Residential Status of Company & Tax Incidence

Section 6 of the Income-tax Act, 1961 (here referred to as "the Act") specifies the criteria for determining a person's residency in India for several categories. Section 6(3) of the Act specifies the conditions that must be satisfied for a Company to be deemed to have been a resident of India in any prior year. A company was considered to be resident in India in any prior year if it was an Indian company or if, throughout that year, the control and management of its business were located entirely in India. This was before the notion of Place of Effective Management (POEM) was introduced. The Finance Act 2015 changed the aforementioned clause to state that a company would be considered to have had its POEM in India during any prior year if it is an Indian company.

 

The POEM is regarded as the location where the key management and business decisions that are critical to the overall success of a company are being made. The notion of POEM has been delayed for one year; it is now applicable effective from the previous year, 2016–17, to offer clarity to the conditions for the applicability of some Income tax rules. 

Residential status of the company

As per Section 6(3) of the Act, the residential status is determined as follows:

Section	Company	Residential Status	Explanation
6(3)(i)	Indian company	Always resident in India	An Indian company will always be resident of India. Even though it is controlled from a location outside of India, it is still a resident of India.
6(3)(ii)	Foreign company (having turnover/gross receipts in the PY above Rs. 50 crs).	This will be resident in India if POEM during the relevant previous year is present in India.	A foreign company is a resident in India if its POEM during the relevant previous year is in India (Circular No. 6/2017, dated 24.01.2017).
6(3)(ii)	A foreign company (whose turnover/gross receipts in the previous year is up to Rs. 50 crores)	Always non-resident in India	A foreign company cannot be resident in India from the AY 2017-18 onwards (Circular No. 8/2017, dated 23.02.2017).

 

 

Place Of Effective Management (POEM)

An internationally accepted method for determining the residence of a company formed in a foreign country is called the place of effective management. The facts and circumstances of any particular case will determine any POEM determination. The concept of POEM emphasizes substance over form.

A company may have multiple places of management, but only one of those locations can be functional at any given time. Since "residence" must be determined annually, POEM will likewise need to be determined annually. The process of calculating POEM will be based mostly on whether the company is actively conducting business outside of India or not.

 

Permanent Establishment (PE)

A Permanent Establishment (PE) is a fixed location of business where an entity conducts all or part of its business or employs an agent who routinely executes contracts, delivers items, or secures orders on behalf of a non-resident.

Company Engaged In Active Business Outside India

Suppose the bulk of the Board of directors meetings are held outside India, and a company does active business outside India. In that case, it is assumed that the POEM is also located outside India.

A company is said to be conducting "active business outside India" if all of the following conditions are met:

1. the passive income does not represent more than 50% of the total income;
2. less than 50% of the total assets are located in India;
3. less than 50% of the total number of employees are from India/residents in India, and
4. the payroll costs associated with such employees do not represent more than 50% of the total payroll costs.

"Passive income" of a company is the sum of -

1. Income from transactions when the company's connected enterprises are both the source of the purchase and the recipient of the goods, and
2. income in the form of royalties, dividends, capital gains, interest, or rental income;

Any interest income, however, will not be deemed passive income in the event of a firm involved in the banking industry or is a public financial institution whose operations are subject to the regulations of the country of incorporation that apply to such activities.

Management Power Exercised In India

Suppose it can be proved via facts and circumstances that the company's Board of directors is evading its obligations and failing to exercise its management authority. In that case, the holding company or any other person(s) in India may be regarded as the place of effective management.

For these purposes, simply adhering to general and objective group policy and guidelines established by the parent entity, which may be in the fields of accounting, payroll, IT infrastructure and network platforms, human resources functions, supply chain functions, and conventional banking operational procedures, but is not necessarily related to any one company or a group of companies per se, would not involve a case of the Board of Directors acting deceptively.

Other examples

For companies other than those mentioned above, determining POEM would involve two stages, namely:

 

●        The first stage would be to identify or determine the individual who makes the critical managerial and commercial decisions for the company's overall operation.

●        The second stage would be to determine the place of the actual decision-making process.

 

The place of these management decisions would be more significant than the location of their implementation. The substance rather than the form would be to determine POEM.

 

The following are some of the guiding factors that could be used to determine the POEM:

1. A company's place of effective management may be where the Board of Directors regularly convenes to meet and make decisions, provided that the Board.
2. maintains its power to manage the company and uses it; and
3.  Makes the important managerial and business decisions required for the operation of the company's business.
4. Suppose the Board has de facto given these senior managers or the other person the authority to make the key management of the company and its business decisions, including any other person, such as shareholders, promoters, financial or legal advisors, and others. In that case,n that is typically where the company's effective management occurs.

The location of a company's head office is a significant aspect in determining the company's place of effective management because it frequently reflects where the majority of the company's key decisions are made.

 

The application of the concept has several effects on the place of effective management. The need for decision-makers to be physically present at a place is no longer valid. As a result, the actual location of a board meeting, executive committee meeting, or senior management meeting may not be where the important decisions are being made. In certain situations, the location of the directors or decision-makers, or the majority of them, may also be an important consideration.

 

When determining the place of a company's effective management, shareholder choices on issues that are statutorily reserved for shareholder vote are irrelevant. These choices could involve selling all or nearly all of the company's assets, dissolving, liquidating, or deregistering the business; changing the rights associated with different classes of shares, issuing a new class of shares; etc.

These decisions typically have an impact on the company's existence or the rights of the shareholders rather than on how the company conducts its business from a managerial or commercial standpoint, and are thus typically irrelevant when determining the place of a company's management.

 

The determination of POEM must take into account all pertinent information about the management and control of the organization and cannot be made solely based on isolated information that does not demonstrate effective management. The following examples serve as an example of this:

 

●        The mere fact that an Indian company fully owns a foreign company will not be sufficient proof that the requirements for establishing POEM in India have been met.

●        The mere fact that a foreign company has a permanent establishment in India does not prove beyond a reasonable doubt that all requirements for establishing POEM in India have been met.

 

Incidence of tax

According to the Act, a taxpayer's tax liability is determined by his residency status as well as the location and timing of when and where income was earned or received.

Understanding "Indian income" and "foreign income" is necessary to comprehend the connection between residence status and tax liabilities.

 

"Indian income" is any one of the following three: 

1. Income obtained in India during the previous year and accrued (or is seen to accrue) in India simultaneously.
2. If income accrues (or arises) outside of India during the preceding year but is received (or perceived to be received) in India.
3. Income received outside of India during the previous year, but that was accrued (or arose, or was deemed to accrue, or was deemed to arise) in India during the previous year.

Income is considered "foreign income" if both of the following conditions are met:

1. The income was not received (or was not deemed to have been received) in India.
2. In India, no income accrues nor arises (or is not presumed to do so).

Type of Income	Residents in India	Non-resident in India
Indian Income	Taxable in India	Taxable in India
Foreign Income	Taxable in India	Non-taxable in India

 

Conclusions

1. Indian income - Regardless of the taxpayer's residency status, Indian income is always taxable in India.
2. Foreign income - Foreign income received by an Indian resident is taxable. Non-residents of India are not required to pay taxes on their foreign income.