Place of Effective Management Test in the Income Tax Act, 1961 : Is It the Right Way Forward?

The Finance Act, 2015 amended §6(3)(ii) of the Income Tax Act, 1961 to introduce a new test for determining the residential status of companies. The new test is called the ‘Place of Effective Management' test for interpretation of which, the Central Board of Direct Taxes has recently issued draft guidelines. This test replaces the erstwhile control and management test which has common law origins and was laid down in a context that best suited the interests of imperial powers. Looking closely at the workings of the erstwhile test and comparing it with the definition and draft guidelines on the Place of Effective Management test, it emerges that there is much similarity. Further, the government's justifications for making this amendment are on shaky ground which raises some fundamental concerns which need to be addressed first. ‘Place of Effective Management' does not have a universally accepted meaning and Organisation for Economic Co-operation and Development which does recognise the concept, has now recommended adopting a case-by-case approach to determine the residential status of companies to tackle tax avoidance. Alignment of the domestic law with the so-called international standard of Place of Effective Management (where it used as a tie-breaker rule in a number of Double Taxation Avoidance Agreements), would only reduce the tie-breaker rule of Place of Effective Management to naught