Introduction: Understanding who is considered a non-resident in India is crucial for tax purposes. The Income Tax Act defines “person” broadly and lays down specific rules for determining non-resident status. In this article, we will explore these rules and provide practical examples to clarify the concepts.
Let’s understand first Who is Person as per Income tax Act
Person includes –
Rule for Determination of Non-resident for individual
Step 1: Determining whether one is a resident or non-resident.
Under the Income-tax Law, an individual will be treated as a resident in India for a year if they satisfy any of the following conditions (i.e., they may satisfy either or both of these conditions):
However, in respect of an Indian citizen and a person of Indian origin who visits India during the year, the period of 60 days mentioned in (2) above shall be substituted with 182 days. The same concession is provided to Indian citizens who leave India in any previous year as crew members or for the purpose of employment outside India.
The Finance Act of 2020, with effect from the Assessment Year 2021-22, amended the above exception to provide that the period of 60 days mentioned in (2) above shall be substituted with 120 days if an Indian citizen or a person of Indian origin whose total income, other than income from foreign sources, exceeds Rs. 15 lakhs during the previous year.
Note: For this provision, income from foreign sources means income that accrues or arises outside India (except income derived from a business controlled in or a profession set up in India). However, such an individual shall be deemed to be an Indian resident only when they are not liable to tax in any country or jurisdiction by reason of their domicile, residence, or any other criteria of a similar nature. Thus, from the Assessment Year 2021-22, an Indian Citizen earning a total income more than Rs. 15 lakhs (other than from foreign sources) shall be deemed to be a resident in India if they are not liable to pay tax in any country.
“Liable to tax” in relation to a person and with reference to a country means that there is an income tax liability on such a person under the law of that country for the time being in force. It shall include a person who has subsequently been exempted from such liability under the law of that country.
If an individual does not satisfy any of the above conditions, they will be treated as a non-resident in India.
Rule for Determination of Non-resident for HUF, firm, AOPs/BOIs, local authorities, and artificial Judicial persons
HUF (Hindu Undivided Family): If the HUF’s decision-making and overall management happen entirely outside India, it will be classified as a non-resident HUF. In simpler terms, if the person in charge, known as the Karta or Manager, is not a resident of India, the HUF is considered non-resident.
Firms, AOPs (Association of Persons), BOIs (Body of Individuals), Local Authorities, and Artificial Judicial Persons: When it comes to these entities, such as business partnerships or local authorities, if the individuals who are members or partners reside outside India and have the authority to make decisions and run the business, then the control and management are considered to be outside India. In other words, these entities are non-resident if the people making important decisions live outside India.
Rule for Determination of Non-resident for Company
A company incorporated in India as per companies Act will always be considered as resident of India in all circumstances. A company Which is not incorporated in India as per companies Act (i.e., a foreign company) is said to be resident in India during a year, if its place of effective management, in that year, is in India otherwise its Non-Resident Company
Place of effective management (POEM) means a place where key management and commercial decisions that are necessary for conduct of the business of an entity as a whole are in substance made.
Concept of Substance made.
The POEM concept is one of substance made. It may be noted that 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. Since “residence” is to be determined for each year, POEM will also be required to be determined on year-to-year basis.
CBDT has issued guideline for determination of Place of Effective management (‘POEM’) of a company Which is not incorporated as per companies Act in India (i.e., a foreign company) – [Circular No. 6/2017, dated 24.01.2017 & Circular No. 8/2017, dated 23-02-2017]:
The guidelines do not apply to a company having turnover or gross receipts of INR 50 crores or less in a financial year.
This guidelines on POEM contain unique features is test of Active Business Outside India (ABOI). The guidelines prescribe that a company shall be called engaged in ‘active business outside India’ if;
To determine this above test, the average of the data of the previous year and two years prior to that shall be considered. 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.
The Guidelines said 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, in case the Board exercising its powers of management which being exercised by the holding company resident in India, then POEM shall be in India.
Note The guidelines have clarified that mere following of global policies laid down by the Indian holding company would not constitute that Board is standing aside.
In cases of companies not 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, make the key management and commercial decision for conduct of the company’s business.
(ii) Second stage would be determination of place where these decisions are in fact being made.
The place where these management decisions are taken would be more important than the place where such decisions are implemented.
Some of the guiding principles which may be considered for determining the POEM are as follows:
(a) Location of Board Decisions: The location where the company’s Board of Directors meets and makes key management and commercial decisions is an important factor in determining POEM. It’s not just about formal meetings but where actual decisions are made.
(b) Location of Executive Committee: If the Board delegates authority to committees like an executive committee, the location where these committees make key strategies and policies may be considered as the company’s POEM.
(c) Location of Head Office: The company’s head office often represents where key decisions are made. It depends on where senior management is primarily based and where they formulate strategies and policies.
(d) Use of Modern Technology: In the digital age, physical presence is not always required for decision-making. The location where key decision-makers usually reside may also be relevant.
(e) Circular Resolution or Voting: The location of the person with the authority to make decisions via circular resolution or voting is important. Shareholders’ decisions on certain matters may not be relevant unless they effectively manage the company.
(f) Shareholder Involvement: Shareholders can become effectively involved in management through formal arrangements or their actual conduct, potentially impacting POEM.
(g) Day-to-Day Operational Decisions: Routine operational decisions by lower-level management are generally not relevant for determining POEM. It’s the broader strategic and policy decisions that matter.
Secondary Factors for POEM Determination If the above factors are inconclusive, consider:
Let’s Understand the Whole concept with Certain examples.
PQR Corp. is a foreign company with a significant number of employees based in India, but key management decisions are made abroad.
The fact that PQR Corp. has a substantial number of employees in India might not be enough to determine POEM. If the key management decisions are made outside India, PQR Corp. could be considered a non-resident company.
ABC Pvt. Ltd. is a foreign company with most of its board meetings held in India. The majority of key management and commercial decisions are made in India.
In this case, ABC Pvt. Ltd. would be considered a resident in India for tax purposes because the place of effective management, where key decisions are made, is in India
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 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.
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 is 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 is also satisfied. Therefore, company is engaged in active business outside India.
The other facts remain same as that in Example 3 with the variation that A Co. has a total of 50 employees. 47 employees, managing the warehouse, storekeeping, and accounts of the company, are 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 RS 5 crore. The annual payroll expenditure in respect of MD, CEO and sales head is of Rs 3 crore.
Although most of limb of active business test is satisfied by A Co Like ; 40% of its total income is passive in nature; more than 50% of the employees are 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 employee’s resident in India exceeds 50% of the total payroll expenditure. Therefore, A Co. is not engaged in active business outside India.
The basic facts are same as in Example 3. 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 London and one in Singapore.
The A Co. is engaged in active business outside India as the facts indicated in Example 3 establish. Also, The majority of board meetings have been held outside India. Therefore, the POEM of A Co. shall be presumed to be outside India.
The facts are same as in Example 5 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 Rs10 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.
These facts suggest that the effective management of the A Co. may have been taken 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.
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 exercised by 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.
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 B Co., C Co., and D Co. are independently engaged in active business outside India nd 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.
There’s an HUF family in India, with the father serving as the Karta (head of the family), along with his sons. The Karta is responsible for managing the family’s finances, which include their income and investments within India. However, the Karta decides to relocate to the United States while the rest of the family members continue to reside in India.
In this scenario, even though the Karta has moved to the USA, the core of the family remains in India. The HUF’s control and management, primarily carried out by the Karta, still revolve around the family’s financial matters in India. Since the rest of the family remains in India, and the Karta continues to oversee the family’s Indian investments, the HUF would typically maintain its status as a resident HUF.
Example for HUF- Non Resident
Mr. Ram is the Karta of an HUF (Hindu Undivided Family) in India. The HUF is engaged in a diverse range of business activities, including owning rental properties and operating a chocolate trading business. Mr. Ram decides to relocate to the United States, accompanied with entire family. However, the HUF’s business operations in India continue.
Since the key decision-maker, the Karta, and his family have moved to the USA and are actively managing the Indian business from there, the control and management of the HUF’s business affairs in India are now situated outside of India.
So, the HUF being categorized as non-resident.
A business partnership (Firm) in India with several partners. Most of the partners reside in India, but one partner lives in the United Kingdom and actively participates in business decisions. The partners in this Firm give authority to the UK-resident partner for important business functions and decisions.
In this case, the Firm’s control and management would be considered outside India. The reason is that the partner in the UK, who has decision-making authority, is not residing in India. Therefore, the Firm would be categorized as a non-resident for tax purposes.
Conclusion: Determining non-resident status in India is a crucial aspect of tax compliance, with specific rules for individuals, HUFs, firms, and companies. The concept of place of effective management (POEM) plays a pivotal role in assessing the residency of companies. Practical examples shed light on how these rules apply in various scenarios, ensuring a clear understanding of the criteria for non-resident classification in India.
Disclaimer: The information provided in this article is intended for informational purposes only and does not constitute legal or tax advice. It is essential to consult with a qualified professional for accurate guidance on specific tax and residency matters.