Transfer Pricing – Deemed to be Associate Enterprise (Part-2)
Introduction : In current scenario it is possible that entity is operating not only in multiple state but also in multiple country; for said purpose it is important to understand whether entity is required to comply any additional law; how income tax will be levied if one of the branches of entity which is operating in tax free zone makes transfer of goods or service to another branch who is operating in taxable zone or vice-versa. In this article we will cover all compliance and related interpretation of transfer pricing.
In part-1 we have discussed what do we mean by associate enterprise by its actual definition, in this part we will cover what do we mean by deemed to be associated enterprise.
Deemed to be treated as Associate Enterprise:
1) Due to Ownership: One enterprise holds 26% or more of the Voting Power, directly or indirectly, in the other enterprise.
Illustration : X Ltd. holds 80% of G Ltd., G Ltd. holds 70% of C Ltd. and C Limited holds 50% in S Ltd.
Here X Ltd. indirectly holds 28% in S Ltd. and therefore X Ltd. to be treated as associate enterprise of S Ltd.
2) Substantial voting power in two entities by common person: Any person or enterprise holds 26% or more of the voting power, directly or indirectly, in each of two different enterprises.
Illustration : Mr. M holds 60% in AIO Limited and 70% in SIO Limited 26% in BIO Limited
Here AIO, SIO and BIO all will be treated as associate enterprise of each other.
3) Advancing of substantial sum of money: One enterprise advances loan to the other enterprise of an amount of 51% or more of the book value of the total assets of other enterprise.
Illustration : Hari and Co. has given loan amounting to Rs. 700 Crores to SIA Limited. The book value of total asset of SIA Limited is Rs. 1200 Crores. The Book value of Hari and Co. is Rs. 2100 Crores.
Here Hari and Co. and SIA Enterprise will be treated as Associate Enterprise as loan given by Hari and Co. is exceeding 51% or more of the book value of the total assets of SIA Limited.
4) Guarantee in respect of borrowing by other enterprise: One enterprise guarantees 10% or more of the total borrowings of the other enterprise.
Illustration: L Ltd. has given guarantee in respect of loan taken by K Ltd. The amount of loan is Rs. 60 Crores, total borrowing of L Ltd. is Rs. 180 Crores and of K Ltd. is Rs. 670 Crores.
Here, L Ltd and K Ltd. will not be treated as associated enterprise as condition required to be fulfilled is One enterprise guarantees 10% or more of the total borrowings of the other enterprise. Total borrowing of K Ltd. is Rs. 670 Crore and guaranteed amount by L Ltd. is 60 Crores which is not 8.95% of total borrowing of K Ltd.
5) Appointment of majority directors of 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 other enterprise.
Illustration: D Ltd. has 12 directors on his board out of which 7 are appointed by C Ltd. Here C Ltd. and D Ltd. will be treated as associated enterprise as more than half of the board of directors is appointed by C Ltd.
What if only one executive director was appointed by C Ltd.
In such case also D Ltd. and C Ltd. would have been treated as associated enterprise as one or more executive directors is appointed by C Ltd.
6) Appointment of majority directors of two different enterprises by same persons: 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.
Illustration : Mr. Hari has right to appoint 6 out of 10 directors of K Ltd. and 3 out of 5 directors of Y Ltd. In said case K Ltd. and Y Ltd. will be treated as associate enterprise
7) Dependence in terms of Intangible Assets, where other enterprise has exclusive rights: 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.
Illustration : Docdonald has exclusive Intangible rights for producing X quality of product. The said rights has been given by Docdonald to CIZA Ltd. CIZA Ltd. is dependent on Docdonald as Docdonald holds exclusive right of said product.
Here Docdonald and CIZA Ltd. will be treated as associate enterprise as they are fulfilling the above specified conditions.
What if the said rights for manufacturing X quality products are also available with other two enterprise; In such case Docdonald and CIZA will not be treated as associate enterprise.
8) Dependence on raw material supplied by other enterprise: 90% or more of raw materials and consumables required for the manufacture or processing of goods 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.
It shall be noted that even though raw material is not supplied by enterprise but if it is supplied by any other person on instruction of enterprise and where price and other condition pertaining to transaction is been influenced by said enterprise, enterprise on whose instruction raw material is supplied and enterprise to whom raw material is supplied will be treated as associated enterprise.
9) Dependence on sale: The goods or articles manufactured or processed by one enterprise, are exclusively (100%) 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.
10) Control by common individual: 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.
It has been very clearly mentioned that in case an individual is controlling two or more enterprise than such enterprise will deemed to be treated as associated enterprise.
Elaborating this further it has also been stated that where one enterprise controlled by HUF and other enterprise is controlled by any other member of HUF than both the enterprise will be deemed to be treated as associate enterprise.
11) Residuary : If there is any mutual interest between two enterprise both will be deemed to be treated as associated enterprise.
The definition of associate enterprise and deemed associate enterprise has been prescribed in very detail manner by the department, and such has been done with the intention to cover large number of entities under the compliance part.