Residential Status of a Company and Tax Incidence under Income Tax Act

Table of Contents

1. Residential status of a company [Sec. 6(3)]

2. Incidence of tax [Sec. 5]

3. Receipt of income

4. Accrual of income

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1. Residential status of a company [Sec. 6(3)]

Residential status of a company is determined as follows –

Notes –

1. An Indian company is always resident in India. Even if an Indian company is controlled from a place located outside India (or even if shareholders of an Indian company controlling more than 51 per cent voting power are non-resident and/or located outside India), the Indian company is resident in India. An Indian company can never be non-resident.

2. A foreign company is resident in India if its place of effective management (POEM), during the relevant previous year, is in India. For this purpose, the 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. For this purpose, a set of guiding principles (to be followed in determination of POEM) have been issued by the Board in Circular No. 6/2017, dated January 24, 2017. These guiding principles are briefly explained in para 28.1.

3. Provisions of section 6(3)(ii) shall not apply to a foreign company having turnover or gross receipts of Rs. 50 crore or less in a financial year – Circular No. 8/2017, dated February 23, 2017. In other words, a foreign company (whose annual turnover/gross receipts is Rs. 50 crore or less) cannot be resident in India from the assessment year 2017-18 onwards.

1.1 Place of effective management (POEM) as per Circular No. 6/2017

“Place of effective management” (POEM) is an internationally recognised test for determination of residence of a company incorporated in a foreign jurisdiction. Any determination of the POEM will depend upon the facts and circumstances of a given case. The POEM concept is one of substance over form. 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. Since “residence” is to be determined for each year, POEM will also be required to be determined on year to year basis. The process of determination of POEM would be primarily based on the fact as to whether or not the company is engaged in active business outside India.

1.1.1 Company engaged in active business outside India

The place of effective management in case of a company engaged in active business outside India shall be presumed to be outside India if the majority meetings of the board of directors of the company are held outside India.

• • Active business outside India – A company shall be said to be engaged in “active business outside India” if –

(a) the passive income is not more than 50 per cent of its total income;

(b) less than 50 per cent of its total assets are situated in India;

(c) less than 50 per cent of total number of employees are situated in India or are resident in India; and

(d) the payroll expenses incurred on such employees is less than 50 per cent of its total payroll expenditure.

• • Passive income – “Passive income” of a company shall be aggregate of, —

(a) income from the transactions where both the purchase and sale of goods is from/to its associated enterprises; and

(b) income by way of royalty, dividend, capital gains, interest or rental income;

However, any income by way of interest shall not be considered to be passive income in case of a company which is engaged in the business of banking or is a public financial institution, and its activities are regulated as such under the applicable laws of the country of incorporation.

1.1.2 Management power exercised in India

If on the basis of facts and circumstances it is established that the Board of directors of the company are standing aside and not exercising their powers of management and such powers are being exercised by either the holding company or any other person(s) resident in India, then the place of effective management shall be considered to be in India. For this purpose, merely because the Board of Directors follows general and objective principles of global policy of the group laid down by the parent entity which may be in the field of Pay roll functions, Accounting, Human resource (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; would not constitute a case of Board of Directors of companies standing aside.

1.1.3 Other cases

In cases of companies other than those discussed above, the determination of POEM would be a two stage process, namely –

– First stage would be identification or ascertaining the person or persons who actually make the key management and commercial decision for conduct of the company’s business as a whole.

– Second stage would be determination of place where these decisions are in fact being made.

The place where these management decisions are taken would be more important than the place where such decisions are implemented. For the purpose of determination of POEM it is the substance which would be conclusive rather than the form.

• Guiding principles – Some of the guiding principles which may be taken into account for determining the POEM are as follows –

1. The location where a company’s Board regularly meets and makes decisions may be the company’s place of effective management provided, the Board –

(a) retains and exercises its authority to govern the company; and

(b) does, in substance, make the key management and commercial decisions necessary for the conduct of the company’s business as a whole.

2. If a board has de facto delegated the authority to make the key management and commercial decisions for the company to the senior management or any other person including a shareholder, promoter, strategic or legal or financial advisor, etc., and does nothing more than routinely ratifying the decisions that have been made, the company’s place of effective management will ordinarily be the place where these senior managers or the other person make those decisions.

3. A company’s board may delegate some or all of its authority to one or more committees such as an executive committee consisting of key members of senior management. In these situations, the location where the members of the executive committee are based and where that committee develops and formulates the key strategies and policies for mere formal approval by the full board will often be considered to be the company’s place of effective management.

4. The location of a company’s head office will be a very important factor in the determination of the company’s place of effective management because it often represents the place where key company decisions are made.

5. The use of modern technology impacts the place of effective management in many ways. It is no longer necessary for the persons taking decision to be physically present at a particular location. Therefore, physical location of board meeting or executive committee meeting or meeting of senior management may not be where the key decisions are in substance being made. In such cases the place where the directors or the persons taking the decisions or majority of them usually reside may also be a relevant factor.

6. The decisions made by shareholder on matters which are reserved for shareholder decision under the company laws are not relevant for determination of a company’s place of effective management. Such decisions may include sale of all or substantially all of the company’s assets, the dissolution, liquidation or deregistration of the company, the modification of the rights attaching to various classes of shares or the issue of a new class of shares etc. These decisions typically affect the existence of the company itself or the rights of the shareholders as such, rather than the conduct of the company’s business from a management or commercial perspective and are therefore, generally not relevant for the determination of a company’s place of effective management.

7. Day to day routine operational decisions undertaken by junior and middle management shall not be relevant for the purpose of determination of POEM.

8. The determination of POEM is to be based on all relevant facts related to the management and control of the company, and is not to be determined on the basis of isolated facts that by itself do not establish effective management, as illustrated by the following examples –

– The fact that a foreign company is completely owned by an Indian company will not be conclusive evidence that the conditions for establishing POEM in India have been satisfied.

– The fact that there exists a Permanent Establishment of a foreign entity in India would itself not be conclusive evidence that the conditions for establishing POEM in India have been satisfied.

– The fact that one or some of the directors of a foreign company reside in India will not be conclusive evidence that the conditions for establishing POEM in India have been satisfied.

– The fact of, local management being situated in India in respect of activities carried out by a foreign company in India will not, by itself, be conclusive evidence that the conditions for establishing POEM have been satisfied.

– The existence in India of support functions that are preparatory and auxiliary in character will not be conclusive evidence that the conditions for establishing POEM in India have been satisfied.

1.1.4 Prior approval of  Principle CIT/CIT Required

In case the Assessing Officer proposes to hold a foreign company, on the basis of its POEM, as being resident in India then any such finding shall be given by the Assessing Officer after seeking prior approval of the collegium of three members consisting of the Principal CITs or CITs, as the case may be, to be constituted by the Principal Chief Commissioner of the region concerned, in this regard. The collegium so constituted shall provide an opportunity of being heard to the foreign company before issuing any directions in the matter.

1.2 Case studies

P1. X Ltd. is an Indian company. It has 10 shareholders who are foreign citizens and non-resident in India. The business of the company is fully controlled from outside India. Find out the residential status of X Ltd. for the assessment year 2022-23.

X Ltd. is an Indian company. An Indian company is always resident in India. This rule is equally applicable even if shareholders are foreign citizens as well as non-resident or even if business is controlled from outside India.

P2. Y Ltd. is a company incorporated in Mauritius (turnover more than Rs. 50 crore). It has 10 shareholders who are Indian citizens and resident in India. The company has active business outside India and is controlled wholly from outside India by a team of professionals. What is the residential status of Y Ltd. for the assessment year 2022-23.

Y Ltd. is a foreign company. It is controlled wholly from outside India (POEM is outside India). It is, therefore, non-resident in India for the assessment year 2022-23. Residential status of shareholders is irrelevant. Likewise, the nationality of shareholders is not taken into consideration.

P3. Z Ltd. is incorporated in Japan. It has 15 shareholders (10 are Indian citizens and resident in India). The company has no active business in Japan. Gross annual turnover of the company for the previous year 2021-22 is Rs. 48 crore mainly from operations conducted from Korea, Sri Lanka and India. The company is managed by a team of professionals from India. Find out the residential status of Z Ltd. for the assessment year 2022-23.

Z Ltd. is a foreign company. Gross turnover of the company for the relevant previous year is Rs. 48 crore. A foreign company (whose turnover/gross receipts is not more than Rs. 50 crore) is treated as non-resident in India.

P4. B Ltd. is an Indian company. A Ltd. is a Mauritius company and it is 100 per cent subsidiary of B Ltd. The assets of A Ltd. are situated in Mauritius. All employees of A Ltd. are also located in Mauritius. The average income wise break-up of total income of A Ltd. for the current year and last 2 years is as follows –

– 32 per cent of income is from transaction where purchases are made from parties which are non-associated enterprises and sold to associated enterprises;

– 34 per cent of income is from transaction where purchases are made from associated enterprises and sold to associated enterprises;

– 27 per cent of income is from transaction where purchases are made from associated enterprises and sold to non-associated enterprises; and

– 7 per cent of the income is by way of interest, royalty, dividend, capital gain and rent.

Find out the residential status of A Ltd. for the assessment year 2022-23 (turnover of A Ltd. is more than Rs. 100 crore).

Passive income of A Ltd. is 41% (i.e., 34% + 7%). Passive income of A Ltd. is not more than 50% of its total income. Besides, A Ltd. satisfies the following condition –

(a) less than 50 per cent of its total assets are situated in India;

(b) less than 50 per cent of total number of employees are situated in India or are resident in India; and

(c) the payroll expenses incurred on such employees is less than 50 per cent of its total payroll expenditure.

A Ltd. is engaged in active business outside India. POEM of A Ltd. is outside India. Consequently, A Ltd. is non-resident in India.

P5. Make the following changes in Problem 28-P4 and determine the residential status of A Ltd. –

1. A Ltd. has 90 employees. 87 employees manage accounts, store and warehouse in Mauritius. Managing director, Chief Executive Officer and Sales Head are posted in Mumbai. Total payroll expenditure of 87 employees is Rs. 3.3 crore. Annual payroll expenditure of managing director, Chief Executive Officer and Sales Head is Rs. 3.8 crore.

2. Tax is deducted under section 192 out of salary of Rs. 3.8 crore.

Only 41% of total income of A Ltd. is passive in nature. Further, more than 50% of the employees are also situated outside India. All the assets are situated outside India. However, the payroll expenditure in respect of the managing director, Chief Executive Officer and Sales Head (being employees resident in India) exceeds 50% of the total payroll expenditure. Therefore, A Co. is not engaged in active business outside India. The Assessing Officer may conclude that POEM of A Ltd. is situated in India and, consequently, A Ltd. is resident in India. However, before recording this finding the Assessing Officer will have to take prior approval of the collegium of three members consisting of the Principal CITs or CITs, as the case may be, to be constituted by the Principal Chief Commissioner of the region concerned, in this regard. The collegium so constituted shall provide an opportunity of being heard to A Ltd. before issuing any directions in the matter.

P6. In Problem 28-P4, assume that A Ltd. has 5 directors. These directors are Indian citizens and resident in India. During the relevant previous year, 2 meetings of board of directors are held in India, 3 meetings are held in Mauritius and 1 meeting is held in Maldives. Determine the residential status of A Ltd.

A Ltd. is engaged in active business outside India (as discussed in Problem 28-P4). The majority of board meetings have been held outside India. Therefore, the POEM of A Ltd. is situated outside India. A Ltd. is non-resident in India.

P7. The facts are same as in Problem 28-P6. However, it is noted by the Assessing Officer that A Ltd.’s senior management team signs all the contracts up to Rs. 15 lakh. For all the contracts above Rs. 15 lakh, A Ltd. must submit its recommendation to its Indian holding company B Ltd. In such cases, B Ltd. takes the final decision from India. It is also noted from the records that during the current previous year more than 98 per cent of the contracts are above Rs. 15 lakh (over past 2 years this percentage is 99 per cent). Find out the residential status of A Ltd.

These facts suggest that the effective management of the A Ltd. may have been usurped by the holding company B Ltd. Therefore, POEM of A Ltd. cannot be presumed to be outside India, even though A Ltd. is engaged in active business outside India and majority of board meeting are held outside India. Therefore, A Ltd. is resident in India. However, before recording this finding the Assessing Officer will have to take prior approval of the collegium of three members consisting of the Principal CITs or CITs, as the case may be, to be constituted by the Principal Chief Commissioner of the region concerned, in this regard. The collegium so constituted shall provide an opportunity of being heard to A Ltd. before issuing any directions in the matter.

P8. An Indian multinational group has a local holding company A Ltd. in Singapore. A Ltd. also has 100 per cent downstream subsidiaries B Ltd. and C Ltd. in Hong Kong and D Ltd. in Cyprus. A Ltd. has income only by way of dividend and interest from investments made in its subsidiaries. The POEM of A Ltd. is in India and is exercised by ultimate parent company of the group. B Ltd., C Ltd. and D Ltd. are engaged in active business outside India. The meetings of Board of Director of these companies are held in Hong Kong and Cyprus. Find out the residential status of B Ltd., C Ltd. and D Ltd.

Merely because POEM of A Ltd. (i.e., intermediate holding company) is in India, the POEM of its subsidiaries shall not be taken to be in India. Each subsidiary has to be examined separately. B Ltd., C Ltd. and D Ltd. are independently engaged in active business outside India and majority of board meetings of these companies are also held outside India. The POEM of these companies shall be presumed to be outside India.

Dive Deeper:
All-About the Residential Status under the Income-tax Act

2. Incidence of tax [Sec. 5]

Under the Act, incidence of tax on a taxpayer depends on his residential status and also on the place and time of accrual or receipt of income.

2.1 Indian income and foreign income

In order to understand the relationship between residential status and tax liability, one must understand the meaning of “Indian income” and “foreign income”.

• • “Indian income” – Any of the following three is an Indian income —

1. If income is received (or deemed to be received) in India during the previous year and at the same time it accrues (or arises or is deemed to accrue or arise) in India during the previous year.

2. If income is received (or deemed to be received) in India during the previous year but it accrues (or arises) outside India during the previous year.

3. If income is received outside India during the previous year but it accrues (or arises or is deemed to accrue or arise) in India during the previous year.

• • Foreign income – If the following two conditions are satisfied, then such income is “foreign income” —

1. income is not received (or not deemed to be received) in India; and

2. income does not accrue or arise (or does not deemed to accrue or arise) in India.

2.2 Incidence of tax

Tax incidence is as follows—

2.3 Conclusions

The following broad conclusions can be drawn —

1. Indian income – Indian income is always taxable in India irrespective of the residential status of the taxpayer.

2. Foreign income – Foreign income is taxable in the hands of resident in India. Foreign income is not taxable in the hands of non-resident in India.

3. Receipt of income

Income received in India is taxable in all cases irrespective of residential status of the assessee.

The following points are worth mentioning in this respect :

3.1 Receipt v. Remittance

The “receipt” of income refers to the first occasion when the recipient gets the money under his control. Once an amount is received as income, any remittance or transmission of the amount to another place does not result in “receipt” at the other place—Keshav Mills Ltd. v. CIT [1953] 23 ITR 230 (SC). For instance, an assessee, after receiving an income outside India, cannot be said to have received the same again when he brings or remits the same to India. The position will remain the same if income is received outside India by an agent of the assessee (maybe a bank or some other person) who later on remits the same to India. Income after the first receipt merely moves as a remittance of money. The same income cannot be received by the same person twice, once outside India and once within India.

3.2 Actual receipt v. Deemed receipt

It is not necessary that an income should be actually received in India in order to attract tax liability. An income deemed to be received in India, in the previous year, is also included in the taxable income of the assessee.

The Act enumerates the following as income deemed to be received in India :

• • Annual accretion (i.e., interest in excess of 9.5 per cent) to the credit balance of an employee in the case of recognised provident fund.
  • Excess contribution of employer (i.e., in excess of 12 per cent of salary) in the case of recognised provident fund.
  • Contribution made by the Central Government or any other employer in the previous year, to the account of an employee under a notified pension scheme referred to in section 80CCD.
  • Transfer balance.
  • Tax deducted at source.
  • Deemed profit under section 41.

3.3 Cash v. Kind

It is not necessary that income should be received in cash. Income may be received in cash or kind. For instance, value of a free residential house provided to an employee is taxable as salary in the hands of the employee though the income is not received in cash.

3.4 Receipt v. Accrual

Receipt is not the sole test of chargeability to tax. If an income is not taxable on receipt basis, it may be taxable on accrual basis.

4. Accrual of income

Income accruing in India is chargeable to tax in all cases irrespective of the residential status of the assessee. The words “accrues” and “arises” are used in contradistinction to the word “receive”. Income is said to be received when it reaches the assessee ; when the right to receive the income become vested in the assessee, it is said to accrue or arise.

Dive Deeper:
Residential Status under Income-tax Act
Overview of Tax Residence in India under Income Tax