Residential Status of Companies

The scope of taxation of income of a company is dependent upon its residential status and the source of income. A company which is resident in India is taxable on its worldwide income. The current Income-tax law (ITA) provides that a foreign company is regarded as a resident in India in any year, if the control and management of its affairs is situated wholly in India during the year. Thus, even partial control of a company outside India is sufficient to hold the company as a non-resident [ Radha Rani Holdings (P) Ltd. v. ADIT – 2007-TIOL-335-ITAT-DEL].

As indicated in the explanatory memorandum to the Finance Bill, 2015 (Memorandum), due to the requirement that whole of control and management should be situated in India and that too for whole of the year, the condition has been rendered to be practically inapplicable. A company can easily avoid becoming a resident by simply holding a board meeting outside India. This facilitates creation of shell companies which are incorporated outside but controlled from India.

To overcome this anamoly, it is proposed that a foreign company will be treated as a resident in India if its place of effective management is in India at any time in the year. For this purpose, ‘Place of Effective Management’ (PoEM) means a place where key management and commercial decisions necessary for the conduct of the business of the entity as a whole are, in substance made. This provision would apply from 1 st April 2015. Thus, a company having its PoEM in India would now be taxable in India on its worldwide income. Other implications, including tax compliance requirements, would consequently follow.

PoEM is an internationally recognized concept for determining residence of a company incorporated in a foreign jurisdiction. Most of the Indian t ax treaties recognize the concept of PoEM for determining residence of a company as a tie-breaker rule for avoidance of double taxation. Many countries prefer the POEM test to be an appropriate test for determination of residence of a company. This principle is recognized and accepted by Organisation of Economic Cooperation and Development (OECD) also. The definition of PoEM as proposed in the ITA is in line with the definition of PoEM that was indicated in the Direct Taxes Code, 2013.

PoEM is a narrower concept than ‘control and management’. As per commentary on OECD Model Tax Convention, the place of effective management will ordinarily be the place where the most senior person or group of persons (e.g. board of directors) makes its decisions. All facts and circumstances must be examined to determine the place of effective management. An entity may have more than one place of management, but it can have only one place of effective management at any one time.

The proposed amendment could impact foreign companies having Indian branches, foreign subsidiaries of Indian parent, overseas company having global reporting structure with India connection and Regional headquarters. It would be relevant in such cases to review the current decision making process and consider the impact on account of the proposed amendment.

Activities likely to trigger PoEM in India could include board meeting of foreign company in India, decision taken by a director / officer of the foreign company while in India, decision taken by the board of the Parent Company relating to the affairs of the foreign company in India, Regional roles e.g. Group CEOs / CFOs sitting in India and approving decisions for foreign company, functions carried on in India by Global Heads for foreign companies, Indian directors attending Board Meeting of foreign company through video-conferencing / teleconference etc.

However, the above may not be an issue where the tax treaty protection is available to the foreign company – for example, even if a foreign company has a Board meeting in India, PoEM under the tax treaty as per tie-breaker rule may prevail and PoEM will not be in India.

There could be ambiguity in relation to interpretation of certain terms such as ‘key management and commercial decisions’, ‘as a whole’ and ‘in substance made’ in the proposed definition of PoEM. As mentioned in the explanatory memorandum to the Finance Bill, 2015, it is proposed to issue a set of guiding principles to be followed in determination of PoEM, in due course. This would provide clarity to the taxpayers and tax administration, and avoid litigation in the future.

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