Case studies on Place of Effective Management (POEM)
The POEM norms introduced in the Finance Act, 2015 for determining corporate tax residency, could impact overseas entities controlled and managed from India. Tax authorities may now closely scrutinize the functioning of overseas entities to determine situs where key management and commercial decisions that are necessary for the conduct of the business of overseas entity as a whole are, in substance made. The concept of POEM is broadly aligned with internationally accepted practice. Detailed guidelines for determining POEM are awaited from the Central Board of Direct Taxes.
We have enumerated below few case studies to understand the concept of POEM in more detail:
Case study 1: Indirect control and management exercised by ICo:
ICo has a wholly-owned subsidiary outside India, FCo, having two segments; A (manufacturing segment) and B (service segment). CFO of ICo is on the Board of FCo. The other directors of FCo are local residents of the country where FCo is incorporated. The manufacturing segment is significant in terms of turnover, profitability and manpower. The service division constitutes the non-core business of the subsidiary. All the major decisions pertaining to budget, capital expenditures, pricing key appointments, marketing, and other activities relating to division A are taken by the CFO of ICo after consultation with the Board of ICo. The decisions concerning division B are left to the local management. The key personnel of division A are deputed/seconded from ICo and the low level staff is outsourced locally.
FCo can be said to have a POEM in India on the grounds that key commercial and management decisions as a whole are taken in India. Though ICo is only concerned with the decisions pertaining to division A, considering the above facts, the Tax authority in India may contend that division A comprises of the business of the subsidiary as a whole. What is relevant is the situs of the authority making the decisions as a whole, which lies in India and not the place where the actual board meetings are held, i.e., overseas. It can be stated that the board of FCo has been delegated power to decide on the small or insignificant aspect of its business. Thus, the mere situs of board meetings overseas may not avoid residency in India, under the amended provisions of the Act.
Case study 1 Variation:
If the facts are modified slightly, say the core functions of division A, namely finance, legal, human resources, marketing, etc., are managed by a select group of executives, based both in India and the foreign country where FCo is incorporated. Each of the executive looks after a particular segment and independently takes the final decisions for the running of the business. The board of these companies routinely ratify the decisions of the executives. The issue is whether there is POEM exposure in India, considering that personnel in charge of various segments of FCo are distributed among countries.
As stated earlier, POEM is triggered where crucial decisions for the business as a whole are in substance made. In the fact pattern mentioned here, it would be difficult to say with certainty that situs of decisions for the business as a whole are in India. If it can be demonstrated that activities and decisions undertaken outside India are critical to the functioning of the business of the FCo, there may not be high POEM exposure in India.
Case study 2: SPV operates independently. However, critical decisions in a particular year are taken in India
ICo has an overseas subsidiary FCo1, which has downstream investment in an operating subsidiary FCo2. FCo1 does not have any other business, except investments in FCo2. All the directors of FCo1 are executives in FCo2. FCo1 sells FCo2 to a third party. All the major decisions regarding the sale of FCo2 such as finding the buyer, negotiations with the buyer, valuations and the terms of sale, appointment of external consultants for sale-related services, etc., are undertaken by ICo.
In this case, the Tax authorities may take a view that all the decisions taken by the executives of ICo with respect to the sale of the investment, amounts to key managerial and commercial decisions of the business of FCo1 as a whole, and may allege FCo1 to be resident in India. In case FCo1 is regarded as an Indian tax resident, the capital gains arising from the transfer of FCo2 shares may become taxable in India. An analysis needs to be done as to whether the decisions taken by ICo are in the nature of shareholder’s activity or are management decisions, as the former may not trigger POEM in India.
The case studies highlighted above are only a few instances wherein Indian-controlled foreign entities may have to analyze POEM exposure. The determination of POEM is a fact-based exercise and has to be tested on a yearly basis. It’s quite possible that the foreign entity may not trigger POEM on an year-to-year basis, but may fall in the trap of POEM in India in a particular year, depending on the nature of the transaction, kind of restrictive authority being enjoyed by the foreign company to take the decision, etc. Considering that the implications arising on the POEM trigger are very significant and have a far-reaching impact, it would be advisable for Indian corporates to take early steps to evaluate existing structures, and take precautionary measures before making new investments.