by the Tax Authorities. Thus, transfer pricing is crucial for your business, as proceeding without having an International Transfer Pricing is important as it serves two main purposes – 1) Understanding the internal Profitability and Costing of all Units of the same Organisation 2) Compliance with extensive reporting requirements placed n appropriate pricing structure in place, may expose you to penalties for non-compliances and also gaps in your performance and profitability analysis. However, transfer pricing doesn’t automatically apply to all internal commercial transactions of an organization. For a transaction to be covered by Transfer Pricing regulations, it must take place between two ‘Associated Enterprises’. Therefore, it is imperative to understand and analyze the inter-company structure and relationships, to identify the ‘Associated Enterprises’.

Meaning of Associated Enterprises

Section 92A(1) of the Income Tax Act, 1961 defines the Associated Enterprise.

As per the aforesaid section, when one enterprise 1) can participate in the second enterprise; or 2) a third enterprise participates in both the first and second enterprise; directly, or indirectly, or through one or more intermediaries, and where such participation is through the capital, management or control, then such first and second enterprises are known as ‘Associated Enterprises’.

If we breakdown the definition, there are two ways in which enterprises may be associated –

  • Participation by one enterprise in another enterprise

e.g. If Alphaparticipates in Beta, then Alpha and Beta are Associated Enterprises

  • Participation by a third entity or a third person, in both the enterprises

e.g. If Gamma participates in both Alpha and Beta, then Alpha and Beta are Associated Enterprises

This participation can be of three types

  • Direct

e.g. Alpha is a subsidiary of Beta, then Alpha and Beta are Associated Enterprises

  • Indirect

e.g. Alpha is holding company of omega which is holding company of Beta; therefore, Alpha is indirectly participating in Beta, and thereby, all three entities are Associate Enterprises

  • Through one or more intermediaries

e.g. Gammais holding company of Omega and Theta which in turn hold a 25% percent participation in Alpha respectively. Now, individually Omega and Theta cannot be associated with Alpha as their participation is below the threshold, however, Gammathrough its intermediaries have 40% participation in Alpha. Therefore, Gamma and Alpha are also Associated Enterprises.

Now, this participation can be through the following three channels–

  • Participation in Capital of the enterprise

e.g.Alpha holds shares carrying voting power in Beta

  • Participation in the Management of the enterprise

e.g.Alphahas the right to appoint the board of directors in Beta

  • Participation in Control over the enterprise

e.g.Alphamajorlysells all its products to Beta or majorly buys all its materials from Beta

Therefore, a combination of the above factors would establish an association between the two enterprises, and thereby, the two enterprises would be called as ‘Associated Enterprises’.

Exhaustive Illustrations of Associated Enterprises

Section 92A(2) lists the ways in which one enterprise may participate in the Capital, Management, or Control of another enterprise. These illustrations can be divided into three segments – those relating to Capital, those relating to Management, and those relating to Control.

  • Participation in Capital[Clause (a) to (d)]

Case 1 – Alpha holds shares carrying 26% voting power in Beta

Case 2 – Gamma holds shares carrying more than 26% of the voting power in both Alpha and Beta

Case 3 – Alphaadvances a loan which amounts to more than 51% of the book value of the total assets of Beta

Case 4 – Alpha guarantees 10% or more of the total borrowings of Beta

In all the above cases, Alpha and Beta would be Associated Enterprises.

  • Participation in Management [Clause (e) and (f)]

Case 1 –Alpha has the right to appoint more than half of the board of directors in Beta

Case 2 –Gamma has the right to appoint more than half of the board of directors in both Alpha and Beta

In both the above cases, Alpha and Beta would be associated with Enterprises.

  • Participation in Control [Clause (g) to (i)]

Case 1 – Alpha carries out manufacturing or processing of goods which is wholly dependent on patent or such intangible held by Beta exclusively

Case 2 – 90% or more of the raw materials and consumables required Alpha are supplied by Beta directly or by a person specified by Beta where Beta influences the prices or conditions of supply

Case 3 – The goods manufactured by Alpha are sold to Beta or to persons specified by Beta, where Beta influences the prices or conditions of supply

In all the above cases, Alpha and Beta would be Associated Enterprises.

The way section 92A(2) is articulated, the participation in Capital, may be direct, indirect or through intermediaries, however, the Participation in Management or Control has to be direct, since the clauses do not include the phrase ‘directly, indirectly or through intermediaries’.

Non-Corporate Entities as Associated Enterprises

Section 92A(2) also specifies cases where Non-Corporate Entities may be the reason why two enterprises become Associated Enterprises or the Non-Corporate enterprise itself becomes an Associated Enterprise.

  • Non-Corporate Entity as the medium of Association[Clause (j) and (k)]

Case 1 – Mr. A is an individual who controls Alpha and also directly or through his relatives or jointly with relatives controls Beta

Case 2 – ABC is a Hindu Undivided Family (HUF) controls Alpha and also directly or through the members of HUF, or through the relatives of members or jointly with any member or their relative controls Beta

In both the above cases, Alpha and Beta would be Associated Enterprises.

  • Non-Corporate Entity as an Associated Enterprise[Clause (l)]

Case 1 – ABC is a Partnership Firm (or a Body of Individuals, or an Association of Persons) and Beta holds 10% or more of the interest in such firm

Others Cases of Associated Enterprises

Clause (m) of Section 92A(2) is a residual clause that provides powers to the government to prescribe any other relationship of mutual interest. However, no such relationships have been prescribed under this clause so far.

Under Section 94A(2)(i), there are special provisions for transactions with countries where there is a lack of effective exchange of information. Accordingly, if taxpayer transacts with any entity in a Notified Jurisdictional Area, then all enterprises involved in such transactions are deemed to be Associated Enterprises, irrespective of the fact that whether a relationship exists between them or not. So far, the Government has notified ‘Cyprus’ as one such country. So, any entity located in Cyprus would be an Associated Enterprise, and provisions of Transfer Pricing would apply to the same.