INTRODUCTION

The present case deals with the concept of the Residential Status of a company. Section 4A(C) of the 1922 Act which corresponds with section 6(3) of the 1961 Act, formerly provided that the company is a resident of India for taxable purposes if the Control and management of affairs is situated wholly in the taxable territory or if the income earned in the taxable territory exceeds the income arising without the taxable territory in that year.[1] The company is considered to be non resident, if the control and management of its business affairs is wholly or partly outside the India. By section 4 of the Finance Act, 1958 the clause was substituted by provisions which have now been adopted in section 6(3) of the Act. Later in the year 2015, the provision undergone a amendment through Finance Act 2015. According to the new amendment, the company to be a resident of India has to a Indian company or it should have its POEM in India for that assessment year.[2]  

• Control and Management 

The word Indian company has been defined in section 2(26) of the Act – “a company which is formed and registered under any law which is in force in India”.[3] Under the Act, even if the company is not an Indian company, it shall be treated as a resident of India for that year if the company satisfies the above-mentioned conditions. The control and management mentioned in the Act refers to the central power and authority and not carrying day to day business persay.[4]

It is defined as a place where the key management and commercial decisions that are necessary for the doing of business are taken.[5] To determine the company as a resident of India, it must be established that there is de facto exercise of control and management of its affairs within India. The word affairs within section 6(3) of the Act means which have some relation to income. Regarding control and management of the subsidiary, it will not always vest with the parent company.[6]

• Place of Effective Management

Under section 2(30) of IT Act, 1961 defines non resident companies and states if a corporation is not an “Indian company” and its “place of effective management” during that year is outside of India, then the status of the company would be non resident.[7] The guiding principles to determine the POEM. It is the place where a company board regularly meets and makes decisions provided that the board has the power to exercise the authority. If a foreign company whose turn over is more than RS 50 Crore and its POEM is in India then it is resident of India and if  a foreign company whose turn over is 50 crore or less than that then it is non resident in India.[8]

Let us see an illustration, there is a company named A&Co a Australian Company managed from India and the directors of the company A&Co are residents of India. The company will be resident of India if its control and management is wholly situated in India. If A&Co is an Indian company, then it will always be resident of India for the tax purposes

ANALYSIS OF NAROTTAM AND PAREKH LTD V COMMISSIONER OF INCOME TAX

• Facts of the case

The assessee company is a subsidiary company of the Scindia Steam Navigation Co. Ltd and it is carrying out its business of loading and unloading cargo to or from ship, commonly known as stevedoring in Ceylon (Sri Lanka). The company is registered in Bombay and its registered office is also situated in Bombay, India. Besides, the meetings of the Board of Directors and the meeting of the shareholders are also conducted in Bombay, India. 

• Issues

1. Whether the assessee company is a resident of India for tax purposes in the assessment years 1944-45 and 1945-46?
2. Whether the control and management of the assessee company is within the directors who are residing in Bombay, India?

• Contentions of the Appellant

1. It was argued on behalf of the appellant that a company will said to be control and manage at a certain place because the affairs of the company are carried on at that place, and carried by the people who are appointed by the company with management powers.
2. It was argued that since the business is carried out in Ceylon and the income which is in question is also, so the company is a resident of Ceylon.
3. It was contended by the counsel of the appellant that the power to look after its affairs was vested with the two managers in Ceylon. They had been conferred with the widest power under the “Power of Attorney”. The legal or judicial power was exercised by these two managers in Ceylon and actual control and management were exercised by two managers in Ceylon. So, the company cannot be said to be a resident of India. 
4. It was argued relying upon Bhimji Naik V Commissioner of Income-tax[9], that one has to consider “De Facto control and not De Jure control” while deciding the residential status of a company. It has to be seen who is exercising the actual control and management and not who has the right or capacity to exercise the control and management. The de facto control and actual management were being carried out by the managers in Ceylon. 
5. Further, the counsel for the appellant relied on the principles laid by Fazl Ali in Subbayya Chettiar V CIT[10]that the central control and management of a company can be divided, and the company may have businesses in more than one place and it may have two centers of control and management. But the important factor that one needs to take into consideration is where the “head and brain of the company lie”.
6. Furthermore, the counsel argued that the word affairs must mean the affairs which are relevant for IT Act, 1922 and has some relation with income. The majority of the income that is Rs. 3,28,108 is earned from the business done in Ceylon itself. The counsel argued that one has to consider the affairs of the company but not the business which is carried out by the company while determining the head and brain of a company.
7. It was argued that, to consider a company as a resident of India, the control and management of the company has to be wholly situated within the territory of the taxable country. But in this case, it cannot be said that the control and management were wholly within the territory of India. 
8. According to the appellant, the head, brain, and the affairs of the company were being carried out in Ceylon. So, the company is a resident of Ceylon and not a resident of India. Hence, it is not liable to be taxed as a resident of India under the Income Tax Act, of 1961.  

• Contentions on behalf of the respondent 

1. “Section 4A(c) of the 1922 Act” states that to determine the residential status of a company, one has to see whether the control and management of its affairs is wholly situated within the taxable territory. In this present case, the company is registered in India, its registered office is in Bombay, India and its control and management is wholly situated in India. So, the company is a resident of India. 
2. It is argued on behalf of the respondent that the minutes of the Board meetings also show that the control and management are in India.
3. It is argued that the power of attorney vested with managers does not confer full control and authority on them. It is not the case that the company had nothing to do with authority and left it some agency. Still, the company in Bombay has the power of control and management.
4. It is argued that both De facto control and management of the company are in Bombay. 
5. The test of determining the residential status of a company is to see where its head and brain lie. The same lies in Bombay and not in Ceylon. So, the company is a resident of India.

• Reasoning given by the High Court

The court held that,

To determine the residential status of a company, it is necessary to see whether “the control and management of the affairs is situated wholly in taxable territory or not Or its income earned in taxable territory should exceed its income without the taxable territory.” The court observed that the present case does not fall in the second category because the income earned in the Indian territory is RS 3,791, whereas the income earned outside the territory of India is RS 3,28,108.[11] So, the question for determination is where the control and management of the affairs of the company situated.  

The word wholly in the provision indicates that the “control and management of the affairs should be situated wholly in the taxable territory” and if any part of the control and management of affairs is situated outside the territory of India then the company cannot be said to be resident of India. The court observed that the contention raised by the petitioner that since the business is carried out and income which is liable to be taxed is earned in Ceylon, the company is resident of Ceylon has no merit. Because it was not the intention of the legislature to determine the residential status based on the place of business and where the income is earned. But, the legislature had mentioned the words, control and management and the words do not mean carrying on day to day business by the agents. 

The real test to see where the controlling and directing power lies, is to determine where the head and brain lie. The court held that a company may have a dozen or more local branches which are located in different places outside India. For each branch, an agent will be appointed by the principal company and such agent will be conferred with full power and authority to carry out the business in that branch. Yet, the control and management can be retained with the principal company. We cannot say that since the agents were authorized to carry out business in different places, the company is a resident of all those places. 

Further, it was argued that since two managers were conferred with the widest power possible through POA, the company is a resident of Ceylon. The court did not find any merit in this contention. The court held that it is true that the power was conferred with managers to carry on business but doing business does not constitute controlling and managing powers. The POA can be canceled at any time and even though the managers are carrying business in Ceylon, a vigilant eye in Bombay is always observing the acts of the managers. The court held that the counsel of the petitioner is correct in holding that it is De facto control and management that has to be considered and not De Jure. One has to see whether there is actual control and management and not whether there is a right to control and manage. This is not a case where the company has conferred all its power to control and manage on the agent. It is observed that the company still has actual power to control and manage its affairs. So, the court held that the de facto control is still vested in Bombay.

The court held that to determine the “head and brain”, we are not concerned with all other work that a company does except the business that yields income. Finally, it held by applying the test of head and brain concerning particular business that the head and brain lie in Bombay and not in Ceylon.

• Decision of the court

The court held that the test for determining the residential status of a company is where the control and management lie. Further, control and management is not merely a theoretical power but an actual exercise of control and management. To be precise, “it is defacto control and not de jure control and management”. Further, it held that the most important test is to see where the head and brain of the assessee company lies. The managers in Ceylon were acting under the control and management of the company and it is not the case where the assessee company in Bombay does not retain any power so, “there is not only de jure control but also a de facto control and management” which is being exercised by the company in Bombay. The control and management was being carried out by the Board of Directors in Bombay. 

The court held that to determine where the head and brain lie, it is not considered with any other work that the company does, except the business which yields profits. Even after considering the stevedoring business in Ceylon, the court held that the Head and Brain of the company about the business is in Bombay and not in Ceylon. The questions were answered in the affirmative. The assessee company is a resident of India for tax purposes during the assessment years 1944-45 and 1945-46.

• Analysis of the rule of construction adopted in the case 

The use of the word Wholly before the control and management indicates that the company in order to be a resident of India, the control and management has to be situated wholly in India itself. If not, or any part is situated outside the territory of India then the company is not a resident of India. This condition is different from the other provisions dealing with the concept of residence. A clear distinction was drawn between the residential status of Hindu Undivided Family, firms, and other associations of persons on one side and company on the other side. Concerning the former under section 6(2) of the Income Tax Act of 1961, a HUF, firm, or association of persons will be a resident of India if its control and management of its affairs is wholly or partly situated in India. But whereas under section 6(3) of the IT Act, 1961 for companies, the control and management should be wholly situated in India. It shows that the legislature intended to take a strict approach when it comes to the residential status of the company. 

It was correctly identified by the court that, it is the de facto control that needs to be considered and not the de jure control. One should see the fact where the actual control and management of the country is being exercised and not the fact of who has the right to control and management. The sole test of determination of residence of a company is where the control and management of the company lies. After the amendment to section 6(3)(ii) through the Finance Act, 2016, the provisions of the residential status of the company have undergone change and the words control and management were replaced “with Place of Effective Management”. If a company has its place of POEM in India then it shall be considered as resident of India for the tax purposes. 

References:

[1] Income Tax Act 1961, s 6(3).

[2] Dr. Jyoti Rattan, Taxation Laws (Raman Kumar Sharma 14^th edn 2022) 54.

[3] Income Tax Act 1961, s 2(26).

[4] Income Tax Act 1922, s 4A(c).

[5] Income Tax Act (Taxmann 62^nd edn 2018).

[6] K. Chaturvedi, S.M. Pithisaria Income Tax Law (M.K Pithisaria, Abhishek Pithisaria 8^th edn 2024).

[7] Rishi Pandey, ‘Residential Status of Firm and Company’ (Live Law, 4 January 2023) <https://www.livelaw.in/columns/income-tax-act-residential-status-assessee-partnership-firm-company> accessed 15 February 2024.

[8] ‘Residential Status of a Company and Tax Incidence under Income Tax Act’ (Taxmann, 28 November 2023) <https://www.taxmann.com/post/residential-status-of-company-and-tax-incidence-under-income-tax-act/> accessed 16 February 2024.

 

[9] Bhimji Naik V Commissioner of Income-tax, AIR 1945 Bom 271.

[10] Subbayya Chettiar V CIT,  1951 AIR 101.

[11] Narottam and Parekh Ltd V Commissioner of Income Tax, AIR 1954 BOMBAY 67.