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Meaning of passive income

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February 16, 2022

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4 mins read

Meaning of Passive Income

In order to ascertain if a company has a Place of Effective Management in India, the Meaning of passive income is an important criterion. A company shall be said to be engaged in ‘Active Business Outside India’ if amongst other conditions, its passive income is 50% (or less) of its total income.

Generally speaking about meaning, “passive income refers to income received on a regular basis, which requires minimal or no effort by the recipient, to maintain it.”

For the purpose of,  this clause, Passive income of a company shall be calculated as the sum  of : –

Income from the transactions,  where both the purchase, and the sale of goods is from/ to its Associated Enterprises. In this case, the transaction would be with an  Associated Enterprise.

NOTE : –

Income from sale of goods to Associated Enterprise will be considered as passive income only when goods are also purchased from Associated Enterprise.

  • Income by way of royalty, dividend, capital gains, interest or rental income. However, interest income of banking companies and public financial institutions  would not be regarded as passive income.

NOTE : –

Such income will be considered as passive income even if there is no involvement of associated enterprises.

Calculation of Income 

The question which arises is,  how should one calculate  income in ascertaining the meaning of passive income ?  There are various questions that needs to be considered, like : –

  • Whether one should consider the accounting or tax income ?
  • If one has to consider the tax income, which laws should be applied, i.e  whether the tax laws of India or the country of incorporation should be applied ?

For this purpose the jurisdiction has to be divided into two categories : –

  • Where the laws of the country of incorporation require separate computation for tax purposes – It means the income which is computed for tax purpose in accordance with the laws of the country of incorporation. FOR EXAMPLE:- In case of company, incorporated in USA, passive income will be computed as per the taxation laws of USA.
  • Where the laws of the country of incorporation do not require separate computation for tax purposes – Income will be taken as per the books of accounts.

For any queries, please write them in the Comment Section or Talk to our tax expert

Arinjay Jain

Bio of author

Arinjay is a Chartered Accountant with more than 20 years of post-qualification experience. He worked as Director, in the M&A Tax Division at KPMG in India. Presently, he is advising several MNCs in UAE on Economic Substance Regulations and impact of the UAE Corporate Tax Law on their business and clients across globe on International Tax issues . He is a well recognised Trainer of International Tax and UAE Corporate Tax. The areas of service include the following : - Advise and Compliance relating to International Tax Issues; Advise relating to UAE Corporate Tax Issues; Advise and Compliance relating to UAE Economic Substance Regulations; Advise and Compliance relating to Indian Income Tax Issues; Other connected matters from a Regulatory perspective.

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