Indian companies for purposes of the ITA would be Resident in India.

Why POEM?

POEM was introduced in Indian Income Tax Act w.e.f. 1.4.2017 in place of earlier condition of ‘control and management of affairs’ being wholly situated in India. The defect in the existing conditions was that foreign company having some control and management outside India but having major control and management in India was being treated as Non-resident in India under Indian Income Tax Act.

Key Practical Aspects of POEM

  1. Applicable to a company having turnover or gross receipts of more than INR 50 crore in a financial year.
  2. Residential status is to be determined every year so POEM test to be applied every year to eligible companies.
  3. Eligible companies for POEM is foreign companies having active business in India and earnings income which should be subject to tax in India but trying to evade tax by merely incorporating or set of directors operating from outside India.
  4. However, certain functions such as payroll, accounting, HR, IT infrastructure and network platforms, supply chain, routine banking operational procedures, not being specific to any entity or grout of entities per se, it itself, may not constitute key functions. This is to ensure hassle free working to outsourcing activities in India.
  5. Built-in control is that, Assessing officer (AO) shall, before initiating any proceedings for holding a company incorporated outside India, on the basis of its POEM, as being Resident in India, seeks prior approval of the Principal Commissioner or the Commissioner. And the collegium so constituted, by The Principal Chief Commissioner of the region concerned consisting of the Principal Commissioner or the Commissioners, shall provide an opportunity of being heard to the Company before issuing any direction in this matter.
  6. Subsidiaries of the intermediate holding company cannot be covered under POEM if that intermediate holding company is covered under POEM. Each company shall be tested separately for POEM irrespective of any interrelationships between them.
  7. POEM and DTAAs: POEM is incorporated in most of DTAAs, accordingly Article 4 of DTAA which deals with residential status of person provides that Residential of the Contracting state means any person, who under the law of that state, is liable to tax therein- by the reason of his domicile, residence, place of management or any other criteria of a similar nature. And further provides that where a person other than individual is Resident of both the states, then it shall be deemed to be Resident of the state in which POEM is situated. If the POEM can’t be determined, then competent authorities of both the states shall decide by MAP or else no Treaty benefits are available like in Indo-USA tax treaty.
  8. POEM and MLI: No major changes are incorporated in DTAAs due to POEM. But, MLI incorporates Article-7 on prevention of treaty abuse as one of the minimum standards. Accordingly, entitlement of Treaty has to be test on two principles; one Principal Purpose Test (PPT) and second the Simplified limitation of benefit (SLoB). Therefore, if a person fails the PPT test or SLoB test, then he shall be disqualified for obtaining Treaty benefits.

Concluding Remark:

POEM is not a new concept for tax treaties but it was introduced in domestic tax laws very recently. Place of Effective Management (POEM) impacts Foreign Companies in the times to come especially when these companies are doing active business in India while avoiding residential status and taxability in India.

(Disclaimer: This content is meant for our clients or professional friends only for stimulating discussion on the subject matter not to frame any commercial opinion. All efforts are made to compile correctly with no guarantee of extreme accuracy)

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