TRANSFER pricing is triggered whenever there are transactions between associated persons where one party has control over the other, or where both parties are controlled by a third party, or are relatives of each other.
Determining whether there is control in a transaction between parties is fundamental. If there is no control, the issue of transfer pricing doesn’t arise, and the transaction becomes an arm’s length transaction because the transaction will be regarded as having taken place between parties who are unconnected with one another.
The general perception of control is that one has to own more than 50% of the other enterprise or must have direct or indirect control of the business of the enterprise. The law dealing with the word “control” is mostly prescriptive and the analysis should start dealing with the prescriptive requirements in the law, and where it is still uncertain, then the subjective requirements to define “control” have to be examined.
Prescriptive requirements of control
If one party has more than 50% ownership of the issued share capital and is able to exercise control over the affairs of the company, then he will be deemed to have control over the company. Control is not limited to just one party, and it can be jointly controlled by up to five persons, provided they jointly or together with their nominees are able to exercise control over the company’s affairs.
In determining control in the above paragraph, the shareholders either on their own or jointly must own or be entitled to acquire more than 50% of the issued share capital of the company, or receive a greater part of any income upon distribution to the shareholders, or in the event of a winding up, receive greater part of the assets upon distribution to the shareholders.
Where there is a joint venture or a consortium, transactions between members of the joint venture or consortium and the joint venture/consortium will be covered under the meaning of control and therefore such transactions will be subject to the transfer pricing regulations.
The next prescriptive rule is the 20% ownership rule. Here, control refers to a person who owns 20% or more of the share capital of the company, and the business depends on the proprietary rights such as patents, non-patented know-how, trademarks, or copyrights provided by the other person. Control will also exist if the person has at least 20% ownership of the company and has influence over the business activities of the company, this could involve sales, purchases, provision or receipt of services, by the other person. Control could also exist if the 20% shareholder has the power to appoint directors to the board of directors of the company.
The subjective element of control
The subjective element arises here because control can also be indirect over the company’s affairs. In such a situation, even when the shareholding is nominal, the shareholder may have de facto control through other means such as shareholder agreements that restrict other shareholders from exercising control without consent of the nominal shareholder. There could be negative covenants built into the constitution that allows the nominal shareholder to control the activities of the company. In determining control, it is important to look at the underlying documents and agreements to determine the true nature of control.
It is also common to find groups of companies controlled by the same individual shareholders without a common holding company structure. Since the same shareholders are involved in all the companies, such arrangements would be regarded to be under common control of the family, and therefore transactions between the companies would fall within the transfer pricing regime.
This article is contributed by Thannees Tax Consulting Services Sdn Bhd managing director SM Thanneermalai (www.thannees.com).
