Definitions of certain terms relevant to determination of arm’s length price, etc.

173

In this section and sections 161, 162, 163, 165, 171 and 172, unless the context otherwise requires,—

• (a) “arm’s length price” means a price which is applied or proposed to be applied in a transaction between persons other than associated enterprises, in uncontrolled conditions;
• (b) “enterprise” means a person (including a permanent establishment of such person) who is, or has been, or is proposed to be, engaged in any activity relating to–– (i) the production, storage, supply, distribution, acquisition or control of articles or goods; or (ii) know-how, patents, copyrights, trade-marks, licences, franchises or any other business or commercial rights of similar nature; or (iii) 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 (iv) provision of services of any kind; or (v) carrying out any work in pursuance of a contract; or (vi) investment or providing loan; or (vii) business of acquiring, holding, underwriting or dealing with shares, debentures or other securities of any other body corporate, whether such activity or business is carried on, directly or through one or more of its units or divisions or subsidiaries, or whether such unit or division or subsidiary is located at the same place where the enterprise is located or at a different place or places;
• (c) “permanent establishment”, referred to in clause (b), includes a fixed place of business through which the business of the enterprise is wholly or partly carried on;
• (d) “specified date” means the date one month before the due date for furnishing the return of income under section 263 (1) for the relevant tax year;
• (e) “transaction” includes an arrangement, understanding or action in concert,— (i) whether or not such arrangement, understanding or action is formal or in writing; or (ii) whether or not such arrangement, understanding or action is intended to be enforceable by legal proceeding.

Explanation

Section Summary:

This section provides definitions for key terms used in determining the arm’s length price (ALP) and related concepts under the income tax law. These definitions are crucial for understanding and applying transfer pricing rules, which ensure that transactions between associated enterprises (e.g., subsidiaries of the same parent company) are conducted at fair market value, as if they were unrelated parties.

Key Changes:

1. Clarification of "Enterprise": The definition of "enterprise" has been expanded to include a wide range of activities, such as investment, loans, and dealing with securities, in addition to traditional business activities like production, supply, and services.
2. Inclusion of "Permanent Establishment": The term "permanent establishment" is explicitly defined to include any fixed place of business, whether wholly or partly used for business activities.
3. Broad Definition of "Transaction": The term "transaction" now explicitly includes informal arrangements, understandings, or actions in concert, even if not legally enforceable or documented in writing.

Practical Implications:

1. Transfer Pricing Compliance: Businesses engaged in cross-border or domestic transactions with associated enterprises must ensure that their pricing aligns with the arm’s length principle. This requires detailed documentation and analysis to justify the pricing of goods, services, or intangibles.
2. Broader Scope of Activities: The expanded definition of "enterprise" means that more types of transactions (e.g., loans, investments, intellectual property licensing) are subject to transfer pricing scrutiny.
3. Informal Arrangements: Even informal or unwritten agreements between associated enterprises must be evaluated for compliance with the arm’s length principle.

Critical Concepts:

1. Arm’s Length Price (ALP): The price that would be charged between independent parties in an open market under similar conditions. It is used to ensure that associated enterprises do not manipulate prices to shift profits and reduce tax liabilities.
2. Permanent Establishment: A fixed place of business (e.g., office, factory, branch) through which an enterprise conducts its operations, either wholly or partly.
3. Transaction: Any arrangement, understanding, or action in concert, whether formal or informal, written or unwritten, and regardless of enforceability.

Compliance Steps:

1. Documentation: Maintain detailed records of all transactions with associated enterprises, including the rationale for pricing and methods used to determine the ALP.
2. Transfer Pricing Study: Conduct a transfer pricing study to demonstrate that transactions comply with the arm’s length principle. This may involve benchmarking against comparable transactions between independent parties.
3. Reporting: Ensure that all relevant transactions are disclosed in the tax return, along with the required transfer pricing documentation.

Examples:

1. Scenario 1: Company A (based in India) sells goods to its subsidiary, Company B (based abroad), at a discounted price. The tax authorities may scrutinize this transaction to ensure the price aligns with what Company A would charge an unrelated buyer (ALP).
2. Scenario 2: Company X licenses its trademark to its subsidiary, Company Y, for a nominal fee. The tax authorities may require Company X to justify the fee based on comparable licensing agreements between unrelated parties.
3. Scenario 3: An informal agreement between two associated enterprises to share costs for a joint project must still comply with the arm’s length principle, even if no formal contract exists.

This section ensures that all transactions between associated enterprises are conducted at fair market value, preventing profit shifting and ensuring tax compliance.