How to determine Residential Status of a Company

Introduction:

Section 6 of the Income Tax Act, 1961 provides the rules for determination of residential status of assessee in India. The principles governing the determination of residential status in case of the companies are given in section 6(3) of the Act. Earlier, a company was said to be a resident in India if it was an Indian company or if the control and management of its affairs were situated wholly in India. The control and management of any company is vested in Board of Directors (BOD). Therefore, a company could be incorporated outside India for which some of the Board meeting held outside India and claim itself to be a “Non-resident” even though major policy decisions in respect of such companies were taken in India. Thus, the old provision facilitated creation of shell companies outside India which in reality were controlled from India. This was evident from the decision of the Delhi Tribunal in the case of Radha Rani Holdings vs. ACIT [2007]. Further, internationally and under various tax treaties, the concept of Place of Effective Management (POEM) is accepted. These two reasons prompted the Indian Government also to accept and introduce the concept of POEM in India.

The Finance Act, 2015 therefore, amended section 6(3) to provide that a company (other than an Indian company) shall be resident in India if its POEM in that year is in India. It implies that if a foreign company fulfils the conditions of POEM, it will be treated as “resident” in India and it’s global income shall be taxable in India. The provisions of POEM were made applicable from 1^st April, 2016. However, the applicability of the same was deferred for one year and hence, made effective from 1^st April, 2017 i.e. Assessment year 2017-18 (Previous year 2016-17).

Section-6(3): Residential Status of company

“A company is said to be resident in India in any previous year, if, -
(i) It is an Indian company; or
(ii) Its place of effective management (POEM), in that year, is in India;

Explanation- For the purposes of this clause, “Place of Effective Management” means a place where key management and commercial decisions that are necessary for the conduct of the business of an entity as a whole are, in substance made.”

Analysis:

The definition of “Indian company” is given under section 2(26) of the Act. According to section 2(26), “Indian company” means a company formed and registered under Companies Act or any other law in India including a corporation established by a Central or State Act. It is further provided that the registered office or principal office should be in India.
An Indian company shall always be considered as “Resident” in India. The guidelines of POEM shall not apply to such companies.
The concept of POEM is relevant only in case of foreign companies. If POEM of any foreign company is outside India, it shall be treated as “Non-resident” in that year and if POEM is determined to be in India, it shall be treated as “Resident” in India resulting in taxability of “global income” in India.
The POEM is required to be determined every year.
The place where decisions relating to day-to-day routine operations are taken and support functions (like in case of Liaison Office) that are preparatory or auxiliary in nature are performed are not relevant in determining POEM.

Guidelines for determination of Place of Effective Management (POEM) of a company [Circular No. 6/2017]

Circular No. 6/2017 dated 24/01/2017 prescribed the guiding principles for determination of POEM of a company as prescribed under section 6(3) of the Income Tax Act, 1961. Further, Circular No. 8/2017 dated 23/02/2017 clarified that POEM guidelines as per Circular No. 6/2017 shall not be applicable to a company having turnover or gross receipts of upto Rs. 50 crores in a financial year. Therefore, POEM guidelines shall be looked into only in case of a foreign company which is having a turnover or gross receipts more than Rs. 50 crores in a financial year.

Any determination of POEM will depend upon the facts and circumstances of a given case. The POEM concept is one of substance over form. It may be noted that an entity may have more than one place of management, but it can have only one place of effective management at any point of time.

According to POEM guidelines, a foreign company can be classified into 2 categories for this purpose:

Companies engaged in “Active Business Outside India” (ABOI) or
Companies other than those engaged in “Active Business Outside India”

TEST-1: COMPANIES ENGAGED IN ACTIVE BUSINESS OUTSIDE INDIA:

A company is said to be engaged in “Active Business Outside India” if it satisfies ALL the following prescribed conditions:

Conditions to be satisfied

Detailed description

Passive Income is 50% or less than 50% of its Total Income

Income shall be:

(a) Computed as per the tax laws of the country where such company is incorporated or
(b) As per books of account where the laws of that country do not require such a computation.

Meaning of “Passive Income”:

Aggregate of:

(i) Income from transactions where both the purchase and sale of goods is from/ to its associated enterprises and
(ii) Income by way of royalty, dividend, capital gains, interest or rental income (whether from associated or non-associated enterprises)

Note: In case of a banking company or public financial institution whose activities are regulated under applicable laws in the country of incorporation, interest income shall not be considered as passive income.

Less than 50% of its total assets are situated in India

Value of Assets =

(a) In case of depreciable assets: Average of its value for tax purposes in the country of incorporation at the beginning and at the end of the previous year +
(b) In case of other assets: Value as per books of accounts

Less than 50% of the total number of employees are situated in India or are resident in India

Number of employees:

Average of number of employees (regular + contractual) at the beginning and at the end of the previous year

Payroll expenses incurred on employees situated in India or resident in India is less than 50% of the total payroll expenditure

Payroll shall include cost of salaries, wages, bonus plus employees’ compensation including pension and social costs borne by the employer.

Note:

For the purpose of determining ABOI, the average of the data of relevant previous year and preceding 2 previous years shall be taken into account. In case the company has been in existence for a shorter period, the data for shorter period shall be considered. For example, in case of AY 2021-22 (FY 2020-21), the average of data of FY 2020-21, 2019-20 & 2018-19 shall be taken into account.
Where the accounting year for tax purposes in accordance with the tax laws of the country of incorporation are different from previous year, then the data of accounting year that ends during the relevant previous year and two accounting years preceding it shall be considered.
If all the above 4 conditions are satisfied by a company, it will be treated as a company engaged in “Active Business Outside India”.

TEST-2:

If Test-1 is successful i.e. the company is found to be engaged in "Active business Outside India", then check the place whether the BOD meetings are held outside India. Place of Effective Management (POEM) in case of a company engaged in “Active Business Outside India” shall be PRESUMED TO BE OUTSIDE INDIA if the MAJORITY of the Board meetings are held outside India.

Analysis:

However, if on the basis of facts and circumstances, it is established that the Board of Directors are standing aside and not exercising their powers of management and such powers are exercised by holding company or any other person resident in India, then POEM shall be considered in India.
For this purpose, it has been clarified that merely because the BOD follows general and objective principles of global policy of the group laid down by the parent entity which may be in the field of Payroll functions, Accounting, Human Resources (HR), IT infrastructure and network platforms, supply chain functions, Routine banking operational procedures, and not being specific to any entity or group of entities per se; would not constitute a case of BOD of companies standing aside.
Circular No. 25/2017 dated 23/10/2017: POEM may be triggered in cases of certain MNCs with regional headquarter structure merely on the ground that certain employees having multi-country responsibility or oversight over the operations in the other countries of the region are working from India. So it is clarified that so long as the Regional Headquarter operates for subsidiaries/ group companies in a region within the general and objective principles of global policy of the group laid down by the parent entity in the field of payroll functions, accounting, HR functions, IT infrastructure and network platforms, supply chain functions, routine banking operational procedures, and not being specific to any entity or group of entities per se, it would, in itself, not constitute a case of BOD of companies standing aside and such activities of Regional Headquarter in India alone will not be a basis for establishment of POEM for such subsidiaries/ group companies.
It is further mentioned that the provisions of GAAR contained in Chapter X-A of the Act, may get triggered in such cases where the above clarification is found to be used for abusive/ aggressive tax planning.

Example: Company X is a sourcing entity, for an Indian multinational group, incorporated in Mauritius and is 100% subsidiary of Indian company (Y). The warehouses and stock in them are the only assets of the company and are located in Mauritius. All the employees of the company are also in Mauritius. The average income-wise break up of the company’s total income for 3 years is below:

30% of income is from transactions where purchases are made from parties which are non-associated enterprises and sold to associated enterprises.
30% of income is from transaction where purchases are made from associated enterprises and sold to associated enterprises.
30% of income is from transaction where purchases are made from associated enterprises and sold to non-associated enterprises; and
10% of the income is by way of interest.

Solution:

Since passive income of the company X is less than 50% i.e. 40% of the total income the entity and both the assets and employees employed in India in ‘Nil’, therefore the company is deemed to be having “Active Business Outside India”. If majority of the BOD meetings are held outside India, then POEM of the company X is outside India.

COMPANIES OTHER THAN THE COMPANIES ENGAGED IN ACTIVE BUSINESS OUTSIDE INDIA:

In case of companies other than engaged in ABOI, a two-stage process for determination of POEM is being prescribed:

Stage-1: Identify the persons who actually make the key management and commercial decisions for conduct of company's business as a whole

Stage-2: Determination of place where the decisions are in fact made. The place where management decisions are taken will be more important than the place where such decisions are implemented.

Circular No. 6/2017 prescribes guiding principles for determination of POEM which will help us in identifying the key management personnel or senior management who is making major management and commercial decisions and thereby deciding the place where POEM exists. Please refer Circular No. 6/2017 for the detailed guiding principles at the following link: https://www.incometaxindia.gov.in/News/Circular06_2017.pdf

Quick Links