Domestic Transfer Pricing - Related Party – Sec. 40A(2)(b)

Related Party – Sec. 40A(2)(b)

The amended sec. 40A(2)(b) reads as under:-

"(i) in clause (a), the following proviso shall be inserted, namely:—

"Provided that no disallowance, on account of any expenditure being excessive or unreasonable having regard to the fair market value, shall be made in respect of a Specified Domestic Transaction referred to in section 92BA, if such transaction is at arm's length price as defined in clause (ii) of Section 92F."

(ii) In clause (b), in sub-clause (iv), after the words "or any relative of such director, partner or member", the words "or any other company carrying on business or profession in which the first mentioned company has substantial interest" shall be inserted."

In the amended definition group companies are added which were hitherto not there in the erstwhile definition. "Substantial interest" is defined in explanation as the interest of a beneficial owner of shares carrying not less than 20 per cent of the voting power.

3.1 As per the definition it is not clear whether indirect holding of substantial interest is covered within the purview of "Related Party". Explanation to sec. 40A(2)(b) talks about beneficial ownership with regard to substantial interest held in an entity. Beneficial ownership is not defined under the Income-tax Law. Beneficial ownership is understood as a concept beyond the titular ownership. In other words beneficial ownership is not confined to legal ownership, in this regard we can rely on the ratio laid down by the Hon’ble Supreme Court in the case of CIT v. Podar Cements P. Ltd(1997) 226 ITR 625. Operative portion of the judgment reads as under

"We are conscious of the settled position that under the common law owner means a person who has got valid title legally conveyed to him after complying with the requirements of law such as Transfer of Property Act, Registration Act, etc. But in the context of Section 22 having regard to the ground realities and further having regard to the object of the Act, namely, 'to tax the income', we are of the view that the owner is a person who is entitled to receive income from the property in his own right."

Accordingly it was held by the Apex Court that an assessee who purchased a house property and enjoying the same pending formal registration was held to be the beneficial owner under sec.22 of the I.T. Act. In line with the same ratio the Apex Court also held that business assessee who owned a building pending registration was allowed to claim depreciation – Mysore Minerals v. CIT (1999) 239 ITR 775 (SC).

Therefore beneficial ownership obviously includes direct as well as indirect interest. One needs to look at the substance and find out who is the real owner. Applying the same analogy in the context of definition of related party under sec. 40A(2)(b) it would be incorrect to confine the scope only to direct holding of an interest in the entity. Thereby in the context of Domestic Transfer Pricing it is obviously justified to consider indirect holding as the same would come within the purview of beneficial ownership.

3.2 As per the definition of the related party under sec. 40A(2)(b) the following persons would be covered:

Sr. No	Payer / assessee	Payee
(i)	Individual	Any relative [defined in sec. 2(41) to mean husband, wife, brother, sister, lineal ascendant or descendant] Definition of Relative u/s. 56(2) not relevant
(ii)	Company	any director or relative of such director
	Firm (includes LLP)	any partner or relative of such partner
	AOP	any member or relative of such member
	HUF	any member or relative of such member
(iii)	Any assessee	any individual having substantial interest in the assessee’s business or relative of such individual
(iv)	Any assessee	a Company, Firm, AOP, HUF having substantial interest in the assessees business or any director, partner, member or relative of such director, partner or member or (newly inserted) any other company carrying on business or profession in which the first mentioned company has substantial interest. X Ltd. (subsidiary co.) A Ltd. (holding co.) Y Ltd. (subsidiary co.)