Place of Effective Management

Before the government made the move to amend the provisions of the Income Tax Act relating to the residential status of a company, the law was that any company was considered as resident in India in any financial year if the company was an Indian company or if during that year the control and management of company’s affairs was wholly situated in India. The old provisions encouraged tax avoidance since the company can easily escape the residential status by shifting events related to control and management outside India. In order to control such tax evasion, the Government has amended the provisions o section 6(3) of the Income Tax Act, effective from 1st April 2016, and as a result of the amendment, the concept of the place of effective management was introduced.

Section 6(3)

As per the amended provisions of section 6 (3) of the Income Tax Act, as effective from 1 st April 2016, the company qualifies as a resident of India in any previous years, if –

The company is an Indian Company, or
The company's place of effective management during the financial year is in India.

Place of Effective Management

In order to understand the residential status of any company in India, it is very important to briefly understand the concept of the place of effective management. The definition of place of effective management as provided under the Act 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. The concept of the place of effective management is internationally accepted and various tax treaties entered into by India even speak about the concept of a place of effective management for the purpose of deciding the residential status of any company.

Determining Place of Effective Management

As per the principles, the company shall be said to be engaged in ‘active business outside India’, if the following factors are satisfied:

Passive income of the company is not more than 50% of its total income, and
Out of the total assets of the company less than 50% are situated in India, and
Out of the total number of employees, less than 50% are situated in India or less than 50% are resident in India, and
Out of the total payroll expenses incurred by the company less than 50% of payroll expenditure is incurred for such employee.

In order to understand the above principles, it is necessary to understand the following terms:

Passive Income

Passive Income is the aggregate of the following –

Income from the transactions, wherein, purchase and sale is from an associated enterprise of the company, and
Income from royalty, dividend, capital gains, interest or rental income.

Income

Income includes the following:

Income as computed for tax purpose (in accordance with laws of the country of incorporation); or
Income as per books of accounts (in case laws of the country of incorporation does not require any computation)

Value of Assets

In case of an individually depreciable asset, the value of an asset shall be average of its value for tax purpose at the beginning and at the end of the previous years.
In case of a pool of fixed assets being treated as a block, the value of the assets shall be average of its value for tax purpose at the beginning and at the end of the previous years.
In case of any other assets, the value of the assets shall be value as per books of accounts.

Number of Employees

The number of employees would be the average of the number of the employee as at the beginning and at the end of the year, including, the persons who are not directly employed in the company, however, such person performs the task similar to those performed by the employee of the company.

Payroll

Payroll includes the cost of salaries, wages, bonus and all other employee compensation including related pension and social cost borne by the employer.

Other Criteria

The average data of the previous year and two years prior to that shall be taken into account while determining whether 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 assumed to be outside India even in a case where the majority of the meeting of the board of directors of the company are held outside India.

DETERMINING PLACE OF EFFECTIVE MANAGEMENT FOR COMPANIES OTHER THAN COMPANIES ENGAGED IN ACTIVE BUSINESS OUTSIDE INDIA –

In the case of other companies (i.e. other than companies engaged in active business outside India), the place of effective management shall be determined as follows:

First Stage

It should be first identified the persons who are actually engaged in key management of the company.

Second Stage

Secondly, it should be determined the place where these decisions are in facts being made. If the place of effective management cannot be determined on the basis of the above two criteria, the following additional factors would help to determine the same –

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

Disclaimer

Circular no. 6/2017 dated 24.01.2017, mentions that principles mentioned are only for guidance. The place of effective management cannot be determined by applying the principles for a particular moment. However, the actual determination should be based on activities performed over a period of time during the preceding years.