Chapter X of the Income-tax Act contains the provision to check there is no profit shifting by the MNCs. to the group located in tax heaven jurisdiction. As a part of this chapter, rudiments of Transfer pricings are contained in 92 to 92F of the Act.
The provision of the transfer pricing gets trigger only when there is firstly an “International Transaction” and secondly that these transactions are with the “Associated Enterprises”. So, it become very important to decode the meaning of the term “associated enterprise” to check the applicability of the Transfer pricing provisions in a situation.
This article summarized various and important judgements in respect of the meaning of “Associated Enterprises”.
Meaning of Associated Enterprises as contained in Section 92A
The section 92A of the Income-tax Act, defines AE as below:
“ 92A. (1) For the purposes of this section and sections 92, 92B, 92C, 92D, 92E and 92F, "associated enterprise", in relation to another enterprise, means an enterprise—
(a) which participates, directly or indirectly, or through one or more intermediaries, in the management or control or capital of the other enterprise; or
(b) in respect of which one or more persons who participate, directly or indirectly, or through one or more intermediaries, in its management or control or capital, are the same persons who participate, directly or indirectly, or through one or more intermediaries, in the management or control or capital of the other enterprise.
(2) For the purposes of sub-section (1), two enterprises shall be deemed to be associated enterprises if, at any time during the previous year; -
(a) one enterprise holds, directly or indirectly, shares carrying not less than twenty-six per cent of the voting power in the other enterprise; or
(b) any person or enterprise holds, directly or indirectly, shares carrying not less than twenty-six per cent of the voting power in each of such enterprises; or
(c) a loan advanced by one enterprise to the other enterprise constitutes not less than fifty-one per cent of the book value of the total assets of the other enterprise; or
(d) one enterprise guarantees not less than ten per cent of the total borrowings of the other enterprise; or
(e) more than half of the board of directors or members of the governing board, or one or more executive directors or executive members of the governing board of one enterprise, are appointed by the other enterprise; or
(f) more than half of the directors or members of the governing board, or one or more of the executive directors or members of the governing board, of each of the two enterprises are appointed by the same person or persons; or
(g) the manufacture or processing of goods or articles or business carried out by one enterprise is wholly dependent on the use of know-how, patents, copyrights, trade-marks, licences, franchises or any other business or commercial rights of similar nature, or any data, documentation, drawing or specification relating to any patent, invention, model, design, secret formula or process, of which the other enterprise is the owner or in respect of which the other enterprise has exclusive rights; or
(h) ninety per cent or more of the raw materials and consumables required for the manufacture or processing of goods or articles carried out by one enterprise, are supplied by the other enterprise, or by persons specified by the other enterprise, and the prices and other conditions relating to the supply are influenced by such other enterprise; or
(i) the goods or articles manufactured or processed by one enterprise, are sold to the other enterprise or to persons specified by the other enterprise, and the prices and other conditions relating thereto are influenced by such other enterprise; or
(j) where one enterprise is controlled by an individual, the other enterprise is also controlled by such individual or his relative or jointly by such individual and relative of such individual; or
(k) where one enterprise is controlled by a Hindu undivided family, the other enterprise is controlled by a member of such Hindu undivided family or by a relative of a member of such Hindu undivided family or jointly by such member and his relative; or
(l) where one enterprise is a firm, association of persons or body of individuals, the other enterprise holds not less than ten per cent interest in such firm, association of persons or body of individuals; or
(m) there exists between the two enterprises, any relationship of mutual interest, as may be prescribed.”
From the plain reading of the section 92(1) one can interpret that the two enterprises are related in case one enterprise participates in the management, control, capital of the other enterprise directly, indirectly or through one or more intermediaries.
And as we go further to read section 92(2) then one can understand that the two enterprises can be deemed to the “Associated Enterprises” in case the any of condition specified in clause (a) to (m) contained in this subsection is satisfied.
Also, it is pertinent to note the memorandum to Finance Bill, 2002 has explained the amendment made to the section 92(2) by FA 2002. The relevant text of the memorandum is reproduced as below:
“It is proposed to amend sub-section(2) of the said section to clarify that the mere fact of participation of one enterprise in the management or control or capital of the other enterprise or the participation of one or more persons in the management or control or capital of both the enterprises shall not make them associated enterprise unless the criteria specified in sub-section (2) are fulfilled.”
From the reading above the following queries emerges: -
i. If the two enterprises satisfy the condition of section 92(1) of the Act, can they be termed as the associated enterprises irrespective of the fact that none of conditions mentioned in section 92(2) are being satisfied? or
ii. If the two enterprises satisfy the condition of section 92(2) of the Act, can they be termed as the associated enterprises irrespective of the fact that none of conditions mentioned in section 92(1) are being satisfied? or
iii. For the enterprises to be termed as associated enterprises, the conditions mentioned in both section 92(1) and section 92(2) should be satisfied?
The above issues can be examined in the light of the following judicial judgements:
1. Veer Gems: - The Ahmedabad Bench of the Income-tax Appellate Tribunal in Veer Gems, interpreted 92A (2) to be exhaustive illustrations of participation in management, capital or control as envisaged in Section 92A (1) of the Act. The Tribunal held that, where one enterprise satisfies the condition of Section 92A (1) due to there being de facto or de jure participation in management, capital or control by one of the enterprises in the other enterprise, the two enterprises do not become AEs, unless the conditions specified in Section 92A (2) of the Act are satisfied. The Tribunal further held that Section 92A(1) and (2), in that sense, are required to be read together, even though Section 92A(2) does provide several deeming fictions which prima facie stretch the basic rule in Section 92A(1) quite considerably on the basis of, what appears to be, manner of participation in "control" of the other enterprise. This order of the tribunal was upheld by the Gujrat High Court. Also, the SLP against the said approval has been rejected by Hon’ble Supreme Court in the judgment reported as PCIT Vs Veer Gems [(2018) 95 taxmann.16].
2. Obulapuram Mining Co. (P.) Ltd.
The Assessing Officer held that GLATIPL was an AE of the assessee company as per section 92A on basis that ‘J’, a director of the assessee company, was appointed as a director of GLATIPL on 19.12.2007 and thereafter, on 21.12.2007, the entire share capital of GLATIPL being only one share of the value of 1 Singapore Dollar was transferred to GLATIPL registered in the isle of MAN and ‘J’ was one of the directors of that Co. also i.e. (GLATIPL). Subsequently, said share of GLATIPL was transferred by GLATIPL to ILSGL. The assessee submitted that even if the allegation of the A.O. was accepted that GLAITPL was an AE of the assessee for this reason that ensure share capital of GLAITPL was transferred to GLATIPL on 21.12.2007, then also it was an AE of the assessee for two days only because the said one share of GLATIPL was transferred by GLATIPL to ILSGL on 22.12.2007 and with this company or its directors, the assessee company or its directors had no relationship. Held that for the purpose of sub-section (1) of section 92A, at least one condition out of 13 conditions prescribed in sub-section (2) as per clauses (a) to (m) has to be satisfied. Since the only one share of GLATIPL was held by ILSGL and the assessee company or its directors were not holding any share in that company and none of the directors of the assessee-company was a director of ILSGL, none of the conditions specified in sub-section (2) of section 92A was satisfied. Since the parameters laid down in sub-sections (1) and (2) of section 92A were not fulfilled, there was no relationship of AE between the assessee-company and GLATIPL and therefore, the provisions of Chapter X of the Act had no application.
3. Page Industries Limited:
Background: The taxpayer was engaged in the manufacturing and sale of ready-made garments. The taxpayer licensed the brand name ’Jockey’ for exclusive manufacturing and marketing of Jockey readymade garments to Jockey International Inc. USA (‘JII’).
Assessment Proceeding: The TPO by using the bright line test method made an adjustment of INR 20 crores (approx.) on the advertisement expenditure incurred by the taxpayer.
DRP Proceedings: In DRP the taxpayer contended tax the adjustments made by the TPO are grossly wrong since the transaction of the taxpayer with JII is not the international Transactions as because the JII is not the AE of the taxpayer. The taxpayer contented that since none of the conditions specified under section 92(1) existed between the JII and taxpayer, they cannot be said to be the AE.
However, on the other hand the department contended since the condition specified under clause g of section 92(2) existed between the JII and the taxpayer therefore the transaction should have complied with the Arm’s length principle. Accordingly, DRP upheld the adjustments made by the TPO.
The ITAT has decided the matter as follows: -
a. The taxpayer was merely a licensee of the brand name and owned the entire manufacturing facility, capital and employees by itself. Further, there was no participation of JII in taxpayer’s management, capital or control of the taxpayer. Considering the memorandum mentioned above, ITAT emphasized that on the face, it appears that requirements of both sub-section (1) and (2) have to be met for constitution of AEs.
b. Where two provisions of a statute exist then while interpreting law preference should be given to the one whose principle stands effective without making the other provision redundant. Drawing inference to this case if one were to conclude that the taxpayer and JII were indeed associated under section 92A(2) then provision of section 92A(1) would become superfluous.
ITAT ruling: It was held that since the taxpayer and JII do not meet the parameters laid down in section 92(A)(1) they cannot be constituted as AEs and accordingly provisions of Chapter X do not get invoked.
4. Kaybee Private Limited
Brief Fact of the Case:
The Kaybee Private Limited is an Indian company and 99.9% of its shareholding is held by a person by the name of Govind Karunakaram (GK). The assessee had certain business transactions, which admittedly fall in the definition of ‘international transactions’, with a Singapore based entity by the name of Kaybee Exim Pte Ltd (KE- S, in short). GK is also one of the three directors in KE-S. It was also noted by the Assessing Officer that KE-S website shows the assessee company as a “representative company”. It was in this backdrop that the Assessing Officer observed that under section 92A(1)(b) “an associated enterprise, in relation to another associated enterprise, means an enterprise in respect of which one or more persons who participate, directly or indirectly or through one or more intermediaries, in its management or control or capital of the other enterprise”. As regards plea of the assessee that relationship between the assessee company and KE-S does not satisfy the conditions laid out in section 92A(2), and, therefore, the assessee and KE-S cannot be treated as AEs, the Assessing Officer observed that “sub section (2) [of section 92A] does not negate the provisions of section (1) [of section 92A]”. In other words, according to the learned Assessing Officer, the provisions of Section 92A (1) are required to be read on standalone basis rather than in conjunction with Section 92A (2). The assessee and KE-S were thus held to be AEs. Aggrieved, assessee carried the matter in appeal before the CIT(A) but without any success. The assesse being aggrieved with order of CIT(A) filed further appeal before ITAT.
Since in the “for the purpose of Section 92A(1)” were inserted in Sub Section 92A(2) with a specific purpose, as unambiguously set out in the Memorandum to the Finance Bill 2002, to the effect “It is proposed to amend sub-section (2) of the said section to clarify that the mere fact of participation by one enterprise in the management or control or capital of the other enterprise, or the participation of one or more persons in the management or control or capital of both the enterprises shall not make them associated enterprises, unless the criteria specified in sub-section (2) are fulfilled”. This aspect of the matter is further evident from the CBDT circular no. 8 of 2008 which states that “the Finance Act, 2002, has amended sub section (2) of section 92A to clarify that where any of the criterion specified in sub section (2) is fulfilled, two enterprises shall be deemed to be associated enterprises” (emphasis supplied by us now). The only insertion in section 90A (2) was of the words “for the purposes of sub section (1)” of Section 92A, which thus restricted the scope of section 92A (1). Except for these words, all the provisions of Section 92A (2) were anyway there prior to amendment as well. The clarification was possible only on this restriction on section 92A (1).
The extract of the ruling pronounce by ITAT is as follows: -
“In view of the above discussions, as also bearing in mind entirety of the case, we have to hold that the relationship between the assessee and the KE-S was not of the AEs, and, accordingly, no arm’s length price adjustments could be made on the transactions between these two entities. Ground no. 3 is thus allowed, and, as a corollary thereto, the impugned ALP adjustment must, therefore, be deleted for this short reason alone. Ordered, accordingly.”
Interplay of the Tax treaties:
India’s tax treaties are based on both UN Model and OECD Model, with importance to source- based taxation. Article 9 of OECD and UN Model conventions, which deal with AE, is virtually identical in both model conventions. The scope of Article 9 under both the model conventions extends only to enterprise which participates directly or indirectly in the management, control or capital of an enterprise of the other contracting state. It is germane to note that treaties do not provide for illustrations or circumstances, deeming certain relationship to constitute AE. Accordingly, even if relationship of AE exists on the basis of application of any of the clauses of Section 92A(2) of the Act, it can be argued that by virtue of application of the treaty, unless there is actual participation in control, capital or management by enterprise into another, the transacting enterprises cannot be regarded as AE, applying the treaty law.
Based on the analysis of above judgements read along with CBDT Circular 8 of 2008 and memorandum to the Finance bill 2002, one can conclude that the Sections 92A (1) and 92A (2) are to be read together and conjunctively. Besides the specific conditions laid down in sub-section (2), the condition of participation in the control, capital, and management of an enterprise by another enterprise should be independently satisfied in order to treat the two enterprises as AE of each other. Additionally, even the treaty law mandates the condition of actual participation in control, capital, and management for invoking the transfer pricing provisions.