CHAPTER VIII - CONCEPT OF RESIDENCE IN THE CASE OF A COMPANY INCORPORATED OUTSIDE INDIA - Revised Discussion Paper – Direct Tax Code (DTC)

1. Chapter-IV of the Discussion Paper on the draft Direct Taxes Code (DTC) discusses the test of residence of a person for tax purposes. The tax residence of companies (that is, where companies are established or carry on business) is usually based on either place of incorporation (legal seat), location of management (real seat) or a combination of the two. The DTC provides that a company incorporated in India will always be treated as resident in India. However, a company incorporated abroad (foreign company) can either be resident or non-resident in India. It has been proposed in the DTC that a foreign company will be treated as resident in India if, at any time in the financial year, the control and management of its affairs is situated „wholly or partly‟ in India (it need not be wholly situated in India, as at present).

2. It has been pointed out that under the new test for determining residence in the DTC, a foreign company whose control and management is partly in India will be treated as a resident of India and thus liable for taxation in India on its global income. The word „partly‟ used in the DTC sets a very low threshold for regarding a foreign company as a resident in India. Apprehensions have been expressed that it could lead to a foreign multi-national company being held as resident in India on the ground that some activity like a single meeting of the Board of Directors is held in India. Also, a foreign company owned by residents in India could be held to be resident in India as part of the control of such company may be in India. It has been represented that this will result in uncertainty in taxation and will impact foreign direct investment into India. Modification of the phrase „wholly or partly‟ has therefore been suggested.

3.1 Generally, the test of residence for foreign companies is the „place of effective management‟ or „place of central control and management‟. At the same time, it is noted that the existing definition of residence of a company in the Income Tax Act, 1961 based on the control and management of its affairs being situated wholly in India is too high a threshold.

3.2 „Place of effective management‟ is an internationally recognized concept for determination of residence of a company incorporated in a foreign jurisdiction. Most of our tax treaties recognize the concept of „place of effective management‟ for determination of residence of a company as a tie-breaker rule for avoidance of double taxation. It is an internationally accepted principle 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 as a whole, are, in substance, made. In case of a company incorporated outside India, the current domestic law is too narrow compared to our tax treaties as the test of residence of a foreign company is based on "whole of control and management" lying in India. However a test of residence based on control and management of the foreign company being situated "wholly or partly" in India as proposed in the DTC is much wider.

3.3 It is therefore proposed that a company incorporated outside India will be treated as resident in India if its „place of effective management‟ is situated in India. The term will have the same meaning as currently laid down in the Tenth Schedule to the Code as under:
„place of effective management of the company‟means-
(i) the place where the board of directors of the company or its executive directors, as the case may be, make their decisions; or
(ii) in a case where the board of directors routinely approve the commercial and strategic decisions made by the executive directors or officers of the company, the place where such executive directors or officers of the company perform their functions."

3.4 As an anti-avoidance measure, in line with internationally accepted practices, it is also proposed to introduce Controlled Foreign Corporation provisions so as to provide that passive income earned by a foreign company which is controlled directly or indirectly by a resident in India, and where such income is not distributed to shareholders resulting in deferral of taxes, shall be deemed to have been distributed. Consequently, it would be taxable in India in the hands of resident shareholders as dividend received from the foreign company.