The concept of Place of effective management rules has been introduced to provide a method to reclassify the residential status of foreign companies and classify them as Indian companies specifically in cases where such companies had been set up for the purposes of treaty shopping or avoiding taxes in India.
Place of effective management guidelines issued
First introduced in the year 2015, Place of effective management had been amended in the year 2016 to provide that a company shall be deemed to be a resident of India if :
- it is an Indian company; or
- its place of effective management in that year is in India
Place of effective management in this case was defined by the finance act 2016 to mean a 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, are made.
This definition is obviously nebulous, by the dint of this definition the place of management of a company is a mobile concept which can move to several places in the world depending upon where the management or decision making authorities were at any given point of time. Challenges posed by the earlier regulations have been discussed in detail in our earlier note on this subject.
What do the guidelines say?
Draft Place of effective management guidelines had been earlier issued in the year 2015 ( You can refer to our note on the draft guidelines ).
Under the new guidelines , determination of POEM shall be based upon the facts and circumstances of each case and will need to be determined objectively on a year to year basis.
The place of effective management of a company engaged in active business outside india shall be deemed to be outside India if the majority meetings of the board of directors are held outside india.
For this purpose, a company is said to be in active business outside India if all of the following conditions are satisfied:
- its passive income is not more than 50% of its total income
- Less than 50% of its total assets are situated in India
- Less than 50% of the total number of employees are situated in India or are resident in India
- Payroll expenses incurred on employees situated or resident in India is less than 50% of its total payroll expenditure
To determine whether a company’s active business status, data for the previous year and two years prior shall be considered, where available.
Head office a company shall be deemed to be situated where the company’s senior management or support staff are located. in case they are located in more than one location, the place where they are normally or primarily located is considered the head office of the company.
Where a company is not carrying out active business outside India, determination of place of effective management shall be done in two stages
Stage 1: Identification of persons responsible for making key management and commercial decisions for the company’s business as a whole
Stage 2: Determination of the place where such decisions are made
The place where such decisions are made, would be deemed to the place of effective management of such company.
Should the aforementioned two step process not lead to the identification of a clear place of effective management, secondary factors that can be used are :
- Place where main and substantial activity of the company is carried out, or
- Place where the accounting records of the company are kept
Due process to be followed
The principles as enumerated in the guidelines have been prescribed for guidance sake only and will not be decisive in themselves.
The AO before initiating any proceedings for according resident status to any foreign entity shall have to seek prior approval of the Principal Commissioner or the commissioner as the case may be
Any proposal to accord resident status to a foreign company on the basis of POEM will have to be given after the approval of a collegium of Principal Commissioners or commissioners as the case may be. The guidelines also mandate that an opportunity should be provided to the company to present its case in this matter.
Arkay & Arkay Comment
The clarity introduced by the new guidelines is a welcome step in ensuring that foreign companies are not caught up in needless litigation while working in India. The fact that these guidelines are being introduced only for guidance sake and not as enshrined principles is however a cause for concern that an overzealous officer may choose to sidestep them when needed.
The secondary process of determination of the place of effective management, is also going to be very difficult to determine in a cloud centric world where substantial activity and accounting records are all located online.
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