QUESTION
ABC Inc., a Swedish company headquartered at Stockholm, not having a permanent establishment in India, has set up a liaison office in Mumbai in April, 2021 in compliance with RBI guidelines to look after its day-to-day business operations in India, spread awareness about the company's products and explore further opportunities. The liaison office takes decisions relating to day-to-day routine operations and performs support functions that are preparatory and auxiliary in nature. The significant management and commercial decisions are, however, in substance made by the Board of Director at Sweden.
Determine the residential status of ABC Inc. for A.Y.2022-23.
ANSWER
SECTION 6(3) provide that a company would 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 .
In this case, ABC Inc. is a foreign company. Therefore, it would be resident in India for P.Y. 2021-22 only if its place of effective management, in that year, is in India.
Explanation to Section 6(3) defines "Place of effective management" 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.
In the case of ABC Inc., its place of effective management for the PY 2021-22 is not in India, since the significant management and commercial decisions are in substance made by the Board of Directors outside India in Sweden.
ABC Inc. has only liaison office in India through which it looks after routine day to day business operations in India. The place where decisions relating to day-to-day routine operations are taken and support functions that are preparatory or auxiliary in nature are performed are not relevant in determining the place of effective management.
Hence, ABC Inc. being a foreign company is a non-resident for AY 2022-23 since its place of effective management is outside India in the PY 2021-22.
LET'S CONSIDER SOME EXAMPLES
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 are 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 are 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 crores.
The annual payroll expenditure in respect of MD, CEO and sales head is of Rs. 3 crores.
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 exercisedby 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 company is in India, the POEM of its subsidiaries shall not be taken to be in India. Each subsidiary has to be examined separately. As indicated in the facts since companies B Co., C Co., and D Co. are independently engaged in active business outside India and majority of Board meetings of these companies are also held outside India. The POEM of B Co., C Co., and D Co. shall be presumed to be outside India.
Footnotes
PRINCIPLES OF DETERMINATION OF PLACE OF EFFECTIVE MANAGEMENT OF A COMPANY
PLACE OF EFFECTIVE MANAGEMENT‘ (POEM) is an internationally recognized test for determination of residence of a company incorporated in a foreign jurisdiction. Most of the tax treaties entered into by India recognizes the concept of ‘place of effective management' for determination of residence of a company as a tie-breaker rule for avoidance of double taxation. The guiding principles to be followed for determination of POEM are enumerated in the following paragraphs.
For the purposes of these guidelines, -
(a) 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
(ii) less than 50% of total number of employees are situated in India or are resident in India; and
(iii) the payroll expenses incurred on such employees is less than 50% of its total payroll expenditure.
EXPLANATION: For the aforesaid purpose, -
(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.
(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.
"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;
"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.
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.
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.
"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).
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 made.
PLEASE NOTE THAT
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.
DISCLAIMER: the case study presented here is only for sharing information and knowledge with the readers. The views expressed are personal. In case of necessity do consult with professionals for more clarity and understanding on subject matter.
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