Between two non-related enterprises, transactions are usually commercial in nature where both parties represent their own interests and settle midway. However, a transaction between two related enterprises, may not be necessarily carried out of their own interests, but may also have been entered into, to accomplish the interests of the business group as a whole. In fact, many enterprises in a group, are formed solely to fulfill the purpose of carrying out a pre-decided stream of transactions, to represent the group’s interests, and no other objects of its own. This turns the price at which these transactions are entered into, irrelevant for the group, as it is merely an exchange of hands within the group, however, when we look at the enterprise in isolation, the price becomes really crucial, especially if they are geographically apart.
This is the reason why tax laws have transfer pricing regulations in place. Transfer Pricing, in simple terms, is determining the price for a transaction between two enterprises. However, for the purposes of tax laws, only transactions that qualify as an ‘International Transaction between two Associated Enterprises’, are relevant for transfer pricing. In the earlier article, we explained how two enterprises may be associated and end up as ‘Associated Enterprises’. In this article, we will explain which transactions are covered by the term ‘International Transaction’.
Meaning of International Transaction
Before we get into the definition of ‘International Transaction’, it is pertinent to first understand the term ‘Transaction’ as defined under the Income Tax Act.
Section 92F(v) of the Income Tax Act, 1961 defines Transaction in an inclusive manner, to include any arrangement, understanding, or action in synchronization, apart from the usual understanding of the term in common parlance. More importantly, the definition rules out the manner i.e. whether in writing or not, and the intention to be legally enforceable, as irrelevant for the purpose of defining a transaction. Thus, it is important to note whether an arrangement is conducted formally or informally, in dialogue or in writing, or if its non-performance leads to or doesn’t lead to legal action, it would still be called a ‘Transaction’ under Income Tax Act.
Section 92B of the Income Tax Act, 1961 defines an International Transaction. As per the aforesaid section, for a transaction entered into by an enterprise would be called as an international transaction if –
- Direct Transaction –the transaction is with associated enterprises, and at least, one of them is a Non-Resident in India
e.g.Alpha and Beta are associated enterprises. Alpha is registered in USA and Beta is registered in India. Therefore, transactions between Alpha and Beta are ‘International Transactions’ for both the companies, while being taxed in India.
- Indirectly Controlled Transaction – the transaction is with independent enterprises, however, there exists a prior agreement between enterprises associated to the enterprise and the independent enterprises, or the terms of transactions are determined in substance by the associated enterprise, where at least one of the associated enterprises is a Non-Resident.
e.g. Beta (situated in India) enters into a transaction to supply material to ABC (an independent entity, situated anywhere). However, the terms of this agreement have been pre-decided with Alpha (an associated enterprise, situated anywhere) in a different agreement. In such a case, the transaction between Alpha and ABC would be considered as an ‘International Transaction’ between Alpha and Beta, while being taxed in India.
Nature of International Transactions
From the definition, we can clearly understand there are only two primary components of International Transaction, first is being a transaction and second is being a transaction between entities as specified above. There are no specifications as to the nature of transactions, which any kind of transaction can be International Transaction, irrespective of their nature, subject to satisfying conditions in relation to parties involved in the transaction.
However, owing to litigations, the definition of International Transaction was further explained to specifically include the following types of transactions, apart from usual transactions. The extended definition included the following transactions, as an international transaction:
- Transactions which are in the nature of purchase, sale or lease of properties, irrespective of whether the property is tangible or intangible in nature;
- Transactions involving the provision of services amongst the enterprises;
- Transactions in the nature of capital financing involving both borrowing and lending money either for short-term or long-term purposes
- Any kind of cost allocation or apportionment between the associated enterprises
- Any kind of business restructuring and reorganization transactions e.g. merger of two entities
- Any other type of transaction having any bearing on the profits, income, losses, or assets of the enterprise.