FACULTY OF LAW

JAMIA MILLIA ISLAMIA

SESSION 2018-19

SEMESTER VI

TOPIC RESIDENTIAL STATUS UNDER TAX LAW

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 Table of Contents
F ACULTY OF LAW............................................................................................................................................1
JAMIA MILLIA ISLAMIA....................................................................................................................................1
SESSION 2018-19..........................................................................................................................................1
SEMESTER VI..................................................................................................................................................1
LIST OF CASES..............................................................................................................................................3
1. INTRODUCTION.......................................................................................................................................4
1.1 Overview............................................................................................................................................4
1.2 Definitions.........................................................................................................................................5
1.3 Taxability...........................................................................................................................................6
2. RESIDENCE, DOMICILE AND CITIZENSHIP................................................................................................7
2.1 Residence..........................................................................................................................................7
2.2 Domicile.............................................................................................................................................7
2.3 Citizenship.........................................................................................................................................8
2.4 Difference between Domicile and Residence....................................................................................9
3. PROVISIONS RELATED TO RESIDENCE................................................................................................10
3.1 Difference in Chargeability on the basis of Residence:....................................................................10
4. Tests of Residence for an Individual:.................................................................................................12
5. Tests of residence for HUF, Undivided Family, Firm or Association of Persons.................................13
6. Tests of residence for a Company:.....................................................................................................14
A. Residential Status of Companies under the Income Tax Act, 1961:..................................................15
B. Guidelines determining POEM (whether in India):............................................................................16
C. Examples:..........................................................................................................................................18
7. Tests of residence for Ordinary Resident:..........................................................................................18
8. JUDICIAL INTERPRETATION................................................................................................................19
8.1 Union of India v. Azadi Bachao Andolan..........................................................................................19
8.2 Vodafone International Holdings B.V. v. Union of India & Anr.........................................................19
9. CONCLUSION.....................................................................................................................................20
BIBLIOGRAPHY............................................................................................................................................iv

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 LIST OF CASES
 Choudhury v UOI 186 ITR 329

 CIT v Avtar Singh 247 ITR 260

 CIT v Nandlal 40 ITR 1 (SC)

 Erin v CIT 34 ITR 1 (SC)

 IRC v. Duke of Westminster [1935] All ER 259 (H.L.)

 Khambhaty v CIT 61 ITR 30

 Levene v IR 13 TC 486

 Lysaght v IR 13 TC 511 (HL)

 Mohammed v CIT 10 ITR 484

 Narasimha v CIT 18 ITR 181

 Narottam v CIT 23 ITR 1, 7 (SC)

 Ram Kumar v UOI 252 ITR 205

 Re Kamdar 14 ITR 158

 Re Sarupchand 13 ITR 245

 San Paulo (Brazilian) Rly Co Ltd v Carter 2 TC 407 (HL)

 Sanofi Pasteur Holding v. The Department Of Revenue(2013) 354 ITR 316

 Shrigopal v CIT 119 ITR 980

 Subbayya Chettiar v CIT [1951] 19 ITR 168 (SC)

 Union Of India v Azadi Bachao Andolan, (2004) 10 SCC 1

 Vodafone International Holdings B.V. v Union of India, (2012) 6 SCC 613

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  Wallace v CIT 16 ITR 240 (PC)

1. INTRODUCTION

1.1 Overview
The income tax liability of a taxpayer is based on his/her residential status in the previous year.
Also, while filing income tax return, the taxpayer must declare his/her residential status in the tax
return. Under Income Tax Act, taxpayers are divided into the three categories of residential
status, namely:

1. Resident but not ordinarily resident.

2. Resident and ordinarily resident.

3. Non-resident.

Tax incidence on an assessee depends on his residential status. For example, whether income
accrued to an individual outside India is taxable in India, depends on the residential status of the
individual. Likewise, whether income earned by a foreign national is taxable in India depends on
the residential status. The determination of residential status is therefore significant to determine
one’s tax liability.

The Income Tax Act 1961 envisages three types of residential status: resident and ordinarily
resident, resident but not ordinarily resident, and non-resident. This categorization becomes
important, as tax rates vary according to the residential status of the assessee.

For the purpose of determining residential status, the taxable entities are grouped into-

(a) individuals [s 6(1)];

(b) Hindu undivided families, firms or other association of persons [s 6(2)];

(c) companies[s 6(3)]; and

(d) every other person [s 6(4)].

An assessee can enjoy different residential status for different assessment years. It is also
possible for a person to be a resident of two different countries in the same year. the burden of

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proving resident status is on the assessee. There are various tests laid down to determine an
assessee’s resident status.

1.2 Definitions
 Resident and Ordinarily Resident or “Ordinary Resident”

A person is said to be “not ordinarily resident” in India in any previous year if such person is-

1. An individual who has been a non-resident in India in nine out of the ten previous years
preceding that year, or has during the seven previous years preceding that year been in
India for a period of, or periods amounting in all to, seven hundred and twenty-nine days
or less; or

2. Hindu undivided family whose manager has been a non-resident in India in nine out of
the ten previous years preceding that year, or has during the seven previous years
preceding that year in India for a period of, or periods amounting in all to, seven hundred
and twenty-nine days or less. Thus, an “ordinary resident” would be a resident who is
outside the purview of the above definition.

 Resident but Not Ordinarily Resident (RNOR)

An individual is a resident but not ordinarily resident in India in any previous year if he fulfils
any one of the following two conditions-

1. He/she is in India in that year for 182 days or more, or

2. That he/she has been in India for at least 365 days in the four years immediately
preceding that year, and is in India for 182 days or more in that year, subject to some
conditions.

RNOR is special status given to NRI returning to India. RNOR in India can continue to enjoy tax
benefit like NRI. RNOR has to pay taxes only on the income generated from India. They will
continue to enjoy tax benefit on Foreign Income. In the other words “Income which has no
relation with India” will be tax free.

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  Non-Resident (NR)

An individual is non-resident in India in any year if he does not fulfil any of the above-
mentioned conditions in point 1.

The classification of who falls under non-residency status is determined in each region by set
circumstances such as the amount of time spent within the region during the calendar year. This
classification is focused on where the person resides and does not focus on citizenship.

For example, many individuals live in one state but have business in another region and derive
income from sources within that region. A non-resident who has worked in a state where s/he is a
non-resident for more than 184 days will have to file two tax returns – a resident return and a
non-resident return. A taxpayer who lives in New Jersey but commutes to New York daily for
work would file a non-resident return in New York and a resident tax return in New Jersey. A
non-resident only has to file in the state of non-residency if s/he earned income there. So, a
snowbird who escaped Chicago during the frigid winter months to her vacation home in Houston
may not need to file taxes in Houston since she only lived there briefly and earned no income
from working there. However, certain types of income are taxable to non-residents even though
an individual does not work in a state. 

1.3 Taxability
Resident: A resident will be charged to tax in India on his global income i.e. income earned in
India as well as income earned outside India.

NR and RNOR: Their tax liability in India is restricted to the income they earn in India. They
need not pay any tax in India on their foreign income.

Also note that in a case of double taxation of income where the same income is getting taxed in
India as well as abroad, one may resort to the Double Taxation Avoidance Agreement (DTAA)
that India would have entered into with the other country in order to eliminate the possibility of
paying taxes twice.

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 2. RESIDENCE, DOMICILE AND CITIZENSHIP

2.1 Residence
Black’s Law Dictionary1 defines residence as “the place where one actually lives, as
distinguished from a domicile”. It additionally states that residence merely requires bodily
presence in a particular place, and nothing further. This is what distinguishes it from domicile,
and the reason why a person can have more than one residence at any given point of time, but
only one domicile.2

Residence refers to a place of abode that is more than merely temporary. It is also used
interchangeably with the term "domicile". Although a person may have more than one residence,
a person may have only one legal domicile, which is their primary residence for purposes of
obtaining the jurisdiction of the court in the area of domicile. 

Accordingly, a resident is one who lives in a particular place. A resident can also be a citizen
and/or domiciliary, though not necessarily. This distinction is important, as each term has its own
distinct requirements. Who exactly qualifies as a resident depends on the statutory definition,
which differs from country to country.

2.2 Domicile
Domicile is best defined as the place where a person is physically present, and regards as home. 3
It requires the bodily presence of a person, along with the intention to make the place one’s
home. In law, domicile is the status or attribution of being a lawful permanent resident in a
particular jurisdiction. A person can remain domiciled in a jurisdiction even after he has left it, if
he has maintained sufficient links with that jurisdiction or has not displayed an intention to leave
permanently (i.e. if that person has moved to a different state but has not yet formed an intention
to remain there indefinitely).

1
Black’s Law Dictionary, 9th edn., 2009, p 1423.
2
ibid.
3
ibid at 558.

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Traditionally many common law jurisdictions considered a person's domicile to be a
determinative factor in the conflict of laws and would, for example, only recognize
a divorce conducted in another jurisdiction if at least one of the parties were domiciled there at
the time it was conducted.

Domicile is the place where the person intends to return to, and remain there, even if currently
residing elsewhere. Therefore, at the end of the day, there is always just one country that can be
called one’s domicile.4 Residence, as mentioned above, is more of a transient term, and merely
requires physical presence.

2.3 Citizenship
The status given to a citizen is known as citizenship. A citizen is one who either by birth or
naturalisation is a member of a civil state. The basis of nationality is the membership of a
particular community. This status entitles one to the rights and privileges offered by the state. 5
Generally, these rights include the right to vote, right to work, right to own property, etc.

Nationality is often determined by the state laws. It is a link through which an individual can
enjoy the benefits of international law.

Starke state its importance as under;

1)      Protection of rights of diplomatic agents

2)      Prevention of offences

3)      Loyalty to particular state

4)      State can refuse to extradite its own nationals

5)      Enemy character is determined on the basis of nationality

6)      Jurisdiction of state over their nationals

4
ibid at 1423.
5
Black’s Law Dictionary, 9th edn., 2009, p278.

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Tax is usually calculated and levied on the basis of residence, which is why it is important to
understand what exactly constitutes residence, and how it is distinct from both domicile and
citizenship.

2.4 Difference between Domicile and Residence

Domicile is a person’s permanent place of dwelling.  It is a legal relationship between a person
and a locality.  It may or may not be of same meaning as the term ‘residence’.

The concept of domicile has different meanings in different context.  For purposes of
jurisdiction, “domicile” means a legal residence which is the place where a person has fixed
dwelling with an intention of making it his/her permanent home.6

Domicile is a combination of two factors namely, residence and intent to remain.  As the term
domicile includes residence, the scope and significance of the term domicile is larger than the
term residence.  An individual may have several residences whereas; s/he will have only one
domicile.  Domicile is more used in reference to personal rights, duties and obligations.7

Generally residence is referred to a place, where one person lives.  It is also a building used as
home.  Residence is of a more temporary nature compared to domicile.  An individual’s present
physical location of stay is residence. 8  It may be one among several places where a person may
be present.  Residence can also be referred to a person’s fixed place of stay without any intention
to move from there.

Domicile involves intent of an individual whereas, residence is something objective.  A person

may have his/her residence in one place and his/her domicile in another.9

Whether the term ‘residence’ used in a statute will be construed as having the meaning of
‘domicile’, or vice versa, depends on the purpose of the statute.  Also, the nature of the subject
matter as well as the context in which the term is used would be taken into consideration.10

6
Snyder v. McLeod, 971 So. 2d 166 (Fla. Dist. Ct. App. 5th Dist. 2007).
7
McIntosh v. Maricopa County, 73 Ariz. 366 (Ariz. 1952).
8
 George Zulakis, Personal Representative of the Estate of Charles M. Decker v. Auto-owners ins. Co., 2001 Mich.
App. LEXIS 1874 (Mich. Ct. App. Nov. 20, 2001)
9
Missouri Pacific R. Co. v. Lawrence, 215 Ark. 718, 223 S.W.2d 823, 12 A.L.R.2d 748 (1949).
10
McIntosh v. Maricopa County, 73 Ariz. 366 (Ariz. 1952).

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The terms are given equivalent meaning when used in connection with subjects of domestic
policy.  These terms are given equal meaning where a statute stipulates residence as a
qualification for the enjoyment of a privilege or the right of voting in an election.11

Residency is a more flexible concept than domicile, and permanency is not a requirement for
residency.  Even a temporary and transient place of dwelling can qualify as residence. In
addition, a minor is legally unable to establish a residence separate and apart from their parents.12

Residence takes meaning from the context in the term is found.  A definition which fits one
situation will not be apt when used in another context or in a different sense.13

3. PROVISIONS RELATED TO RESIDENCE

Section 4 of the Act states that every person will be charged on the basis of their total income.
The Act defines ‘total income’ as the ‘total amount of income referred to in Section 5, computed
in the manner laid down in this Act’.14

Section 5 lays down the scope of ‘total income’ and what that means for different categories of
assessees. There are three categories of assessees:

i. Resident and ordinarily resident;

ii. Resident but not ordinarily resident; and

iii. Not resident

By and large, the burden of tax is largest for one who is a resident and ordinarily resident,
smaller for one who is a resident but not ordinarily resident, and the smallest for non- residents.
Residence is always calculated on the basis of the previous accounting year; residence during the
assessment year is irrelevant.15

11
Id.
12
McLeod v. Allstate Ins. Co., 789 So. 2d 806 (Miss. 2001).
13
State v. Tustin, 322 S.W.2d 179, 180 (Mo. App. 1959).
14
Section 2(45), Income Tax Act, 1961.
15
Wallace v CIT 16 ITR 240, 244 (PC).

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3.1 Difference in Chargeability on the basis of Residence:
For persons who are Residents and Ordinarily Resident, tax is charged on:

- Income which is received or deemed to be received in India in the accounting year. The
place and date of accrual of such income plays no role for the purpose of calculating
tax.16

- Income which accrues or arises or is deemed to accrue or arise in India during the
accounting year. The place or date of receipt of such income is immaterial for calculating
tax.17

- Income which arises or accrues outside India during the accounting year, even if it is not
received or even brought into India. 18

For persons who are resident in India in the accounting year, but not ordinarily a resident, the
rules remain the same as those for a resident. There is just one special exception granted to this
type of assessee – income accruing outside India is exempt from tax, unless it is derived from a
business controlled in, a profession or vocation set up in India or, is deemed to accrue in India, or
is received or deemed to be received in India. 19

For non-residents, tax is charged on the income received or deemed to be received in India in the
accounting year. For this purpose, date or place of accrual of income is immaterial. Tax is also
charged on the income which accrues or arises, or is deemed to do so in India in the accounting
year, the date or place of its receipt being immaterial.

All assessees, resident or not, are charged on the income that accrues, arises or received, or
deemed to do so, in India. Only residents are taxed for income that accrues or arises and is
20
received outside India, even if it the transaction is never brought into India. However, the law
stated in these provisions is subject to the remaining provisions of this Act. This would mean that
provisions not in harmony with this section act as an exemption, even if it would have normally
been chargeable under section 5.21

16
Section 5(1)(a), Income Tax Act, 1961.
17
Section 5(1)(b),Income Tax Act, 1961.
18
Section 5(1)(c), Income Tax Act, 1961.
19
Section 5(1)(c) proviso, Income Tax Act, 1961.
20
CIT v Avtar Singh 247 ITR 260.
21
Re Kamdar 14 ITR 158.

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 4. Tests of Residence for an Individual:
Section 6 of the Act deals with the technical requirements for one to be considered a resident,
resident but not ordinarily resident and a non- resident. This section looks at the physical
22
presence of the person in India as a determination of the same. A person’s residential status is
determined every year, and cannot be calculated only on the basis of the previous years. This is
because the physical presence of the person can change every year, and tax must be charged
accordingly. 23

For an individual, the tests are alternative. An individual is considered a resident if he is in India
for a total of 182 days or more in the previous year,24or if he has lived in India for a total of 365
days or more in four years preceding the accounting year and for 60 days or more in the
accounting year.25Therefore, it is clear that a person who is treated as a resident one year can be
treated as a non-resident the next, if he stays outside the country for the entire year.

If the assessee is put up in various hotels for the duration of his stay in India, he will still be
considered a resident, as long as he satisfies the aforementioned conditions. 26 Similarly, a person
is constantly wandering about within the country can’t be used as a factor for him to not be a
resident.27 Therefore, permanence in settlement is not a requirement at all. The statute merely
requires the person to be within the country for the required period of time, as stated above.
When the section says that the person must be in India for a certain period, it means that the
person must be within the geographical territory that is considered India, and therefore, includes
Indian territorial water. Hence, a boat or yacht on Indian waters is considered Indian Territory. 28
Similarly, a person aboard an Indian ship in international waters, or foreign waters, cannot be
considered to be staying in Indian Territory.29

22
CIT v Avtar Singh 247 ITR 260.
23
Wallace v CIT 13 ITR 39, 44; Narasimha v CIT 18 ITR 181.
24
Section 6(1)(a), Income Tax Act, 1961.
25
Section 6(1)(c), Income Tax Act, 1961.
26
Lysaght v IR 13 TC 511 (HL).
27
Levene v IR 13 TC 486, 492.
28
Brown v Burt 5 TC 667.
29
CIT v Avtar Singh 247 ITR 260. Further, the explanation to s 6(1), amended by the Finance Act, 1990, which states
that Indian seamen working on an Indian ship would be treated as a resident only if they stay in India for 182 days
or more in that year.

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The determination of residence is not subject to the person’s will to reside in the country. Even if
the person is made to stay against his will, e.g. if he is imprisoned, he will still be considered a
resident, if he satisfies the conditions mentioned in the section. The differences between the
resident and domicile being highlighted in the previous chapter, it is significant to point out that
a person may be a resident in of two different countries in a year, but can have only one
domicile. 30 The burden of proof to prove that a person is a non- resident is on the person himself,
and must be done on the basis of material on record; 31 it cannot simply be presumed that because
an Indian national is staying in Nepal, for e.g., he automatically is a non-resident Indian.32

5. Tests of residence for HUF, Undivided Family, Firm or Association

of Persons
A Hindu Undivided Family , firm or other association of persons is considered a resident in
every case except where the management and control of its affairs is situated outside India in the
relevant year.33 Therefore, in order to be considered a resident, the whole or part of the
34
management and control of the association must lie within India. Partial control is sufficient to
determine residential status, therefore,(much like an individual), a firm can also have two places
of residence.35Residence of individual members of a HUF or partners of a firm is immaterial,
unless it affects the management and control of the association. 36

Control and management refers to where ‘the head and brain of the trading adventure’ 37 is
situated’. Place of control of business isn’t necessarily where the operations are actually carried
out.38 In Subbayya Chettiar v CIT39 it was held that a HUF is presumed to reside in India. The
burden of proving otherwise rests on the assessee, and is to be done by showing that the

30
Levene v IR 13 TC 486, 505 (HL).
31
Choudhury v UOI 186 ITR 329, 337.
32
Ram Kumar v UOI 252 ITR 205.
33
Section 6(2), Income Tax Act, 1961.
34
Khambhaty v CIT 61 ITR 30.
35
Erin v CIT 34 ITR 1 (SC); Re Sarupchand 13 ITR 245.
36
Shrigopal v CIT 119 ITR 980, 983.
37
San Paulo (Brazilian) Rly Co Ltd v Carter 2 TC 407, 410 (HL); CIT v Nandlal 40 ITR 1, 7 (SC).
38
Erin v CIT 34 ITR 1 (SC); Narottam v CIT 23 ITR 1, 7 (SC).
39
19 ITR 168.

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management and control is wholly outside India. Acts of actual control by a partner or karta
residing in India is proof of the firm or HUF being a resident of India. 40

6. Tests of residence for a Company:

Section 6 provides a test in the alternative to determine the residence of a company. A company
is a resident in the previous year if: (i) it is an Indian company, or (ii) the control and
management of its affairs is situated wholly in India in the accounting year. 41

Therefore, every Indian company is deemed to be a resident of India, even if its management and
control is situated outside, as per cl (i). A non-Indian company is considered resident only if it’s
control and management is situated wholly in India. A non-Indian company that is partially or
wholly situated outside India is to be considered a non-resident. 42

The test of control and management is similar to that for firms and HUFs. The place where
directors’ meetings are held is often considered an indication of the place of residence of the
company.43 The de facto exercise of power is what is relevant for the determination of residential
status. Since the place of control and management can change, so can the residence of a
company. A company that is considered a resident one year, can be considered a non-resident
the next. 44

Section 6 of the Income tax Act, 1961 provide for conditions in which residence in India is
determined in case of different category of persons. Section 6(3) deals with conditions to be
satisfied for a Company to be treated as resident in India in any previous year. Prior to the
introduction of the concept of POEM, a Company was said to be resident in India in any
previous year if it was an Indian company or during that year, the control and management of its
affairs was situated wholly in India. The Finance Act, 2015 amended the above provision so as
to provide that a Company would be resident in India in any previous year if it is an Indian
company or  its Place of Effective Management (POEM) in that year is in India. The POEM was
defined to mean a place where key management and commercial decisions that are necessary for
40
Erin v CIT 34 ITR 1 (SC); Mohammed v CIT 10 ITR 484.
41
Section 6(3), Income Tax Act, 1961.
42
Narottam v CIT 23 ITR 1, 7 (SC).
43
Narottam v CIT 23 ITR 1, 7 (SC); San Paulo (Brazilian) Rly Co Ltd v Carter 2 TC 407, 410 (HL).
44
Kanga, Palkhivala and Vyas, THE LAW AND PRACTICE OF INCOME TAX, 9th ed, p 357.

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the conduct of the business of an entity as a whole are in substance made. In order to bring
clarity about the applicability criteria of certain Income tax provisions, the concept of POEM
has been deferred for one year the same has been made applicable w.e.f. previous year 2016-17.

The concept of POEM is important to determine the residential status of a foreign company
operating in India. For Example, a foreign company fulfilling the conditions of POEM will be
deemed as Indian Resident and the global income of such foreign company is taxable in India.

A. Residential Status of Companies under the Income Tax Act, 1961: 

Section 6(3) of the Income tax Act, 1961 provides that a Company is said to be resident in India
in any previous year if:

 The Company is an Indian Resident; OR

 Its place of effective management, in that year, is in India.

Place of Effective Management (POEM) means a place where key management and commercial
decisions that are necessary for the conduct of business of an entity as a whole are, in substance
made. 

Analysis:

 In case the Company is registered under the Companies Act, 2013 or any other previous
Company law is termed as Indian Company and the principles of POEM are of no
relevance for such Company since an Indian Company is always an Indian Resident.

 Determination of whether the Place of Effective Management (POEM) is India for any
Company  is relevant for foreign company since the residential status will determine the
vicinity of income which will be taxable in India. For Example, in case of a foreign
company is having POEM in India, then the global income of such Company will be
treated as “taxable in India”.

 The percentage of tax rate will not be determined by the residential status but Company
needs to check whether it is a Domestic Company or not. In case the Company is a
Domestic Company (i.e. Indian Company or any other Company which has made
prescribed arrangements for declaration and payment of dividend within India), then the
lower rate of tax i.e. 30% or 29% or 25% (as the case may be will be levied) otherwise
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 the income will be taxable at higher rate of 40%. Needless to mention that the tax is
further increased by Surcharge and Cess as applicable.

 The POEM is required to be determined each year since the residential status is required
to be ascertained each year.

 Circular 8/2017 dated February 23, 2017 issued by CBDT has clarified that the
provisions of POEM will not be applicable to a Company having turnover of Rs. 50
crores or less in a financial year.

B. Guidelines determining POEM (whether in India):

General Principle:

The POEM 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.

Analysis:

 Conditions when POEM in India is not applicable to a Company:

o Company is engaged in active business outside India; and

o Majority of Board Meeting are held Outside India.

 Active Business Outside India:

A Company is said to be active business outside India if its passive income is not more than
50% of the total income of such Company and:

♦ Assets in India are < 50% of the total assets

(Assets will be taken as average of opening and closing);

♦ Employees in India < 50% of the total employees

(No. of employees will be taken as average of opening and closing);

♦ Payroll Expenses in India < 50% of the total payroll expenses.

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Passive Income means Income in relation to transactions of purchase and  sale with Associated
Enterprises (AEs) or Income generated from Royalty, Dividend, Interest, Rental or Capital
Gains. 

 It is to clarify that merely because the Board of Directors (BOD) follows general and
objective principles of global policy of the group laid down by the parent entity which
may be in the field of Payroll functions, Accounting, Human resource (HR) functions, IT
infrastructure and network platforms, Supply chain functions, Routine banking
operational procedures, and not being specific to any entity or group of entities per se;
would not constitute a case of BOD of companies standing aside and in such case also
the BOD are considered to be effectively managing the business of the Company.

 The Company needs to analyze the data of assets, no. of employees etc. in relation to the
relevant previous year and two years prior to that year in order to determine that
whether Company is having any active business outside India.

Specific Principles:

The Guidance further provides that  in cases of Companies other than those that are engaged in
active business outside India referred to in above, the determination of POEM would be a two
stage process, namely:

Stage 1: First stage would be identification or ascertaining the person or persons who actually
make the key management and commercial decision for conduct of the company’s business as a
whole (WHO TAKE THE DECISIONS).

Stage 2: Second stage would be determination of place where these decisions are in fact being
made (WHERE THE DECISIONS ARE IMPLEMENTED). 

IN CASE THE DECISIONS UNDERTAKEN BY THE COMPANY ARE IN INDIA (NOT

SUCH DECISIONS WHICH ARE OF ROUTINE NATURE TAKEN BY MIDDLE OR
LOWER LEVEL MANAGEMENT) AND SUCH DECISIONS TAKEN BY THE BOD OR
SENIOR MANAGEMENT HAVE ACTUALLY BEEN IMPLEMENTED IN INDIA, THEN
THE POEM SHALL BE CONSIDERED AS IN INDIA AND THE COMPANY WILL BE
DEEMED AS INDIAN RESIDENT. 

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C. EXAMPLES:
Example: 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 located 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,

 30% of income is from transaction where purchases are made from parties which are non-
associated enterprises and sold to associated enterprises;

 30% of income is from transaction where purchases are made from associated
enterprises and sold to associated enterprises;

 30% of income is from transaction where purchases are made from associated enterprises
and sold to non-associated enterprises; and

 10% of the income is by way of interest.

Solution: Since passive Income of the Company is less than 50% i.e. 40% of the total income of
such entity and both the assets and employees are working in country X, therefore the Company
is deemed to have active business outside India.

7. Tests of residence for Ordinary Resident:

For an individual to be considered a ‘not ordinarily resident’ she must be a non-resident for 9 out
of 10 previous years preceding that year, or must have lived in India for 729 days or less in the 7
years preceding that year.45 Therefore, to be an ordinary resident, the assessee must fulfill both
conditions, i.e. be a resident in India for 9 out of 10 years preceding the year, and has lived in
India for at least 730 days in the 7 years preceding that year. 46 If either condition is not fulfilled,
the person is a ‘not ordinarily resident’.

45
Section 6(6)(a), Income Tax Act, 1961.
46
Kanga, Palkhivala and Vyas, The Law and Practice of Income Tax, 9 th ed, p 359.

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 8. JUDICIAL INTERPRETATION

8.1 Union of India v. Azadi Bachao Andolan47

It was this confusion that arose in Azadi Bachao Andolan as well, as it was believed that the
McDowell case rejected tax planning. Accordingly, the court held that tax planning is legitimate,
and that McDowell was an exception to the law. The two cases were seen as conflicting
judgments on the same area, a position that was clarified in Vodafone.

These two cases are important from a ‘residence’ point of view, as in an attempt to reduce tax
liability, assessees may take shelter of the provisions of the law by diverting the transaction in a
manner that it falls outside the tax jurisdiction of India. Corporations are similarly set up to avoid
taxes. However, just because a nonresident sets up an intermediary entity to take advantage of
the law, the transactions entered into by the intermediary cannot be held to be invalid. Even if the
motive was to avoid taxes, the motive plays no role in determining the legality of
transactions.48The only situation where tax avoidance is problematic is when it falls outside the
framework of the law, by using colourable devices.

8.2 Vodafone International Holdings B.V. v. Union of India & Anr49

The concept of residence played an important role in this landmark judgment. The dispute was
over whether a transaction between two non residents for sale of shares of an Indian company
would be taxable in India.

Here, Vodafone International Holdings BV (non-resident entity) entered into an agreement with
Hutchison Telecommunications International Limited (non-resident entity) for the purchase of
CGP Holdings, a subsidiary of Hutch (situated in Cayman Islands). CGP owned approximately
66.9% in Huchison Essar, now Vodafone Essar, (Indian entity). The IT Department claimed that
as there was transfer of a controlling business situated in India, tax was payable in India.
Therefore, the question was whether the transaction can be deemed to arise in India, under
section 9.

47
(2004) 10 SCC 1.
48
Mathews George and Pankhuri Agarwal, ‘Use of the Corporate Vehicle for Tax Planning: The Vodafone Case and
Direct Taxes Code’ 3 NUJS L. REV. 201 (2010) 201,
49
(2012) 6 SCC 613.

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Section 9 of the IT Act provides that all income that arises from the transfer of a capital
assetsituated in India,is deemed to arise in India.50Here, there was no direct transfer of shares in
India, and the court held that the transaction could not be taxed in India.

Since CGP was situated outside India, the asset in the given case was held to not have significant
nexus with India. The source of the income is the place where the transaction takes place, all of
which was outside India.

The Supreme Court clarified that there is no conflict between McDowell and Azadi Bacaho
Andolan cases. Tax planning is a legitimate activity. The court upheld the ‘look at’ test, stating
that if a transaction is genuine, the court cannot look through it, to find an underlying substance.
As long as it’s within the framework laid down by the law, tax planning is not illegal. It did hold
that colourable devices for the same are not permissible, as it does not constitute tax planning.
Here, CGP was in place since 1998, and the transaction could therefore not be deemed a sham
transaction. It was not undertaken to avoid taxes.

Therefore, the offshore transaction between two nonresident entities falls outside the jurisdiction
of Indian tax law.

However, post- Vodafone, the legislature has amended the IT Act, which has overruled the
decision of Vodafone. Further, these changes have been drafted to be retroactive. Indirect
transfers are now covered under the provision of section 9, which makes the Vodafone judgment
bad law. Now, any transaction outside India, between foreign residents shall fall within the
jurisdiction of India, if the transaction has any effect on an asset situated in India..

However, it has been heldin Sanofi Pasteur Holding v. The Department Of Revenue 51that these
amendments do not override tax treaties. Therefore, if India has entered into a treaty agreement
with any other country, providing against double taxation, these amendments leave the treaty
provisions untouched.

9. CONCLUSION
Though the provisions laying out the tests to determine residential status is quite simple and
clear, tax issues arecomplex in reality. As seen through the three cases discussed, particularly the

50
Section 9(1)(i), Income Tax Act, 1961.
51
(2013) 354 ITR 316.

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high profile case of Vodafone, while determination of individual residential status is simple
enough, there are several externalities and other factors that increasingly complicate the issues.

The provisions of the IT Act are simple enough, and lay down the requirements for the three
categories of assessees. It also provides for conditions when the assessee is an individual, and
association of partners, or a company. The text requires a literal reading to understand the tax
liability of each category of assessees.

Every assessee will try to reduce his or her tax liability. However, in the process, they may cross
the law and take steps to evade tax. Setting up sham corporations is an example of using dubious
methods to evade tax. The law seeks to prevent this. While the law isn’t against tax planning, it
is certainly against using dubious methods to evade taxes.

These methods are going beyond the contours of the law, and are actually violating the law. The
first two cases, McDowell and Azadi Bacaho, both deal with the legality of tax planning. The
relevance of these cases to ‘residence’ is that since the statutory liability on a nonresident is the
lowest, most tax planning will be aimed at securing that status. However, in doing so, these cases
lay down that colourable devices cannot be legitimately used. Tax planning is legal, but tax
evasion is not. The Vodafone judgment is a real- world application of these principles. The
Indian tax authorities tried to bring a transaction between two nonresidents, taking place outside
India, within the ambit of Indian law. However, the Supreme Court held against this. The
government then went on to reverse this decision by passing retroactive amendments which
allow taxing foreign residents for a transaction outside India which has any bearing on assets
situated within India. This was to ensure that the Indian government does not lose out on large
amounts of tax from these types of transactions in the future.

However, this is extremely troubling for foreign investors, as it increases their liability, and in
turn, would deter them from coming anywhere near India. The Sanofi decision is the only relief
for these investors.

The concept of residence is extremely important, and can get very technical, as seen with these
cases. With a multitude of parties involved, the residential status of each, and the form of the
transactions need to be determined. This topic has far- reaching implications for foreign entities
who are party to transactions that are connected to India.

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 10.

BIBLIOGRAPHY

Books and Articles:

 Mathews George and Pankhuri Agarwal, ‘Use of the Corporate Vehicle for Tax
Planning”

 SP Gupta, ‘The McDowell Dictum- Vanishing Line between Tax Avoidance and Tax
Evasion’, (2003) 5 SCC (Jour) 15

 Vodafone Case and Direct Taxes Code’ 3 NUJS L. REV. 201 (2010) 201.

 Kanga, Palkhivala and Vyas, The Law and Practice of Income Tax, 9th ed

 V Venkatesan, ‘The Tax Avoidance Debate’, Frontline, Vol 29, Issue 5, Mar 10-23, 2013

 VK Singhania and K Singhania, Taxmann’s Direct Taxes Law & Practice, 46th ed

 Black’s Law Dictionary, 9th edn., 2009

 Kanga and Palkhivala, Law of Income Tax, 10th ed

 Sampath Iyengar’s, Law of Income Tax, 10th ed

 Arvind Dubey, Taxtion- Direct Tax, 1st Ed., Lexis Nexis

Websites:

 http://www.taxmann.com

 http://www.itatonline.org/

 http://www.frontline.in/

 http://www.thehindubusinessline.com/

 http://law.incometaxindia.gov.in/

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