CA Ganesh Rajgopalan Intensive Workshop on Transfer Pricing JB Nagar CPE Study Circle jointly with...

Associated EnterprisesCA Ganesh Rajgopalan

Intensive Workshop on Transfer PricingJB Nagar CPE Study Circle jointly with the WIRC

26th October, 2012

CA Ganesh Rajgopalan 2

Transfer pricing provisions◦ International transactions◦ Specified domestic transactions

Associated Enterprises

October 26, 2012


Association for International Transactions

October 26, 2012


Relevance for International transactions

Whether AE?

International Transaction?

TP provisions apply

October 26, 2012


“For the purposes of this section and sections 92, 92C, 92D and 92E, "international transaction" means a transaction between two or more associated enterprises, either or both of whom are non-residents, in the nature of purchase, sale or lease of tangible or intangible property, or provision of services, or lending or borrowing money, or any other transaction having a bearing on the profits, income, losses or assets of such enterprises,….” [Sec. 92B] Characteristics-◦ a transaction ◦ Between two or more AE◦ At least one of whom is a NR

Excluded-◦ Transactions between non-AEs

transaction presumed at arm’s length◦ Transactions between AEs where both (all) are residents

Transactions between foreign PEs of Residents?◦ Non-business transactions?

Between individuals/HUF

Meaning of international transaction

October 26, 2012


A person (including a permanent establishment of such person) Engaged-◦ In any specified activity, or◦ in investment, or providing loan or ◦ in business of acquiring, holding, underwriting or dealing with securities

whether such activity or business is carried on, directly or through one or more of its unit/divisions/subsidiaries, or

whether such unit/division/subsidiary located at the same or different place

Enterprise defined –Sec. 92F(iii)

October 26, 2012


In common parlance-

◦ Economic activity capable of producing profits◦ Exercised in an independent manner◦ Consisting of well defined actions◦ Having economic character

Enterprise and business -synonymous “Engaged in” –

◦ connotes doing more than one act,

◦ continuity of action “Enterprise” signifies activity as also the organisation Person and enterprise distinct terms

◦ Personal investments not amounting to business whether enterprise?◦ Personal transactions whether covered?

Enterprise

October 26, 2012


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.

October 26, 2012

Associated Enterprise- general rule

http://www.taxmann.com/directtaxlaws/fileopen.aspx?Page=act&htmlfile=D://TaxmannDataStore_IntTax//Files//Act//DirectTaxLaws//ITACT//HTMLFiles//2012//section92.htm

http://www.taxmann.com/directtaxlaws/fileopen.aspx?Page=act&htmlfile=D://TaxmannDataStore_IntTax//Files//Act//DirectTaxLaws//ITACT//HTMLFiles//2012//section92b.htm

http://www.taxmann.com/directtaxlaws/fileopen.aspx?Page=act&htmlfile=D://TaxmannDataStore_IntTax//Files//Act//DirectTaxLaws//ITACT//HTMLFiles//2012//section92c.htm

http://www.taxmann.com/directtaxlaws/fileopen.aspx?Page=act&htmlfile=D://TaxmannDataStore_IntTax//Files//Act//DirectTaxLaws//ITACT//HTMLFiles//2012//section92d.htm

http://www.taxmann.com/directtaxlaws/fileopen.aspx?Page=act&htmlfile=D://TaxmannDataStore_IntTax//Files//Act//DirectTaxLaws//ITACT//HTMLFiles//2012//section92e.htm

http://www.taxmann.com/directtaxlaws/fileopen.aspx?Page=act&htmlfile=D://TaxmannDataStore_IntTax//Files//Act//DirectTaxLaws//ITACT//HTMLFiles//2012//section92f.htm


Sub-section (1)(a)◦ An enterprise ◦ which participates◦ Directly or indirectly or through intermediaries ◦ in management or control or capital of another enterprise

Sub-section (1)(b)◦ One or more persons ◦ participates◦ Directly or indirectly or through intermediaries ◦ in management or control or capital of two enterprises

Refers not to a transaction/business but to the enterprise itself “Participate” – to take part “Directly or indirectly”

Associated enterprise-Sec. 92A(1)

October 26, 2012


Sec. 92A(1)(a) Sec. 92A(1)(b)

Basic rule- Sec. 92(A)(1)

A

B

C

A

BD

EC

AEsA-BB-CA-C

AEsC-DC-E

October 26, 2012


Deemed instances [sub-section (2)]◦ By reason of

substantial holding of voting power substantial lending substantial functional involvement Control/interest

Does not create a fiction◦ Only includes what is obvious when one enterprise in a position to control the other

At any time during the year Condition absent in sub-section (1) Whether AE for period before condition is satisfied or after condition ceases?

Essential condition for AE? Owning one share – participation in capital?

Deeming criteria-Sec. 92A(2)

October 26, 2012


Amendment vide Finance Act 2002 Memorandum explaining the provisions of Finance Bill

“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.”

Note on Clauses◦ “Clause 38 seeks to amend section 92A of the Income-tax Act relating to meaning of

associated enterprise.It is proposed to amend the said sub-section (2) so as to insert the words “For the purposes of sub-section (1)”. The proposed amendment is of clarificatory nature.”

CBDT Circular◦ Example about 100% of non-voting capital-not an AE

Sec. 92A(1) & (2) - Interplay

October 26, 2012


Memorandum • not an external aid for construction?

• “usually not an accurate guide of the final Act… In the Explanatory Memorandum, headings are fairly wide and matters collected under the same heading may be diverse not giving a true indication of the object of the legislation” [Shashikant Laxman Kale v Union of India (1990) 185 ITR 104 (SC)]

Whether deeming criteria mandatory or circumscribed by Sub-sec. (1)

Bank lending to an enterprise without participation in management, control or capital

Sanchez Capital Services [26 taxmann.com 61]

Sec. 92A(1) & (2) - Interplay

October 26, 2012


Facts-

◦ Assessee subsidiary of FCo. ZCo (which was 20% shareholder) was shown as AE in Form 3CEB for the past three years. Adjustment made in AY 2008-09.

Revenue’s contentions-◦ shareholding structures and relationships between Z and F groups remain

unexplained◦ No minimum threshold prescribed; even 1% shareholding participation sufficient◦ When two enterprises AE u/s 92A(1), no need to consider deeming provisions in

s.sec (2) Assessee’s contentions

◦ submitted Form No.3CEB by way of abundant precaution◦ sub-section 1 & 2 to be read together to identify whether AE relationship exists;

Memorandum explaining the provisions in the Finance Bill, 2002 relied on Ruling

◦ Just filing Form 3CEB cannot result in these two as AEs unless sec. 92A are satisfied◦ Detailed explanations given how these provisions [sec. 92(2)] not applicable. ◦ However, not clear from records whether there is any relationship as prescribed

u/s 92A(1)(a)(b). Hence remanded.

October 26, 2012

Sanchez Capital Services [26 taxmann.com 61]


“(a) one enterprise holds, directly or indirectly, shares carrying not less than twenty-six per cent of the voting power in the other enterprise;

(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”

Deeming criteria- Control through voting power

Directly or indirectly ◦ Registered holder or beneficial owner

Indirectly – ◦ Proportionate?

Convertible instruments◦ Potential equity interest to be considered?

Voting power-◦ May not apply to non-corporate entities

A

B

C

60%

40%

October 26, 2012


“(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 (receiving) enterprise;

(d) one enterprise guarantees not less than ten per cent of the total borrowings of the other enterprise;”

Lender participation in management or control or capital required? Percentage

◦ at the time of advancing of loan or at any time the loan subsists Total assets not defined

◦ Fixed assets at gross or net block◦ Revalued amount in books or historical cost◦ Net of current liabilities or otherwise◦ Deferred revenue expenditure/ P & L debit

Guarantee◦ Performance guarantee◦ Guarantee relating to trade payables

Deeming criteria- Control through funding

October 26, 2012


(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;

(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;

Actual appointment relevant, not power to appoint Only year of appointment or later years?◦ Instances where JV partners take turns in appointing ED◦ Where the Board strength undergoes change

Appointing CEO/top executives whether covered? Applies to entities other than companies

Deeming criteria- Control through management

October 26, 2012


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;

Also covers services Whether enterprise carrying on single activity or multiple activities Whether activity for which IPR, etc is used is primary activity Whether IPR owner participates in management or control◦ appointment of strategic personnel

Deeming criteria- Control through operations

October 26, 2012


(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;(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;

Does not apply to services Global supply contracts with third party supplies covered Price & other conditions influenced how determined No percentage stipulated for goods sold

Deeming criteria- Control through operations

October 26, 2012


(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; (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; (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;

No percentage specified in (j) & (k) One person (non-individual) controlling two enterprises◦ Clause (k) & (l)

Control- ◦ Management /operational/ownership control?◦ “interest” implies ownership

Deeming criteria- Control /Interest

October 26, 2012


(2) A transaction entered into by an enterprise with a person other than an associated enterprise shall, for the purposes of sub-section (1), be deemed to be a transaction entered into between two associated enterprises, - if there exists a prior agreement in relation to the relevant transaction between such other person and the associated enterprise, or - the terms of the relevant transaction are determined in substance between such other person and the associated enterprise.

October 26, 2012

Transactions between unrelated parties


B is interposed and the terms of the transactions are determined between AE2 and B. U/s 92B(2), AE1 and B are AEs.

Global sourcing arrangements

Transactions between unrelated parties

AE2

B

AE1

October 26, 2012

Sale at 30 days credit

Sale at 365 days credit


Association for Specified Domestic Transactions

October 26, 2012


Does not cover all domestic transactions Coverage◦ Sec. 40A(2)(b)◦ Sec. 80A◦ Sec. 80(IA) ◦Other provisions of Chapter VIA

Sec. 80-IAB, 80-IB, 80-IC, 80-ID, 80-IE◦ Sec. 10AA◦Other transactions prescribed

Specified domestic transaction

October 26, 2012


Transactions with non-residents covered?◦ For instance, A Ltd holds shares of B Ltd carrying 21% voting

power

For the purposes of this section and sections 92, 92C, 92D and 92E, "international transaction" means a transaction between two or more associated enterprises, either or both of whom are non-residents..….[S. 92B]

For the purposes of this section and sections 92, 92C, 92D and 92E, "specified domestic transaction" in case of an assessee means any of the following transactions, not being an international transaction…[S. 92BA]

Specified domestic transaction

October 26, 2012


Expenditure incurred between associates which is excessive or unreasonable having regard to ◦ Fair market value of goods, services or facilities (no disallowance if ALP), or ◦ legitimate needs of the business (Disallowance possible even if ALP) or ◦ benefit derived or accruing therefrom (Disallowance possible even if ALP).

Does not cover income of the taxpayer◦ Durga Rice & Gen Mills vs. AO [TS-446-ITAT-2012 (Chandi)]

Capital expenditure – applicability Deductions in respect of which heads of income

◦ Deduction u/s 57 – applicability [s. 58(2)] Substantial interest defined-

◦ Beneficial owner of shares carrying not less than 20% voting power◦ Beneficially entitled to not less than 20% of profits of business

Direct interest only covered Relative defined

Any expenditure -Sec. 40A(2)

October 26, 2012


Beneficial owner vs. indirect holding

Sec. 40A(2) – substantial interest

A

B

C

A

BD

EC

October 26, 2012

A-B - YB-C - YA-C - N

A-D - YD-E - YB-D - YC-D - NC-E - N


Taxpayer Payee Clause of s. 40A(2)(b)

Individual Relative (i)Company Director/relative (ii)Firm Partner/relative (ii)AOP Member/relative (ii)HUF Member/relative (ii)Any assesse carrying on business or profession

Individual who has substantial interest in assessee’s business

Relative

(iii)

Any assesse carrying on business or profession

Company having SI in assessee’s business or its director or relative of director Another company carrying on business or

profession where the first co. has SI.

(iv)


Firm/AOP/HUF having substantial interest in assessee’s business or

its partner/member or their relative

(iv)

October 26, 2012

Association -Sec. 40A(2)


Taxpayer Payee Clause of s. 40A(2)(b)


If such individual is director/partner/ member of company/ firm/AOP/HUF,

Such a company/firm/ AOP/HUF Directors/partners/members Their relatives

(v)

Individual A person in whose business assesse or his relative has substantial interest

(vi)(A)

Company A person in whose business assesse-co. or its director or relative has substantial interest

(vi)(B)

Firm/AOP/HUF A person in whose business assesse-firm/AOP/HUF or its partner/member or relative has substantial interest

(vi)(B)

October 26, 2012

Association -Sec. 40A(2)


Sec. 2(41) Sec. 56(2)(vi) Expln Sec. 6, Companies Act AS 18 Not specified Member of HUF Member of HUF Not specifiedSpouse Spouse Spouse SpouseFather Father Father FatherMother Mother Mother (including step-mother) MotherSon Son Son (including step-son) SonDaughter Daughter Daughter (including step-daughter) DaughterFather’s father Father’s father Father’s father Father’s mother Father’s mother Father’s mother Mother’s mother Mother’s mother Mother’s mother Mother’s father Mother’s father Mother’s father Son’s son Son’s son Son’s son Son’s daughter Son’s daughter Son’s daughter Daughter’s son Daughter’s son Daughter’s son Daughter’s daughter

Daughter’s daughter Daughter’s daughter

Brother Brother Brother (including step-brother) BrotherSister Sister Sister (including step-sister) Sister

October 26, 2012

Relative defined


Sec. 2(41) Sec. 56(2)(vi) Expln Sec. 6, Companies Act AS 18

Not specified Member of HUF Member of HUF Not specified

Father’s father Father’s father Father’s father

Father’s mother Father’s mother Father’s mother

Mother’s mother Mother’s mother Mother’s mother

Mother’s father Mother’s father Mother’s father

Son’s son Son’s son Son’s son

Son’s daughter Son’s daughter Son’s daughter

Daughter’s son Daughter’s son Daughter’s son

Daughter’s daughter Daughter’s daughter Daughter’s daughter

Brother or sister of spouse

Brother/sister of either parents of the individual

Lineal ascendant/ descendant of spouse

Spouse of brother or sister

Brother’s wifeSister’s husband

Spouse of brother/sister of spouse

Spouse of brother/sister of either parents

Spouse of any lineal ascendant/ descendant

Son’s wife, Daughter’s husband, Son’s son’s wife, Son’s daughter’s husband, Daughter’s son’s wife, Daughter’s daughter’s husband

Spouse of any lineal ascendant/ descendant of spouse

October 26, 2012

Relative defined (contd.)


Whether applies to govt companies where President of India or Governor of a State holds majority of shares and exercises or controls voting rights

Where the registered shareholder does not hold the beneficial interest in the shares

Whether payment of expenditure to a subsidiary covered◦ Held not covered under clause (iv) of Sec. 40A(2)(b) [V.S. Dempo & Co. (P.) Ltd.

[2011] 196 TAXMAN 193 (Bom.)]

October 26, 2012

Sec. 40A(2)


Sec. 80-IA(8) / Sec. 80A(6)◦ Applies to goods and services◦ Deals with two units of same enterprise

Internal transfers Sec. 80-IA(10) Steps-◦ Due to a close connection between the assessee and any other person,

there exists a course of business; and◦ AO determines that transaction is so arranged to produce more than

ordinary profits for the tax holiday unit◦ the transaction price will be substituted by ALP

Close connection Not defined Can one apply association defined under Sec. 40A(2)(b) or sec. 92A? Could cover relative u/s 56(2)(vii)

Sec. 80-IA(8)/(10), 80A(6)

October 26, 2012


Thank you!

Email: [email protected]

October 26, 2012

CA Ganesh Rajgopalan Intensive Workshop on Transfer Pricing JB Nagar CPE Study Circle jointly with...

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