Unit 2: Residential Status of Companies - Subjective Questions

Under Section 2(17) of the Income-tax Act, 1961, a company includes:

• Any Indian company.
• Any body corporate incorporated under the laws of a country outside India.
• Any institution, association or body that was assessed, or was assessable, as a company under the earlier Indian income-tax laws for any assessment year commencing on or before 1 April 1970.
• Any institution, association or body, whether incorporated or not and whether Indian or non-Indian, which is declared by the Central Board of Direct Taxes to be a company.

Thus, the definition is wider than a company incorporated under the Companies Act. It may include certain foreign bodies corporate and notified associations or institutions.

An Indian company, as defined under Section 2(26), generally means a company formed and registered under the Companies Act or under specified laws governing companies and corporations in India.

Its principal features are:

• It is formed and registered under an Indian law.
• It includes certain corporations established by or under a Central, State or Provincial Act.
• It may include specified institutions, associations or bodies declared to be companies under the Income-tax Act.
• Its registered office or principal office must be situated in India in the cases covered by the statutory definition.
• An Indian company is always treated as a resident in India, irrespective of the place from which its business is actually managed.

Therefore, incorporation in India creates an unconditional residential connection with India for income-tax purposes.

Under Section 2(22A), a domestic company means:

• An Indian company; or
• Any other company which, in respect of its income liable to tax in India, has made the prescribed arrangements for the declaration and payment of dividends within India.

The distinction is as follows:

• Indian company: The classification primarily depends on formation or registration under Indian law and the other conditions contained in Section 2(26).
• Domestic company: This category includes every Indian company and may also include a foreign-incorporated company that makes the prescribed arrangements for declaring and paying dividends in India.
• Every Indian company is a domestic company, but every domestic company need not necessarily be incorporated in India.
• The classification as a domestic company is relevant for tax rates and certain provisions concerning dividends and corporate taxation.

Under Section 2(23A), a foreign company means a company that is not a domestic company.

A foreign company can be resident in India for a particular previous year. Incorporation and residential status are separate concepts:

• A company incorporated outside India is not an Indian company merely because it carries on business in India.
• Such a company may nevertheless become resident in India if its Place of Effective Management, or POEM, is in India during the relevant previous year.
• If its POEM is outside India, it is generally treated as a non-resident for that year.
• Residential status must be determined separately for every previous year.

Therefore, a company may simultaneously be foreign by classification and resident in India for tax purposes.

The three concepts may be distinguished as follows:

Thus, classification of a company and determination of its residential status are related but legally distinct exercises.

Under Section 6(3), a company is resident in India in a previous year if either of the following conditions is satisfied:

1. It is an Indian company: An Indian company is always resident in India. The location of its shareholders, directors, business operations or management does not alter this result.
2. Its Place of Effective Management is in India: A company other than an Indian company is resident if its POEM during that year is in India.

POEM means the place where the key management and commercial decisions necessary for conducting the business of the entity as a whole are, in substance, made.

If a foreign-incorporated company has its POEM outside India, it is generally non-resident. Residence is determined for each previous year, so the same foreign company may be resident in one year and non-resident in another.

Place of Effective Management means the place where key management and commercial decisions necessary for conducting the business of an entity as a whole are, in substance, made.

The important expressions are:

• Key management and commercial decisions: These are high-level strategic decisions rather than routine operational decisions.
• In substance: The test examines where decisions are actually made, not merely where documents are formally signed or meetings are recorded.
• Business as a whole: The focus is on decisions governing the entire enterprise, rather than the management of an isolated branch, project or function.
• Place: POEM must ordinarily be identified with reference to the location where the decision-making process is actually carried out.

The concept prevents a company from claiming non-resident status merely by maintaining formal board procedures outside India when effective strategic control is exercised from India.

Residential status is determined separately for each previous year because Section 6 applies with reference to the facts existing during that particular year.

• An Indian company remains resident in every year because its residence follows directly from its legal status.
• In the case of a foreign company, the location of POEM may change as its actual management and decision-making arrangements change.
• A shift in strategic management from one country to another may therefore alter the company's residential status.
• Temporary or isolated events should be evaluated in the context of all relevant facts, rather than treated as conclusive by themselves.
• Residential status is not determined merely by the position in the immediately preceding year.

Consequently, a foreign company may be non-resident in one previous year and resident in India in another previous year if its POEM shifts to India.

The board of directors is relevant because it ordinarily makes the company's key strategic and commercial decisions. However, the formal location of board meetings is not conclusive.

The following factors must be examined:

• Whether the board actually exercises its decision-making authority.
• Where the directors deliberate upon and make key decisions.
• Whether decisions are merely approved at board meetings after being formulated elsewhere.
• Whether the board has effectively delegated its authority to senior management or another person.
• Whether an Indian parent company or controlling shareholder is, in substance, making the foreign company's strategic decisions.

If the board genuinely exercises its powers at meetings held outside India, that location may indicate an overseas POEM. If the board only rubber-stamps decisions made in India, the POEM may be in India despite the formal overseas meetings.

Shareholder control and effective management are not identical:

• Shareholders legitimately exercise powers such as appointing directors, approving major structural changes and protecting their investment.
• A parent company may issue broad policies or monitor the performance of a subsidiary without necessarily managing its day-to-day or strategic affairs.
• Effective management concerns the persons and place where key management and commercial decisions for the company's business as a whole are actually made.
• Mere ownership of shares by Indian residents does not automatically establish POEM in India.
• If the shareholder or Indian parent goes beyond normal oversight and actually makes the subsidiary's strategic business decisions, this may indicate that effective management is exercised from India.

The decisive issue is therefore the substance and degree of control, not merely the existence of a parent-subsidiary relationship.

For the administrative guidelines on POEM, a company is generally regarded as being engaged in active business outside India when the prescribed tests are satisfied. Broadly:

• Its passive income is not more than 50% of its total income.
• Less than 50% of its total assets are situated in India.
• Less than 50% of its total number of employees are situated in or resident in India.
• Payroll expenses relating to employees situated in or resident in India are less than 50% of total payroll expenditure.

Passive income broadly includes income from transactions in which both the purchase and sale of goods are from or to associated enterprises, and income such as royalty, dividend, capital gains, interest or rental income, subject to the qualifications in the guidelines.

The relevant figures are ordinarily evaluated with reference to the prescribed multi-year data and the applicable averaging rules.

Where a company is engaged in active business outside India, its POEM is generally presumed to be outside India if the majority of its board meetings are held outside India.

However, this presumption may not apply where the facts establish that:

• The board does not actually exercise its powers of management; and
• Such powers are being exercised by the holding company or by another person resident in India.

The analysis therefore involves two stages:

1. Determine whether the company satisfies the active-business-outside-India conditions.
2. Examine the location and substance of board-level decision-making.

Routine oversight by an Indian parent does not by itself displace the presumption. On the other hand, if the foreign board merely approves decisions already made in India, the company's POEM may be held to be in India.

For a company not engaged in active business outside India, POEM is generally determined through a two-stage process:

1. Identify the persons who make the key management and commercial decisions: The inquiry determines whether such decisions are made by the board, an executive committee, senior management, a parent company or some other person.
2. Determine the place where those decisions are actually made: The location of real deliberation and decision-making is more important than the place where decisions are formally recorded or implemented.

Relevant evidence may include:

• Board and committee minutes.
• Travel and participation records of directors.
• Delegations of authority.
• Communications between directors and senior executives.
• The location of the head office and senior management.
• Evidence showing where strategic policies are formulated.

The determination is based on the overall facts and substance of management during the relevant previous year.

Modern decision-making may occur without all directors being physically present at one location. Therefore, POEM requires a substance-based analysis:

• Head office: The location where senior management and support staff primarily perform their functions may be an important indicator of where key decisions are made.
• Video or telephone conferences: The focus is on the place where the persons who actually make the decisions are located. The location of the majority or dominant decision-makers may be relevant.
• Circular resolutions: The place where a resolution is formally signed is not necessarily the place where the decision was made. The location where the proposal was discussed, formulated and effectively approved must be examined.
• Minutes and records: These are evidence but are not conclusive if actual conduct shows a different decision-making location.

No single factor automatically determines POEM; the overall pattern of effective strategic management must be considered.

Tax incidence refers to the extent or scope of income that becomes chargeable to tax in India. Residential status is important because it determines whether a company is taxed on worldwide income or only on income having a specified connection with India.

• A resident company is generally taxable in India on its global income.
• A non-resident company is generally taxable only on income received or deemed to be received in India and income accruing, arising or deemed to accrue or arise in India.
• The place where income is earned and the place where it is received may both affect taxability.
• Deeming provisions, such as those relating to a business connection, property, assets, sources of income or transfer of capital assets situated in India, may bring foreign-company income into the Indian tax base.

Thus, residential status is the starting point for determining the geographical scope of corporate income taxable in India.

A resident company's total income generally includes income from all sources, whether located in India or outside India. It includes:

• Income received or deemed to be received in India during the relevant previous year.
• Income accruing or arising, or deemed to accrue or arise, in India.
• Income accruing or arising outside India, whether or not it is received in India.

The scope may be represented as:

Therefore, a resident company is generally subject to tax in India on its worldwide income. Relief may be available under a Double Taxation Avoidance Agreement or under the unilateral-relief provisions when the same foreign income is also taxed in another country.

A non-resident company's total income generally includes only income that has the prescribed territorial connection with India. It includes:

• Income received in India.
• Income deemed to be received in India.
• Income accruing or arising in India.
• Income deemed to accrue or arise in India under the Act.

Income that accrues and is received entirely outside India is ordinarily not taxable in India merely because the company has some unrelated activity in India.

The scope may be summarized as:

The final tax position may also be affected by Section 9, applicable special provisions and any relevant Double Taxation Avoidance Agreement.

The tax incidence differs primarily in geographical scope:

Example 1: A resident company earns business profit in India and rental income from property outside India. Both amounts generally form part of its total income in India.

Example 2: A non-resident company earns profit from an overseas business, and the income accrues and is received outside India without an Indian tax nexus. Such income is generally outside the scope of Indian taxation.

Example 3: If the same non-resident earns royalty deemed to accrue in India, the royalty may be taxable in India, subject to the applicable tax treaty.

The company is incorporated outside India, so it is not automatically resident as an Indian company. Its residential status must be determined by applying the POEM test.

The likely conclusion is that the company is resident in India, because:

• Key financing, production and market-entry decisions are strategic management and commercial decisions.
• These decisions are actually made by senior executives in India.
• The Singapore board merely provides formal approval and does not appear to exercise genuine decision-making authority.
• The place where resolutions are signed or recorded is less important than the place where decisions are made in substance.

Accordingly, the company's POEM is likely to be in India during the relevant previous year. If treated as resident, it would generally be taxable in India on its worldwide income, subject to applicable treaty provisions and statutory adjustments.

The company is incorporated in India and qualifies as an Indian company. Under Section 6(3), an Indian company is always resident in India, irrespective of where its operations are conducted or board meetings are held.

Its tax treatment is as follows:

• Residential status: Resident in India.
• Reason: The statutory test based on being an Indian company is independently sufficient; no POEM inquiry is necessary to establish residence.
• Tax incidence: As a resident company, its global income, including income earned from operations in the United Kingdom, generally forms part of its total income in India.
• Double taxation relief: If the United Kingdom also taxes the income, relief may be available under the India-UK Double Taxation Avoidance Agreement or the relevant provisions of the Income-tax Act.

Therefore, the absence of Indian operations or Indian-source income does not make an Indian company non-resident.