New South African tax guidance explains “place of effective management” test

by Ashish Goel

The South African Revenue Service (SARS), on November 3, issued Interpretation Note (No. 6), which sets out useful guidance on the “place of effective management” (POEM) test for determining the tax residence of a company.

Under section 1(1) of the South African Income Tax Act, a company is said to be a resident in South Africa if it is incorporated in the country, or has its POEM there. POEM, as a test of domestic residence, is also included in Article 4 of most of the tax treaties that South Africa has signed with other countries. Article 4 uses POEM as a tie-breaker test in situations where a company is considered, before the application of the tie-breaker, to be a dual resident of both treaty countries.

As a general rule, the guidance follows the OECD’s definition of POEM, that is, “the place where key management and commercial decisions that are necessary for the conduct of a company’s business as a whole are in substance made.” The guidance stresses that the POEM test is one of “substance” over “form” and that the test seeks to identify those persons in a company who actually “call the shots” and exercise “realistic positive management.” The guidance relies on several judicial precedents to corroborate this viewpoint.

SARS concedes that, under the OECD’s reasoning, a company may have more than one place of management but further states that a company can only have one POEM at any one time. The guidance states: “If a company’s key management and commercial decisions affecting its business as a whole are made at a single location, that location will be its POEM. However, if those decisions are made at more than one location, the company’s POEM will be the location where those decisions are primarily or predominantly made.”

The guidance suggests that the place where operational management decisions are made, namely, the location of oversight of day-to-day business operations, is generally of limited relevance in determining a company’s POEM and must be distinguished from the place of “realistic positive management.”

The guidance also states that the extent of a company’s economic nexus with a country is generally irrelevant in the determination of its POEM, and so are other legal factors such as a company’s place of incorporation, formation or establishment, and the location of its registered office or public officer.

The guidance explains, using hypothetical illustrations, the multiple factors that need to be taken into account to determine POEM (some of these factors are described in the OECD Commentary).

These factors include the location of a company’s head office housing senior management (such as the managing director or the finance director); location of a company’s executive committee comprising key members of senior management; location where a company’s board regularly meets to make, in substance, key management and commercial decisions; and the influential role of shareholders in steering key business decisions, among other things.

SARS however cautioned that “definitive rules cannot be laid down in determining the POEM and all relevant facts and circumstances must be examined on a case-by-case basis.”

Indeed, determination of residence of company is important in that a resident company is liable to be taxed on its worldwide income. Also, one of the limitations of availing treaty benefits is the requirement that a company be resident in a treaty country for the purposes of the applicable tax treaty. And, since a company can be considered tax resident in only one country, POEM as a tie-breaker test has proved to be an effective tool in allocating taxing rights between two countries and at the same time preventing double taxation.

Importantly, the OECD, under BEPS action 6 on preventing treaty abuse, is seeking to leave it to the treaty countries’ competent authorities to determine by mutual agreement a company’s country of residence for tax treaty purposes, having regard to its POEM, the place where it is incorporated or otherwise constituted, and any other relevant factors.

This proposal, according to the OECD, supports and takes into account the view of many countries that those cases where a company is a dual-resident often involve tax avoidance arrangements.

— Ashish Goel is an independent international tax professional specializing in transfer pricing and treaty disputes.

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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

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