India clarifies “place of effective management” test for determining corporate tax residency

by Ashish Goel

The Indian government has released key guidance on the interpretation and application the new “place of effective management” (POEM) test to determine corporate residency for tax purposes.

The guidance, released in draft form on December 23, 2015, clarifies recently amended Section 6(3) of the IT Act, which provides that a company shall be considered tax resident in India in any previous year if it is an Indian company, or its POEM, in that year, is in India. The change, introduced through the 2015 Finance Act, will take effect from April 2016.

The explanation to section 6(3) defines POEM as the “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 guidance notes that the concept of POEM is one of “substance” over “form” and that an entity may have more than one place of management, but it can have only one POEM at any point of time.

The guidance states that the POEM of an entity will depend on whether or not the company is engaged in active business outside India. The POEM of an entity engaged in active business outside India shall be presumed to be outside India if the majority of meetings of the board of directors of the entity are held outside India and the board is actually exercising their powers of management from outside India.

An entity is said to be engaged in active business outside India if its “passive income” is not more than 50 percent of its total income; less than 50 percent of its total assets are situated in India; less than 50 percent of its total employees are resident in India; and the payroll expenses incurred on such employees is less than 50 percent of its total payroll expenditure. For this purpose, the average of the data of the previous year and two years prior to that shall be taken into account. Besides, in case the company has been in existence for a shorter period, then data of such period shall be considered.

The guidance notes that the POEM of entities not engaged in active business outside India shall be determined in two stages, namely, identification or ascertaining the person or persons who actually make the key management and commercial decision for conduct of the company’s business as a whole; and determination of place where these decisions are in fact made. This will involve consideration of several factors including the location where the entity’s board regularly meets and makes decisions; the location of the entity’s head office; and the location where the members of the executive committee on whom decision-making authority is vested are based.

According to the guidance, the tax authority may also consider other secondary factors in determining the POEM of an entity, such as the place where main and substantial activity of the entity is carried out; or the place where the accounting records of the entity are kept. The guidance also sets out several illustrations to emphasize that the determination of POEM shall be based on all relevant facts related to the management and control of the company and not on the basis of isolated facts that by itself do not establish effective management.

Ashish Goel

Ashish Goel

Ashish Goel is an international tax lawyer currently based out of India.

Ashish has advised large companies operating in various sectors such as defence, pharmaceuticals, steel etc. in relation to their cross-border legal and tax issues in the UK and India. Ashish specializes in corporate tax issues, including treaty disputes and transfer pricing.

Ashish studied law at the National University of Juridical Sciences (NUJS) and holds a LL.M in international tax law from King’s College London. He has taught international tax law at NUJS and at the Indian Society of International Law.

Ashish tweets on international tax developments at @ashish_nujs