Introduction
Taxation of A Corporate Entity happens on its global income, if the Corporate Entity is considered to be a resident in India. Of course, this rule is to be found under Indian Income Tax, 1961, and the ultimate tax implications will be governed by the ‘Double Tax Avoidance Agreement’.
Apart from the taxation of global income of Corporate Entity in India, a Foreign Corporate Entity could be taxed in India, if it has any income deemed to accrue or arise in India in terms of Section 9 of the Income Tax Act, 1961, which covers various instances of the income deemed to be accruing in India including the income accruing or arising through any business connection, through or from any property in India, through or from any asset or source of income in India, or through the transfer of capital asset situated in India.
Although Section 9 as well provides for taxation of such an income deeming to be accruing or arising in India, whether or not such income will ultimately be taxable in India will be determined again by the provisions of the Double Taxation Avoidance Agreement between India and the country of residence of a foreign entity, considering the provisions under Double Taxation Avoidance Agreement pertaining to permanent establishment, income from capital assets, etc.
For the purpose of this article, we confine our discussion to when a Corporate Entity will be considered to be a resident of India and what will be the obligations under Income Tax Act, 1961 for such an entity.
Residential Status of a Company under Indian Income Tax, 1961
In terms of the provisions of Section 6(3)(i), any company which is an Indian Company (i.e. incorporated under the laws of India) will always be considered to be resident in India. In terms of the provisions of Section 6(3)(ii), a foreign company i.e. a company which is not a domestic or an Indian company will be considered to resident in India, if it has got ‘Place of Effective Management’ in India, during the previous year.
The provisions of Section 6(3) were amended by the Finance Act, 2015; unamended provisions provided that if during the previous year, control and management of affairs of a given foreign company is situated wholly in India, only in that case it will be considered to be residence in India. In light of this, different corporations sought to artificially create a residence in a foreign country through different means by shifting partial (generally insignificant) control and management outside of India. The provisions of Section 6(3) were amended and the test of ‘Place of Effective Management’ was introduced.
What is Place of Effective Management (“POEM”)?
The Place of Effective Management for corporation is defined to mean a place where key management and commercial decisions necessary for conduct of the business of an entity as whole are, in substance, made.
While POEM is an internationally recognized concept, the guiding principles for determination of POEM are notified by the Central Board of Direct Taxes through Circular No. 06 of 2017 dated 24.01.2017. These principles could be found at https://pdicai.org/docs/circular-06_2017_271201710597837.pdf.
Broadly stated, above guidelines in Paragraph No. 5(a) define what constitutes “Active Business Outside India”, “Head Office” of a company, “Passive Income” of a company & “Senior Management” of a company.
In Paragraph No. 7, the guidelines provide that POEM of a company engaged in active business outside India shall be presumed to be outside India if the majority of meetings of the board are held outside India.
Paragraph No. 7.1., clarifies that if in the facts and circumstances, it is established that Board of Directors of a Company have been standing aside and not exercising the powers of the Management, and the same are being exercised by any person resident in India or a Holding Company resident in India, then the POEM will be considered to be in India.
For the companies, which are not engaged in active business outside India, the guidelines prescribe the determination of POEM through two stage process providing that: –
- First Stage would be Identification of ascertaining the Person/s who actually make the key management and commercial decisions for conduct of company’s business as whole.
- Second Stage would be determination of the place where such decisions are in fact being made.
Paragraph No. 8.1 provides that the place where these management decisions as referred to in Paragraph No. 8 would be more important than the place where such decisions are implemented for determination of POEM as it is a substance which would be conclusive rather than form.
Paragraph No. 8.2 of he guidelines provide certain guiding principles for determination as to who are the Person/s making key management and commercial decisions and guidelines in Paragraph No. 8.2 deal with various distinct situations through different examples including the Board having defacto delegated the authority to make the key management and commercial decisions, Board doing nothing more than routinely ratifying the decisions already made, the delegation of the powers to the members of executive committee, relevance of the location of Head Office of the company, finding POEM in case of employment of modern technology, circular resolutions, etc.
Paragraph No. 8.3 of the guidelines provides that if the factors given in Paragraph Nos. 8.1 & 8.2 do not lead to clear identification of POEM, for determination POEM, additional relevant factors will be the place where main and substantial activities of the company is carried out or the place where the accounting records of the company are kept.
Paragraph No. 9 of the guidelines provide that for determination of POEM of a foreign company in India, the fact that the foreign company is completely owned by Indian Company will not be conclusive evidence for establishing POEM of such foreign company in India. It further provides that existence of the permanent establishment of a foreign entity in India will also not be conclusive for establishing POEM of such foreign entity and nor would be the fact of residence of certain directors of foreign company in India.
Paragraph No. 9 generally provides that the POEM is to be decided based on all relevant facts related to management and control of the company and is not to be determined on the basis of isolated facts and for exemplify the same, the examples as stated above and certain other examples have been given in the guidelines.
Procedural safeguards
The guidelines in Paragraph No. 11 contain procedural safeguards for any company incorporated outside India before initiating any proceedings under the Income Tax Act, 1961 against such company on the basis of establishment of a POEM for such company to find that it is resident in India.
Paragraph No. 11 provides that before the Assessing Officer could initiate such proceedings, he must seek prior approval of the Principal Commissioner or the Commissioner as the case may be.
Paragraph No. 11.1 provides that when the Assessing Officer proposes to hold a company incorporated outside India as being resident in India on the basis of POEM, any such finding should be given by the Assessing Officer only after seeking prior approval of the collegium of three members consisting of Principal Commissioners or the Commissioners, as the case may be, to be constituted by the Principal Chief Commissioner of the region concerned in this regard.
Implications of finding a Company to be resident in India in terms of the test of POEM and Transitional Arrangements
There will be various aspects and issues relating to the applicability of different provisions of the Income Tax Act, 1961, relating to the payment of advance tax obligations, relating to withholding tax (TDS), set off and carry forward of the losses, application of the transfer pricing region and the manner thereof, etc., which will arise for a foreign company held to be resident in India on the basis of POEM as the provisions relating to the above aspects contain various requirements of reporting and compliance as well as penalty for non-compliance which apparently would not have complied with by the corporation prior to its having held to be a resident in India.
Such a situation could pose great difficulties for the company held to be a resident in India based on the POEM test and owing to the same, pursuant to the inputs of different stakeholders, the provisions of Section 115JH were introduced in the Income Tax Act, 1961 to be applicable from the assessment year 2017-2018.
Section 115JH provides that where a foreign company is said to be resident in a previous year and such foreign company had not been resident in India in any of the previous year’s proceedings before such previous year, notwithstanding anything contained in the Income Tax Act, 1961 and subject to the conditions to notified by the Central Government, the provisions of the Income Tax Act relating to computation of total income, treatment of unabsorbed depreciation, carry forward and set-off of losses, collection and recovery and special provisions relating to avoidance of tax shall apply with such exceptions, modifications and adaptations as may be specified in the notification in said previous year.
We shall deal with the exceptions contained in Section 115JH of the Income Tax Act, 1961 and the notification issued under Section 115JH in separate article.