Meaning of associated enterprise.

162(1)

In this Chapter, “associated enterprise”, in relation to another enterprise, means an enterprise—

• (a) which participates, directly or indirectly, or through one or more intermediaries, in the management or control or capital of the other enterprise; or
• (b) in respect of which 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.

162(2)

Without affecting the generality of the provisions of sub-section (1), two enterprises shall be deemed to be associated enterprises if, at any time during the tax year,—

• (a) one enterprise holds, directly or indirectly, shares carrying at least 26% of the voting power in the other enterprise; or
• (b) any person or enterprise holds, directly or indirectly, shares carrying at least 26% of the voting power in each of such enterprises; or
• (c) a loan advanced by one enterprise to the other enterprise constitutes at least 51% of the book value of the total assets of the other enterprise; or
• (d) one enterprise guarantees at least 10% of the total borrowings of the other enterprise; or
• (e) 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 one enterprise, are appointed by the other enterprise; or
• (f) 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 or persons; or
• (g) the manufacture or processing of goods or articles or business carried out by one enterprise is wholly dependent on the use of know-how, patents, copyrights, trademarks, licences, 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 enterprise is the owner or in respect of which the other enterprise has exclusive rights; or
• (h) 90% or more of the raw materials and consumables required for the manufacture or processing of goods or articles carried out by one enterprise, are supplied by the other enterprise, or by persons specified by the other enterprise, and the prices and other conditions relating to the supply are influenced by such other enterprise; or
• (i) the goods or articles manufactured or processed by one enterprise, are 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; or
• (j) 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 relative of such individual; or
• (k) where one enterprise is controlled by a Hindu undivided family, the other enterprise is controlled by a member of such Hindu undivided family or by a relative of a member of such Hindu undivided family or jointly by such member and his relative; or
• (l) where one enterprise is a firm, association of persons or body of individuals, the other enterprise holds at least 10% interest in such firm, association of persons or body of individuals; or
• (m) there exists between the two enterprises, any relationship of mutual interest, as prescribed.

162(3)

In relation to a specified domestic transaction entered into by an assessee, associated enterprise shall also include—

• (a) other units or undertakings or businesses of such assessee in respect of a transaction referred to in section 122 or 140(9);
• (b) any other person referred to in section 140(13) or 205(4) in respect of a transaction referred to therein; and
• (c) other units, undertakings, enterprises or business of such assessee, or other person referred to in section 140(13) in respect of a transaction referred to in section 144 or the transactions referred to in Chapter VIII to which the provisions of section 140(9) or (13) are applicable.

Explanation

Section Summary:

This section defines the term "associated enterprise" under the new income tax law in India. It outlines the conditions under which two enterprises are considered "associated" for tax purposes. This is particularly important for determining transfer pricing rules, where transactions between associated enterprises must be conducted at arm's length to prevent tax evasion or profit shifting.

Key Changes:

1. Expanded Definition: The new law broadens the definition of "associated enterprise" compared to the previous Income Tax Act. It includes more scenarios where enterprises can be deemed associated, such as through loans, guarantees, or control over raw materials and sales.
2. Specific Thresholds: The law introduces specific thresholds (e.g., 26% voting power, 51% loan-to-asset ratio) to determine association, providing clearer guidelines.
3. Domestic Transactions: The new law explicitly includes specified domestic transactions under the scope of associated enterprises, which was not as clearly defined in the previous law.

Practical Implications:

1. Transfer Pricing Compliance: Businesses must ensure that transactions with associated enterprises comply with arm's length pricing rules. This may require additional documentation and reporting.
2. Increased Scrutiny: Tax authorities may scrutinize transactions more closely, especially in cases involving loans, guarantees, or shared control.
3. Impact on Domestic Transactions: Enterprises involved in specified domestic transactions (e.g., transactions between units of the same company) must now treat these as transactions with associated enterprises, potentially increasing compliance requirements.

Critical Concepts:

1. Associated Enterprise: An enterprise is considered associated if it meets any of the conditions listed in the section, such as holding significant voting power, providing loans, or controlling raw materials or sales.
2. Specified Domestic Transactions: These are specific types of transactions between units or businesses of the same assessee or related persons, which are now treated as transactions between associated enterprises.
3. Arm's Length Principle: Transactions between associated enterprises must be conducted as if they were between independent parties, ensuring fair market value is applied.

Compliance Steps:

1. Identify Associated Enterprises: Review ownership structures, loans, guarantees, and other relationships to determine if any enterprises meet the criteria for being associated.
2. Document Transactions: Maintain detailed records of all transactions with associated enterprises, including pricing methodologies and supporting documentation.
3. Report Specified Domestic Transactions: Ensure that specified domestic transactions are reported accurately in tax filings, adhering to the new requirements.

Examples:

1. Voting Power: Company A holds 30% of the voting shares in Company B. Under the new law, Company A and Company B are considered associated enterprises because the voting power exceeds the 26% threshold.
2. Loan Dependency: Company X provides a loan to Company Y that constitutes 60% of Company Y's total assets. This makes Company X and Company Y associated enterprises due to the loan-to-asset ratio exceeding 51%.
3. Domestic Transaction: A manufacturing unit of a company sells goods to another unit of the same company at a discounted price. Under the new law, this transaction is treated as a specified domestic transaction between associated enterprises, requiring arm's length pricing and proper documentation.

This section ensures that transactions between related entities are transparent and comply with tax regulations, preventing profit shifting and tax evasion.