Etymology of Transfer Pricing (TP) And Concept of Associate Enterprises (AEs), International Transaction And Domestic Transaction
The aim of this paper is to uncover some of the arcane and puzzling mysteries surrounding the concept of transfer pricing. Though in essence, section 90 of the Income-tax Act 1961 is the cornerstone which lays the foundation of the transfer pricing matrix in India. But the concept as such cannot be read aloof and in ignorance of the DTAA and model tax conventions. Any such attempt is a fallacy and will be counterproductive. The bevy of materials available on the subject is itself befuddling and will deter any new tyro from taking up taxation law as an area of practice. In spite of the Ballyhoo surrounding the subject, the concept of transfer pricing is based on a few cardinal principles. They can be narrowed down to a) International transactions, b) between associate enterprises, and c) Arm’s length prices. The jurisprudence pertaining to the transfer pricing is ad-infinitum. I have only anatomized three concepts to make it more amble vis-a-vis:
1. Associate enterprises;
2. International transactions; and
3. Specified Domestic Transaction.
The scope of section 90 was examined in detail in the UOI V/s Azadi Bachaao Andolan. The power to levy tax is the inherent part of the sovereign power of the state, and as such, the entries 10 and 14 of Schedule- VII of the constitution enables the Parliament to legislate on all topic concerning treaties. The Central Government is the delegate of the legislation and has the power to grant an exemption under the Income-tax Act 1960, in the absence of any specific exemption being granted by the Parliament. Therefore, a conjoint reading of Art 253 r/w Art 73 enables the Central Government to enter into agreements embodying the transaction in nature of clause (a) to (d) of s 90 by just an official Gazette notification.
Section 90, in general, is an extension of the Section 49A of the 1922 Act, which only provided a) grant relief against double taxation on the same income; b) avoidance of double taxation of income. The scope was expanded in 1972; section 90 (which replaced s 49A) added two more provisions; c) relating to the exchange of information and d) relating to the recovery of income tax.
Associated Enterprises
The s92A was introduced vide the Finance Act 2001, and the scope of the section was somewhat extended by the interpolation of Subsection (2) section 92A. The easiest way to annotate the section would be to understand the wide contours of the definition, then follow up with subsections (1) and (2) and link it with the permanent establishment.
The term “Enterprise” is defined in section 92 F(iii) and includes a person engaged in a variety of activities. The definition is expansive enough to cover all types of business entities. The s92A begins with the mean clause and defines that if an enterprise “Participates“ in the management, control or capital of another enterprise or when two enterprises are controlled, managed or have capital from the same person or persons, then they are associated enterprise.
The use of the word “Participation” makes the definition very open-ended; for example, if a person is an independent director in two companies, the two companies become associated enterprises (“AE”); similarly, a shareholder, by virtue of his shareholding in two companies who have purchased his shares in the stock market would render the company associated enterprises.
The amendment made to s 92A further adds a layer of qualification to be classified as an AE. In essence, unless the requirement of s 92A (2) is satisfied, subsection (1) cannot be applied at all. Thus, the word participate must assay the test as mentioned in clause (a) to (m) of subsection (2) section 92A.
The oddity introduced by the amendment is clearly visible; on a simple reading, first, the implication of the 92A (2) must be fulfilled for an enterprise to be an AE does not follow from the reading/draft of the section, and secondly, it renders the s 92A (1) otiose as the only relevant consideration to look for is whether the activity falls within the list under the clause(a) to (m).
Further, what constitutes management and control is not defined, but a general understanding is that it means a de jure control and not merely de facto control. For much clarity, one may refer to the definition of the term control in SEBI (Substantial Acquisition of Share And Takeover) Regulation 1997.[1]
There is also a lot of interplay between the concept of PE and AE. The definition used in the s 92F(iiia) is drafted in the same line as that of the OECD model DTA Art 5(1), and thus, it covers only fixed place PE. The effect is that the Indian branch of the foreign company is an “Enterprise”, and the foreign company is itself an “Enterprise” this makes them AE, and thus, any transaction will be subject to the transfer pricing provisions.
International Transaction
The definition of the term International transaction given in section 92B(1)(2) covers transactions not only between two associated enterprises which are in the nature of purchase, sale, lease of tangible and intangible or any transaction having any bearing on the profit, losses or asset or, income but it also covers the deeming provision wherein a prior agreement in relation to the relevant transaction exist between the other person and associated enterprises.
The definition of the term is simply very wide, and every transaction can be subsumed in the phrase ”any other transaction affecting profit ..” this will even include any unwritten agreement/understanding between two related enterprises if one enterprise uses the IP or Brand for the promotion of its own intangible and tangibles products. So, the Legal ownership of the Brand/IP is with one corporation and the economic exploitation is done by others. As the Indian contract Act 1872 does recognise oral contract, all the revenue department has to do is show that such an arrangement exists where significant expenditure or cost is incurred by one enterprise without having any agreement in writing. The term Transaction, as defined by s92(F)(v), explains it as an “arrangement or understanding” which will even bring within its ambit all informal understanding as well. But the contention of the revenue department can’t be based on conjecture or surmise but rather on believable sets of facts which explain the nature of expenditure and the surrounding circumstance of such expenditures incurred.
The Bombay High Court in CIT vs Patni Computer Systems[2] has unequivocally stated the above aspect and has held that an inference as to the” Arrangement” cannot be drawn without concrete primary facts being established.
With reference to the explanation inserted in the 92B, the Delhi High Court in PCIT v Kusum Healthcare Pvt[3] ltd state that the inclusion of the explanation of the expression “receivable” does not mean that dehors the context ever items of receivable appearing in the accounts of an entity which have dealings with foreign AE would automatically be characterized as International Transaction.
So, in essence, we can infer that the approach of the revenue must be to establish a pattern of transactions clearly discerning the criterion given in clause 92B r/w the explanation, which would then result in the establishment of the existence of an international transaction not otherwise.
Specified Domestic Transaction
The need for introducing any provision applicable to the domestic companies arose out of the obiter dicta of the Hon’ble Supreme Court in CIT vs Glaxo Smith Kline. The Court opined about the possibility of two domestic enterprises manipulating inter se transfer price if one of them is taxed at a lower rate of tax or enjoyed a tax holiday.
To illustrate the above, let’s assume a company is newly established u/s 10A in Free trade zone and its related entity, which supplies the major bulk of the raw material, has no such tax holiday, then it is obvious that the raw material would be supplied at the lowest rate so as to keep more profit with the 10 (A) unit in the free trade zone.
The transaction will only be subject to the transfer pricing scrutiny under s 93BA as specified domestic transaction if the aggregate value of the transaction exceeds Rs 20 Crore in the previous year. This monetary threshold was revised from the early threshold of Rs 5 Crore in 2016.
The section is an assortment of six various provisions of the Act, which classify them as specified domestic transactions. Clause 92BA(i), which dealt with the specific payment made to a person as classified u/s 40A, has been deleted and is not applicable from the AY 2017-2018. Clause(ii), in my opinion, only applies to 80A(6), where a significant amendment has been made to make it more attuned to this provision. Clause (iii) refers to any transaction referred u/s 80- IA(8) wherein there is a transfer from one business of the assessee to another business of the same assessee. Clause(iv) refers to S 80 IA(10), which essentially states that if the transaction by the eligible business is less than Rs 20 Cr, the provision of S 80 IA(10) will applies, but if the transaction is over Rs 20 Crore Chapter-X will apply. The computation of income expenses or allocation of expenses between two enterprises for the specified domestic transaction shall be at arm’s length price.
Conclusion
India is one of the harbingers in the negotiation and discussion of BEPS Action Plan 2015. India has officially ratified the MLI in Paris. The implementation of the Action Plan 13- Transfer Pricing documentation will be a shot in the arm in addressing the issue of base erosion and will make the provision of Transfer pricing more synchronized and harmonious with the global regime; reducing the cost of litigation and pendency in Indian courts.
[1] “Control “shall include the right to appoint a majority of the directors or to control the management or policy decision exercisable by a person or persons acting individually or in concert directly or indirectly, including by virtue of their shareholding or management rights or shareholders or voting agreements or in any other manner.”
[2] CIT vs Patni Computer Systems 215 Taxman 108
[3] PCIT vs Kusum Healthcare Pvt ltd 389 ITR 60
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