International Taxation – Associated EnterprisesAtul Khurana
Yesterday we have discussed about the basics of international taxation and covered basic aspects regarding the Arm Length’s Price principles and the reason behind the introduction of transfer pricing provisions in the Income Tax Act, 1961.
Hope you have gone through it.
Let’s proceed further and today we will cover other aspects of transfer pricing.
**TP means Transfer Pricing
**ALP means Arm Length Price
Section 92: COMPUTATION OF INCOME FROM TRANSACTION WITH NON-RESIDENT
Section 92 provides that any income arising from an “international transaction” shall be computed having regard to “the arm’s length price”.
Therefore, the allowance for any expense or interest shall be determined on the basis of arm’s length price.
Please remember, that transfer pricing provisions are applicable only in case of transactions between Associated enterprises and therefore, all the transactions that takes place between the associated enterprises should be determine on the basis of ALP principle.
But there is one more twist in the law.
The Transfer Pricing principle is applicable only in the case when Income computed as per ALP is more than the income declared by the assessee and the simple reason behind that is the protection of revenue by the Income tax Department. Ultimately, taxation authorities wants to secure themselves in terms of lost of revenue,
The objective of transfer pricing provisions is to protect the tax base of India and to ensure that due to inter company transactions, there is no reduction in the taxable profits or the taxes paid by the Indian taxpayer. And therefore, Section 92(3) provides that the transfer pricing provisions contained in Section 92 shall not apply if the same has the effect of reducing the income chargeable to tax or increasing the loss of the assessee for the year under consideration. The same can be understood with the help of the following example:
As you can see that in points 2 to 4, TP provisions are not applicable because the profit so determined by the taxation authorities as per ALP is less than the profit declared by the assesse. Now suppose if income tax department apply this concept in all the cases then the situation will be like this:
Profit declared by the assessee : 100 lacs
Tax computed by assessee @ 30%: 30 lacs
Profit as per ALP (By income tax dept.): 80 Lacs
Tax computed as per ALP @ 30%: 24 lacs
So, there will be loss to the department of 6 lacs (30-24) in terms of tax collection. Therefore, the taxation authorities took a clever & selfish move and apply these provisions only in the case when the profit is more as per ALP principles as compared to profits declared by the assessee.
Section 92A – Associated Enterprises:
Meaning of Enterprise:
The term “enterprise” is defined in section 92F(iii) to mean a person (including its certain specified Permanent Establishment) who is, or has been, or is proposed to be, engaged in any activity,
- relating to the production, storage, supply, distribution, acquisition or control of articles or goods, or know-how, patents, copy rights, 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
- the provision of services of any kind, or in carrying out any work in pursuance of a contract, or in investment, or providing loan or in the business of acquiring, holding, underwriting or dealing with shares, debentures or other securities of any other body corporate, whether such activity or business is carried on, directly or through one or more of its units or divisions or subsidiaries, or whether such unit or division or subsidiary is located at the same place where the enterprise is located or at a different place or places.
Meaning of Associated Enterprise:
Associated Enterprises are those which are owned or controlled by the same or common entity/person.
Section 92A(1) of the Act, associated enterprise refers to:
1. An enterprise which participates, directly or indirectly, or through one or more intermediaries, in:
- management of the other enterprise, or
- control of the other enterprise, or
- capital of the other enterprise
A Ltd. directly participates in management of B Ltd. Therefore, both A Ltd. & B Ltd. are associated enterprises.
A >>>>>>>>>>>>>> B
Now, consider a situation where A Ltd. directly participates in management of B Ltd. and B Ltd. directly participates in management of C Ltd. In such situation, A Ltd. has direct participation in management of B Ltd. but has an indirect participation in management of C Ltd. Therefore, in such scenario, C Ltd. is also an associated enterprise of A Ltd.
A >>>>>>>> B >>>>>>>> C
2. If one or more persons participates, directly or indirectly, or through one or more intermediaries in:
- management of the two different enterprises.
- control of two different enterprises.
- capital of two different enterprises Then, those two enterprises are associated enterprises.
Example: Mr. A directly has control in A Ltd. and B Ltd. In such a scenario, both A Ltd. & B Ltd. are associated enterprises since they have a common person i.e. Mr. A, who controls both entities A Ltd. & B Ltd.
Mr. A >>>>> A Ltd.
Mr. A >>>>> B Ltd.
This was the little info. about the concept of Associated Enterprises. But this was only the trailer, Here I am presenting the full movie i.e. Deemed Associated Enterprises.
Let us see….
Deemed Associated Enterprises:
Two enterprises are deemed to be associated enterprises if they fall under any one or more of the situations contained in section 92A(2). This section provides 13 such situations during which associated enterprise relationship is deemed to be established and they will fall under the category of Associated Enterprises. Two enterprises are deemed to be associated enterprise if:
Situation I: Enterprise ownership – One enterprise holds 26% or more of the voting power, directly or indirectly, in the other enterprise.
A Ltd. holds 33% of voting power in B Ltd. and B Ltd. holds 40% voting power in C Ltd.
A Ltd. >>> 33% >>> B Ltd. >>> 40% >>> C Ltd.
In above situation, A Ltd. holds 33% of voting power in B Ltd. directly and 40% of voting power in C Ltd. indirectly (i.e. through B Ltd.). Therefore, both B Ltd. & C Ltd. are deemed associated enterprises of A Ltd.
Situation II: Voting power by common person – Any person or enterprise holds 26% or more of the voting power, directly or indirectly, in each of two different enterprises.
Example: Mr. A holds 40% of shareholding in both X Ltd. and Y Ltd. where neither X Ltd. has any holding in Y Ltd. nor Y Ltd. has any holding in X Ltd.
Mr. A >>>40% >>> X Ltd.
Mr. A >>>40% >>> Y Ltd.
In this situation, since Mr. A directly holds 40% of shareholding in both X Ltd. and Y Ltd., X Ltd. & Y Ltd. will be deemed associated enterprises.
Situation III: Lender – One enterprise advances loan to the other enterprise of an amount of 51% or more of the book value of the total assets of the such other enterprise
Example: Book value of total assets of Y Ltd. is ` 100 crores. X Ltd. advances loan of ` 60 crores to Y Ltd.
Since, in this case, X Ltd. advances loan of ` 60 Crores to Y Ltd, which is 60% of the book value of total assets of Y Ltd. Hence, X Ltd. & Y Ltd. are deemed associated enterprises
Situation IV: Guarantor – One enterprise guarantees 10% or more of the total borrowings of the other enterprise.
Example: P Inc. has total loan of 1 million dollars from XYZ Bank of America. Out of that, A Ltd., an India company, guarantees 20% of total borrowings in case of any default made by P Inc. In such scenario, since, A Ltd. guarantees 20% of total borrowings of P Inc., P Inc. and A Ltd. are deemed associated enterprises.
Situation V: Appointment of Board by other enterprise – One Enterprise appoints 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 another enterprise.
Example: X Ltd. has 15 directors on its Board. Out of that, Y Ltd. has appointed 8 directors. In such case, X Ltd. and Y Ltd. are deemed associated enterprises
Situation VI: Appointment of Board of two different enterprises by same person(s) – 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.
Example: Mr. A appointed 9 directors out of 15 directors of X Ltd. and appointed 2 executive directors on the board of Y Ltd. In such case, since a common person i.e. Mr. A appointed more than half of the directors in X Ltd. and appointed 2 executive directors in Y Ltd., both X Ltd. and Y Ltd. are deemed associated enterprises.
Situation VII: Dependence on intangibles – The manufacture or processing of goods or articles or business carried out by one enterprise is wholly dependent (i.e. 100%) on the know-how, patents, copyrights, trade-marks, licenses, 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 entity is the owner or in respect of which the other enterprise has exclusive rights.
Situation VIII: Dependence on supply in manufacturing process – 90% or more of raw materials and consumables required for the manufacture or processing of goods or articles or business carried out by one enterprise, are supplied by the other enterprise, or by persons specified by the other enterprise, where the prices and other conditions relating to the supply are influenced by such other enterprise.
Situation IX: Dependence on sale – 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.
Situation X: Individual control – 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 his relatives.
Example: Mr. A and Mr. B are relatives. Mr. A has control over X Ltd. and Mr. B has control over Y Ltd. Therefore, both X Ltd. and Y Ltd. will be deemed associated enterprises.
Suppose Mr. A is father of Mr. B
Mr. A >>> Control >>> X Ltd.
Mr. B >>> Control >>> Y Ltd.
X Ltd and Y Ltd is Ghar wali Baat (Baap Bete ki companies)
Situation XI: Control by Hindu Undivided Family – Where one enterprise is controlled by a Hindu undivided family (HUF) and the other enterprise is controlled by a member of such HUF or by his relative of a member of such HUF or jointly by such member and his relative
Khurana HUF >>> Control >>> A Ltd.
Atul Khurana (Member of HUF) >>> Control >>> B Ltd.
Same here, Ghar wali Baat
Situation XII: Holding in a firm, association of persons or body of individuals – Where one enterprise is a firm, association of persons or body of individuals, the other enterprise holds 10% or more interest in firm/HUF/BOI.
Situation XIII: Mutual interest relationship – There exists between the two enterprises, any relationship of mutual interest, as may be prescribed.
So, This much for today. It was a lengthy article but it was necessary because this is the base of International Taxation.
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