A Solution Rigged with Theoretical Problems – The RMLNLU Law Review Blog

A Solution Rigged with Theoretical Problems – The RMLNLU Law Review Blog

A Solution Rigged with Theoretical Problems – The RMLNLU Law Review Blog

By- Prabal Karthikheyan


In India, the test for Corporate Tax Residency was initially based on the first while ‘Control and Management’ test (hereinafter ‘C&M test’), which was based on the ‘Central Control and Management’ in the UK. This test leaves the determination of the company’s residence to the place where the head and brain are located and important decisions are being made. However, the problem of shell companies and tax evasion still seemed to persist owing to companies having certain isolated instances of control being able to evade tax by contending that the control did not rest wholly in India, but elsewhere. This prompted the introduction of the ‘Place of Effective Management’ test (hereinafter ‘POEM test’). Although guidelines have been provided on how the POEM is to be determined, it is vague and unclear as to what POEM signifies. This lack of clarity becomes problematic because of the cause of unpredictability and uncertainty, which lock horns with Article 14 of the Constitution. Practical concerns surrounding POEM owing to burgeoning Information and Communications Technology have been addressed in existing literature. This article aims at supplementing them by mounting a challenge to the constitutionality of the POEM test and suggesting other alternatives that could be suitably adopted to determine Corporate Tax Residency.


A company is said to be a resident for the purpose of income tax determination if either it is an Indian company or its ‘Control and Management’ is wholly living in India. Till 2015, the C&M test was prescribed whereby the ‘head and brain’ of the company had to be located based on the location where significant business decisions were made. An unwarranted implication of the C&M was manifested in the findings of the SC in Radha Rani Holdings (P) Ltd. v. DIT: Even if isolated instances of control materialises outside India, a company cannot be regarded as resident of India for the purposes of taxation. However, this led the government to denounce the test claiming it empowers companies to avoid tax simply by conducting one board meeting abroad.

Only companies whose control was ‘wholly situated in India’ would be regarded as Indian residents; this prompted the government to lower the threshold by introducing the POEM test. For better clarity, the Ministry of Finance has released the guidance regarding POEM. The determination is required to be based on the following factors: Firstly, it is to be determined whether the company is engaged in Active Business Outside India (herein after ‘ABOI’), through determining whether less than 50% of its income is passive, less than 50% of the company’s employees are in India and the payroll expenses on Indian employees is less than 50% of the total payroll expenditure.

If a company is engaged in ABOI, the question of residency in India does not arise. However, if he is not involved in ABOI, follow two steps: One, determining the persons who makes the key managerial and commercial decisions and two, determines the place where the decision is being made. The above two factors must be determined based on other guiding principles namely, location of regular board meetings, delegation to executive committees, head office, types of decisions and the people making them. However, the next section argues that the guidance laid down culminates in uncertainty and unpredictability, resulting in arbitrariness.


The POEM test appears to have no defined contours nor does its usage by different jurisdictions lead to any defined understanding of the phrase. For example, South Africa provides for the place where the management functions are executed, whether in a single location or different locations with one place of strongest economic nexus. However, in Ireland, it is the place where the pivot or axis of the operations of the company hinges. Likewise, in India, though guidance is provided as regards the factors to be taken into account, the ultimate decision requires consideration of all the relevant factors, on a case-by-case basis.

Two canons of taxation become pertinent at this point: Canon of certainty and canon of equality. Adam Smith propounded that certainty implies that the time, manner, and quantum of payment of tax must be certain for both the taxpayer and the tax authorities. There must be certainty on the quantum of tax expected to be paid by the taxpayer upon the liability arising. The canon of equality entails that taxes must be levied based on the amount of earnings of the taxable entity. Horizontal equity implies that uniform taxes must be levied on taxpayers earning equal. Prima facie, the application of the POEM test is at loggerheads with both of these canons, but the contraventions of the canons of taxation could be looked at in conjunction with arbitrariness under Article 14. The following section would argue that the POEM as conceived and applied in India results in arbitrary determinations which is in contravention of Article 14 of the Indian constitution.

The rule of law embodied in Article 14 excludes the existence of any arbitrariness, of prerogative or even wide discretionary power on the part of the government. Decisions should be made by application of known principles such that they are predictable. Manifest arbitrariness results from the rules being made capriciously, irrationally and/or without adequate guiding principles. Therefore, the principles laid down must be in harmony with the adequacy of guidance required, in a manner that leads to predictability and certainty in executive decisions. In the context of POEM, the guidance leads to incertitude as regards the manner of implementing the test. For example, the guidelines employ the terms key management and commercial decisions, formulating key strategies and overseeing their implementation and key company decisions. The usage of incongruous and unclear terminology makes it difficult to comprehend what decisions are covered within its ambit. These are mere guidelines, and any determination must give due regard to all relevant factors.

This confers a high amount of discretion in the assessing officer without providing substantive guidance. Lack of intelligibility raises constitutional issues because: firstly, the guiding principles rest on the determination of the place where key managerial and commercial decisions are being made and the people making them. Determining what decisions are covered within this ambition becomes a precursor to applying the guiding principles. However, there is no guidance on what decisions would fulfill the threshold of ‘key managerial and commercial decisions’. Thereby, the basis on which the guiding principles are based is uncertain and unpredictable, leading to arbitrary determinations. Secondly, the ultimate determination rests on considering the facts and circumstances of the case, being a determination of substance over form. The determination should be made after considering all the relevant factors, on a case-by-case basis. However, this gives rise to the apprehension of there not being any adequate guidance on what these other relevant factors may be. What may be relevant to one assessing officer may not be relevant to another. Even if it is argued that key managerial and commercial decisions provide guidance in this regard, what decisions are covered within its ambit remains a question?

Supposedly two companies are placed in similar circumstances and are adjudged to have POEM in India and in Singapore respectively owing to dissimilar comprehension by two assessing officers of key managerial and commercial decisions. In this scenario, two similarly placed companies would be judged differently with different consequences, one with a lower tax rate and one with a higher tax rate. Treating similarly situated companies differently leads to manifest arbitrariness. However, the clarification called for at this point is that differential determinations are not a problem per se, but if such differences arise out of a lack of conceptual clarityit locks horns with Article 14.

Thirdly, what are the consequences if assessing officers make arbitrary determinations based on their subjective sense of relevance of factors? Even if the judiciary is said to be a check on such arbitrary determinations, it becomes problematic if many such determinations are regarded as arbitrary by companies and they appeal until the decision comes in their favour. Would it not make the litigation landscape worse by increasing the number of cases and appeals? Even otherwise, leaving aside the problem of filing numerous cases and appeals, it would be unjust to put companies genuinely intending to pay taxes through such unnecessary harassment. Therefore, the POEM test as conceived and applied gives rise to arbitrariness in the contradiction of Article 14 of the Indian Constitution.


The government’s move to replace the C&M test with the POEM test due to the high threshold of ‘wholly situated in India’ is intelligible. However, the lack of adequate guiding principles leads to unpredictability and uncertainty, leading to arbitrariness in decisions leading to contravention of Article 14. If the POEM test involves theoretical concerns, what is the way forward? Either a new test can be introduced altogether, such as the place where the economic nexus is the strongest, or a hierarchy could be established. If replacement is considered, the economic nexus test appears more defensible because not only does it reduce ambiguity but also is fair because taxes would be collected by the states whose resources are being employed in the conduct of the company’s operations. Alternatively, if a hierarchy is opted for, a set of tests including economic nexus, incorporation or Mutually Agreed Procedure with a suitable order of priority would be the way forward.

(Prabal Karthikheyan is a law undergraduate at National Law University, Tamil Nadu. The author may be contacted via email at [email protected]).

Cite as: Prabal Karthikheyan‘Place of Effective Management: A Solution Rigged with Theoretical Problems’, 10 June 2023) date of access.

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