NAME: Soumya Swarup Mohanty

ID NUMBER: ADCTX02_21

SUBJECT NAME: Paper I- Foundations of Corporate Taxation and Corporate Tax Residency

TOTAL NUMBER OF PAGES: 7 (including first page)

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PLACE OF EFFECTIVE MANAGEMENT AND ITS ROLE IN DETERMINING
CORPORATE RESIDENCY

Section 2(23A) defines the “foreign company” as a company which is not a domestic company.A
domestic company has been defined in Section 2(22A) means an Indian company, or any other
company which, in respect of its income liable to tax under the IT Act, has made the prescribed
arrangements for the declaration and payment, within India, of the dividends (including dividends on
preference shares) payable out of such income. An Indian company as per Section 2(26) means a
company formed and registered under the Companies Act, 1956 (now Companies Act, 2013), and
includes statutory corporations, any institution, association or body which is declared by the Board to
be a company. Thus, companies incorporated in India or declared to be Indian companies for purposes
of the IT Act would be resident in India. Thus the foreign company inorder to come under the ambit
of the definition of resident in India, must fulfil the requirement s as provided in the guidelines of
Place of Effective Management (PoEM)

THE GUIDELINES PROVIDED UNDER THE POEM:

As per Circular No. 6/2017 (“PoEM guidelines”) the procedure of decidingthe POEM would be
mainly focused on the fact as to whether or not the company is engaged in active business outside
India. The theory of PoEM is one of substance over form and since “residence” is to be determined
for each and every year, POEM will also have to be determined on yearly basis. 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.

The test of PoEM is based on whether the entity is earning only passive income and its operations are
so structured that it is present or active in a country without paying applicable taxes. Thus, a company
having key managerial people stationed in India with substantial asset base in India and selling goods
through a subsidiary may yet claim that it has no PE in India and being incorporated outside India, it
could end up paying very little tax.

As per the PoEM guidelines, 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

i. Less than 50% of its total assets are situated in India; and
(In the present case, The said company is into the business of breeding, purchasing, pasturing
and selling Indian cattle in India through extensive cattle stations located in various Indian
villages and more than 50% of assets of the company are located in India)
ii. Less than 50% of total number of employees are situated in India or are resident in India; and
(in the present case, 60% of its workforce of the said company are functioning in India)

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 iii. The payroll expenses incurred on such employees is less than 50% of its total payroll
expenditure.

TEST OF PASSIVE INCOME AND PRESENCE:

In order to determine whether a company is engaged in active business the average of the data of the
previous year and two years prior to that shall be taken into account unless the company has been in
existence only for a shorter period. The conditions of having earned passive income of less than 50%
and having less than 50% or assets, employees and payroll expenses have to be satisfied cumulatively.
As . Nearly 70% of the total income of GoKool is derived from this business activity carried on in
India.60% of its workforce and more than 50% of assets are located in India. Therefore the said
company satisfies all the requirements for further examination.

The idea is to identify such companies who may be trying to evade taxes by merely having
incorporation or a set of directors operating from outside India while in substance it is carrying out
activity in India and earning incomes which should be subject to tax in India.

“PASSIVE INCOME” OF A COMPANY SHALL BE AGGREGATE OF:

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

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.

As per PoEM guidelines, 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 it is established that the 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.

JUDICIAL ROLE IN THE DEVELOPMENT OF POEM:

Judicial precedents in India have consistently held that C&M of an entity is situated at the place where
the direction, management and control, “the head and seat and directing power” of the entity’s affairs
is situated. In the context of companies, this may conventionally be the place where the directors
meetings are held and consequently, it may be said that a company would be resident in this country if

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the meetings of directors who manage and control the business are held here. The following rulings,
in the context of C&M are noteworthy in this regard:

 Nandlal Gandalal (40 ITR 1) (SC) (relying on Chettiar’s case):

The expression “control and management” signifies controlling and directive power, “the
head and brain” as it is sometimes called. Furthermore, the expression “control and
management” means de facto control and management and not merely the right or power to
control and manage
 Erin Estate, Galah, Ceylon v CIT (1958)(34 ITR 1)(SC):
What is relevant is de facto control and power actually exercised in the course of the conduct
and management of the affairs of the firm is relevant, and not the de jure control. Control
and management evidently refers to the controlling and directing power. Often enough, this
power has been described in judicial decisions as the “head and brain”; the affairs of the firm
which are subject to the said control and management refer to the affairs which are relevant
for the purpose of taxation and so they must have some relation to the income of the firm.

In the Indian context, there are certain decisions which have dealt with the concept of tie-breaker rule
under Article 4(3) or in the context of Art. 8 and in the process dealt with the concept of POEM

Saraswati Holding vs. DDIT (2007)(111 TTJ 334) (Del.): The US investors who floated Mauritian
entity had given POA to India residents who were also the directors of Mauritius company. The
Tribunal held that tie-breaker test may be relevant provided Mauritius company may be found to be
resident in India. Since the total control of MauCo was not in India, MauCo was not regarded as
resident in India, it was no more necessary to apply the test of POEM. In the course of the judgment,
the Tribunal held that the control and management of affairs does

not mean the day-to-day affairs of the business but it refers to the head and brain which deals with
vital policies.

SIGNIFICANCE OF POEM:

The earlier law facilitated the creation of shell companies outside India which in reality were
controlled from India. This was evident from the decision of the Delhi Tribunal in the case of Radha
Rani Holdings vs. ACIT [2007] 110 TTJ Delhi 920. The amendment, thus, brings such shell or fraud
companies into the tax bracket using the concept of POEM.

The tax authorities took note of the extracts of the minutes of the board meeting held in April 2001
and May 2001, at the registered office of the company in Singapore and compared the same with the
passport details of the director who held the 99% stake and established that the said director was not
in Singapore at the time the board meetings were held.

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It was noticed that the Taxpayer did not have any employees in Singapore and the office premises in
Singapore were merely for the purpose of having an address. The tax authorities held that the
Taxpayer had been incorporated outside India (in Singapore) solely for the purposes of routing money
and making investments in a group of companies in India (i.e. the Singaporean entity was merely a
paper company to route the money from outside India).

The tax authorities accordingly concluded that the control and management of the Taxpayer was
wholly in India and as such, was to be assessed to tax in India as a "resident" as per Sec. 6 of the ITA
as well as under the Tax Treaty. But the said observation was not accepted and later the company was
declared to be a non resident company. Now with the introduction of Place of Effective Management
principle, the outcome of the given case would have been different.

The Finance Bill, 2015 also provided an Explanation under Section 6(3) of the Act for POEM to mean
any place where key management and commercial decisions that are necessary for the conduct of a
business of the entity as a whole are, in substance made.

The meaning of ‘key management and commercial decisions’ would be derived from the facts and
circumstances of each case and thus, is very subjective. In the present case the director who was the
owner of 99 percent of the shares of the company was resident India and the director did not attend
the Board meeting of the company which was taking place in Singapore. Therefore the key
managerial decisions were not being taken outside India.

POEM of such company would be presumed to be outside India if the majority meetings of the board
of directors (BOD’s) of the company are held outside India. However, whether such reference to the
majority meetings pertains to the majority of the meetings where key decisions are taken or a majority
of overall meetings would need clarification.

However, if BOD’s are standing aside and not exercising their power of management and such power
is actually exercised by either the holding company or any other person(s) resident in India, then
POEM would be considered to be in India.

PROVISION FOR DETERMINATION WHETHER A COMPANY IS ENGAGED IN ACTIVE

BUSINESS OUTSIDE INDIA (ABOI)

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

i. its passive income is not more than 50% of its total income; and
ii. less than 50% of its total assets are situated in India; and
it was noted that in the name of asset, the said company only had an office registered in
Singapore and beside that all the major assets of the company were in India.

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 iii. less than 50% of the total number of employees are situated in India or are resident in India;
and
it was discovered that the company did not have any employees employed in Singapore.
iv. the payroll expenses incurred on such employees is less than 50% of its total payroll
expenditure.

Therefore it is quite evident that the said company has no active business outside India. Thus
following the guidelines of the PoEM, the said company would have been declared as a resident in
India adnwould have been taxed accordingly.

IMPLICATIONS OF THE POEM:

If any foreign company is found to have a POEM in India, the same would lead to the following
consequences:

The foreign company would be termed as a resident u/s 6(3) of the Income Tax Act, 1961. The entire
global income of such foreign company would be subjected to tax in India as per Sec 5(1) of the Act.
The rate of tax applicable would be 40% i.e. the rate which is applicable to foreign companies in
India.

Even though such foreign company is treated as a resident in India, the rate as applicable to resident
Indian companies is not made applicable to a foreign company treated as a resident in India. Other
implications are applicable as mentioned in Sec 115JH as mentioned in the transition mechanism
which is discussed in detail earlier. And the same procedure and law would have been applied to
company as discussed above.

CONCLUSION:

As it presently seems, POEM can be considered as located where the head and brain of the company
is. The historical development seems to recommend that the authority which panels the management
and commerce of a establishment is typically the BOD of the company. The task lies in establishing:
how exactly does Board Of Directors (BOD) of overseas company perform; is it that the BOD of
Indian company or KMP in India who virtually regulate BOD of overseas establishment either by
virtue of daunting personality of KMP or because BOD of overseas company has effectively
delegated its functions to Indian KMPs. Also, bearing in mind that various countries have
implemented different laws for their own domestic law, it is possible that the India tax authorities may
also like to ‘cherry pick’ convinced factors of benefit which may battle with the general
understanding. For example, if the feature of business operations or the reason of day to day
administration is considered as relevant, the operating companies in outbound building may have
greater comfort. But, the inbound companies may face struggle if the operations are largely India
centric.

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One hopes that the Guidelines are realistic enough to permit for ease of doing business. They ought to
hopefully reason the realities of group control centres over companies in an outbound structure. One
also hopes that POEM is not used as a armament of revenue generation; that, its pertinency is limited
to cases of shell structure.