The Income Tax Act, 1961 governs how authorities tax income for various entities, known as assessees. Section 6 outlines the concept of residential status of an assessee which decides the scope of taxable income. It differentiates between income taxed in India and income that escapes taxation there. This article focuses on the residential status of company which is given under Section 6(3) of the Act. Companies face unique implications due to their global operations and cross-border activities. Authorities determine the residential status of company based on incorporation and control factors. Recent amendments highlight the Place of Effective Management (POEM). Businesses must understand this to comply with tax laws, avoid penalties, and plan effectively. The rules have evolved to stop tax evasion through overseas shell companies. They ensure that authorities tax companies with significant management in India accordingly.
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Residential Status of a Company (Section 6(3))
Section 6(3) of the Income Tax Act, 1961, talks about the residential status of company. It categorizes them as residents or non-residents using incorporation and management criteria. This approach simplifies taxation.
Authorities always consider an Indian company, defined under the Companies Act, 2013, as a resident in India under Section 6(3)(i). This rule applies regardless of control location or shareholders' residency. Even if foreign entities own most shares or the board meets outside India, the company qualifies as a resident. This ensures that all companies incorporated in India pay into the nation's tax system. It promotes fiscal responsibility.
Under Section 6(3)(ii) of the Income Tax Act, 1961, a foreign company is considered as a resident in India if its Place of Effective Management (POEM) is in India during the relevant previous year. As per CBDT, the POEM guidelines do not apply to foreign companies with turnover or gross receipts of Rs. 50 crore or less in a financial year.
POEM indicates where managers make key commercial decisions. However, the Central Board of Direct Taxes (CBDT) treats foreign companies with turnover of Rs. 50 crore or less as non-residents. This exemption eases compliance for smaller foreign businesses.
For example, If an Indian company is run by non-resident shareholders from abroad, authorities view it as a resident company. A foreign company in Mauritius is seen as a non-resident if it has no effective management in India and its turnover hits the required threshold.
Importance of Determining Residential Status
Authorities determine a residential status of company to establish tax liabilities and ensure compliance with the Income Tax Act. This process shapes the "incidence of tax" under Section 5. It defines the income subject to taxation in India.
Resident companies face taxation on all income, whether from India or abroad, with allowances for exemptions and deductions. This wide reach fosters transparency in international operations but may raise tax costs. Non-resident companies pay taxes only on income that accrues, arises, or arrives in India. This protects their foreign earnings from Indian taxes. Multinational corporations must note this difference, as errors could cause double taxation or conflicts with tax officials.
Residential status also influences access to tax treaties, double taxation avoidance agreements (DTAAs), and perks like reduced withholding taxes. Mistakes in determination might trigger penalties, interest charges or lawsuits. In today's global economy, companies operate worldwide.
Accurately setting residency supports strategic tax planning, minimizes risks, and improves financial results. It matches international norms, such as those from the Organisation for Economic Co-operation and Development (OECD), to fight base erosion and profit shifting (BEPS).
Learn about more Income Tax Rules.
Place of Effective Management (POEM)
POEM is a globally accepted criterion for establishing the tax residency of companies which was introduced in India via the Finance Act, 2015, effective from April 1, 2017. It focuses on the substance over form, identifying where the real control of the company lies. POEM is assessed annually based on facts, not just legal documents. The CBDT's Circular No. 6/2017 dated January 24, 2017, provides detailed guiding principles.
Company engaged in active business outside India
A foreign company is seen to have its POEM outside India if it does business mainly abroad and most of its board meetings happen outside India. To be considered an "active business outside India," a company must meet four conditions:
Passive income must be no more than 50% of total income.
Less than 50% of its assets should be in India.
Fewer than 50% of its employees should be in India.
Payroll expenses for these employees must be under 50% of total payroll.
Passive income includes dividends, interest, royalties, rental income, capital gains, or income from associated enterprises. However, interest is not passive for banks or regulated financial institutions. This provision protects genuine foreign businesses from being inadvertently classified as residents.
Management power exercised in India
If the board of directors delegates or abdicates its powers, and these are effectively exercised by a holding company or persons resident in India, the POEM is deemed to be in India. Mere adherence to global group policies (e.g., HR or IT functions) does not imply abdication unless key commercial decisions are overridden from India.
For example, if a foreign subsidiary's strategy is dictated by its Indian parent without independent board input, POEM shifts to India. This targets shell companies where decisions are rubber-stamped abroad but made in India.
Other cases
For companies not falling under active business criteria, POEM determination follows a two-stage process. First, identify persons making key decisions (e.g., senior executives or board members) and where these decisions occur. Second, assess if the place is active (substantive) or passive (routine). Factors include the location of head office, use of technology for meetings and delegation levels. If multiple locations exist, the place with the highest authority prevails.
Prior approval of Principle CIT/CIT Required
Before deeming a foreign company's POEM in India, tax officers must obtain prior approval from the Principal Commissioner of Income Tax (PCIT) or Commissioner of Income Tax (CIT). For cases involving collegium approval, it goes to a panel of three PCIT/CIT members. This safeguards against arbitrary assessments and ensures consistency
Also, Learn about Deductions under Section 80C of Income Tax Act, 1961.
CBDT Guidelines on POEM
The Central Board of Direct Taxes (CBDT) provides detailed guidelines through Circular No. 6/2017, dated January 24, 2017. These clarify how to determine POEM. They advocate a fact-based, case-by-case method.
Key points include:
Active businesses have POEM where the board meets, if the board controls decisions.
Authorities assess senior roles, like CEOs and CFOs, by decision-making locations.
Support areas (e.g., IT, HR) do not set POEM unless they affect core choices.
Shareholders' input matters only if it overrules management.
The guidelines describe a two-step process: identify decision-makers and locate their actions. They emphasize overall analysis over single facts. These apply from Assessment Year 2017-18. Companies can seek advance rulings for clarity.
Incidence of Tax
Section 5 links tax incidence to residential status of company. Authorities tax resident companies on:
Income received or deemed received in India.
Income accruing or arising in India.
Foreign income, except exemptions.
They tax non-residents solely on Indian-sourced income. This promotes equitable taxation and blocks evasion.
Receipt of Income
Authorities consider income received in India if the assessee first possesses it there, no matter where earned. For example, a salary paid abroad but sent to India counts as received here. Deemed receipts cover interest added to Indian accounts.
Accrual of Income
Accrual occurs when income becomes due, even unpaid. It arises in India if the entitlement stems from Indian activities, such as business ties or local property.
Summary
The Income Tax Act, 1961, under Section 6(3), decides the residential status of company, which affects its tax obligations. Indian companies always count as residents, paying tax on worldwide income. Foreign companies with turnover above Rs. 50 crore are residents if their Place of Effective Management (POEM) is in India, meaning that the major decisions are taken here. Smaller foreign companies are non-residents, taxed only on Indian income. POEM considers where the board or executives make major decisions. Correctly determining status helps companies plan taxes, avoid penalties, and comply with rules. Businesses should seek expert advice to navigate these regulations.
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Residential Status of Company: FAQs
Q1. What are the types of residential status?
There are three types i.e. Resident, Non-Resident, and Resident but Not Ordinarily Resident (for individuals/HUFs).
Q2. What is the residential status of a company?
A company is resident in India if it's an Indian company or its POEM is in India, unless exempted by CBDT for turnover less than Rs. 50 crore.
Q3. What to mention in residential status?
State if you are a Resident, Non-Resident, or Resident but Not Ordinarily Resident. If it's a company, indicate if the Place of Effective Management (POEM) is in India.
Q4. How do I determine my residential status?
For individuals, check days spent in India under Section 6(1); for companies, determine if incorporated in India or if POEM is in India (if turnover > Rs. 50 crore).
Q5. What is the residential status of an employee?
An employee’s residential status depends on days spent in India (183 days or more for Resident) as per Section 6, not employment status.
Q6. What does POEM mean?
POEM identifies where managers make key business decisions. It sets residency for foreign companies.
