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Thursday, December 31, 2015

CBDT's guidelines for Place of effective management would lead to increase in tax litigation

Place of effective management - "concept is one of substance over form"

CBDT has issued certain guidelines, providing clear rules to establish if a company has effective management in India. This has to be determined on the basis of facts and circumstances of each case depending 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. 

Sec-6(3) of the Income Tax Act, 1961 provided that a company is said to be a resident in India in any previous year if it is an Indian company or if during that year the control and management of its affairs is situated wholly in India. This allowed companies to avoid paying tax in India by artificially escaping the residential status by shifting insignificant or isolated events related with control and management outside India. Finance Act, 2015 amended the existing provision of Sec-6(3) w.e.f. 1st April 2016. The concept of 'effective' management has been incorporated into the provision. Now the provision provides that a company will be said to be a resident in India in any previous year if it is an Indian company or its place of effective management in that year is in India. 

"Place of effective management" means 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. 

As per the guidelines, a company shall be said to be engaged in "active business outside India" if the passive income is not more that 50% of the its total income and less than 50% of its total assets situated in India, less than 50% of total number of employees are situated in India or are resident in India and the payroll expenses incurred on employees is less than 50% of its total payroll expenditure. 

The determination of place of effective management would be a two stage process which would include the identification and ascertainment of  the person/ or persons who actually make the key management and commercial decision for conduct of the company's business as a whole and secondly the determination of place where such decisions are made. Hence, its the place where these management decisions are made would be more important than the place where such decisions are implemented.

Mere formal holding of Board meetings at a place would not be conclusive for determination of place of effective management being at that place. If the key decisions of the directors are taken in a place other than the place where formal meetings are held then such other place would be relevant for place of effective management. 

Location of company's head office is an important factor in determination of company's place of effective management. There are some deciding factors that determines the location of the head office of the company; such as, if company's senior management and the staffs are based in a single location and that location is held out to the public as company's principle place of business then that place would be considered as location where the head office is situated.

Another interesting fact is that, since 'residence' is determined for each year, place of effective management will also be required to be determined on year to year basis. The guidelines emphasizes that determination of PoEM will be based on the relevant facts related to the management and control of the company and not to be determined on the basis of isolated facts since that by itself do not establish effective management. For example - fact that if one or some of the directors of foreign company reside in India will not be conclusive evidence that satisfies the conditions for establishing PoEM in India. The guideline lays down that before holding a company incorporated outside India on the basis of its PoEM, as being resident in India by the Assessing officer, prior approval from the Principal Commissioner or Commissioner has to be obtained. 

The norms clarified that 'snapshot' approach is not to be adopted and no single principle will be decisive in itself. Since, the guidelines have left room for interpretation, this would lead to litigation. 

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