Section 92 of the Income-tax Act, 1961 (‘the Act’) provides that any income arising from an international transaction shall be computed, having regard to the arm’s length price. The expression “international transaction” is defined in Section 92B of the Act to mean a transaction between two or more “Associated Enterprises” (‘AE’), either or both of whom are non-residents.
The expression AE is defined under section 92A of the Act in two parts. Section 92A(1) of the Act defines AE to mean an enterprise (a) which participates in the management or control or capital of the other enterprise, or (b) in which persons participating in management or control or capital are the same persons who participate in the management or control or capital of another enterprise. Section 92A(2) of the Act contains a deeming provision, giving specific illustrations [clauses (a) to (m)], to indicate when two enterprises will be deemed to be AE.
The scope of this article is limited to examine if, any of the clauses (a) to (m) of sub-section (2) is satisfied, the transacting enterprises ipso facto become AEs without satisfying the requirement of sub-section (1); or whether fulfilment of conditions of either sub-section (1) or sub-section (2) is suffice for creating a relationship of AE in the context of transfer pricing provisions contained in the Act. In another words, this article deals with the question as to whether sub-sections (1) and (2) of Section 92A of the Act are to be read together conjunctively or these sections operate independent of each other.
Legislative history of Section 92A
Section 92A of the Act was inserted by the Finance Act, 2001 with sub-section (2) having the opening words “Two enterprises shall be deemed to be AEs if, at any time during the previous year …”. It was soon after amended by Finance Act, 2002 wherein the said phrase was substituted with the phrase “For the purposes of sub-section (1), two enterprises shall be deemed to be AEs if, at any time during the previous year …”. Noticeably, when the sub-section (2) was initially introduced, it served as an independent condition for treating two enterprises as AEs. However, post the amendment in 2002, a link was established between the two sub-sections (1) and (2).
The memorandum to Finance Bill, 2002 clarified the purpose of amendment. As per the memorandum, for considering an enterprise as an AE of the other enterprise, not only conditions of section 92A(1) but also any of the clauses of section 92A(2) must be satisfied.
Judicial Precedents
The Ahmedabad Bench of the Income-tax Appellate Tribunal in Veer Gems [see End Note 1] 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 enterprise 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 [see End Note 2].
The Bangalore Bench of Tribunal in Page Industries [see End Note 3] held that to constitute a relationship of AE, parameters laid down in both sub-sections (1) and (2) must be cumulatively satisfied. The Tribunal also held that, even if any of the clauses of sub-section (2) is applicable, if conditions of sub-section (1) are not satisfied, the enterprises would not be regarded as AE. The principle laid down in this order was followed by Chennai bench of the Tribunal in Orchid Pharma [see End Note 4].
At this juncture, it is also apropos to refer to another decision of the Tribunal in Kaybee [see End Note 5] wherein it was held that section 92A(2), being a deeming fiction, enlarges the scope and meaning of expression 'AE' provided under section 92A(1), but still, the conditions stipulated in the clauses of section 92A(1) must be fulfilled for enterprises to be regarded as AE. A conjoint reading of these decisions suggest that two enterprises can be regarded as AE only if the conditions stipulated in Section 92A(1) as well as in Section 92A(2) are cumulatively satisfied.
Authors viewpoint
As it is clear from the clauses enumerated in section 92A(2) of the Act, none of them independently prescribe any benchmark to imply that when one enterprise participates in the management or control or capital of two or more enterprises. The conditions prescribed therein are only indicative of the existence of such participation. Therefore, satisfaction of any of the conditions mentioned in 92A(2) will not by itself result in the enterprises being regarded as AE.
Accordingly, it can be inferred that section 92A(2) must be read with of section 92A(1) as the fiction provided under section 92A(2) comes into play only when conditions stipulated under section 92A(1) are satisfied. Thus, there is a strong reasoning to say that if any clause of section 92A(2) is independently satisfied, it will not automatically result in establishing relationship of AE.
Analysis of the treaty law
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.
Conclusion
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.
[The author is an Associate, in Direct Tax Team of Lakshmikumaran & Sridharan at Mumbai]
End Notes:
4. Orchid Pharma Limited v. Deputy Commissioner of Income-tax, [2016] 162 ITD 303 (Chennai).