Incorporating a company outside of India: importance of Place of Effective Management

While incorporating a company outside of India, it is important to understand the concept of Place of Effective Management (POEM) as it will determine your tax liability.

Ordinarily, companies that are incorporated abroad, are considered non-resident entities and are liable to pay taxes in the countries of incorporation only. These entities do pay taxes in India on income that result from a connection with India or comes from a permanent business established in India, for instance a wholly owned subsidiary. For a Resident Company, taxes on the worldwide income have to be paid in India and a credit is given for the taxes paid in other country(ies) by the tax authorities. However, when companies that are incorporated in other countries are controlled and managed from a company in India, they is regarded as a Resident Company for taxation purposes. Therefore, a Company is a resident in India if its Place of Effective Management (POEM) is in India. POEM is defined as "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."

The Indian Central Board of Direct Taxes (CBDT) has issued guiding principal to determine the POEM for the companies having turnover of more than INR 50 crores.

Active Business Outside India (ABOI):

If a Company is doing ABOI, the POEM is will automatically be outside India if majority of its board meetings are held outside India.

The Company is considered to be engaged in ABOI if;

  1. Its "Passive Income" is not more than 50% of its total income;
  2. 50% or more of its total assets are situated outside India;
  3. 50% or more of its total number of employees are situated outside India or they are not resident in India; and
  4. Total Payroll cost of such employees are less than 50%.

Passive Income of a Company would mean income from:

  1. Transactions where both the purchases and sales of goods is from/to its related enterprises; and
  2. Royalty, Interest, Dividend, Rental income, Income from Capital Gains etc.

The value of assets is the value as per Company’s books of accounts. In case of depreciable assets, the value shall be its average value for the tax purpose at the beginning and at the end of the previous year. The number of employees has to be the average number of employees at the beginning and at the end of the previous year.

The data to be considered for the purpose of above calculation shall be the data of Three years i.e. the previous year in question and two years prior to that year. In case of existence of the Company for a shorter period, the data of such period shall be considered.

Active Business is NOT Outside India:

If a Company is not doing ABOI, the POEM can be determined as follows: 

  1. Identification of the person/s who actually make the key management and commercial decisions for the conduct of the Company's business as a whole;
  2. Determination of place where these decisions are made.

The place of decision-making (i.e. POEM) is more important than the place where these decisions have to executed.

When a company is not doing ABOI, POEM can be established as follows: 

  • The location where the Companies' Board regularly meets and takes key management decisions;
  • In case the Companies' board has delegated some of its authority to an executive committee consisting of some key members of management, the location where the executive committee meets and formulates key strategic and policies on behalf of the board;
  • The location where the Company's senior management and their support staff are based, and that location is held out to public as Company's principal place of business or its Headquarter;
  • It is quite prevalent that the members of senior level management operate from different locations. They participate in the board meetings via video conferencing. In such situation, the Head Office would normally be considered to be the location where highest level of management like Managing Director and CFO and their support staff are located.

Note:

POEM cannot be determined by the fact that a foreign entity is wholly owned by an Indian company; whether there is a Permanent Establishment of a foreign entity in India; whether one or some of the directors of foreign company reside in India; or if some of the support functions that are preparatory and auxiliary in nature are performed from India.

Disclaimer: These guidelines are merely intended to provide general information regarding the POEM.  For specialist advice, please get in touch with experts at Miss Legal India.

 

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