My Presentation on Place of Effective Management at STEP Arabia - Dubai

1. Concept of Place of Effective Management for
determination of Corporate tax residency in India

2. Content
• Concept of Place of Effective Management
• Amendment to Section 6(3) of the Income Tax
Act, 1961
• Comparison with Controlled Foreign
Corporation rules with POEM test
• Overview of draft guidelines of determination
of POEM
• Few Aspects to ponder

3. Concept of Place of Effective Management

4. Concept of Place of Effective
Management ( POEM)
• POEM is an internationally recognised test for determination of
residence of a company incorporated in a foreign jurisdiction.
• POEM is often a tie-breaker test used in tax treaties, various Indian
and International tax treaties use this concept also.
• Determination of POEM is thus subjective.
• A Foreign company was so far considered resident in India only if
the control and management of its affairs was wholly in India in the
relevant year.
• However it was felt that by shifting insignificant or isolated events
related with control and management, this provision was made
ineffective. Hence, it is proposed to make POEM the primary test
to determine Indian tax residence for Corporates.
• Now proposed guidelines are issued which aims to outline specific
set of criteria to determine POEM and thus tax residency in India.

5. Amendment to Section 6 of Indian Income Tax Act

6. Corporate Tax Residence Rules as per Indian Income
Tax Act
Law prior to
1 April 2016
Section 6(3) – A company (other than a
company incorporated in India) shall be said to
be a resident in India for a tax year if during
that year:
No specific rules for determination of control
and management – Thus reliance on Judicial
interpretation.
New law w.e.f.
1 April 2016
New section 6(3) introduced – A company (other than a
company incorporated in India) is a resident in India for a
tax year if during that year:
The control and management of its affairs is
situated wholly in India
Its Place of Effective Management, is in India
► ‘Head & Brain’ of the company
► BOD who take strategic decisions, decide
policies and hold meetings
Control and Management:
► Place where key managerial and commercial decisions
► Necessary for conduct of business of an entity as a
whole
► Are in substance made
Draft guidelines on POEM issued by CBDT for Public
suggestions/ recommendations
Place of Effective Management:

7. Amendment to Section 6(3) of the
Income Tax Act 1961
• A Company is said to be resident in India in any
previous year, if :
– It is an Indian company; or
– Its Place of effective management in that year is in
India.
• Explanation : For the purpose of this clause
“place of effective management” means 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 made.

8. Change from the Previous Position
• Before amendment of Section 6(3) a company
was said to be resident in India in any previous
year, if
– It is an Indian company; or
– during that year, the control and management of its
affairs is situated wholly India.
• The expression “control and management”
referred to in Section 6(3)(ii) is “central control
and management” and not carrying day to day
business by employees or agents.

9. Distinction between Control & Management and POEM
Control & Management
• Whole of the control & management
should be in India for the whole year
• Partial control of the company outside
India sufficient to hold foreign company
as non-resident
• Holding even one Board of Directors
meeting outside India was arguably
sufficient to hold foreign company as
non resident
• Scope for creation of shell companies
which are incorporated outside India
but are controlled from India
Place of Effective Management
• Emphasis on Key Management and
commercial decisions that are
necessary for conduct of entity
business as a whole which are in
substance made
• A resident Indian who is also a Director
of Foreign Company does not attend
even single Board meeting of foreign
company however, takes all major
decisions for foreign company, the
foreign company could be held as
resident in India
• Directors and Key managers discharging
their roles or directions are provided to
Foreign Companies are also covered
• Foreign Directors coming to India and
taking major strategic & Commercial
decisions for the entire corporate group
will also get covered

10. • Various principles on residency of a company laid out by Indian Courts in the pre-POEM era are as follows
(Based on the judicial precedents):
• Residential status of a company is the place where the real business is carried out
• A company is a resident of the state where its “head and brain and directing power” is situated
• ‘Ultimate control’ or ‘day to day management’ being of significance will need to be evaluated based on
the facts of every case – certain cases have also regarded as ‘day to day management’ and
‘implementation’ as important
– Key factors for determining POEM based on guidance provided in the OECD commentary (Based on OECD
extracts):
• Place where key management and commercial decisions necessary for conduct of entity’s business as a
whole are in substance made
• Place where most of the senior persons make decisions
• Place where board meetings are usually held
• Place where the CEO and other senior executives usually carry on their activities
• Place where company’s headquarters are located
• Place where accounting records, statutory records, etc. are kept
• Country’s law which governs the legal status of the company
• Place where senior day to day management activities are carried on
Control & Management v. POEM

11. POEM – Possible tax impact
Possible tax implications if a foreign company becomes resident in India due to its POEM being India:
 Global income including active overseas income taxable at a higher rate of 40% in India (plus applicable
surcharge and cess)
 Not eligible to adopt special presumptive tax regime applicable for business income of a non-resident from
business of exploration of mineral oils (i.e. section 44BB where 10% of gross revenue is considered as
income). Hence, maintenance of tax books of accounts compulsory. Applicability of MAT* provisions - to be
examined further in view of proposed explanation in Finance Bill 2016
 Transfer Pricing regulations may apply to all transactions with associate entities overseas as global income
is taxable
 Such Overseas entity could also be subjected to domestic withholding tax obligations.
 Dividend from downstream foreign subsidiary will be taxed at 40% (plus applicable surcharge and cess)
without underlying tax credit and concessional tax rate of 15% (only Indian companies eligible)
 There are certain tax exemptions / incentives which may apply only to Indian company (and not to a
domestic / resident company), illustratively, capital gains exemption for transfer between 100% subsidiary
and its holding company if the transferee is an Indian Company
 In tax treaties like India – USA, trigger of dual residency may result in denial of treaty benefit. Under BEPS,
trigger of dual residency requires competent authorities to resolve treaty residency issue through mutual
agreement
* tax @ 18.5 % (plus applicable surcharge and cess) on book profits is payable, if the tax calculated under net income basis is less than 18.5 % of book profits

12. Controlled Foreign Company Rules v POEM Rules

13. Controlled Foreign Company (CFC)
Rules
• A Controlled Foreign Company means a foreign company
which satisfies the following conditions, namely:—
– for the purposes of tax, it is a resident of a territory with lower
rate of taxation;
– the shares of such company are not traded on any stock
exchange recognized by law of the territory of which it is a
resident for the purposes of tax;
– one or more persons, resident in Home Country, individually or
collectively exercise control over the company;
– It is not engaged in any active trade or business;
– Generally earns Passive Income – e.g. Interest, Dividend, Royalty
and gains on disposal of shares / IP rights.
• Thus, Main trigger of taxation is direct / indirect ownership
and control of an entity in Low / No tax country

14. CFC Rules v POEM Rules
CFC Rules
• Main Trigger is a resident having
ownership & control of a foreign
company
• Only targeted toward entities
earning only passive income –
active business is generally
excluded
• Results in current taxation on
accrual basis while exempting the
receipts
• Listed entities will avoid CFC rules
• Mainly targets entities in Low /
No tax jurisdictions
POEM Rules
• Main Trigger is a resident
influencing “Effective
Management” of the foreign
company
• It covers even active business
conduct if its between related
entities
• Results in current taxation on
accrual basis – no provision for
exempting receipts
• Listed entities will also be
exposed to POEM
• Need not be concerned only with
entities in Low / no tax locations

15. Overview of draft Guidelines to determine POEM

16. Draft Guidelines
Central Board of Direct Taxes (CBDT), vide Press Release dated 23
December 2015, issued draft guidelines for determination of POEM of
foreign companies in India. These guidelines emphasize that the test of
POEM is one of ‘substance over form’. They also provide for
determination of POEM based on whether or not a company has Active
Business Outside India. Accordingly, the determination of POEM is
discussed in the following slides

17. Deciphering POEM Guidelines
Is Company Engaged in Active
Business Outside India (ABOI)
1.Whether Majority of the
meetings of Board of
Directors held outside India;
and
2. Whether Board has
sufficient Powers of
Management and has not
delegated these powers.
1. Identification of who
makes key management &
Commercial decisions ; and
2. Place where those
decisions are being made
YES NO

18. Active Business Outside of India…
• Active Business outside India, if :
– “Income Test” - Passive Income is less than 50% of total
income; and
– “Asset / Employee Test”
• Less than 50% of its assets are situated in India; and
• Less than 50% of total employees are resident in India; and
• Payroll expenses on such employees is less than 50% of total
payroll expenses
• Passive Income
– Income from the transactions where both purchase and
sale of goods is from / to its associated enterprise; and
– Income by way of royalty, dividend, capital gains, interest
or rental income
For determining the ABOI test, average data of the tax year and two prior years shall be taken into account

19. If ABOI tests are not met….
For those who do not meet tests of Active Business
Outside India (ABOI)…Following stages of tests:
Stage 1 : Identification of Key Management Team
Stage 2 : Determination of Location of meetings
of such Key Management / decision making team
– Location Criteria
Residual / Criteria of Last resorts
Matters that may not impact above
determination

20. Stage 1 – Identification of Key
Management / Decision Making team
• Board of Directors (BOD) – Location of Board
– Board retains and exercises authority to govern the
company; and
– Does, in substance, make the key management and
commercial decisions necessary for conduct of business
– It is not mere formal organisation of meetings for records;
and
– Authority to govern has not been de facto delegated to
Senior Management team and board merely routinely
ratifies these decisions.

21. Stage 1 – Identification of Key
Management / Decision Making team
• Delegation to Committees
– If a board has de facto delegated the authority to make the key
management and commercial decisions for the company to the
senior management and does nothing more than routinely ratifying
the decisions, the company’s POEM will ordinarily be the place
where these senior managers make those decisions.
– Where a board delegates some or all of its authority to one or
more committees such as an executive committee consisting of key
members of senior management, the location where the members
of the executive committee are based and where that committee
develops and formulates the key strategies and policies for mere
formal approval by the full board will often be considered to be the
company’s POEM.

22. Stage 2: Determination of Head Office
Location
Situation Head Office
Company’s Senior Management and their
support staff are based in a single location
which is held out to the public as
company’s principal place of business or
headquarters
Such principal place of business or
headquarters.
Company is more decentralized and
hence, Senior Management operates
from time to time at offices in various
countries
Location where these senior managers:
• are primarily or predominantly based;
or
• normally return to following travel to
other locations; or
• meet when formulating or deciding
key strategies and policies for the
company as a whole.

23. Stage 2: Determination of Head Office
Location
Situation Head Location
Members of Senior Management operate
from different locations on a more or less
permanent basis and members
participate in various meetings via
telephone / video conference
Location, if any, where the highest level of
management (e. g.: Managing Director
and Financial Director) and their direct
support staff is located
Where the Senior Management is so
decentralised that it is not possible to
determine company’s Head Office with a
reasonable certainty
Location of the Head Office would not be
much relevant in determining POEM

24. Residual test / Criteria of last resort…
• Day to day routine operational decisions taken by
junior and middle management is not relevant
• Due to use of modern technology, if place is not clearly
defined, the place where directors or persons taking
decision or majority of them usually reside is relevant
• If none of above is clear the following secondary
factors are considered:
– Place where main and substantial activity is carried out; or
– Place where accounting records of the company are kept.

25. Matters not impacting determination
Foreign company is completely owned by
Indian company
One or some of the directors of foreign
company reside in India
Local management situated in India in respect
of some activities of foreign company
Existence in India of support functions that are
preparatory and auxiliary in character.

26. Few Aspects to Ponder

27. ► I Co is a leading Pharmaceutical manufacturer who sells its products in India,
USA and other European countries
► Overseas companies in its website / letterhead states that it is part of
overseas operating companies of I Co Group headquartered in India
► I Co sells products to Dubai Co
► Dubai Co sells products to overseas subsidiary of I Co which acts as a
Regional Distributor (retaining 5% of sales as Arm’s Length margin)
Case study – International trading company
Mechanics
I Co
US Co
India
UAE
100%
100%
Europe
Europe Cos
Board of
directors
►Two Directors – One being local director (paid a fixed fee) and the
other is the MD of I Co
►Local director merely stamps minutes and limited knowledge of
business
►Meetings of the Board held in Dubai with MD of I Co present.
Pricing
policy
►Purchase price determined based on the TP Study of I Co
►Selling price determined based on TP Study of US Co / Europe Cos
Substance ►No offices / employees
►Management consultant prepares agenda / minutes / other company
compliances as directed by I Co and invoices overseas subsidiary
Financial
Control
►No power provided to local director / management consultant –
retained by MD of I Co
►Signing authority also retained by MD of I Co
Dubai Co
Background
Sales Modality
Other information on Dubai Co

28. Case study – International trading company
Impact analysis
 Entire income of Dubai Co is passive income, as all transactions are with
Associated Enterprises
 Infrastructure test would not be applicable as Dubai Co has no Indian asset
or employees
ABOI
 Even though meetings of the board are held in Dubai, the same does not
conclusively decides that POEM is in Dubai
 The resident director of Dubai Co (local director) has limited knowledge of
the business and merely rubber stamps all decisions
 For a trading company, buying and selling are important commercial
decisions which are also taken from India
Board Meetings
 Overseas subsidiary signifies that they are part of I Cos Group
 Senior management are designated as Group CEOs, CFOs who are based
out of India
Head office

29. Aspects to Ponder….in relation to
Active Business Outside India?
 Are transactions between AE – actually Passive ?
 If for example – entire purchase is from AE and majority of sales ( say
more than 75%) to third parties – would the income be still Passive?
 If Foreign company is IP owner and only earns Royalty since it is in
business of commercially exploiting IP that it owns – and if its income is
from third parties – would it still be passive?
 If Foreign company is into Banking or NBFC or asset management business
and its income is in the form of Interest – would it still be Passive?
 Similarly, if rental income is earned from third parties would it still be
passive income?
 If income is earned from AE but is not from Purchase or sale of goods –
e.g. Management Fees, Commission Income, Consultancy fees, license
fees, etc. – would this be automatically deemed as active business – since
not specifically mentioned in guidelines?
 Independent directors – Qualification and Experience should be relevant
 Should revisit current trading model to may be services ( commission)
model.

30. Thank You