Place of Effective Management (POEM)

'Place of effective management' (POEM) is an internationally recognised test for determination of

residence of a company incorporated in a foreign jurisdiction. Most of the tax treaties entered into by
India recognises the concept of 'place of effective management' for determination of residence of a
company as a tie-breaker rule for avoidance of double taxation.

Section 6(3) of the Income Tax Act : 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 in that year is in India .

Place of effective management" is defined in the Act to mean 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.

W.e.f. Assessment Year 2017-18, The guiding principles to be followed for determination of POEM
are enumerated as follows :

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. 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.
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.

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. However, 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 the purpose of determining whether the company is engaged in active business outside India, the
average of the data of the previous year and two years prior to that shall be taken into account. In
case the company has been in existence for a shorter period, then data of such period shall be
considered.

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

 the passive income is not more than 50% of its total income; and
 less than 50% of its total assets are situated in India; and
 less than 50% of total number of employees are situated in India or are resident in India;
and
 the payroll expenses incurred on such employees is less than 50% of its total payroll
expenditure.
Explanations : -
(A) the income shall be, -
(a) as computed for tax purpose in accordance with the laws of the country of
incorporation; or
(b) as per books of account, where the laws of the country of incorporation does not
require such a computation.

“Passive income” of a company shall be aggregate of, -

(i) income from the 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;

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.

(B) the value of assets, -

(a) In case of an individually depreciable asset, shall be the average of its value for tax
purposes in the country of incorporation of the company at the beginning and at end of the
previous year; and
(b) In case of pool of a fixed assets being treated as a block for depreciation, shall be the
average of its value for tax purposes in the country of incorporation of the company at the
beginning and at end of the year;
(c) In case of any other asset, shall be its value as per books of account;

(C) the number of employees shall be the average of the number of employees as at the beginning
and at the end of the year and shall include persons, who though not employed directly by the
company, perform tasks similar to those performed by the employees;

(D) the term “pay roll” shall include the cost of salaries, wages, bonus and all other employee
compensation including related pension and social costs borne by the employer.

(E) Merely because the Board of Directors (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 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 BoD of companies standing aside.

F. Where the accounting year for tax purposes, in accordance with laws of country of
incorporation of the company, is different from the previous year, then, data of the accounting year
that ends during the relevant previous year and two accounting years preceding it shall be
considered.
In cases of companies other than those that are engaged in active business outside India, the
determination of POEM would be a two stage process, namely:-

(i) 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.
(ii) Second stage would be determination of place where these decisions are in fact being
taken.

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.

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

(a) The location where a company’s Board regularly meets and makes decisions may be the
company’s place of effective management provided, the Board-

(i) retains and exercises its authority to govern the company; and
(ii) does, in substance, make the key management and commercial decisions
necessary for the conduct of the company’s business as a whole.

It may be mentioned that mere formal holding of board meetings at a place would by itself not be
conclusive for determination of POEM being located at that place. If the key decisions by the
directors are in fact being taken in a place other than the place where the formal meetings are held
then such other place would be relevant for POEM. As an example this may be the case where the
board meetings are held in a location distinct from the place where head office of the company is
located or such location is unconnected with the place where the predominant activity of the
company is being carried out.

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.

“Senior Management” in respect of a company means the person or persons who are generally
responsible for developing and formulating key strategies and policies for the company and for
ensuring or overseeing the execution and implementation of those strategies on a regular and on-
going basis. While designation may vary, these persons may include:

i. Managing Director or Chief Executive Officer;

ii. Financial Director or Chief Financial Officer;
iii. Chief Operating Officer; and
iv. The heads of various divisions or departments (for example, Chief
Information or Technology Officer, Director for Sales or Marketing).
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.

The delegation of authority may be either de jure (by means of a formal resolution or Shareholder
Agreement) or de facto (based upon the actual conduct of the board and the executive committee).

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. “Head Office” of a company would be the place where the company's
senior management and their direct support staff are located or, if they are located at more than one
location, the place where they are primarily or predominantly located. A company’s head office is
not necessarily the same as the place where the majority of its employees work or where its board
typically meets;
The following points need to be considered for determining the location of the head office of the
company:-

If the company’s senior management and their support staff are based in a single location and that
location is held out to the public as the company’s principal place of business or headquarters then
that location is the place where head office is located.
If the company is more decentralized (for example where various members of senior management
may operate, from time to time, at offices located in the various countries) then the company’s head
office would be the location where these senior managers,-

(i) are primarily or predominantly based; or

(ii) normally return to following travel to other locations; or
(iii) meet when formulating or deciding key strategies and policies for the company.

Members of the senior management may operate from different locations on a more or less
permanent basis and the members may participate in various meetings via telephone or video
conferencing rather than by being physically present at meetings in a particular location. In such
situation the head office would normally be the location, if any, where the highest level of
management (for example, the Managing Director and Financial Director) and their direct support
staff are located.

In situations where the senior management is so decentralised that it is not possible to determine the
company’s head office with a reasonable degree of certainty, the location of a company’s head
office would not be of much relevance in determining that company’s place of effective
management.

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.

If the above factors do not lead to clear identification of POEM then the following secondary
factors can be considered :-

(i) Place where main and substantial activity of the company is carried out; or
(ii) Place where the accounting records of the company are kept.

It needs to be emphasized that 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:

(i) 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.
(ii) 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.
(iii) 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.
(iv) 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.
(v) 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.

What is not relevant :

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.

However, the shareholder’s involvement can, in certain situations, turn into that of effective
management. This may happen through a formal arrangement by way of shareholder agreement etc.
or may also happen by way of actual conduct. As an example if the shareholders limit the authority
of board and senior managers of a company and thereby remove the company’s real authority to
make decision then the shareholder guidance transforms into usurpation and such undue influence
may result in effective management being exercised by the shareholder.

Therefore, whether the shareholder involvement is crossing the line into that of effective
management is one of fact and has to be determined on case-to-case basis only.

It may be clarified that day to day routine operational decisions undertaken by junior and middle
management shall not be relevant for the purpose of determination of POEM. The operational
 decisions relate to the oversight of the day-to-day business operations and activities of a company
whereas the key management and commercial decision are concerned with broader strategic and
policy decision. For example, a decision to open a major new manufacturing facility or to
discontinue a major product line would be examples of key commercial decisions affecting the
company’s business as a whole. By contrast,
decisions by the plant manager appointed by senior management to run that facility, concerning
repairs and maintenance, the implementation of company-wide quality controls and human
resources policies, would be examples of routine operational decisions.

It is reiterated that the above principles for determining the POEM are for guidance only. No single
principle will be decisive in itself. The above principles are not to be seen with reference to any
particular moment in time rather activities performed over a period of time, during the previous
year, need to be considered. In other words a “snapshot” approach is not to be adopted. Further,
based on the facts and circumstances if it is determined that during the previous year the POEM is
in India and also outside India then POEM shall be presumed to be in India if it has been mainly
/predominantly in India

The Assessing Officer (AO) shall, before initiating any proceedings for holding a company
incorporated outside India, on the basis of its POEM, as being resident in India, seek prior approval
of the Principal Commissioner or the Commissioner, as the case may be.

12. Illustrations:

The following are certain illustrations intended to highlight applicability of certain principles
enumerated in the foregoing paragraphs of the guidelines. The facts assumed have been simplified to
highlight the principle. Actual determination of POEM of a company shall depend on all relevant
facts.

Example 1: Company A Co. is a sourcing entity, for an Indian multinational group, incorporated in
country X and is 100% subsidiary of Indian company (B Co.). The warehouses and stock in them are
the only assets of the company and are located in country X. All the employees of the company are
also in country X. The average income wise breakup of the company’s total income for three years
is, -

(i). 30% of income is from transaction where purchases are made from parties which are non-
associated enterprises and sold to associated enterprises;
(ii). 30% of income is from transaction where purchases are made from associated enterprises and
sold to associated enterprises;
(iii). 30% of income is from transaction where purchases are made from associated enterprises and
sold to non-associated enterprises; and
(iv). 10% of the income is by way of interest.

Interpretation: In this case passive income is 40% of the total income of the company. The passive
income consists of, -
(i). 30% income from the transaction where both purchase and sale is from/to associated
enterprises; and
(ii). 10% income from interest.
 The A Co. satisfies the first requirement of the test of active business outside India. Since no
assets or employees of A Co. are in India the other requirements of the test is also satisfied.
Therefore company is engaged in active business outside India.

Example 2: The other facts remain same as that in Example 1 with the variation that A Co. has a total
of 50 employees. 47 employees, managing the warehouse, storekeeping and accounts of the
company, are located in country X. The Managing Director (MD), Chief Executive Officer (CEO)
and sales head are resident in India. The total annual payroll expenditure on these 50 employees is of
Rs. 5 crore. The annual payroll expenditure in respect of MD, CEO and sales head is of Rs. 3 crore.

Interpretation: Although the first limb of active business test is satisfied by A Co. as only 40% of its
total income 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
MD, the CEO and the 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.

Example 3: The basic facts are same as in Example 1. Further facts are that all the directors of the A
Co. are Indian residents. During the relevant previous year 5 meetings of the Board of Directors is
held of which two were held in India and 3 outside India with two in country X and one in country
Y.

Interpretation: The A Co. is engaged in active business outside India as the facts indicated in
Example 1 establish. The majority of board meetings have been held outside India. Therefore, the
POEM of A Co. shall be presumed to be outside India.

Example 4: The facts are same as in Example 3 but it is established by the Assessing Officer that
although A Co.’s senior management team signs all the contracts, for all the contracts above Rs. 10
lakh the A Co. must submit its recommendation to B Co. and B Co. makes the decision whether or
not the contract may be accepted. It is also seen that during the previous year more than 99% of the
contracts are above Rs. 10 lakh and over past years also the same trend in respect of value
contribution of contracts above Rs. 10 lakh is seen.

Interpretation: These facts suggest that the effective management of the A Co. may have been
usurped by the parent company B Co. Therefore, POEM of A Co. may in such cases be not
presumed to be outside India even though A Co. is engaged in active business outside India and
majority of board meeting are held outside India.

Example 5: An Indian multinational group has a local holding company A Co. in country
X. The A Co. also has 100% downstream subsidiaries B Co. and C Co. in country X and D Co. in
country Y. The A Co. has income only by way of dividend and interest from investments made in its
subsidiaries. The Place of Effective Management of A Co. is in India and is exercised by ultimate
parent company of the group. The subsidiaries B, C and D are engaged in active business outside
India. The meetings of Board of Director of B Co., C Co. and D Co. are held in country X and Y
respectively.

Interpretation : Merely because the poem of an intermediate holding co. is in India, the poem of the
subsidiaries shall not be taken to be in India. All three subsidiaries are to be examined separately as
all are engaged in ABOI. Since majority of their Board meetings held outside India, they have their
POEM outside India.

Article 304 of Constitution of India – Restrictions on trade, commerce and intercourse among States
Notwithstanding anything in Article 301 or Article 303, the Legislature of a State may by law
(A) impose on goods imported from other States or the Union territories any tax to which similar goods
manufactured or produced in that State are subject, so, however, as not to discriminate between goods so imported
and goods so manufactured or produced; and
(B) impose such reasonable restrictions on the freedom of trade, commerce or intercourse with or within that State
as may be required in the public interest: Provided that no Bill or amendment for the purposes of clause shall be
introduced or moved in the Legislature of a State without the previous sanction of the President.
Summary of the case

Radha Rani Holdings (P) Ltd. vs Additional Director Of Income Tax

Facts in brief are
 that the assessee company incorporated under the laws of Republic of Singapore filed its return
of income on 21st Oct., 2002 showing interest income of Rs. 12,28,770 in the status of a non-
resident company.

 The AO noticed that the paid-up capital of the company consisted of 100 shares out of which
Mrs. Geeta Soni held 99 shares and Mrs. Juliana Kassim, a resident of Singapore, held one
share. Mrs. Geeta Soni is a resident of India and is an income-tax assessee in India.

 The assessee filed extracts of the minutes of the meetings of the board of directors allegedly held
on 18th April, 2001 and 2nd Feb., 2001 at the registered office of the company in Singapore. In
both these meetings Mrs. Juliana Kassim and Mrs. Geeta Soni were stated to be present. The
AO noticed that on 18th April, 2001, Mrs. Geeta Soni was in India and in fact she left India on
the same day for Bangkok and came back to India on 2nd May, 2001. Thus, there was no
possibility of her being present in Singapore and attend a meeting there on 18th April, 2001 at
10.30 A.M. He mentioned that the Indian High Commission in Singapore had duly
authenticated the minutes of the meeting. Therefore, the AO observed that the assessee had
tried to submit a forged document with the intention of misleading the Department and thereby
trying to evade the due tax. Therefore, AO asked the assessee to show-cause as to why it should
not be treated as resident within the meaning of Section 6(3) of the IT Act, since its control and
management was wholly in India.

Further Observations of AO

 Mrs. Geeta Soni holding 99 per cent of the shares was the resident of India and the other
director, Mrs. Juliana Kassim, was holding only 1 per cent of the share.

 There are only two directors, Mrs. Geeta Soni and Mrs. Juliana Kassim. Mrs. Juliana Kassim
was not paid any remuneration as a director and she was not the full-time director of the
company. Thus, Mrs. Juliana Kassim was roped in merely to fulfil the legal requirement for
incorporation in Singapore.

 The entire investments of the company in the group companies (Motherson Group of companies
)were controlled from India and the money for these investments had been provided by the
associate companies free of interest and without any fixed term of repayment. He, therefore,
concluded that the assessee company was incorporated outside India merely for the purpose of
routing money and making investment in Motherson Group of company in India.

 Mrs. Geeta Soni was the sister of Mr. V.C. Sehgal, who is the chairman and director in a
number of companies of the Motherson Group of company.

 He observed that there was no employee of the company in Singapore and the office premises in
Singapore was used merely for the purpose of having an address in Singapore.
 It is further observed that on perusal of the P&L a/c of year ended on 31st March, 2002
furnished by the assessee, it is noticed that no expenses relating to maintenance of an office at
Singapore such as rent, salary etc. were shown by the assessee to be incurred during the year.
Thus, it is clearly established that the company was not having any operating office in
Singapore during this previous year.
  It is also relevant to note that the authority to operate all the bank accounts of the company also
vests in Mrs. Geeta Soni 'singly'.

 Hence, the central control and management on the affairs of the company lies with Mrs. Geeta
Soni.
 The assessee company was merely a paper company to route the money through abroad.

In view of these observations the AO held that the control and management of the assessee company
was wholly in India and hence he held the company to be resident in India within the meaning of
Section 6(3)(ii) of the IT Act as well as under the DTAA between India and Singapore.

The learned Counsel for the assessee has submitted that the following facts may be taken note of in
support of his contention of the assessee that control and management of the affairs of the company was
wholly at Singapore namely:

(1) Registered office of the company is located at 101, Upper Cross Street, 12-25, People's Park Centre,
Singapore 058358.

(2) Director, Mrs. Juliana Kassim, is a permanent resident and citizen of Singapore-not having visited
India.

(3) All board meetings have been held in Singapore only.

(4) Mrs. Geeta Soni was a resident of Singapore for three years i.e. from asst. yr. 1996-97 to asst. yr.
1998-99 and during the year she was not ordinarily resident in India.

(5) Tax residency certificate issued by Singapore taxation authority.

(6) The statutory auditors of company were appointed in Singapore and also belong to Singapore.

(7) The company has raised funds from abroad and made investment also from abroad.

(8) Decisions to maintain the loans and investments by constant monitoring and maintaining relations
with the clients are all taken at Singapore.

(9) Study of the financial result of the entities in which the investments have been made for taking vital
decisions was at Singapore.

(10) The company is being maintained at Singapore i.e. day-to-day affairs relating to administrative
and business matters are being considered in Singapore only.

(11) Maintenance of statutory books of account and statutory records are at Singapore.

(12) The meetings of board of directors and also of the shareholders of the company are held at
Singapore and maintenance of the minute books are also at Singapore.

(13) The bank accounts are maintained at Singapore and opening and operation of bank accounts
elsewhere are being controlled from Singapore.

(14) Correspondence relating to business operation of the company is being carried out from Singapore.

(15) Regular steps are being taken at Singapore to maintain the corporate existence of the company at
Singapore on regular basis.
 The tax returns are regularly being filed at Singapore.
The company secretary has been appointed at Singapore and he regularly functions from there.

On the basis of the above facts, learned Counsel for the assessee has contended that the control and
management of the company is situated in Singapore and not in India.

COURT’S OBSERVATION

The meaning of the expression 'control and management' as used in Section 6(3)(ii) of the Act was the
subject-matter of judicial interpretation in the past. The legal position is now well-settled that the
expression "control and management" means central control and management and not carrying on a
day-to-day business. It may be mentioned that for the proposition that even a partial control of the
company outside India is sufficient to hold the company as a non-resident finds support from the
decision in the case of V.VR. N.M. Subbayya Chettiair v. CIT (1951) 19 FIR 168 (SC). In the case of
CIT v. Nandlal Ganda Lal , the Hon'ble Supreme Court has

 It is found from record that all the board meetings of the assessee company have been held at
Singapore and never in India. It is not important where one or more of the directors normally
reside but where the board actually meets for the purpose of determination of the key issues
relating to the company. Thus, whether Mrs. Geeta Soni is a normal resident in India or not, is
of very little consequence for determinating the issue under consideration.

 So far as the meetings of the board are concerned, all the directors enjoy equal powers
irrespective of the actual shareholding position by the respective directors. Rather, chairman of
the board enjoys some special powers in board meeting. Therefore, it will be incorrect to say
that simply because Mrs. Geeta Soni holds 99 per cent shares of the company, she was having
special power over the other.

 There is no dispute about the fact that the other member of the board, who happened to have
acted as chairman of all the meetings of the board of directors of the company during the
relevant year viz., Mrs. Juliana Kassim, is not only a resident of Singapore but also never visited
India.

 The contention that the affairs of company mostly comprise of and related to matters in India
like funds, investments and loans is of little consequence in the matter. The company being an
investment company may invest its entire funds in India but so long as such investment
decisions are taken outside India.

 Similarly, the operation of bank account of the company by Mrs. Geeta Soni alone will not
determine the position and status of control and management of the company. Such power has
been conferred on her in the meeting of the board of directors of the company held at
Singapore.

 Further, the contention that assessee company is having close connection with Motherson
Group operating in India does not make the assessee company as 'resident' in India. An Indian
company can have a wholly-owned subsidiary company abroad. If the company is controlled
and managed from the country of its incorporation, then their residential status would continue
to be in that country irrespective of the fact whether they own other companies.

 As regards the contention of the Department about the correctness of minutes of board meeting
held in Singapore on 18th April, 2001 at 10.30 A.M. that there are ample evidence that on the
relevant date and time, Mrs. Geeta Soni was in India and that she left Bangkok on the same day
has no force inasmuch as in the days of technological advancements conducting meetings by
 telephonic conversations or video conferencing process is very much prevalent in the world and,
therefore, the actual presence of a person at the exact place of meeting or conference may not be
necessary.

 The Revenue has drawn an inference without any basis particularly when the minutes of the
board of directors of the company held on 18th April, 2001 at Singapore have been
authenticated by the Indian High Commission in Singapore. Thus, we are of the view that
genuineness of the minutes of meeting of the board held on 18th April, 2001 at 10.30 A.M. at
Singapore cannot be doubted.

 It is seen that in the case of Azadi Bachao Andolan (supra), the Hon'ble Supreme Court held
that tax residency certificate issued by the Government of other Contracting State would be a
conclusive proof of residential status of the company. The assessee company while relying upon
this decision of Hon'ble Supreme Court has submitted that tax residency certificate has been
issued by the Singapore taxation authorities in favour of the assessee. Thus, it itself establishes
the residential status of the assessee i.e. Singapore.
 we find force in the argument of the learned Counsel for the assessee that the "tax residence
certificate" issued by the Singapore taxation authorities is the material evidence to establish the
residence of the assessee company.

In view of the above observation, we hold that the control and management of the company during the
year has been conducted at Singapore only. Hence, the provisions of Section 6(3)(ii) of the Act relating
to the 'control and management' of the company being situated wholly in India, are not satisfied in this
case. Therefore, we hold that the assessee company was a 'non-resident' in India during the year under
consideration.

In the result, the appeal of the assessee is allowed.

 Appellants:ANGLO-FRENCH TEXTILE COMPANY, LTD.
Vs.
Respondent:COMMISSIONER OF INCOME TAX, MADRAS : NO. 2.

Direct Taxation - Following question referred under Section 66(1) of the Act - 1.
"Whether, in the circumstances of this case, the assessee company had any
business connection in British India within the meaning of Sections 42(1) and
42(3) of the Income-tax Act ?" - 2. "Whether any profits could reasonably be
attributed to the purchase of entire cotton made in British India by the secretaries
and agents of the assessee-company within the meaning of Section 42(1) and
42(3) of the Income-tax Act ?" - High Court answered both these questions in the
affirmative - Held, raw materials were purchased systematically and habitually
through an established agency having special skill and competency in selecting the
goods to be purchased and fixing the time and place of purchase - Such activity
appeared to be well within the import of the term "operation" as used in Section
42(3) of the Indian Income-tax Act - It was not in the nature of an isolated
transaction of purchase of raw materials - First contention of the assessee
therefore negatived - Terms of the agency stated in the earlier part of this
judgment fully establish that Messrs. Best & Co. Ltd. were carrying on something
almost akin to the business of a managing agency in India of the foreign company
and the latter certainly had a connection with this agency - View taken by the High
Court uphold - Hence appeal dismissed.

Industry: Textile

JUDGMENT

Mehr Chand Mahajan, J.

1. This is an appeal from the judgment of the High Court of Judicature at Madras dated 18th
January, 1950, delivered on a reference by the Income-tax Appellate Tribunal under
Section 66 (1) of the Indian Income-tax Act, whereby the High Court answered the two
questions referred in the affirmative.

2. The appellant is a public limited company incorporated in the United Kingdom and owns a
spinning and weaving mill located at Pondicherry in French India. The year of account of the
appellant is the calendar year. In the year 1939 no sales of yarn or cloth manufactured by
the company were effected in British India, though in the previous year such sales were
effected. All the purchases of cotton required for the mills were made in British India by
Messrs. Best & Co., Ltd. Under an agreement between the appellant and Messrs. Best & Co.,
Ltd., Madras, dated 11th July, 1939, Messrs. Best & Co., Ltd., were constituted the agents of
the appellant for the purpose of its business in India. Messrs. Best & Co., Ltd., have under
the terms of the agreement full powers in connection with the business of the appellant in
the matter of purchasing stock, signing bills and other negotiable instruments and receipts
and settling, compounding or compromising any claim by or against the appellant. The
agents are empowered to borrow money on behalf of the appellant and to make advances.
They are also expected to secure the best commissions, brokerages, rebates, discounts and
other allowances in respect of and in connection with the business of the appellant. They are
enjoined to keep proper accounts of the appellant and to pay over to the appellant the sum
standing to its credit. They are remunerated by a salary of Rs. 6,500 per month and a
percentage commission on the profits made. During the relevant year all the purchases of
cotton required for the mill at Pondicherry were made by the agents in British India and no
purchases were made through any other agency. The agents exercised their judgment and
skill and purchased such qualities and quantities of cotton and at such prices as they in their
experience considered most advantageous in the interests of the company.

3. Prior to 1939-40 the appellant was assessed to income-tax in British India on the profits
computed on a turnover basis earned by the sales in British India of the goods
manufactured by the appellant. In the course of the assessment year 1939-40 the appellant
stated that it discontinued its business in British India with effect from 1st April, 1939, and
claimed relief under Section 25(3) which was granted. In the course of his further enquiries
the Income-tax Officer found that though the appellant was not selling its goods in British
India and earning a profit thereby, it continued to have an active business connection in
British India having regard to the way in which the business of purchasing goods and
materials for the mills was carried on. Thereupon the Income-tax Officer held that such
purchases of cotton in British India constituted a business connection in British India and
that the profits attributable to the purchases were liable to tax under Section 42(1) and
42(3) of the Act. The net income of the company was computed to be Rs. 2,81,176 and ten
per cent. of this sum was apportioned under Section 42(3) of the Act as being the profits
and gains reasonably attributable to that part of the business operations which were carried
out in British India. The appellant appealed against the said order of the Income-tax Officer
to the Appellant Assistant Commissioner, who confirmed the order of the Income-tax
Officer. A further appeal by the appellant to the Tribunal was unsuccessful.

4. At the instance of the held Tribunal stated a case and referred the following question for
the decision of the High Court under Section 66(1) of the Act :-

"1. Whether, in the circumstances of this case, the assessee company

had any business connection in British India within the meaning of
Sections 42(1) and 42(3) of the Income-tax Act ?

2. Whether any profits could reasonably be attributed to the

purchase of entire cotton made in British India by the secretaries and
agents of the assessee-company within the meaning of
Section 42(1) and 42(3) of the Income-tax Act ?"

5. The High Court answered both these questions in the affirmative and, in our
opinion, rightly.

6. The learned counsel for the appellant reiterated before us the arguments that he had
addressed in the High Court and contended that on the facts of this case there was no scope
for the finding that any profits or gains accrued to the assessee directly or indirectly through
or from any business connection in India. It was argued that a mere purchase of raw
materials or goods in British India does not result in the accrual or arising of profits and that
the profits on the sale of goods arise and accrue only at the place where the sales are
effected and that in the present case, there being no sales effected in British India in the
year of account 1939, no profits accrued or arose to the company in British India nor could
any profits be deemed to have accrued or arisen in British India. In support of his
proposition, the learned counsel placed reliance on a number of cases, inter alia, on Board of
Revenue v. Madras Export Co., Jiwan Das v. Commissioner of Income-tax, Lahore, Rahim v.
Commissioner of Income-tax, Commissioner of Income-tax, Bombay v. Western India Life
Insurance Co. and Commissioner of Income-tax v. Littles Oriental Balm Ltd. Most of these
decisions were given under the Act of 1922, before the insertion of Section 42(3) in the Act
of 1922 by the amending Act of 1939.

7. As against the cases relied upon by the learned counsel for the appellant, several
authorities have been cited to us which have proceeded on the footing that even purchase of
raw materials could be an operation in connection with a business and if it was carried on in
British India it might make the profits attributable to such operation taxable under
Section 42 of the Indian Income-tax Act. The case Rogers Pyatt Shellac Co. v. Secretary of
State for India is one of the leading decisions on this point. This case was decided under
Section 33 of the Indian Income-tax Act, 1918, and the judgment shows that the principle
followed in the case was similar to that which was subsequently embodied in
Section 42(3) of the Income-tax Act, 1922. The question referred to the High Court in that
case was in these terms :-

"Is this company which purchased shellac and mica in India for sale in the open
market in America liable to be assessed to income-tax and super-tax under either
Income-tax Act, VII of 1918, or Act XI of 1922 and the Super-tax Act, VIII OF 1917."

8. And it was answered in the affirmative. The same line of reasoning was adopted by the
Rangoon High Court in Commissioner of Income-tax, Burma v. Steel Bros. Co. Among recent
cases on this point which were decided under Section 42 of the Income-tax Act, 1922, can
be mentioned the case of Motor Union Insurance Co. Ltd. v. Commissioner of Income-tax,
Bombay and that of Webb Sons & Co. v. Commissioner of Income-tax, East Punjab In the
last case, the assessee company which was incorporated in the United States of America
was carrying on in America the business of manufacturing carpets. Its only business in
British India was the purchase, through its agent in British India, of wool as raw material for
use in the manufacture of carpets. It was held that the purchase was an operation within the
meaning of Section 42(3) and the profits from such purchases could be deemed to arises in
British India and it was consequently assessable under Section 42(3) of the Indian Income-
tax Act. The questions referred to the High Court in this case and relevant to this enquiry
were these :-

"(i) Is mere purchase of raw material an operation within the meaning

of Section 42(3) of the Act ?

(ii) Can any profit arise out of mere purchase of raw material ?"

While answering these questions in the affirmative it was said :- "It is clear
that the purchase of raw material by a firm of manufacturers is one of the
processes or operations which contributes to an appreciable degree to the
ultimate profit which is realized on the sale of manufactured articles."

9. There is thus no uniformity of judicial opinion on the question that the mere act of
purchase produces no profit.

10. In our judgment, the contention of the learned counsel for the appellant, - and on which
his whole argument is founded - that it is the act of sale alone from which the profits accrue
or arise can no longer be sustained and has to be repelled in view of the decision of this
Court in Commissioner of Income-tax, Bombay v. Ahmedbhai Umarbhai & Co. That was a
case that arose under the Excess Profits Tax Act, XV of 1940. A firm which was resident in
British India and carried on the business of manufacturing and selling groundnut oil, and
owned some oil mills within British India also owned a mill in Raichur in the Hyderabad State
where oil was manufactured. The oil manufactured in Raichur was sold partly within the
State of Hyderabad and partly in Bombay. It was held by this court that the profits of that
part of the business, viz., the manufacture of oil at the mill in Raichur, accrued or arose in
Raichur even though the manufactured oil was sold in Bombay and the price was received
there, and, accordingly, that part of the profits derived from sales in Bombay which was
attributable to the manufacture of of the oil in Raichur was exempt from excess profits tax
under the proviso to Section 5 of the Act. Reference in this case was made to the decision of
the House of Lords in In re Commissioner of Taxation v. Kirk wherein it was held that where
income was in part derived from the extraction of ore from the soil of New South Wales
Colony, and from the conversion in the latter Colony of the crude ore into a merchantable
product, this income was assessable under the New South Wales Land and Income-tax
Assessment Act of 1895, Section 15, sub-section (3) and (4), notwithstanding that the
finished products were sold exclusively outside the colony. Lord Davey while delivering the
judgment of the Privy Council observed as follows :-

"It appears to their Lordships that there are four processes in the earning or
production of this income -(1) the extraction of the ore from the soil; (2) the
conversion of the crude ore into a merchantable product, which is a
manufacturing process; (3) the sale of the merchantable product; (4) the
receipt of the money arising from the sale. All these processed are necessary
stages which terminate in money, and the income is the money resulting less
the expenses attendant on all the stages. The first process seems to their
Lordships clearly within sub-section 3, and the second or manufacturing
process, if not within the meaning of trade in sub-section 1,is certainly
included in the words any other source whatever in sub-section 4.

So far as relates to these two processes, therefore, their Lordships think that
the income was earned and arising and accruing in New South Wales."

11. On a parity of reasoning it can well be said in this case that the profits accrue
or arise to the appellant from three business processes or operations, those being
(1) the purchase of cotton in British India; (2) its conversion by the process of
manufacture in Pondicherry into yarn or cloth; and (3) the sale of the
merchantable product, and those have to be apportioned between these three
operations. The same line of reasoning was adopted by the Madras High Court in Banglore
Woollen Cotton & Silk Mills Co. Ltd. v. Commissioner of Income-tax, Madras There it was
held that the purchase of raw materials by the managing agents in British India would be an
operation within the meaning of Section 42(3) and it was reasonable to attribute a portion of
the profits to such purchases in British India.

12. After a careful consideration of the decided cases on the subject and in view of the
insertion of Section 42(3) in the Act of 1922 by the amending Act of 1939, we have reached
the conclusion that in the present state of the law there is hardly any scope for maintaining
the view contended for by the learned counsel for the appellant and we therefore agree with
the High Court in repelling it. While maintaining the view taken by the High Court in this
case we wish to point out that it is not every business activity of a manufacturer that comes
within the expression "operation" to which the provisions of Section 42(3) are attracted.
These provisions have no application unless according to the known and accepted business
notions and usages the particular activity is regarded as a well defined business operation.
Activities which are not well defined or are of a casual or isolated character would not
ordinarily fall within the ambit of this rule. Distribution of profits on different business
operation or activities ought only to be made for sufficient and cogent reasons and the
observations made here are limited to the facts and circumstances of this case. In a case
where all that may be known is that a few transactions of purchase of raw
materials have taken place in British India, it could not ordinarily be said that the
isolated acts were in their nature "operations" within the meaning of that
expression. In this case the raw materials were purchased systematically and
habitually through an established agency having special skill and competency in
selecting the goods to be purchased and fixing the time and place of purchase.
Such activity appears to us to be well within the import of the term "operation" as used in
Section 42(3) of the Act. It is not in the nature of an isolated transaction of purchase of raw
materials. The first contention of the assessee is therefore negatived.

13. The learned counsel argued in a rather half-hearted manner that there was no business
connection of the assessee in British India. This contention does not require serious
consideration. An isolated transaction between a non-resident and a resident in British India
without any course of dealings such as might fairly be described as a business connection
does not attract the application of Section 42, but when there is a continuity of business
relationship between the person in British India who helps to make the profits and the
person outside British India who receives or realizes the profits, such relationship does
constitute a business connection. In this case there was a regular agency established in
British India for the purchase of the entire raw materials required for the manufacture
abroad and the agent was chosen by reason of his skill, reputation and experience in the
line of trade. The terms of the agency stated in the earlier part of this judgment fully
establish that Messrs. Best & Co. Ltd. were carrying on something almost akin to the
business of a managing agency in India of the foreign company and the latter certainly had
a connection with this agency. We therefore negative this contention of the learned counsel
as well.

14. For the reasons given above we uphold the view taken by the High Court and dismiss
the appeal with costs.

Appeal dismissed