parent co

In this blogpost, Ankita Sen, Student, National Law University, Odisha writes about the meaning of parent company and subsidiary company and explains the relationship between the two. She further writes about pricing rules applicable to such companies.

Companies that function both at the national and international level often adopt the system of incorporating subsidiary companies in different countries. However, the matter of concern does not lie here. The problem arises when the companies start incorporating subsidiaries mostly in countries with low or nil tax rates. The hint of loss to the domestic economy in which country the company is based raises questions pertaining to tax evasion. This article aims at posing before the readers a neutral view of the problem at hand, citing arguments both for and against it and the suitable legislations enacted to tackle the same.

Parent and Subsidiary Company- A Conceptual Understanding.

The terms ‘parent company’ and ‘subsidiary company’ have been defined in the Companies Act, 2013. It is important to note that a holding company is a company that is so, in relation to company that is its subsidiary.[1] Section 2(87) of the Companies Act, 2013 defines a subsidiary of a particular holding company as a company wherein the holding company meaning of a holding company and a subsidiary company can be understood in terms of each other.[2] Notwithstanding the prominent differences between the business functioning of a subsidiary and its parent company, a substantial degree of influence of the parent company can be assumed on its subsidiary. There might be distinctness among the assets of both, but loss suffered by one will inevitably affect the other, thus blurring the separateness between a parent company and its subsidiary in legal terms.[3] Thus, activities of one are likely to impact the other.

Transferring Income Abroad- Reality Check.

A parent company and its subsidiary are intertwined such that financial assistance by the parent to its subsidiary becomes commonplace and a matter of regular commercial nature. Often parent companies provide its subsidiaries such comforts that would enable them to seek debt funding at favourable rates from the credit market in the global scenario.[4] It is this guise that companies today use, in order to transfer portions of their income to subsidiaries abroad. However, it stands highly disputed as to what constitutes income. Often, an interest that could have been derived on the loans advanced interest free to the subsidiaries is also considered as income (though passive in nature) for the parent company. While one end of the coin focuses on the commercial health and need of the subsidiary, the flip side weighs the impact on the domestic economy of the country in which the parent company is based in.

The primary reason behind such transfer of income to foreign subsidiaries is claimed by many critiques as a move to evade taxes. The rationale behind such attack is backed by the fact that companies most commonly transfer their income to subsidiaries based in ‘tax havens.’ It is now important to understand the meaning and implications of a ‘tax haven’. A tax haven is in simple words, a jurisdiction with minimal or nil tax rates, sometimes also termed as ‘secrecy jurisdictions.’[5] Such tax havens can be commonly used to evade the tax legislations and rules prevalent in other jurisdictions; tax liability minimization is a key feature of a tax haven.[6] The following sections deal in detail with the arguments given by the opposing parties to the battle, namely the parent companies and the domestic tax authorities

Arguments- The Flip Sides.

The Companies’ Perspective:

The plea most commonly adopted by companies is that the parent is providing the necessary financial assistance to the subsidiary. Support for this plea has been lent by various judgments delivered by Courts across nations. Such financial assistance is provided by the parent companies in various forms. A major category of such help is provided as equity support to the subsidiary company- a parent company is said to provide integral equity strength to its subsidiary when it effectively controls its capital structure and undertakes activities to supplement the creditworthiness of its subsidiary.[7] Other forms of financial assistance provided to the subsidiaries are in the forms of interest-free loans, corporate guarantees, etc. The argument of commercial assistance to the subsidiary is also strengthened to a considerable extent by the Organization for Economic Development and Cooperation (OECD) Guidelines, 1995, that provide- any activity undertaken by a group member, a parent company essentially for its ownership interest in the subsidiary or other member/s of the group, such activity would be a ‘shareholder activity’ and in such case, no payment can be demanded.[8] A logical backup of implicit support works for this argument. In simple words, a parent company may provide to its subsidiary extra-contractual financial support as and when financial hardship is faced by the particular subsidiary.[9]

Contrasting Opinion of the Tax Authorities:

The tax authorities and the domestic legal system of the country state that the parent company is incorporated in, however, opposes this financial support structure put up by the parent company. This is primarily because, even though such a structure of transferring income in the cover of financial assistance to the subsidiary company does no harm to the parent company, it affects the domestic economy. It is the government that is deprived of the revenue received from income tax, by the shifting of profits and income to countries with low tax rates.[10]

The debate thus takes a turn of tax evasion versus tax planning. The companies on one hand argue that they are justified in channelling their business and other financial activities in a way so as to reduce certain tax liabilities as a part of their tax planning. On the other hand, the tax authorities claim such activities undertaken by the company as a part of tax evasion that is strictly prohibited by the laws of the country. The question is whether to view such activities as a part of tax planning or as a furtherance of a tax evasion motive.

Tax Planning v. Tax Evasion:

Tax evasion refers to a process of illegally trying to avoid the payment of such taxes that the taxpayer is bound to pay rightfully.[11] Tax planning, on the other hand, refers to a legitimate process of reducing one’s tax liability. The question as to whether or not conducting activities in a way so as to reduce the tax to be paid to the Government is permitted has been dealt with by various Courts, in various judgments. The issue was first discussed in the case of IRC v. Duke of Westminster[12] , wherein the House of Lords upheld the tax payer’s right to plan his activities in a way to reduce tax liability. It was in the case of CTO v. McDowell and Co. Ltd.[13], that the issue first came up before the Hon’ble Supreme Court of India. The apex Court of the country herein held that tax planning that is within the bounds of the law is legitimate. The Court, however, also held that colourable and dubious instruments cannot be considered as a part of legitimate tax planning. A larger bench of the Hon’ble Supreme Court in Union of India v. Azadi Bachao Andolan[14] dealt with this issue once again and upheld the Westminster principle. Finally, in the year 2012, the matter was again discussed by the Apex Court of the country in the case of Vodafone International Holdings B.V. v. Union of India[15] , wherein the Court has clearly held that the Westminster principle stands valid in the Indian pretext and a taxpayer is entitled to legitimately plan his activities so as to reduce tax liabilities and a motive to avoid taxes cannot per se invalidate the particular transaction. The Court also clarified that there was no conflict between the cases of Mc Dowell and Azadi Bachao Andolan. However, it still remains a question as to which transaction can be considered as a part of legitimate tax planning and which cross the boundaries of tax planning to fall in the ambit of tax evasion.

Substance or Form – The Question Remains:

Generally, it is imperative to look at the form of the transaction and not its substance if it is a genuine transaction.[16] It is important however, to note that if a company misutilizes the legal form of a transaction (bereft of any reasonable commercial purpose), the Revenue and the respective tax authorities may disregard the form of the transaction and consider the economic substance of the transaction, re-characterize it and tax it accordingly. It is thus when a transaction is used as a colourable instrument to illegally avoid the payment of taxes, the doctrine of substance over form may be used. However, this brings us again to the question as to whether a transaction has a motive of tax evasion or is a part of legitimate tax planning by a company.

Transfer Pricing Rules- Need of the Hour.

Companies shift profits to nil or low tax jurisdictions from high tax countries by pricing commodities and/or services to affiliation. However, in order to properly assess the income, the prices charged to related companies or affiliates must be equal to prices charged to unrelated parties.[17] This scenario led to the growth of transfer pricing guidelines in various nations all over the world. The transfer pricing rules and regulations across countries deal with computation of an arm’s length price at which international transactions between associated enterprises or related parties must take place. For instance, according to transfer pricing rules, a subsidiary company would have to pay arm’s length guarantee fee to its parent company in return for a corporate guarantee given by the parent company on behalf of its subsidiary.[18]

In India, Chapter X of the Income Tax Act, 1961 deals with transfer pricing regulations in regard to international transactions as well as specified domestic transactions. It is thereby important to understand the meaning and concept of the following keywords-

Arm’s length price- Section 92 of the Income Tax Act, 1961 specifies that income that arises due to international transactions must be at arm’s length price. According to the arm’s length price principle, a price that is set for the purpose of transactions between associated enterprises or related parties must for the taxation purposes be derived from the charge that would have worked out between unrelated parties. This principle applies only to associated enterprises.[19] The principle of arm’s length price is the most accepted process of determining transfer prices between associated enterprises.[20]

International Transaction- Section 92B of the Income Tax Act, 1961 deals with the concept of international transactions. International transactions refer to transactions between two non-resident enterprises or between one resident and another non-resident enterprise when the transaction concerns any of the following-

  • Tangible property
  • Intangible property
  • Capital financing
  • Provision of services
  • Business restructuring.[21]

Associated Enterprise- Section 92A of the Income Tax Act, 1961 deals with the meaning of ‘associated enterprise’. According to the Section, two enterprises are termed as ‘associated’, when they are controlled or owned, pursuant to the same interest.[22] The definition in Section 92A portrays two situations-

  • Where the between the two enterprises, one controls the other or is controlled by the other
  • Where the two enterprises share a mutual interest relationship or one of indirect ownership.

Article 9(1) of the OECD Model Convention with Respect to Taxes on Income and on Capital, also discusses the concept of associated enterprise in terms of direct or indirect participation in the management, capital or control of the concerned enterprise.


It is hence clear that a parent company and its subsidiary are associated enterprises and in a situation where at least either is situated outside India, transactions between the two, falling in the ambit of international transactions must comply with the arm’s length price principle in accordance with the transfer pricing regulations. Thus, in spite of all the arguments advanced by the companies, compliance to transfer pricing rules remains a reality worldwide. Economies around the world continue to accord importance to the substance of the transaction, often covered by the colourable form.

[1]Section 2(46), Companies Act, 2013.

[2]Civil Services Preliminary Examination Commerce, L.N Koli, Upkar Prakashan, pg no. 554C.

[3]The Case Of Oneness Of Group Companies, Rimali Batra,

[4]The Application Of Section 482 Transfer Pricing Principles To Financial Transactions, Steven L. Walker, State Bar Of California Taxation Section, pg no. 2.

[5]Vodafone International Holdings B.V v. UOI, Civil Appeal No. 733 of 2012.

[6]Identifying Tax Havens and Offshore Finance Structures, available at

[7]Kohinoor Food Ltd. v. ACIT, .T.A. no. 3669/Del/2012 (ITAT, Delhi).

[8]Tax Law On Intra Group And Shareholder Security From A Transfer Pricing Perspective, Jakob Bundgaard, International Transfer Pricing Journal, 2006, pg no. 81.

[9]Rupert Macey-Dare, Transfer Pricing and Generalized Implicit Support Networks, available at

[10]International Tax Avoidance and Evasion, Jane G. Gravelle, Congressional Research Service, pg no. 6, available at

[11] Worldwide Tax View Substance Over Form: Where Is The Limit?, Srinivasa Rao, available at

[12] [1935] All ER 259.

[13] AIR 1986 SC 649.

[14] (2003) ITR 706 SC.

[15]Civil Appeal No. 733 of 2012.

[16]Direct Taxes, BB Lal and N. Vashisht, 29th ed., 2008, pg no. 49.10.

[17] International Tax Avoidance and Evasion, Jane G. Gravelle, Congressional Research Service, pg no. 12, available at

[18] The Application Of Section 482 Transfer Pricing Principles To Financial Transactions, Steven L. Walker, State Bar Of California Taxation Section, pg no. 3.

[19] The Concept Of Associated Enterprises, Ramon J. Dwarkasing, Kluwer Law Online, available at

[20] International Transfer Pricing In The Ethical Pharmaceutical Industry, Karl Winduisch, IBFD, 2nd ed., 2003, pg no. 107.

[21] Accountant’s Report U/S 92E Of The income Tax Act, 1961, CPE Study Circle Meeting At SIRC Of ICAI, available at

[22]Associated Enterprises Under Indian TP- A Detailed Analysis, B Mala and Bhavya Rangarajan, SAPR Advocates, available at

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