Pr CIT vs. M/s Veer Gems (Gujarat High Court)

The Tribunal passed an order dated 3rd January 2017 (ACIT vs. Veer Gems (ITAT Ahmedabad)) in which it held as follows:

(i) In order to invoke the transfer pricing provisions, and deal with the determination of arm’s length price, it is absolutely essential that the international transaction in question must be between the associated enterprises. It is perhaps the most basic aspect of the matter and foundational basis on which transfer pricing provisions are invoked. It is, therefore, wholly unreasonable to decline to deal with this issue on the ground that, in any event, the ALP adjustment in question is also not sustainable in law. The issue whether the transactions between two entities are transactions between the associated enterprises cannot be infructuous or academic just because the transactions are at arm’s length prices, though this proposition would be true the other way round i.e. the issue whether the transactions at arm’s length price or not would be infructuous in the event of enterprises not being associated enterprises. We are unable to see any merits in the approach adopted by the learned CIT(A). In our considered view, the first thing that needs to be adjudicated upon is whether or not the assessee and Blue Gems BVBA are associated enterprises. As we proceed to deal with this question, we may first take note of Section 92A.

(ii) A plain reading of Section 92A makes the legal position quite clear. The basic rule for treating the enterprises as associated enterprises is set out in Section 92A(1). The illustrations in which basic rule finds application are set out in Section 92A(2). Section 92A(1) lays down the basic rule that in order to be treated as associated enterprise one enterprise, in relation to another enterprise, participate, directly or indirectly, or through one or more intermediaries, “in the management or control or capital of the other enterprise” or when “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” . Section 92(A)(2) only provides illustrations of the cases in which such an enterprise participates in management, capital or control of another enterprise. In other words, what Section 92A (1) decides is the principle on the basis of which one has to examine whether or not two or more enterprise are associated enterprise or not. The principle is, as we have noted above, that one of the enterprise, in relation to other enterprise, participate, directly or indirectly, in the management or control or capital of the other enterprise and that persons who participate in such management, control or capital of both the enterprises are common. As long as an enterprise participates in any of the three aspects of the other enterprise, i.e. (a) management; (b) capital; or (c) control, these enterprises are required to be treated as associated enterprise, as also is the position when common persons participate in management, control or capital of both the enterprises. However, the expression ‘participation in management or capital or control’ is not a defined expression. To find the meaning of this expression, one has take recourse to Section 92(2) which gives practical illustrations, which are exhaustive and not simply illustrative- as clarified in the Memorandum explaining the provisions of the Finance Bill 2002 which, while inserting the words “For the purpose of sub section (1) of section 92A” in Section 92A(2), observed that “It is proposed to amend subsection (2) of the said section to clarify that the mere fact of participation by one enterprise in the management or control or capital of the other enterprise, or the participation of one or more persons in the management or control or capital of both the enterprises shall not make them associated enterprises, unless the criteria specified in sub-section (2) are fulfilled”. In this sense, Section 92A(2) governs the operation of Section 92A(1) by controlling the definition of participation in management or capital or control by one of the enterprise in the other enterprise. If a form of participation in management, capital or control is not recognized by Section 92A(2), even if it ends up in de facto or even de jure participation in management, capital or control by one of the enterprise in the other enterprise, it does not result in the related enterprises being treated as ‘associated enterprises’. Section 92A(1) and (2), in that sense, are required to be read together, even though Section 92A(2) does provide several deeming fictions which prima facie stretch the basic rule in Section 92A(1) quite considerably on the basis of, what appears to be, manner of participation in “control” of the other enterprise. What is thus clear that as long as the provisions of one of the clauses in Section 92A(2) are not satisfied, even if an enterprise has a de facto participation capital, management or control over the other enterprises, the two enterprises cannot be said to be associated enterprises. That is a what coordinate bench decisions in the cases of Orchid Pharma Ltd Vs DCIT [(2016) 76 taxmann.com 63 (Chennai – Trib.)] and Page Industries Ltd Vs DCIT {(2016) 159 ITD 680 (Bang)] also hold.

(iii) The case of the revenue hinges on application of clause (j) of Section 92A(2). That is the only clause invoked by the Assessing Officer, and if this clause does not apply to the facts of this case, that is end of the matter. This clause provides that “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”. In the present case, the assessee is a partnership concern and the assessee firm, therefore, cannot be said to be controlled by “an individual” which is starting point for Section 92A(2)(j) being invoked.

(iv) The additional references to clauses (k) and (m) of Section 92A(2) are of no avail either. While clause (k) refers to an enterprise controlled by an HUF but no HUF has anything to do with either of the enterprise, clause (m) is only an enabling provision for prescribing any other relationship of mutual interest that can lead to the enterprises being treated as associated enterprises but then no such relationship has been prescribed as yet. Nothing, therefore, turns of Section 92A(2)(k) and 92A(2)(m) either. In any of the orders of authorities below, or during the course arguments before us, no other parts of Section 92A(2) have been relied upon by the authorities below or by the learned Departmental Representative. While a certain degree of control may actually be exercised by these enterprises over each other, due to relationships of the persons owning these enterprises, that itself is not sufficient to hold the relationship between the two enterprises as ‘associated enterprises’. That would at best satisfy the conditions under section 92A(1) but then, as we have noted earlier in this order and as clarified in the Memorandum explaining the provisions of the Finance Bill 2002 which, while inserting the words “For the purpose of sub section (1) of section 92A” in Section 92A(2), had observed that “It is proposed to amend sub-section (2) of the said section to clarify that the mere fact of participation by one enterprise in the management or control or capital of the other enterprise, or the participation of one or more persons in the management or control or capital of both the enterprises shall not make them associated enterprises, unless the criteria specified in sub-section (2) are fulfilled”. In our considered view, therefore, the assessee and Blue Gems BVBA cannot be said to be associated enterprises. As these enterprises are not associated enterprises, the ALP adjustments in respect of the transactions between these enterprises were wholly unwarranted. For this short reason, and without going any further into the matter, we approve the impugned deletion of ALP adjustment. The plea of the assessee, in cross objection, is upheld and, for that reason, grievance of the Assessing Officer, in appeal, is dismissed as infructuous.

On appeal by the department to the High Court HELD dismissing the appeal:

The Tribunal examined the provisions of Clauses j, k and l of sub-section 2 of Section 92A of the Act to come to the conclusion that none of these provisions would apply in the present case and therefore the assessee M/s. Veer Gems and its supplier of rough diamonds M/s. Blue Gems are not associated enterprises. We have perused the detailed discussion by the Tribunal in this regard. Clause (i) would apply in a case where goods or articles are manufactured or transferred by one enterprise. In the present case, admittedly M/s. Blue Gems does not either manufacture or process any articles. It merely purchases rough diamonds from the international markets and supplies to the assessee. Clause (j) would apply when an enterprise is controlled by an individual. In the present case, both the enterprises are partnership firms. There is nothing to suggest that they are controlled by any individuals. Clause (l) would of course apply in a case where the enterprise is a partnership firm. However, for applicability of the said clause, there has to be an enterprise in the nature of a firm and another enterprise who holds not less than 10% interest in such firms. Such facts are also not applicable in the present case. The Tribunal in our opinion therefore committed no error in holding that the assessee and M/s. Blue Gems not being associate enterprises, the question of applying transfer pricing formula would not arise.