By Mayur B. Nayak
Tarunkumar G. Singhal
Anil D. Doshi
Chartered Accountants
International Taxation
‘Residence’
is one of the primary factors to fasten the tax liability on any taxpayer in a
country, be it an individual, a company or any other entity. Determination of a
residential status of an assessee thus assumes significant importance in
international taxation. Elaborate rules are prescribed in tax laws of every
country and/or in tax treaties prevalent worldwide. Liberalisa-tion of exchange
regulations in India has opened up many opportunities for Indian residents to do
business through global companies incorporated overseas. Many a time, a
controversy arises about the residential status of such companies. In this
write-up, the authors have highlighted crucial aspects of determination of
residential status of a company where control and management assumes
significance over other tests.
1.0 Residential Status under a Tax Treaty :
In order to take advantage of a tax treaty, a company should
be resident of either of the contracting states. Article 4 of the UN Model
Convention (UN MC) and the OECD Model Convention (OECD MC) provide almost
similar definitions except that UN MC also includes place of incorporation as
one of the decisive criteria that may be used for determination of the
residential status in case of entities other than individuals.
Paragraph 1 of Article 4 of the UN MC provides “for the
purposes of this Convention the term ‘resident of a Contracting State’ means any
person who, under the laws of that State, is liable to tax therein by reason of
his domicile, residence, place of incorporation, place of management or any
other criterion of similar nature . . .”
Paragraph 3 of Article 4 further provides that “where by
reason of the provisions of paragraph 1, a person other than an individual is a
resident of both the Contracting States, then it shall be deemed to be a
resident of the Contracting State in which its place of effective management is
situated.”
The place of effective management would be relevant only if
the entity is resident of both the Contracting States.
The position is the same in majority of Indian Tax Treaties.
Thus, a reading of Article 4(1) would show that to determine
the residential status of an assessee in a Contracting State, one has to
necessarily look to the applicable laws of that state and ascertain whether the
assessee is a resident of that Contracting State within the meaning of the laws
of that State1.
Therefore, it is imperative for us to know the provisions of the Income-tax Act
in this regard.
2.0 Residential Status of a Company under the Income-tax Act, 1961 :
U/s.6(3) of the Income-tax Act, 1961, the residential status
of a company is to be determined for the purpose of the said Act in the
following manner :
“(3) A company is said to be resident in India in any
previous year, if :
(i) it is an Indian company; or
(ii) during that year, the control and management of
its affairs is situated wholly in India2.”
U/s.6(3)(ii) of the Act, a company can be said to be a
resident in India if during that year, the control and management of its
affairs is situated wholly in India. Therefore, in the case of a foreign
company, even if some control and management is exercised from outside India, it
would not fall within the ambit of S. 6(3)(ii) of the Act and the company would
be treated as a non-resident. This concept is opposite to the concept of
determining a residential status of HUF, firm or AOP in terms of S. 6(2) of the
Income-tax Act, wherein the entities shall be resident in India even if partial
control and management of their affairs is situated in India. While in the case
of HUF, firm or AOP, it is incumbent on the assessee to establish that control
is wholly outside India for them to be treated as a non-resident, in the
case of a company the Income-tax Department has to establish that the control
and management of its affairs is situated wholly in India for the company to be
treated as a resident in India. The above view finds support from the decision
in the case of Narottam & Pereira Ltd. v. CIT, (1953) 23 ITR 454 (Bom.).
2.1 Meaning of the term ‘Control and Management’ :
The meaning of the expression ‘control and management’ as
used in S. 6(3)(ii) of the Act was the subject-matter of judicial interpretation
in the past. The legal position is now well settled that the expression ‘control
and management’ means control and management and not carrying on a day-to-day
business3.
What is decisive is not the place where the management
directives take effect, but rather the place where they are given. (Klaus Vogel
on Double Taxation Conventions, Para 105 on page 262) Thus, it is ‘planning’ and
not ‘execution’ which is decisive.
Control and management signifies the controlling and
directive power, the head and brain. The head and brain of a company can be
considered to be located at the place where the company does business which
yields profits. [Narottam and Pereira Ltd. v. CIT, (supra)].
In the case of V.V.R. N. M. Subbaya Chettiar v. CIT,
(1951) 19 ITR 168, the Supreme Court held that even a partial control of the
company outside India is sufficient to hold the company as a non-resident.
In the case of CIT v. Nandlal Gandalal, (1960) 40 ITR 1, the Supreme Court has given guidelines as to how the expression ‘control and management’ would operate in different cases. The guidelines in respect of determination of control and management for individuals and companies as mentioned in Nandlal’s case are given below for the benefit of our readers:
- The words’ control and management’ have been figuratively described as ‘the head and brain’.
- In the case of an individual, the test is not necessary because his residence for a certain period is enough; it being clear that within the taxable territories he would necessarily have his ‘head and brain’ with him.
- The head and brain of a company is the Board of Directors and if the Board of Directors exercise complete local control’, then the company is also deemed to be resident.
In the case of Radha Rani Holdings (P.)Ltd.”, it was held that “since the Board of Directors, subject to the overall supervision of shareholders, actually control and manage the affairs of a company effectively as against the day-to-day operation of the company, the situs of the Board of Directors of the company should determine the place of control and management of the company. This does not mean where one or more of the Directors normally reside, but where the Board actually meets for the purpose of determination of the key issues relating to the company.”
In the case of Saraswati Holding Corpn. Inc, the Delhi Tribunal held that “the law is well settled that control and management of affairs does not mean the control and management of the day-to-day affairs of the business. The fact that discretion to conduct operations of business is given to some person in India would not be sufficient. The word ‘control and management of affairs’ refers to head and brain, which directs the affairs of policy, finance, disposal of profits and such other vital things consisting the general and corporate affairs of the company.”
From the above discussion, it is clear that under the provisions of the Income-tax Act, 1961, even if a part of the company’s affairs are controlled and managed from outside India, then such a company would be regarded as a non-resident of India.
3.0 Tie-breaking in case of Dual Residence of a Company:
As seen earlier in terms of Paragraph 3 of Article 4 of the UNMC, when an entity is resident of both the Contracting States, then it shall be deemed to be a resident of the Contracting State in which its place of effective management is situated. However, this presupposes that the entity is resident of both Contracting States. However, in case of Saraswati Holding Corpn. Inc (supra), the Assessing Officer applied the tests of place of effective management to a company which was resident only of Mauritius. The observations of the Delhi Tribunal are worth noting here:
“In the present case it is noticed that the asses-see is a company incorporated in Mauritius. The assessee is not an Indian company. Therefore, the residential status of the assessee has to be determined on the basis of the test laid down in S. 6(3)(ii) of the Act, which provides that during the previous year the control and management of the affairs of the company should be situated wholly in India. It is only when the above test is satis-fied that the provisions of Article 4(3) of the DTAA between India and Mauritius will stand attracted. It is only in such a situation that the test of determining the residential status of the company by looking at the place of day-to-day management of the company can be resorted to. The Assessing Officer as well as the CIT (Appeals) in total disregard of the above legal position have proceeded to analyse the place of effective management of the assessee. This was impermissible in law.”
It must be understood that the test laid down in S. 6(3)(ii) of the Act is different from the test of place of effective management contemplated by Article 4(3) of a tax treaty. While the former deals with the fact of ascertaining the place of ‘control and management’ (in the Indian context whether the same are being situated wholly in India or not ?), the latter deals with ‘place of effective management’. In every treaty situation, before invoking provisions of Article 4(3), in respect of a non-resident company for its source of income in India, one has to first satisfy the test laid down u/ s.6(3)(ii) of the Act. By doing so the non-resident company would be regarded as resident of both the Contracting States, namely, (State of Source and Residence) and then the ‘place of effective management’ criteria would be used to break the tie.
In other words, a tax treaty requires the test of ‘place of effective management’ to be applied only for the purposes of the tie-breaker clause in Article 4(3) which could be applied only when it is found that a person other than an individual is a resident of both Contracting States. There is no purpose or justification in applying treaty provisions in this respect in any other situation.
4.0 Meaning of the term ‘Place of Effective Management’ :
The OECD Model Commentary? states that “The place of effective management is the place where key management and commercial decisions that are necessary for the conduct of the entity’s business are in substance made. The place of effective management will ordinarily be the place where the most senior person or group or persons (for example board of directors) makes its decisions, the place where the actions to be taken by the entity as a whole are determined”. According to the UN Model Commentary in determining the place of effective management, the relevant criteria are: (i) the place where a company is actually managed and controlled, (ii) the place where the decision-making at the highest level on the important policies essential for the management of the company takes place, the place that plays a leading part in the management of a company from an economic and functional point of view, and (iv) the place where the most important accounting books are kept.
To summarise, the criteria generally adopted to identify Place of Effective Management under the treaty are:
- Where the head and the brain is situated.
- Where de facto control is exercised and not where ultimate power of control exists. Where top-level management is situated. Where business operations are carried out. Where directors reside.
- Where the entity is incorporated
- Where shareholders make key management & commercial decisions.
- According to Dr. Klaus Vogel, place of effective management exists where management directives are given and not where they take effect.
The place of residence of a manager who exercises control could also be relevant.
As stated earlier in case of Radha Rani Holdings (P.) Ltd. (supra), it is the situs of the Board of Directors of the company and the place where the Board actually meets for the purpose of determination of the key issues relating to the company, which would be relevant in determining the place of control and management of a company.
5.0 Summation:
The residential status of a company first has to be determined under the domestic tax law of the relevant country. In the Indian context what is relevant is the place of control and management. In order for a foreign company to be resident of India, its control and management should be situated wholly in India. Even if some control and management is situated outside India, then the company cannot be treated as resident of India. By applying the criteria under the domestic tax laws, if the company is found to be resident of both the Contracting States of a Tax Treaty, then and then only the tie-breaking test in terms of ‘Place of Effective Management’ should be applied. In such a scenario the company would be deemed to be resident of the Contracting State from where it is effectively controlled and managed. The place of management of a company exists where management directives are given and not where they take effect. It is also important to note that what is contemplated is de facto control and management and not merely power to control.
