Under Section 92A of the Income Tax Act, two enterprises are treated as Associated Enterprises only when one of the enterprises participates in “management, control or capital” of the other enterprise. Section 92A(1) of the Income-tax Act specifies that and “Associated Enterprise” in relation to another enterprise, means an enterprise which participates, directly or indirectly, or through one or more intermediaries, in the management, control, or capital of the other enterprise. Hence, if an entity participates in the management, capital or control of another enterprise, the latter will be regarded as an associated enterprise of the participating enterprise. Such participation may be direct or indirect, or through one or more intermediaries. Moreover, if one or more persons participate in the management, capital or control of one enterprise and the same personnel performs these functions in another enterprise, both the enterprises will be termed as associated enterprises.

Section 92A(2) of the Income Tax act starts with the term- “For the purposes of sub-section (1), two enterprises shall be deemed to be associated enterprises, if…”. Then the sub-section gives various criterion on which two enterprises shall be deemed to be associated enterprises.

It was a matter of contention that if the definition given in 92A(1) of the Act is complete in itself, i.e. Section 92A(2) is merely illustrative and just expand the meaning of 92A(1) of the Income Tax Act. However, sub-section 92A(2) starts with the clause “for the purposes of sub-section (1)”. Thus it appears that sub-section (2) defines the ambit of sub-section (1) and sub-section (2) is not merely illustrative, it is exhaustive. The issue analysed in this article is that whether requirement of both sub-sections must be satisfied to attract the provision of associated enterprises or not.

The Section 92A(2) was specifically amended by the Finance Bill 2002 [Clause 38, Chapter III]. In the Explanatory memorandum attached to the Finance Bill, 2002, it was explained [under the heading- Clarification Regarding Provisions of Transfer Pricing],

“The existing provisions contained in section 92A of the Income-tax Act to provide as to when two enterprises shall be deemed to be associated enterprises. 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.”

Thus it is clear that the intention of the Parliament was always to apply the provisions of Section 92A(1) and 92A(2) conjointly; i.e. Section 92A(2) restricts the meaning of 92A(1) to the clauses specifically enumerated in Section 92A(2) of the Income Tax Act. The ambit of these provisions was explained by Hon’ble Income Tax Appellate Tribunal in case of , wherein para 10 of the order, the Hon’ble Tribunal explained;

“A plain reading of this statutory provision makes the legal position quite clear. The basic rule for treating the enterprises as associated enterprises is set out in Section 92A(1). The illustrations in which basic rule finds application are set out in Section 92A(2). Section 92A(1) lays down the basic rule that in order to be treated as associated enterprise one enterprise, in relation to another enterprise, participate, directly or indirectly, or through one or more intermediaries, “in the management or control or capital of the other enterprise” or when “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” . Section 92(A)(2)  only provides illustrations of the cases in which such an enterprise participates in management, capital or control of another enterprise. In other words, what Section 92A (1) decides is the principle on the basis of which one has to examine whether or not two or more enterprise are associated enterprise or not. The principle is, as we have noted above, that one of the enterprise, in relation to other enterprise, participate, directly or indirectly, in the management or control or capital of the other enterprise and that persons who participate in such management, control or capital of both the enterprises are common. As long as an enterprise participates in any of the three aspects of the other enterprise, i.e. (a) management; (b) capital; or (c) control, these enterprises are required to be treated as associated enterprise, as also is the position when common persons participate in management, control or capital of both the enterprises. However, the expression ‘participation in management or capital or control’ is not a defined expression. To find the meaning of this expression, one has take recourse to Section 92(2) which gives practical illustrations, which are exhaustive and not simply illustrative- as clarified in the Memorandum explaining the provisions of the Finance Bill 2002 which, while inserting the words “For the purpose of sub section (1) of section 92A” in Section 92A(2), observed that “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”. In this sense, Section 92A(2) governs the operation of Section 92A(1) by controlling the definition of participation in management or capital or control by one of the enterprise in the other enterprise. If a form of participation in management, capital or control is not recognized by Section 92A(2), even if it ends up in de facto or even de jure participation in management, capital or control by one of the enterprise in the other enterprise, it does not result in the related enterprises being treated as ‘associated enterprises’. 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.”

A coordinate bench of the Tribunal, in the case of Page Industries Limited Vs DCIT [(2016) 159 ITD 680 (Bang)] held that even though the provisions of Section 92A(2)(g) are satisfied in a case, the assessee cannot be treated as an associate enterprise of the non-resident company granting it licence to manufacture its products, because the provisions of Section 92A(1) are not satisfied. Thus the provisions of 92A(1) and 92A(2) is required to be read conjointly.

Ahmedabad Bench of the Income Tax Appellate Tribunal, in case of Assistant Commissioner of Income Tax v. Veer Gems [ITA No. 1514/Ahd/2012] held that Section 92A(2) governs the operation of Section 92A(1) by controlling the definition of participation in management or capital or control by one of the enterprise in the other enterprise. If a form of participation in management, capital or control is not recognized by Section 92A(2), even if it ends up in de facto or even de jure participation in management, capital or control by one of the enterprise in the other enterprise, it does not result in the related enterprises being treated as ‘associated enterprises’. 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. What is thus clear that as long as the provisions of one of the clauses in Section 92A(2) are not satisfied, even if an enterprise has a de facto participation capital, management or control over the other enterprises, the two enterprises cannot be said to be associated enterprises.

Similar view was taken by Chennai bench of the ITAT in case of Hospira Healthcare India Pvt. Ltd. v. DCIT [Order dated 28.02.2017]. Gujrat High Court in Pr. CIT v. Veer Gems [TAX APPEAL NO. 338 of 2017; order dated 20.06.2017] has taken the same view.

From the judicial pronouncements above, following position of law emerges-

(i) In order to invoke the transfer pricing provisions, and deal with the determination of arm’s length price, it is absolutely essential that the international transaction in question must be between the associated enterprises. It is perhaps the most basic aspect of the matter and foundational basis on which transfer pricing provisions are invoked. It is, therefore, wholly unreasonable to decline to deal with this issue on the ground that, in any event, the ALP adjustment in question is also not sustainable in law.

(ii) The issue whether the transactions between two entities are transactions between the associated enterprises cannot be infructuous or academic just because the transactions are at arm’s length prices, though this proposition would be true the other way round i.e. the issue whether the transactions at arm’s length price or not would be infructuous in the event of enterprises not being associated enterprises.

(iii) The expression ‘participation in management or capital or control’ is not a defined expression. To find the meaning of this expression, one has take recourse to Section 92(2) which gives practical illustrations, which are exhaustive and not simply illustrative- as clarified in the Memorandum explaining the provisions of the Finance Bill 2002.

(iv) If a form of participation in management, capital or control is not recognized by Section 92A(2), even if it ends up in de facto or even de jure participation in management, capital or control by one of the enterprise in the other enterprise, it does not result in the related enterprises being treated as ‘associated enterprises’. 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. What is thus clear that as long as the provisions of one of the clauses in Section 92A(2) are not satisfied, even if an enterprise has a de facto participation capital, management or control over the other enterprises, the two enterprises cannot be said to be associated enterprises.

Thus, if any one or more of the clauses of 92A(2) is not satisfied, any amount of de facto or de jure control will not make units associated enterprises within the meaning of Section 92A of the Income Tax Act and transfer pricing provisions shall not be attracted.

[The author is Managing Partner of Rajesh Kumar and Associates. The author may be contacted on rajesh@rklegal.org]

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