Indian residents who own a UAE company usually understand that the company's profits are not taxed in India merely because they own it. What is less well understood is that the Income-tax Act looks past incorporation to where the company is actually run. If that is a desk in Mumbai, the UAE company is an Indian resident, and the 9% UAE rate is replaced by the Indian rate for foreign companies of 35% plus surcharge and cess. This note explains the test and how to stay on the right side of it.
The rule
Under section 6(10) (6(3) of the 1961 Act) a foreign company is resident in India in any year if its place of effective management — the place where key management and commercial decisions necessary for the conduct of the business as a whole are, in substance, made — is in India. CBDT's guidelines (Circular 6 of 2017) set out how the test is applied, and Circular 8 of 2017 confines it to companies with turnover or gross receipts above ₹50 crore in the year. Smaller companies are outside POEM, but not outside the other risks discussed below.
Step one: the active business outside India test
A company is treated as having an active business outside India if, on the average of the current and two preceding years, all of the following hold: passive income (royalty, dividends, capital gains, interest, rent, and income from transactions where both purchase and sale are with associated enterprises) is not more than 50% of total income; less than 50% of assets are in India; less than 50% of employees are in India or resident in India; and less than 50% of payroll is paid to those employees. A company that passes is presumed to have its POEM outside India provided the majority of board meetings are held outside India — unless the board is merely ratifying decisions taken by a promoter in India, in which case the place of those decisions is the POEM.
Step two: everyone else
A company that fails the active-business test — a holding company, a company whose only trading is with its Indian affiliate, or one with most staff in India — is assessed on the facts: who makes the key decisions, where the board meets, where the senior management sits, where the head office is, and, if that is inconclusive, where the majority of directors reside. Modern communications do not change the analysis: a director joining every board call from Mumbai and taking the decisions there places the POEM in India.
What happens if POEM is in India
- The UAE company's worldwide income is taxable in India at the foreign-company rate, from the first year of residence, with the transition rules in the 2018 notification governing depreciation, losses and tax credits.
- It must file an Indian return, deduct TDS on payments, and comply with Indian transfer pricing.
- Under the India–UAE treaty a company resident in both states is resident where its POEM is — so the treaty does not rescue the position; it confirms it.
- Prior years can be reopened, and penalties for under-reporting apply.
The other risks below ₹50 crore
Even where POEM does not apply, a UAE company run from India may have a permanent establishment in India — a fixed place of business or a dependent agent concluding contracts — with the profits attributable to it taxed in India. Payments between the Indian and UAE entities are subject to transfer pricing. And the general anti-avoidance rule applies to arrangements whose main purpose is a tax benefit. The UAE company that exists mainly to invoice Indian customers for work done in India is exposed on all three counts regardless of its size.
How to keep management in the UAE
None of this is difficult if it is built in from the start. Appoint at least one UAE-resident director with genuine authority, and have the majority of the board resident outside India. Hold board meetings physically in the UAE — at least the ones that approve budgets, contracts, borrowing and dividends — with agendas, minutes and attendance recorded. Keep the bank mandate, the office lease and the key contracts in the UAE. Employ the people who run the business in the UAE on UAE contracts. Ensure the Indian promoter's role is that of a shareholder and, at most, a director attending meetings abroad, not the person issuing instructions from Mumbai. And keep the evidence: travel records, minutes, and emails that show where decisions were made. The same facts satisfy the UAE Federal Tax Authority's substance requirements for a free zone company and the economic-substance expectations of UAE banks.
A POEM review
For existing structures we review the facts against the guidelines, document the position, and where necessary re-organise governance before the next year begins. For new companies we design it in. Talk to us before the next board meeting, wherever it is being held.
Tax, GST and business setup advisors — Mumbai and Thane. Contact us to discuss your situation.
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