Place of Effective Management: striking the right balance

International taxing principles

There are two main principles under which countries calculate tax on income — source and residency. Income derived by a person is likely to be taxed by a country because of a connection between the country and the generation of the income (source jurisdiction). Countries assert source jurisdiction to tax income on the basis that the income is generated from economic activity within the country. Countries may also tax income if the person earning the income is a resident of that country.

Most countries — including India — tax income on both a source and residence basis. That is, a resident person is usually taxed on income from both domestic and foreign sources, while non-residents are only taxed on domestic source income. Countries may differ in the manner in which they choose to set the jurisdiction for tax under the residence principle. However, there is a degree of consensus on the basic principle that there should be a fairly strong economic nexus with that country. Two basic approaches are used in establishing a personal jurisdictional connection for corporations. One is to focus on some formal legal connection to the jurisdiction such as incorporation. The other is to select some economic connection such as the place of management. Many jurisdictions combine these approaches, treating a corporation as resident if either test is satisfied.

Most instances of double taxation arise due to residence-source jurisdictional conflicts. However, double taxation can also arise from residence-residence conflicts where two States treat a person as a “resident” for tax purposes under their domestic law.

Determining corporate residency

Under the provisions of Indian tax law the threshold for triggering corporate residency for a company not incorporated in India requires “whole of the control and management” to be situated in India. Existence of even part control outside India at any time during the year will preclude residency for such a company. The main criticism of this definition is that it has been proven subject to relatively simple, formalistic manipulation. In a world of mobile capital and assets, a relatively high threshold to determine tax residency is likely to have a potential to become a contributing factor to an emigration of financial capital. The Finance Bill, 2015 therefore, seeks to expand the scope of residence principle of taxation by regarding a company incorporated outside India as resident in India, if the territorial nexus of that company with India is established by virtue of its place of effective management (POEM) being in India.

It may be noted that under the draft Direct Taxes Code (DTC), 2009, a foreign company, whose control and management is wholly or partly in India was treated as a resident of India. The word “partly” used in the 2009 version of the DTC had set a very low threshold for regarding a foreign company as a resident in India. Modification of the phrase “wholly or partly” was therefore suggested. The 2010 version of the DTC proposed that a company incorporated outside India will be treated as resident in India if its POEM is situated in India. POEM was defined to mean the place where the board of directors of the company or its executive directors, as the case may be, make their decisions; or in a case where the board of directors routinely approve the commercial and strategic decisions made by executive directors or officers of the company, the place where such executive directors or officers of the company perform their functions.

The 2013 version of the DTC further refined the definition of POEM by defining it to mean a place where key management and commercial decisions, which are necessary for the conduct of the business of an entity as a whole, are made in substance. The Finance Bill, 2015 has adopted an identical definition for POEM. The proposal in the Finance Bill, 2015 on changing the rule for determining corporate residency seeks to strike a balance between the current definition and the other extreme that was originally proposed in DTC, 2009.

How does one determine POEM?

POEM will ordinarily be where the most senior person or group of persons (for example a board of directors) makes its decisions, the place where the actions to be taken by the enterprise as a whole are determined; however, no definitive rule can be given and all relevant facts and circumstances must be examined to determine the POEM.

In an environment where the most senior managers tend to operate from and meet in a single location such as a head office, it is not difficult to determine the place where key management and commercial decisions are made. However, the communications and technological revolution is fundamentally changing the way people run their business. Due to sophisticated telecommunication technology and fast and efficient transportation, it is no longer necessary for a group of persons to be physically located or meet in any one particular place to run a business. This increased mobility and functional decentralization may have a significant impact on the application of POEM.

If senior management adopt conferencing through the internet, for example, as a key medium for making management and commercial decisions and the management personnel are located throughout the world, it may be difficult to determine a POEM. In such cases, a place of management might be regarded as existing in each jurisdiction where management personnel is located at the time of making decisions, but it may be difficult (if not impossible) to point to any particular location as being the one POEM.

Increasing numbers of enterprises conducting transnational businesses, combined with rapid improvement in global transportation systems, are also likely to have an impact on the POEM concept. In particular, there may be an increased incidence of mobile places of effective management.

Although the use of technology is likely to increase the number of cases where a POEM may exist simultaneously in multiple jurisdictions, this possibility has also been recognized in traditional business operations. See for example, Lord Radcliffe’s statement in Bullock v. The Unit Construction Co. Ltd. 38 TC at page 739, individual cases have not always so arranged themselves as to make it possible to identify any one country as the seat of central management and control at all. Though such instances must be rare, the management and control may be divided or even, at any rate in theory, peripatetic.


Given that POEM is one of substance over form, in theory, it should always produce results, which reflect the true policy intention. In the modern environment, however, the application of the traditional POEM factors may not result in a clear determination of POEM, or may result in an outcome, which does not appear to accord with the policy intentions. The proposed guidance from the CBDT should therefore, seek to address some of the practical situations, which arise by providing illustrations or examples.




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