Income Tax Appellate Tribunal - Mumbai
Merck Ltd., Mumbai vs Assessee on 27 June, 2013
ITA No. 925/Mum/2007 Merck Limited आयकर अपील य अ धकरण " के " यायपीठ मंब ु ई म।
IN THE INCOME TAX APPELLATE TRIBUNAL "K" BENCH, MUMBAI बी.आर. म या यक सद य एवं, राजेसंह, लेखा सद य के सम । BEFORE SHRI B,R, Mittal JM and Rajendra Singh, AM आयकर अपील / ITA No. 925 /Mum/2007 ( नधारण वष / Assessment Year : (2003-04) Merck Limited बनाम/ The Dy. Commissioner Shiv Sagar Estate, Vs. of Income Tax, Circle 6 "A" Annie Besant (3) Road, Worli, Mittal Court Mumbai - 400 018. Nariman Point Mumbai.
थायी ले खा सं . /PAN : AAACE2616F
(अपीलाथ /Appellant) .. ( यथ / Respondent)
अपीलाथ क ओर से / Appellant by : Shri P.J. Pazdiwala
Smt. Aarti Visanjit and
Shri Ajit Shah
यथ क ओर से/ Respondent by : Shri Ajeet Kumar Jain
Smt. Sosmita Misra
सनवाई
ु क तार ख / Date of Hearing : 27-6-2013
घोषणा क तार ख /Date of Pronouncement : 19 -7-2013
आदे श / O R D E R
Per Rajendra Singh
This appeal by the assessee is directed agains the order dated 24.11.2006 of CIT(A) for the assessment year 2003-04. The assessee in this appeal has raised disputes on several grounds relating to domestic as well as international issues.
Page 1 of 71 ITA No. 925/Mum/2007Merck Limited
2. The dispute raised in ground no. 1(a) is general in nature and, therefore, does not require any adjudication.
3. The ground no. 1 (b) is regarding addition of Rs. 8332055/- on account on unutilised modvat credit in the value of closing stock. The AO had made the said addition as the assessee had not included the unutilised modvat credit in the closing stock u/s 145A of the IT Act.
3.1 The assessee disputed the decision of AO and submitted before CIT (A) that similar addition made in the earlier year has been deleted. It was also submitted that in case addition was required to be made into the closing stock, adjustment has also to be made in the purchases as well as in the opening stock. CIT(A) after considering the submissions of the assessee observed that similar issue had been considered in assessment year 2002-03 in which the CIT(A) had held that full effect of provision of section 145A were required to be given by including tax duty etc., in the opening stock/purchases also and not only in the closing stock. CIT (A) thereafter held that addition made by AO in the closing stock was confirmed and directed the AO to make similar adjustment in the opening stock. Aggrieved by the said decision, the assessee is in appeal before Tribunal.
Page 2 of 71 ITA No. 925/Mum/2007Merck Limited 3.2 We have heard both the parties, perused the records and considered matter carefully. The dispute is regarding adjustment to be made on account of tax, duty etc., under the provisions of section 145A. Under the said provisions, the valutiaon of purchases and sale of goods and inventory is required to be made in accordance with the method of accounting regularly employed by the assessee and further adjustment is required to be made to include the amount of any tax, duty cess or fees actually paid or incurred by the assessee to bring the goods to the place of its location and condition as on the date of valuation . It is therfore clear that adjustment on account of tax, duty etc. is required to be made not only to the closing stock but also in the purchases, sales and opening stock. In the present case, the AO had made adjustment only in the closing stock. CIT (A) has directed him to make adjustment in the opening stock also in addition to closing stock. He has however omitted to consider the aspect that adjustment is also required to be made to the purchases and the grievance of the assessee is only on this account. We therefore modify the order of CIT (A) by holding that the adjustment on account of tax duty will also be made in the purchases. The ground raised by the assessee is thus allowed.
4. The dispute raised by the assessee in ground no. 1
(c) is regarding addition on account of royalty payment of Rs. 5647627. The assessee had made total claim on account of Page 3 of 71 ITA No. 925/Mum/2007 Merck Limited royalty at Rs. 2,45,73,524/. The AO noted that in respect of four payments aggregating to Rs. 56,47,627/-, the assessee had neither deducted tax nor deposited the same before the end of the financial year. He, therefore, disallowed a sum of Rs. 56,47,627/- u/s 40(a)(i) r.w.s 195 of the IT Act.
4.1 The assessee disputed the decision of AO and submitted before CIT(A) that the assessee had not remitted the amount to the extent of tax payable to the German company and, therefore, tax had been deducted before 31.3.2003 and which had been paid before 31/5/2003. It was thus argued that no no disallowance could be made. Alternatively, it was also submitted that the claim may be directed to be allowed in assessment year 2004-05, in which the tax had been paid. CIT (A), on examination of the record, noted that the tax have been deducted on 25.4.2003 i.e in the subsequent year. Therefore, it was not a case of tax being deducted in this year and payment made within a period of two months. CIT (A), therefore, held that deduction had to be allowed in assessment year 2004-05 after necessary verfication. Aggrieved by the said decision, the assessee is in appeal before Tribunal.
4.2 We have heard both the parties. The learned senior Counsel appearing for the assessee pointed out that the direction of CIT (A) for allowing the claim in the next year has not been given effect to by the AO. It was also submitted that Page 4 of 71 ITA No. 925/Mum/2007 Merck Limited the assessee will be satisfied if the claim was allowed in the next year. We have considered the matter carefully, we do not see any difficulty in allowing the claim in next year as the CIT(A) has given a clear finding that deduction was made in the next year and the amount was also paid next year. The order of CIT (A) holding that the claim has to be allowed next year is, therefore upheld. The AO will thus allow the deduction in assessment year 2004-05.
5. The dispute raised in ground no.1(d) is regarding disallowance of Rs. 58,91,675/- in respect of bad and irrecoverable debt written off during the year. The assessee had claimed deduction of Rs. 58,91,675/- on account of bad debt written off. The assessee filed names and addresses of debtors alongwith amount written off and the date of raising the bill, before the AO and also made legal submissions on the issue. The assessee explained that the company sold its product in various divisions to various types of customers and many a times amounts were not received from the parties in respect of sales made to them for various reasons such as short receipts of goods, excess freight charges etc. The amounts not recovered, therefore, were, written off as bad debt. The AO however observed that the debt should have been taken into account in computing the income of the relevant accounting year or in the earlier year and it should also have been established to have become bad which was not done. He, therefore, disallowed the claim.
Page 5 of 71 ITA No. 925/Mum/2007Merck Limited 5.1 In appeal CIT(A) observed that the assessee had not produced any details and evidence to show that such debts had been taken into account in computing the income of earlier year. He, therefore, confirmed the disallowance. Aggrieved by the said decision the assessee is in appeal before Tribunal.
5.2 Before us learned senior Counsel appearing for the assessee submitted that the assessee had given details of bills, names and addresses of the debtors and the amounts written off. The assessee had also explained the reasons as to how the amounts could not be collected which related to sales made earlier. It, therefore, could not be said that the amount had not been taken into account in the computation of income of the earlier year. It was also submitted that the assessee had no objection if this aspect was further verified by AO. The learned DR placed reliance on the orders of authorities below.
5.3 We have perused the records and considered matter carefully. The dispute is regarding disallowance of cliam of bad debt. It is a settled legal position as held by Hon'ble Supreme Court in case of TRF Ltd.(323 ITR 347) that after the amendment of the provisions from assessment year 1998-99, burden is no longer on the assessee to establish that the debt has actually become irrecoverable. The only Page 6 of 71 ITA No. 925/Mum/2007 Merck Limited conditions which are required to be fulfilled for allowance of bad debt is that the debt should have been taken into account in the computation on inomce of earlier year and should have been written off in the books of accounts. There is no dispute that the bad debt had actually been written off in the books of accounts. The dispute is only whether the debt had been taken into account in the computation of income of earlier year. CIT (A) has held that the assessee had not produced any detail and evidence to show that such debts had been taken into account in computating the income of ealier year. This aspect in our view requires verification to which the assessee has no objection. We, therefore, restore the issue to the file of AO for a fresh decision after allowing opportunity of hearing to the assessee to show that the debt had been taken into account in computation of income of the earlier year.
6. The dispute raised in ground no. 1 (e) is reagarding disallowance of Rs. 5,32,69,000/-. The AO on examination of quantitative details of trading goods and manufacturing goods noted that there was under statement of closing stock. The assesse explained that the lower stock was because of shortage, free samples and giveaways under the company's bonus scheme. It was also submitted that it was a common practice amongst all pharmaceutical companies to distribute physician samples amongst doctors, hospitals and other users for promoting the sale of goods. It was pointed out that Page 7 of 71 ITA No. 925/Mum/2007 Merck Limited the closing stock did include quantities and values of samples, but since the samples were distributed free of cost, these were reflected as part and parcel of the cost of goods sold in the accounts. This is nothing but sale promotion expenditure. The AO however observed that the assessee when asked to file the names and addresses of the persons, physicians and doctors to whom such free samples were distributed, furnished only region wise samples distributed to medical representatives, and no details of physicians/doctors were given. The AO, therefore, did not accept the genuineness of the claim and added a sum of Rs. 5,32,69,000/- on account of shortage of closing stock on this account.
6.1 The assessee disputed the decision of AO and submitted before CIT (A) that the AO had never asked for details of names and addresses of the persons, physicians and doctors to whim the samples were distributed and, therefore, there was no question of the assessee not producing the same for the purpose of verification. It was also submitted that no disallowance on this account had been made in the past. Alternatively it was also submitted that in case the claim was not allowed the same should be allowed as part of opening stock in the subsequent year. CIT(A) on examination of records observed that the AO in the assessment order had clearly mentioned that the assessee had failed to file the names and addresses persons, physicians and doctors and, Page 8 of 71 ITA No. 925/Mum/2007 Merck Limited therefore the claim of the assessee that the AO had never asked for details was not correct. Even in the course of appellate proceedings, the assessee had not filed complete details except filing quantitative details and sample copies of daily report of marketing employees from which it could not be made out whether the assessee had freely distributed samples of Rs. 5,32,69,002/-. The assessee had thus failed to discharge the onus to prove the genuineness of the claim. CIT (A), therefore, confirmed the addition made by AO. CIT (A) however accepted the alternate claim of the assessee that amount has to be included in the opening stock of next year as the AO had made the addition to the closing stock of this year. Aggrieved by the said decision, the assessee is in appeal before Tribunal.
6.2 Before us the learned senior Counsel submitted that at the time of assessment, the assessee had file the call report of doctors before the AO which contained the names of the doctors. It was also submitted that the AO had not specifically called for the addresses of the doctors. It was pointed out that the assessee was a multinational company which was distributing free samples throughout India and details of the doctors were voluminous. It was also submitted that the assessee could provide such details if required. He also filed the details for the month of March giving names and addresses of the doctors which ran into several pages. It was argued that it was a common practice to distribute free Page 9 of 71 ITA No. 925/Mum/2007 Merck Limited samples and such claims have also been allowed in the past. The disallowance has been made only from this assessment year. The claim should, therefore, be allowed considering the past histroy. Learned DR on the other hand submitted that the burden was on the assessee to establish that the expenditure on account of samples was genuine and had been actually incurred which cannot be discharged without giving full details. It was also submitted that the disallowance could always be made in the subsequent year even if no disallowance had been made in the past. Reliance was placed on the decision of Tribunal in case of Good Year India Ltd. ( 66 TTJ 164) 6.3 We have perused the records and considered the the rival contentions carefully. The dispute raised in this ground is regarding disallowance of expenses on account of free samples. The total claim of expenses on this account is Rs. 5,32,69,000/-. The assessee did not file the names and addresses of persons/physicians/doctors to whom free samples had been given despite specific requisition made by the AO. Such details were not filed even before CIT(A). The authorities below, have, therefore, not found the claim of such expenses genuine and accordingly disallowed the entire expenses. Thus it is not simply a case of estimated disallowance but a case of treating the entire claim as not genuine. It has been submitted before us that the details had not been given as the same were voluminous. The details for Page 10 of 71 ITA No. 925/Mum/2007 Merck Limited the month of march has been submitted before us showing large no. of entries. In our view, the reason for non submission of details requisitioned by AO is not convincing. It is a settled legal position that burden is on the assessee to prove that the expenditure has been incurred wholly and exclusively for the purpose of business and the AO is entitled to make enquiries in relation to any claim made by assessee. Therefore, in case the AO in connection with determination of total income of the assessee, wants to make enquiries in relation to any aspect of business of the assessee, it is required to render assistance in the matter. In case, the transactions were voluminous the assessee could have brought to the notice of AO and in that case it could have given part of the details of expenses relating to each month for sample checking. It has been submitted that no disallowance had been made in the past. Merely because no disallowance had been made in the earlier years is no ground to seek relief in subsequent year. The AO in this year has attempted to make detailed examination of the issue to find out the genuineness of the claim. It was also brought to our notice that similar disallowance has been made in the subsequent years also. Therefore, in our view the exercise initiated by the AO for detailed examination of the issue in this year has to be given a logical conclusion by examining the necessary details. Giving free samples is a normal business practice in pharmaceutical business and, therefore, disallowance of entire expenditure is prima facie unjustified.
Page 11 of 71 ITA No. 925/Mum/2007Merck Limited The matter in our view requires fresh examination after verification of details about names and addresses of doctors before the AO. We, therefore, set aside the order of CIT (A) on this point and restore the issue to the file of AO for passing a fresh order after necessary examination of the details filed by the assessee and after allowing opportunity of hearing to the assessee
7. Ground no. 1(f) relates to transfer pricing issue and will be taken up later.
8. The dispute raised in ground no. 1(g) is regarding deduction of Rs. 91,55,000/- in respect of contribution to LIC Group Insurance Scheme. The learned Senior Counsel at the time of hearing of the apeal did not press this ground. The ground is, therefore, dismissed as not prressed.
9. The ground no. 1 (h) is regarding disallowance of Rs. 5,00,000/- out of discount and commission expenditure claimed by the assessee. The AO noted that the assessee had claimed discount and commission of Rs. 1,89,87,006/-. The AO observed that the assessee had been asked to submit complete details along with names and addresses of the parties with supporting evidences. But the assessee had filed only the broad details. No quantitaive details or any supporting evidence were filed to prove the genuineness of expenses. The AO further observed that the assessee could Page 12 of 71 ITA No. 925/Mum/2007 Merck Limited have at least produced few supporting vouchers/bills on a sample basis to prove genuineness, which has also not been done. AO, therefore, disallowed a sum of Rs. 5,00,000/- on estimate as not incurred wholly and exclusively for the purpose of business.
9.1 The assessee disputed the decision of AO and submitted before CIT (A) that the assessee had been regularly giving discount and commission for promotion of sales and never in the past any disallowance on this account had been made. It was also submitted that the AO never asked for the names and addresses of the parties with supporting evidences. It was also pointed out that the assessee had a well laid down financial and accounting system and adequate internal controls in respect of all its transactions. The expenditure had been incurred for the purpose of business and, therefore, no disallowance should be made. CIT (A) however observed that the assessee during the assessment proceedings vide order sheet noting dated 11.9.2006 had been asked to furnish details of commission party wise, date, name and the linkage to the corresponding bills, which was not furnished by the assessee. The assessee, thereafter, vide order sheet noting dated 10.10.2006 was asked to explain as to why the disallowance should not be made at the rate of 10%. Thereafter the assessee filed only the break up of discount and commission and no other details were furnished. Even during the appellate proceedings the Page 13 of 71 ITA No. 925/Mum/2007 Merck Limited assessee could not furnish the full details. The assessee could not file the copy of agreement for payment of commission, the rate of commission and the details of bills. CIT (A), therefore, confirmed the ad-hoc disallowance of Rs. 5,00,000/- made by AO, aggrieved by which the assessee is in appeal before Tribunal.
9.2 Before us, the learned Senior Counsel appearing for the assessee submitted that the assessee had regularly incurred expenditure on discount and commission for promoting sales. The full details as required by the authorities could not be submitted as the same were voluminous. It was also submitted that no disallowance had been made either in the earlier year or in the subsequent year even in the scrutiny assessments made u/s 143 (3) of the IT Act. He also referred to the comparative details filed at page 835 of the paperbook as per which the commission and discount as percentage of sales this year was .55% compared to .43% in assessment year 2002-03. The difference being not big it was submitted that no disallowance should be made. The learned DR on the other hand strongly supported the orders of authorities below and placed reliance on the finding given in the respective orders.
9.3 We have perused the records and considered the the rival contentions carefully. The dispute raised is regarding estimated disallowance of Rs. 5,00,000/- out of Page 14 of 71 ITA No. 925/Mum/2007 Merck Limited discount and commission expenses of Rs. 1,89,87,006/- claimed by the assessee. The assessee could not submit complete details along with names and addresses of the parties with supporting evidence which was specifically requisitioned by the AO. Such details were also not been filed before CIT(A), and, therefore, he upheld the disallowance. It has been submitted before us, that similar claim had been made by the assessee both in earlier years and in the subsequent years and no disallowance has been made even in the scrutiny assessment u/s 143 (3). In our view, merely because no disallowance had been made in earlier years or in subsequent year cannot be the basis for making claim for relief in this year, because it is not possible for the AO to make detailed examination of each and every issue relating to assessment every year. This year he has taken up the matter for detailed examination and found that the expenses were not supported by details and evidences. It is however a settled legal position that even in cases where the details and evidences are not available, the AO is required to compute disallowance on an objective basis on the basis of material available on the record. In this case from comparative details of expenses filed we find that expenses on account of discount and commission have been claimed at .55% total sales of Rs. 344 crore compared to .43% on turnover of Rs 345 crore in the immediate preceding year. Therefore, if we compute the expenditure this year at the same percentage as in the immediate preceding year, the Page 15 of 71 ITA No. 925/Mum/2007 Merck Limited expenditure comes to Rs. 1.47 crore against the claim of Rs. 1.89 crore. Thus on the basis of claim in the preceding year, there is an excess claim of about 42 lakhs. The AO has made estimated disallowance of only Rs. 5,00,000/-. In our view the disallowance made is quite reasonable and the same is upheld.
10. The dispute raised in ground no. 1 (i) is regarding estimated disallowance of Rs. 20,00,000/- out of sales promotion expenses. The assessee had made claim of sale promotion expenses at Rs. 5,45,77.106/-. The AO during the assessment proceedings had asked for similar details and evidence as in case of discount and commission as discussed earlier. The assessee had however failed to file the full details. Even during the appellate proceedings when the assessee had been specifically asked to to furnish full details, the assessee had given only the break up of sale promotion expenses CIT(A), therefore, observed that in the absence of full details, it could not be established that the expenditure had been incurred fully and exclusively for the purpose of business. He, therefore, upheld the disallowance to the extent of Rs. 10,00,000/- against the estimated disallowance of Rs. 20,00,000/- made by the AO. Aggreived by the said decision, the assessee is in appeal before Tribunal.
Page 16 of 71 ITA No. 925/Mum/2007Merck Limited 10.1 Before us, learned Senior Counsel advanced similar arguments as in case of discount and commission. He also referred to the comparative details given at page 835 of the paperbook to point out that expenditure on account of sales promotion as percentage of sales was lower this year compared to expenditure in the assessment year 2002-03. It was also submitted that no disallowance had been made either in the earlier year or in the subsequent years even in the scrutiny assessment. It was, therefore, urged that the addition made may be deleted. The learned DR on the other hand supported the order of CIT(A) and placed reliance on the findings given in his order.
10.2 We have perused the records and considered the rival contentions carefully. The dispute is regarding estimated disallowance out of sales promotion expenses. The assessee has claimed sales promotion expenses of Rs. 5,45,77,106/-. Estimated disallowance of 20,00,000/- had been made by AO as the assessee could not file full details relating to the claim. CIT(A) reduced the disallowance to Rs. 10,00,000/-. It has been submitted before us, that no disallowance had been made in the earlier years or in the subsequent year even in the scrutiy assessments made by the AO. Comparative details of such claim with respect to earlier years has been filed which shows that the claim made by the assessee this year is at 1.59% of sales compared to 2.2% of sales in the immediate preceding year. Thus the Page 17 of 71 ITA No. 925/Mum/2007 Merck Limited claim made by the assessee is lower this year compared to the immediate preceding year, in which it has been allowed fully. Even if the assessee has not filed full details the disallowance is required to be made by AO on an objective basis on the basis of material available on record. There is no materia placed before us to show that the expenses claimed by assessee is excessive. In fact, we find that the claim is lower this year. Therefore, disallowance of expenses cannot be upheld. We accordingly set aside the order of CIT(A) on this point and delete the addition made.
11. The dispute raised in the ground no. 1 (j) is regarding estimated disallowance of Rs. 10,00,000/- out of travelling, conveyance and vehicle expenses claimed by the assessee at Rs. 11,21,56,760/-. The AO had asked for the details of these expenses with names and addresses of the parties etc., as done in case of discount and commission and sales promotion. The assessee however could not file the full details. The AO, therefore, made estimated disallowance of Rs. 10,00,000/-.
11.1 In apeal CIT (A) observed that during the appellate proceedings also the assessee had been specifically asked to file details of travelling expenses with names and designation of officer, date and purpose etc., which was not filed. CIT (A) therefore, held that in absence of full details it could not be established that the expenditure had been incurred wholly Page 18 of 71 ITA No. 925/Mum/2007 Merck Limited and exclusively for the purpose of business. He, therefore, confirmed the disallowance made by AO, aggrieved by which the assessee is in appeal before the Tribunal.
11.2 Before us, the submissions made by the learned Senior Counsel were similar to those advanced in case of discount commission and sales promotion. It was argued that full details could not be given as the same were voluminous. It was further pointed out that no disallowance had been made on this account either in the earlier years or in the subsequent year even in the scrutiny assessments. He also referred to the comparative details given at page 835 of the paperbook to point out that the claim this year as a percentage of sales was lower compared to in the immediate preceding year. It was further submitted that the assessee being a company no disallowance could also be made on account of personal issues. Reliance was placed on the judgment of Hon'ble High Court of Gujarat in case of Sayaji Iron & Engineering Co. (253 ITR 749). It was, therefore, urged that no disallowance should be made. The learned DR on the other hand supported the order of CIT(A) and placed reliance on the findings given in his order.
11.3 We have perused the records and considered the matter carefully. The dispute is regarding estimated disallowance of Rs. 10,00,000/- out of travelling, conveyance and vehicle expenses of Rs. 11,21,56,760/-. The AO had Page 19 of 71 ITA No. 925/Mum/2007 Merck Limited made estimated disallowance on the ground that full details of expenses with names and addresses of the parties had not been given. CIT (A) has confirmed the disallowance. We find that the issue is similar to the disallowance of sales promotion expenses which we have dealt with earlier. In the absence of full details and evidence the AO is justified in making the estimated disallowance. However such disallowance has to be computed on an objective basis on the basis of material available on record. In this case we find that the claim made by the assessee is at 3.2% of total sales compared to 3.30% of total sales in the immediate preceding year. There is no material placed on record before us to show that the claim made by the assessee is excessive. No part of the claim can also be disallowed on account of personal uses in respect of vehicles etc. as the assessee is a company. Therefore in our view on the facts of the case disallowance made is not justified. We accordingly set aside the order of CIT (A) and delete the addition made.
12. Ground no. 1 (k) is regarding the disallowance of loss in respect of sale of current investments. The AO during the assessment proceedings asked the assessee to file details of loss of Rs. 1,66,054/-, but no details were submitted by the assesse. The AO, therefore, disallowed the claim of loss for want of verification.
Page 20 of 71 ITA No. 925/Mum/2007Merck Limited 12.1 In appeal the assessee submitted before CIT (A) that the AO had not specifically asked for any separate statement in respect of said loss. The assessee filed the statement showing loss on account of sale of investments before CIT (A). CIT(A), after considering the submissions deleted the addition made subject to verification by the AO. He however also directed the AO to verify the claim of the assessee and allow the claim as per law, aggrieved by which the assessee is in appeal before Tribunal.
12.2 Before us, learned Senior Counsel submitted that the assessee had filed the details before CIT (A) who had allowed the claim subject to verification by the AO. However the AO in the appeal effect order dated 22.6.2001 had not given effect to the order of CIT (A). It was, therefore, urged that the AO may be directed to given effect to the order of CIT (A). The learned DR placed reliance on the order of CIT (A).
12.3 We have perused the records and considered matter carefully. The dispute raised is regarding disallowance of loss on account of sale of current investments. The AO had disallowed the claim of loss on the ground that no details had been given. These details however had been submitted before CIT(A) who directedthe AO to allow the claim as per law after verfication of the details filed by the assessee. The AO has however not given effect to the order of CIT(A). In our view such verification of details is not possible before the AO Page 21 of 71 ITA No. 925/Mum/2007 Merck Limited without giving opportunity to the assessee which was not possible at the level of CIT (A) as he had no power to set aside the assessment. We, therefore, set aside the order of CIT (A) on this point and restore the matter to the file of AO for fresh order on this issue after necessary verification of details filed by the assessee and after allowing opportunity of hearing to the assessee.
13. The ground no. 1(l) is regarding allowability of claim of deduction u/s 80-IB in respect of DEPB income of Rs. 22,76,670/-.
13.1 The AO noted that the assessee had claimed deduction of Rs. 2,48,57,018/- u/s 80-IB of the IT Act., which also included deduction in respect of DEPB income. The AO disallowed the claim in respect of DEPB income on the ground that DEPB income was not derived from the business of the undertaking following the judgment of Hon'ble Supreme Court in case of Sterling Foods Ltd. Vs. CIT ( 237 ITR 579) and some other judgments. In appeal CIT (A) confirmed the disallowance made by AO, aggrieved by which the assessee is in appeal before Tribunal.
13.2 We have heard both the parties, perused the records and considered matter carefully. The dispute is regarding allowability of claim of deduction u/s 80-IB in respect of DEPB income. We find that the issue is covered by Page 22 of 71 ITA No. 925/Mum/2007 Merck Limited the judgment of Hon'ble Supreme Court in case of Liberty India Ltd. ( 317 ITR 218) to which both the parties agreed. The Hon'ble Supreme Court in the said case have held that section 80-IB did not cover the profit from the sources beyond the first degree and only the profit of the eligible business of undertaking could be allowed as deduction. It was also held that duty drawback and DEPB were not profit derived from the eligible business. Following the said judgment of Hon'ble Supreme Court, we confirm the order of CIT (A) disallowaing the claim.
14. The dispute raised in ground no. 1 (m) is regarding computation of indirect cost in respect of export of trading goods at Rs. 14,19,046/- in place of 50,000/- estimated by the assessee.
14.1 The learned Senior Counsel at the time of hearing of the appeal did not press this ground. The ground raised is, therefore, dismissed as not pressed.
15. The dispute raised in ground no. 1(n) is regarding deduction of 90% of following receipts from the profits of the business as per Explanation (baa) while computing deduction u/s 80HHC of the IT Act.
Sr. No. Particulars Amount (Rs.) Page 23 of 71 ITA No. 925/Mum/2007 Merck Limited (a) Interest on deposit and others 15,08,235/- (b) Interest on delayed payment 87,65,528/- (c) Insurance Claim 8,60,679/- (d) Export incentives 49,99,990/- (e) Indenting commission received 3,23,12,516/- (f) Income from instrument service 1,18,74,846/- contracts (g) Miscellaneous income 1,08,22,616/-
15.1 AO in the assessment order observed that the receipts mentioned in the table above though fell under the head "profit and gains of business and profession" but the same did not directly arise from export business but were only incidental income. He, therefore, excluded 90% of such receipts from the profit of business as per Explanation (baa) while computing deduction u/s 80HHC.
15.2 The assessee disputed the decision of AO and submitted before CIT (A) that the deposits on which the interest had been earned had been made as margin money or security deposits made for the purpose of business. Similarly interest on delayed payment was from customers, for late payment of sale bills and, therefore, it was an integral part of business income. Similarly insurance claim was on account of loss of goods, damages etc., which was a part and parcel of business. The indenting commission had been received in the course of business for acting as indenting agents for certain Page 24 of 71 ITA No. 925/Mum/2007 Merck Limited parties in India. Therefore, the same arose from the business activity. The income from instruments service contracts had arisen from services rendered in connection with maintenance contracts and other services in respect of imports and sale of medical instruments. The same, therefore, arose from the business operation. It was also submitted that the miscellaneious income included scrap sales, sundry sales etc,. which should be excluded as the same went to reduce the cost of goods produced. CIT(A) however, did not accept the contentions raised and following the decision of his predecessor in assessment year 2002-03 confrimed the order of AO, aggrieved by which the assessee is in appeal before Tribunal.
15.3 Before us learned Senior Counsel argued that the AO had assessed the various receipts mentioned in this ground as income from business and not as income from other sources. As regards the interest on deposits, export incentives and indentin commission, he was agreeable to reduction of 90% as per Explanation (baa) provided only the net amount was reduced in view of the judgment of Hon'ble Supreme Court in case of Associated Capsules (343 ITR 89). In relation to insurance claim it was submitted that the same was covered in favour of the assessee by the Judgment of Hon' High Court of Bombay in case of Pfizer (330 ITR 62). The interest on delayed payment, it was pointed out, had been received from the customers which was integral part of Page 25 of 71 ITA No. 925/Mum/2007 Merck Limited the business operation and, therefore, it could not be considered as per Explanation (baa). Similarly the income from instruments service contract was in respect of maintenance contract in relation to equipments sold by the assessee as a trading item. Therefore, this income was also an integral part of business operations and could not be considered for reduction under Explanation (baa). It was also submitted that the miscellaneous income included scrap sales, sundry sales and cash discount receipts which were integral part of the business and, therefore, not covered by the Explanation (baa). It was accordinlgy urged that these receipts should be excluded from the reduction at the rate of 90%. Lerned DR on the other hand supported the orders of authorities below and placed reliance on the findings given in the respective orders.
15.4 We have perused the records and considered the rival contentions carefully. The dispute is regarding deduction of 90% certain receipts as mentioned in para 15 earlier from the profit of business while computing deduction u/s 80HHC. The AO had excluded 90% of such receipts from the profit of business treating these receipts as covered by the Explanation (baa) of section 80HHC as per which certain receipts such as inerest, commission, rent, charges etc., are required to be reduced from the profit of business at the rate of 90%. These receipts have been assessed by AO as income under the head " profit from business and profession" about Page 26 of 71 ITA No. 925/Mum/2007 Merck Limited which there is no dispute. Dispute is only as to whether 90% of such receipts should be reduced from the profit of business as per Explanation (baa). As regards the interest on on deposits and other export incentive and indenting commission, the learned senior Counsel fairly agreed that 90% of these items may be reduced from the profit of business but he argued that in view of the judgment of Hon'ble Supreme Court in case of ACG Associated Capsules (Supra) 90% of net amount only should be reduced. Since in view of the judgment of Hon'ble Supreme Court, only the net receipts mentioned in Explanation (baa) are required to be reduced, we, therefore, set aside the order of CIT(A) on this point and direct the AO to reduced 90% of such net receipts after necessary verification.
15.5 The interest on delayed payment had been received from the customers for early payment of sale bills. It had been argued that this is an integral part of business operation and, therefore, should not be covered by the Explanation (baa). We agree with the submissions made as in our view interest on delayed payment has the same characteristics as the sale price and, therefore it has to be taken as arising from business operations and is not required to be reduced as per Explanation (baa). The insurance claim, it has been pointed out is covered in favour of the assessee by the judgment of Hon'ble High Court of Bombay in case of Pfizer ( 330 ITR 62). Earlier Hon'ble High Page 27 of 71 ITA No. 925/Mum/2007 Merck Limited Court of Bombay in case of Dresser Rand India Pvt. Ltd. (323 ITR 429) had held that insurance claim was covered by Explanation (baa). however in that case, Hon'ble High Court had proceeded on the conclusion made by the Counsel of the assessee that insurance claim was also covered by the judgment of Hon'ble Supreme Court in case of CIT Vs K. Ravindranathan Nair (295 ITR 228). Hon'ble High Court in case of Pfizer after detailed examination have held that insurance claim has to be taken as an integral part of income arising from the business operations and is not required to reduced as per Explanation (baa). We, therefore, set aside the order of CIT (A) on this point and hold that 90% of insurance claim will not be reduced as per Explanation (baa).
15. As regards the income from instruments service contracts it has been submitted by the assessee that the service contract was a maintenance contract in relation to equipments sold by assessee as a trading item. This claim has not been controverted before us. Therefore, such income has to be considered as integral part of business operations which is not required to be reduced as per Explanation (baa). We, therefore, set aside the order of CIT (A) on this point and direct the AO to not reducte 90% of such income from profit of business as per Explanation (baa). In relation to miscellaneous income, it was submitted that these also included scrap sales, sundry sales and cash discount receipts which were integral part of business operation. This Page 28 of 71 ITA No. 925/Mum/2007 Merck Limited aspect in our view requires verification. We, therefore, restore this issue to the file of AO for passing a fresh order after necessary verification. The receipts on account of scrap sales, sundry sales and cash discount if any which are integral part of business operation will not be reduced by AO as per Explanation (baa). Remaining sums will however be reduced at the rate of 90% but the AO will ensure that only the net amount are reduced after excluding the expenses incurred for earing such income following the judgment of Hon'ble Supreme Court in case of ACG Associated Capsules (Supra).
16. The dispute raised in ground no. 1 (o) is regarding reduction of 100% of interest on FD with banks at Rs. 55,13,547/- and interest on income tax refund of Rs. 75,257/- from the profit of business while computing deduction u/s 80HHC.
16.1 In appeal CIT (A) confirmed the order of AO excluding the interest on income tax refund and FD with banks at the rate of 100% while computing the deduction u/s 80HHC. Aggreived by the said decision, the assessee is in appeal before Tribunal.
16.2 Before us learned Senior Counsel appearing for the assessee submitted that he had no objection for exclusion of interest on income tax refund at the rate of 100%. It was also submitted that the assessee will be satisfied if the interest on Page 29 of 71 ITA No. 925/Mum/2007 Merck Limited FD is also excluded fully provided netting is allowed to the assessee. In other words it was submitted that only net interest income should be excluded while computing deduction u/s 80HHC. The learne DR on the other hand placed reliance on the orders of authorities below.
16.3 We have perused the records and considered the rival contentions carefully. The dispute is regarding exclusion of interest on FD and interest on income tax refund from the profit of business while computing deduction u/s 80HHC. The interest on income tax refund has to be treated as income from other sources and, therefore, the entire amount is required to excluded from the profit of business while computing deduction u/s 80HHC. The learned senior Counsel also fairly agreed that the assessee had no objection if the interest on FD was also excluded from the profit of business providing the netting was allowed to the assessee. We find the claim reasonable because only the net income after deducting the expenses incurred for earning of the income has to be excluded from the profit of business. We, therefore, hold that net FD interest has to be excluded fully from the profit of business. The issue of netting is, however, restored to the file of AO for passing a fresh order after necessary examination and after allowing opportunity of hearing to the assessee.
Page 30 of 71 ITA No. 925/Mum/2007Merck Limited
17. The ground no. 1 (p) is regarding reduction of 90% of the value of reversal of revaluation loss on assets while computing deduction u/s 80HHC as per Explanation (baa).
17.1 The assessee had shown revaluation loss on account of certain assets in the earlier year and in this year the entry has been reversed and the amount debited to the P&L account earlier has been shown as income. The AO treated this income of the nature described in Explanation (baa) and reduced 90% of the same from the profit of business while computing deduction u/s 80HHC. In appeal, CIT (A) upheld the action of AO on the ground that the assessee had made no submissions on the issue. Aggreived by the decision of CIT(A), the assessee is in appeal before Tribunal.
17.2 Before us, the learned AR for the assessee referring to the computation of income made by AO at page 49 of the order submitted that the reversal of revaluation loss has been assessed by AO as income from business. Therefore the same has to be considered as part of profit of business while computing deduction u/s 80HHC. As regards the applicability of provisions of Explanation (baa), it was submitted that the said Explanation was applicable in case of any receipts by way of brokerage, commission, interest etc., included in the profit of business. It was pointed out that the Page 31 of 71 ITA No. 925/Mum/2007 Merck Limited write back of the revaluation loss was not a receipt and, therefore, the Explanation (baa) cannot be applied. Learned DR on the other hand placed reliance on the order of CIT(A).
17.3 We have perused the records and considered the matter carefully. The assessee in the earlier year had debited the P&L account on account of loss arising from revaluation on certain assets. In the current year, the assessee has reversed the entry and credited the P&L account by the said amount which has been assessed as business income by the AO. The dispute is as to whether 90% of such income can be considered for reduction from profit of business as per Explanation (baa). The said Explanation applies to any receipts by way of brokerage, commission, interest, rent charges or any other receipts of similar nature included in the business profit. The amount under consideration is not receipt by the assessee during the year. It is only a write back of loss claimed earlier and credited to the P&L account without any actual receipt. Therefore, we agree with the submission of the learned Senior Counsel that the provisions of Explanation (baa) cannot be applied to such income. The amount has already been assessed as business income by the AO and, therefore, it would be fully eligible for deduction u/s 80HHC. We hold accordingly.
18. The dispute raised in ground no. 1 (q) is regarding reduction of the deduction allowed u/s 80-IB from Page 32 of 71 ITA No. 925/Mum/2007 Merck Limited the profit of business while computing deduction u/s 80HHC. The AO while computing deduction u/s 80HHC has reduced from the profit of business an amount of Rs. 2,43,59,001/- being the deduction allowed u/s 80-IB.
18.1 The assessee disputed the decision of AO and submitted before CIT (A) that only a sum of Rs. 135054 and not Rs. 2,48,57,018/- should be reduced from the business. CIT(A), however, did not accept the contentions raised and agreed with the AO that deduction allowed u/s 80-IB has to be reduced from the profit of business and accordingly upheld the action of the AO. aggrieved by which the assessee is in appeal before Tribunal.
18.2 We have heard both the parties, perused the records and considered matter carefully. The dispute raised in this ground is whether the deduction allowed u/s 80-IB has to be reduced from the profit of business for the purpose of computation of deduction u/s 80HHC. In this case the assessee is eligible for deduction u/s 80-IB as well as u/s 80HHC. The issue is whether the deduction under the both provisions has to be allowed with respect to the same profit of business or the deduction u/s 80HHC has to be considered only in respect of profit of business reduced by the deduction already allowed u/s 80-IB. We find that this issue has already been decided by the Hon'ble High Court of Bombay in case of Associated Capsules (P) Ltd. Vs. CIT (332 Page 33 of 71 ITA No. 925/Mum/2007 Merck Limited ITR 42) in which it has been held that the amount of profit allowed as deduction u/s 80-IA is not required to be reduced from the profit of business while computing deduction u/s 80HHC. The ordre of CIT(A), is therefore, set aside and the AO is directed to compute the deduction accordingly.
19. The dispute raised in ground no. 1 (r) is regarding levy of interest u/s 234B, 234C and 234D.
19.1 The learned Senior Counsel fairly agreed that levy of interest is only consequential. The AO, therefore, will recompute the interest at the time of giving effect to this order.
20. The dispute raised in ground no 1 (s) is regarding disallowance of depreciation in respect of SAP expenses of Rs. 40,55,864/-.
20.1 The AO in the assessment order has treated the SAP expenses of Rs. 40,55,864/- as capital expenditure. The expenditure had been incurred in assessment year 2002-03 in which it was treated as capital expenditure. The AO however did not allow depreciation in assessment year 2002- 03 on the ground that the project had become operational in assessment year 2003-04. The claim however was not allowed in assessment year 2003-04 as the same had not been made in the return of income for assessment year 2003- Page 34 of 71 ITA No. 925/Mum/2007 Merck Limited
04. The authorities below have disallowed the claim following the judgment of Hon'ble Supreme Court in case of Goetze (India) Ltd. vs. CIT (284 ITR 323) as per which any claim before AO has to be made in the return of income. Aggrieved by the decision of CIT(A), the assessee is in appeal before Tribunal.
20.2 Before us the learned Senior Counsel submitted that the same issue had been considered by the Tribunal in assessee's own case in assessment year 2002-03 in ITA no. 2954/Mum/2006 and the Tribunal had restored the matter to the file of AO with certain observations. It was submitted that the claim may be restored to the file of AO this year also to examine afresh in the light of decision of Tribunal in assessment year 2002-03 (Supra). The learned DR placed reliance on the orders of authorities below.
20.3 We have perused the records and considered matter carefully. The assessee had incurred the SAP expenses in assessment year 2002-03 in which it had been treated as capital expenditure. The AO however did not allow depreciation in that year as the project had become operational in the next year i.e. in assessment year 2003-04. In assessment year 2003-04, the claim of depreciation has been disallowed by the authorities on the ground that the assessee had not made the claim in the return of income. The case of the assessee is that the claim was made by way Page 35 of 71 ITA No. 925/Mum/2007 Merck Limited of filing additional ground before CIT (A) after receipt of the order of Tribunal in assessment year 2002-03 as by that time limitation period for revising the return for assessment year 2003-04 had expired. The claim being legal claim has, therefore, to be allowed. We agree with the submission of learned Senior Counsel that the judgment in case of Goetze (India) Ltd.(Supra) does not restrict the power of appellate authorities to consider the legal claim even if the same had not been made in the return of income. The claim had been disallowed in assessment year 2002-03 only on the ground that the project had beomce operational in the next year. The claim has, therefore, to be considered by the AO in assessment year 2003-04 under the provisions of law. We also find that the same issue has already been dealt with by the Tribunal in assessment year 2002-03, in which the Tribunal restored the issue to the file of AO to decide the issue afresh after necessary examination in the light of observations made in that year. We, therefore, following the said decision of Tribunal in assessment year 2002-03 (Supra) set aside this issue to the file of AO for fresh consideration after necessary examination in the light of observations of Tribunal in assessment year 2003 (Supra) and after allowing opportunity of hearing to the assessee.
21. The dispute raised in ground no. 1(t) is regarding set off of long term capital loss of Rs. 52,35,923/- on sale of Goa property.
Page 36 of 71 ITA No. 925/Mum/2007Merck Limited 21.1 The assessee had claimed the said loss in the assessment year 2002-03. On perusal of the sale agreement, the AO noted that the said property had been sold vide agreement dated 12.4.2002. The AO, therefore, concluded that the sale had taken place in assessment year 2003-04. He, therefore, disallowed the claim of loss in assessment year 2002-03. The assessee, thereafter, made the claim in assessment year 2003-04 by filing an additional ground before CIT (A). The AO in the remand report called for by the CIT (A) objected to the allowance of claim on the ground that the same had not been made by filing a revised return at the time of assessment.
21.2 The assessee disputed the decision of AO and submitted before CIT (A) that the assessee could not have made the claim by filing the return of income for assessment year 2003-04 as the assessment order for assessment year 2002-03 disallowing the claim had been received on 31.3.2005. CIT (A) however did not accept the contentions raised and observed that the assessee should have made claim at first instance in assessment year 2003-04 itself which was not done. He, therefore, confirmed the order of AO disallowing the claim aggrieved by which the assessee is in appeal before Tribunal.
Page 37 of 71 ITA No. 925/Mum/2007Merck Limited 21.3 Before us, the learned Senior Counsel submitted that the disallowance of claim in assessment year 2002-03 had been considered by the Tribunal who in the para 8 of the said order confirmed the disallowance after observing that the claim was pending in dispute before the Tribunal for assessment year 2003-04. It was pointed out that the order of Tribunal in assessment year 2002-03 has become final and, therefore, the claim has to be allowed in this year. The learned DR placed reliance on the orders of authorities below.
21.4 We have perused the records and considered matter carefully. The dispute is regarding allowability of claim of long term capital loss from sale of Goa property in assessment year 2003-04. The authorities below have given a clear finding that the sale had taken place vide agreement dated 12.4.2002 which pertain to assessment year 2003-04. However the claim in assessment year 2003-04 has not been allowed by the authorities below on the ground tha the claim had not been made by way of filing revised return as held by Hon'ble Supreme Court of India in case of Goetze (India) Ltd. (Supra). The Hon'ble Supreme Court in the said case have only held that the AO in assessment order cannot entertain any claim other than the claim made in the return or revised return of income. Further it has also been made clear in the said judgment that the judgment does not restrict the power of the Tribunal to consider a claim made for the first time Page 38 of 71 ITA No. 925/Mum/2007 Merck Limited being a legal claim in respect of which the facts are already on record. In this case the allowability of claim is a legal claim and the facts are already on record. Therefore, in our view the claim has to be allowed in this year. However the actual computation etc., of the loss has not been examined. We, therefore restore the issue to the file of AO for considering the claim in accordance with the law after allowing opportunity of hearing to the assessee.
22. We now take up the dispute raised in ground no. 1 (f) relating to transfer pricing adjustment. The AO during the assessment proceedings noted that the assessee during the year had imported Bisoprolol Fumarate a raw material used in the pharmaceutical business from the associate enterprise (AE). The assessee had imported Bisoprolol Fumarate of worth Rs. 1.30 crore from the AE during the year the assessee had also imported from the associate enterprise finished goods being the pigments for a sum of Rs. 29.66 crore in the chemical business the turnover of which was Rs. 23.46 crore. The assessee had also paid a sum of Rs. 1.57 crore to the parent company in Germany as technical know how fees. Since the assessee during the year had entered into international transactions with AE, the AO referred the matter for determination of transfer pricing adjustment to the TPO who after necessary examination recommended certain adjustments in respect of three Page 39 of 71 ITA No. 925/Mum/2007 Merck Limited international transactions mentioned above which are disputed in appeal before Tribunal.
22.1 We first take up the issue of adjustment in relation to import of Bisoprolol Fumarate. The assessee had imported 92.27272 kg of the said ingredient for a sum of Rs. 1,30,80,274/- at the rate of Rs. 1,41,750/- per kg. The said ingredient is used for manufacture of product "Concor" an anti hypertension product. The TPO noted that M/s Unichem Laboratories Ltd was also engaged in manufacturing and sale of similar product i.e. "Corpis" which was operating in the same segment. The TPO obtained the information from the said party who reported that they had manufactured and sold the same during the year at the rate of Rs. 50,000/- per kg. It was also noted that the assessee during the year had purchased small quantity of "Bisoprolol Fumarate" at the rate of 70,000/- per kg from M/s Unichem Laboratories. TPO, therefore, asked the assessee to explain as to why the TP adjustment should not be made based on the purchase rate of Unichem Laboratories.
22.2 The assessee explained that the mateial purchased from M/s Unichem Laboratories Ltd. had been used by the assessee for manufacturing of the product but the said raw material developed higher level of impurity as compared to the raw material imported by the assessee from AE. The product i.e. " Concor " was the trademark developed by the Page 40 of 71 ITA No. 925/Mum/2007 Merck Limited associate enterprise and the assessee did not want to compromise on the reputation of the group. The assessee had, therefore, imported the raw material at a higher price. It was also submitted that the AE had sold the same ingredient to other group entities at a higher price. Therefore, it was submitted that the price at which the assessee had imported was lower than the market price. The assessee had produced a certificate dated 1.3.2005 of the general manager of the assessee company stating that the material purchased locally was showing high level of impurity compared to the imported product.
22.3 The TPO however rejected the certificaate as being non contemporary as the material had been purchased in July 2002 and the certificate had been issued in March 2005 after the query had been raised by the TPO. As regards the raw material sold by the assessee to other group entities the TPO observed that those were related party transactions and not comparable. The assessee had in its transfer pricing study used TNMM method using certain third parties comparables which was also rejected by the TPO on the ground that the only information available in respect of those parties was the annual reports of the companies which did not show clearly how the companies were comparable. TPO also observed that the import by the assessee from the AE was only Rs. 3.49 crore whereas the turnover of the entire pharma segment was Rs. 220 crore. Therefore, the impact of Page 41 of 71 ITA No. 925/Mum/2007 Merck Limited the transaction on the profitability of such high turnover would be too insignificant. The TPO, therefore held that TNMM method was not suitable to determine the arm's length price. It was further observed by him that CUP method was most direct and reliable way to make the TP adjustment. The comparable price of the same active ingredient was available on record which was from the local party operating in the same marketing conditions whereas the sale by the AE to other group entities was in different geographical locations and marketing condtions. The AO, therefore, applying the CUP method adopted the rate at which the assessee had purchased the same ingredient from M/s Unichem Laboratories Ltd. The assessee had purchased at the rate of 70,000/- per kg whereas sale to some other party was at Rs. 50,000/- per kg. The TPO, therefore, adopted the average rate of Rs. 60,000/- and thus adjustment was made at Rs. 75,43,911/- which was followed by the AO in the assessment order.
22.4 The assesse disputed the decision of AO and submitted before CIT (A) who after hearing the assessee accepted the approach adopted by the AO and thus upheld the adjustment made at Rs. 75,43,911/-. Aggrieved by the decision of CIT (A), the assessee is in appeal before Tribunal.
22.5 Before us, the learned Senior Counsel appearing for the assessee reiterated the submissions made before Page 42 of 71 ITA No. 925/Mum/2007 Merck Limited lower authorities that TNMM method was appropriate method for bench marking international transactions. It was pointed out that mean margin in case of comparables selected by the assessee was 13.36% whereas the margin of the pharma division in case of the assessee was 15.90%. Therefore, it was submitted that no adjustment was required. It was also argued that the material purchased from M/s Unichem Laboratories Ltd. was of a lower quality as it did not pass particle size test and bulk density test which determine the quality of the product. It was also submitted that the TPO had not accepted the claim of superior quality of the assessee on the ground that the same was not supported by any independent evidence. It was submitted that the assessee had now obtained an independent third party certificate regarding the superior quality of the material imported by the assessee. The assessee has also obtained the comparative rate of sale in the domestic of similar product manufactured by Torrent Pharma and Unichem Laboratories which show that the assessee was importing at higher rate. It was requested that the said additional evidence may be admitted as the assessee was made aware about these additional evidences only after order of CIT (A). He placed reliance on the order of Jaipur bench of Tribunal in case of Electra (Jaipur) (P) Ltd. Vs. IAC ( 26 ITD 236), in which it has been held that if the evidence produced by the assessee is genuine and reliable to prove the case of the assessee, then the Page 43 of 71 ITA No. 925/Mum/2007 Merck Limited assessee should not be denied the opportunity to produce the same even if it was produced for the first time.
22.6 The learned CIT(DR) responding to the plea of additional evidence submitted that he had no objection to the additional evidence being admitted if the same was sent back to CIT (A) for fresh order after necessary examination and after considering the decision of Tribunal in case of Serdia Pharmaceutical (P) Ltd. Vs. ACIT dated 31.12.2010 in ITA No. 2469/Mum/2006.
22.7 We have perused the records and considered the rival contentions carefully. The dispute raised in this ground is regarding TP adjustment in relation to import of Bisoprolol Fumarate imported by the assessee from the associate enterprise. The assessee had imported the said raw material from the AE for manufacture of hypertension drug in the brand name of "CONCOR" at the rate of Rs. 1,41,750/- per kg. The assessee in its transfer pricing study had applied TNMM for bench marking the international transaction. The assessee had selected certain comparables which gave arithematic mean margin at 13.36% which was lower than the margin of 15.10% in the pharma segment of the assessee. The assessee, therefore, submitted that no adjustment was required . TPO however made local enquiries and found that the Unichem Laboratories Ltd. which was manufacturing the same product had sold the same in the Page 44 of 71 ITA No. 925/Mum/2007 Merck Limited market at 50,000/- per kg. The assessee had also purchased small quantity of this product from the said company at Rs. 70,000/- per kg. The TPO, therefore, applied CUP method and adopted the rate of 60,000/- per kg. for the purpose of making TP adjustment. TPO has also held that TNMM was not suitable in this case as the total import of the product by the assessee was only 3.49 crore whereas the turnover of the pharma segment was Rs. 220 crore. Therefore, the impact on price variation in respect of product on such high turnover would be too insginificant. The TPO, therefore, used CUP method and adopted the price charged by Unichem Laboratories Ltd for bench marking the transaction. The argument of the assessee that the AE had sold the same product to other group entities at a higher price had not been accepted. In our view the stand of the revenue authorities to reject such argument is reasonable as the other group entities were operating in different geographical locations and the transactions were with AE and therefore independent.
22.8 The assessee has also argued that there was major difference between quality of the product produced by the AE which was a branded item compared to the low quality goods manufactured by Unichem Laboratories Ltd. It has been argued that the material produced from Unichem Laboratories Ltd. did not pass the particle size test and bulk density test which determine the quality of the product. A certificate dated 1.3.2005 from the factory manager of the Page 45 of 71 ITA No. 925/Mum/2007 Merck Limited assessee had been produced which had been rejected by the authorities below as being not contemporary. In our view the quality of the product is important as it affects the comparability of the transactions. Quality of product has influence on the pricing of the product. There was however no independent evidence produced before the lower authorities to show superior quality of assessee's product. The assessee vide letter dated 8.2.2010 has filed an additional evidence before the Tribunal in the form of a quality certificate from Bee Pharma Labs (Pvt.) Ltd. an independent accredited third party and also comparative selling rate of the same product produced by Torrent Pharma and Unichem Laboratories Ltd has been filed and it has been requested that the additional evidence may be submitted. It was argued that the assessee was made aware of these additional evidence only after passing of order by CIT (A) and accordinlgy it has been requested for admission of the same. In our view an independent evidence regarding quality of products and comparative prices will be useful in deciding the issue. Learned CIT (DR) had also no objection for admission of additional evidences if the issue was sent back to CIT (A) for fresh examination after considering the decision of Tribunal in case of Sardia Pharmaceutical Vs. ACIT (Supra). We, therefore, admit the additional evidences filed by the assessee and the issue is restored to the file of CIT(A) for passing a fresh order after necessary examination in the light Page 46 of 71 ITA No. 925/Mum/2007 Merck Limited of observations made above and after allowing opportunity of hearing to the assessee.
23. The second transfer pricing dispute is regarding adjustment made by AO on account of import of pigments by the assessee from the AE. The total value of international transaction on this account was Rs. 29.66 crore. The AE also sold some of the products directly to thrid parties in India for which the assessee provides marketing and support services. Therefore, in respect of third party sales by the AE the assessee receives commission. The assessee in its transfer pricing study considered the trading activity and agency activity as a single business and used TNMM for bench marking the international transactions. The assessee selected seven comparables for this purpose. The TPO however rejected the comparables selected by assessee for the various reasons mentioned in the table below:-
Sr. No. Name of the Company Remarks
1 Origon Commercials ltd. Both these entities are engaged in trading
2 Anukuran Commercial of ferrous and no ferrous chemicals.
Enterprises Ltd. Further, Anukuran Commercial Enterprises
Ltd. is engaged in trading in shares.
Segmental information is not available
3 Daga Petrochemicals Ltd. No information has been provided on the
basis of which this company has been
regarded as comparable to the assessee
4 Dhoot Industrial Finance Besides chemical business, this company
Ltd. equally deals in electronics and paper. It
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Merck Limited
also undertakes investments in share.
Segmental information is not available
5 KPL International Ltd. No information has been provided on the
basis of which this company has been
regarded as comparable to the assessee
6 Nikhil Adhesives Ltd. This company deals in synthetic adhesives
and emulsion products.
7 Signet Fincon Ltd. No information has been provided on the
basis of which this company has been
regarded as comparable to the assessee
23.1 The TPO observed that though under TNMM
product similarity was not essential, there has to be close similarity in the functions performed, asset employed and risk assumed between the international transaction and uncontrolled transaction. It was observed by him that annual reports of the comparables had no information to show functional similarity between the assessee and comparables. He, therefore, held that the comparables selected by the assessee were not proper and accordingly rejected the same. The AO, noted that the assessee was trading in goods after importing from the AE which contained both pigments and non pigments. The assessee was also trading in goods purchased from non AE parties. AO, therefore asked the assessee to provide separate trading account to find out profit margin in respect of transactions with AE's and transactions with non AE's.
Page 48 of 71 ITA No. 925/Mum/2007Merck Limited 23.2 The details obtained from the assessee showed that in respect of pigment purchased by the assessee from the AE, the margin was 5% on sale of Rs. 21,94,62,000/-. Similarly non pigment sale of the goods purchased from the AE was Rs. 35,20,98,000/- and the margin was 15%. Furher margin in respect of trading of goods purchased from non AE parties was 16% on turnover of Rs. 23,10,14,000/-. The margin of both AE trading and non AE trading taken together was 15% on total turnover of Rs. 12,34,63,000/-. The AO observed that non AE trading constituted internal TNMM for bench marking international transactions and it was better comparable as functions performed, asset employed and risk assumed by the assessee in respect of both AE trading and non AE trading was comparable. The AO noted that margin in case of pigments which were purchased from the AE was very low at 5% whereas the margin in respect of non pigment AE trading was 15% and it was 16% in case of non AE trading.
23.3 The TPO, therefore, asked the assessee to explain as to why the adjustment should not be made on the basis of margin in case of non AE trading segment. The assessee submitted that market conditions in the AE segment and non AE segment were different and not comparable. Moreover, the products under the AE segment and non AE segment were also not the same. The assessee further submitted that Page 49 of 71 ITA No. 925/Mum/2007 Merck Limited import price from the AE in case of the assesss was lower than the price at which the AE had sold to other group entities. It was also submitted that lower profit margin in case of pigments was not on account of high import price but on account of low selling price in the local market due to severe competition. To substantiate the claim that the assessee was importing at lower price, the assessee referred to the complaint filed by the Sudarshan Chemicals a local manufacturer of chemicals, pigments and pesticides on the basis of which anti dumping duty had been levied in respect of one of the products of the assessee i.e. "Irodine". The very fact that anti dumping was levied by the customs duty authority showed that imports made by the assessee from the AE were at lower rate than the prevailing market price. The assessee also pointed out margin earned by the manufacturers of pigments in India was lower than the margin of 5% earned by the assessee. It was further submitted that Berger Pain had imported the same product at a higher rate.
23.4 TPO however did not accept the contentions raised. It was observed by him that the higher rate charged by the AE to the group entities was not comparable as it was a controlled transaction and sales were made in different geographical locations. Regarding the comparative case of import by the Berger Paint of Irodine at a price higher than the assessee, the TPO observed that it was a single instance Page 50 of 71 ITA No. 925/Mum/2007 Merck Limited in which the end customer had purchased the product which was not comparable to the case of the assessee who was a distributor in India. The TPO also did not accept the plea based on anti dumping duty on the ground that the anti dumping duty had been levied vide notification no. 30/2005 applicable from 2005 onwards and, therefore, the international transaction under reference which related to financial year 2002-03 were not subjected to anti dumping duty. The TPO also observed that the assessee had not provided copies of all submissions made before anti dumping authorities despite specifically being asked to do so. It had provided only the copy of the disclosure statement. The TPO, therefore, determined the TP adjustment on the basis of margin of 16% in respect of non AE trading in assessee's own case and thus recommended adjustment of Rs. 2,50,76,000/- which was followed by the AO in the assessment order.
23.5 The assessee disputed the decision of AO and submitted before CIT (A) that low margin in case of pigment was due to fall in selling price due to severe competition in the market and not because of high import price. The assessee referred to the allegation made by the local manufacturer Sudarshan Chemicals regarding the low price import by the assessee and subsequent levy of anti dumping duty by the custom authorities. It was also submitted that non AE trading segment of the assessee did not have pigment Page 51 of 71 ITA No. 925/Mum/2007 Merck Limited sale and, therefore, the comparison was not proper. It was pointed out tht the assessee had cited independent comparable companies having functions broadly similar to the distributor functions in which margin ranged from .71% to 11.31% with arithematic mean of 3.12% which was much lower than net profit margin of 15% earned by the assessee in the chemical division. Therefore, it was pleaded that no adjustment was called for.
23.6 CIT (A) however did not accept the contentions raised. It was observed by him that the comparables selected by the assessee were not shown to be similar to the case of the assessee as no information was made available to show functional similarity between the assessee and those parties. As regards the argument of the assessee that non AE segment had a different product, CIT (A) observed that under TNMM product similarity was not an essential requirement. CIT (A) also agreed with the TPO that isolated case of Berger Paint was not comparable to the case of the assessee who was distributor in India. He further observed that the e-mail correspendence dated 22.8.2002 submitted by the assessee clearly showed that the assessee was deliberately following the predatory pricing policy in India with a view to finish local competitors. The assessee had also not given the full details of submissions made before anti dumping authorities. Moreover CIT(A) further pointed out that anti dumping duty was restricted to only two types of pigments namely Eriodin Page 52 of 71 ITA No. 925/Mum/2007 Merck Limited 100 and Eriodin 111. The assessee had imported other pigments also. CIT(A), therefore, did not see any merit in the appeal filed by the assessee and accordingly confirmed the adjustment made by AO on account of import of pigments. Aggrieved by the decision of CIT(A) the assessee is in appeal before Tribunal.
23.7 Before us the learned Senior Counsel reiterated the submissions made before lower authorities that low margin in case of pigment was not because of higher import price but because of lower sale price due to severe competition in the domestic market. It was pointed that the anti dumping duty levied by the Government clearly showed that the assessee was importing the products at a very low price. It was futher submitted that though the anti dumping duty order was dated 30 November 2004, a copy of which was placed at page 380 of the paperbook but the period of enquiry was 1.4.2002 to 30th September 2003 as was clear from the details given at page 380 of the paperbook. Therefore, it cannot be said that the anti dumping duty was not relevant to the period under consideration. The learned Senior Counsel also argued that comparison with non AE trading was not proper as the said segment did not contain pigment trading. It was also submitted that the product characteristics was also important in TNMM as was clear from the rule 10B(2) (e). Moreover marketing conditions were also relevant factor which affected comparability as provided Page 53 of 71 ITA No. 925/Mum/2007 Merck Limited in rule 10 B (2) (d) and the market conditions in respect of each product was different. Therefore, comparing the pigment trading with non AE trading which did not contain pigments was not proper. It was also pointed out that the market share of the assessee in the AE segment was only 20% whereas the Sudarshan Chemicals had 80% market shares which was also a distinguishing feature. Referring to the margins, it was pointed out that even the Sudarshan Chemicals which was a manufacturer had shown the net profit margin of only 8.58% and considering that the assessee was a trader, its margin was comparable.
23.8 The learned CIT(DR) on the other hand strongly defended the orders of authorities below. It was submitted that the TPO had selected the internal comparables which are preferable as various conditions such as asset employed risk under taken etc, remained the same. He placed reliance on the decision of Tribunal in case of TECHNIMONT ICB P. LTD. Vs. ACIT in ITA no. 4608/M/2010. It was further submitted that though the non AE segment considered as internal comparable did not include pigment trading, the product similarity was not necessary in case of TNMM and the same was relevant only for CUP method as held by the Mumbai bench of Tribunal in case case of DIAGEO INDIA P.LTD Vs. DCIT in ITA No. 7932/Mum/2011. It was also pointed out that the "transaction" as defined in rule 10A(d) included closely linked transactions. Since the assessee had grouped Page 54 of 71 ITA No. 925/Mum/2007 Merck Limited pigment and non pigment segment together which clearly showed that the transaction were similar. The argument that price charged by the AE was higher to other group entities was not relevant as those entities were operating in different geogrphical locations and transactions were also with AE's which were controlled transactions. As regards the fall in selling price in the domestic market, it was submitted that the assessee at page 364 of the paperbook had given data only in relation to one product i.e IRI-100. The price of other products were not given and, therefore, no conclusion ccould be drawn that steep fall in prices was because of low selling price. It was further pointed out that the anti dumping duty levied by the Government was based on the order from other department which was not relevant as the action taken by other department is not important for determination of arm's length price. Reliance for the said proposition was placed on the decision of Tribunal in case of Sadio Formation (2011/TII/02 ITAT). It was thus argued that the adjustment made by TPO on the basis of intenal comparable was quite reasonable and has to be upheld.
23.9 In reply, the learned Senior Counsel submitted that the assessee had treated the pigment and other products as one segment and on that basis it had prepared the transfer pricing study. It was pointed out that it was the TPO who had split into pigment and other segment and, therefore, it was required that for comparison with pigment Page 55 of 71 ITA No. 925/Mum/2007 Merck Limited segment, he should have considered independent third party pigment traders. The non AE segment with which the TPO had made comparison dealt with different products and, therefore could not be considered as comparable as it was not possible to make any accurate adjustment because of different market conditions and other differences. For proper comparison, it was pointed out, the comparable should be trading in pigments imported from indepensent German parties but no such data had been produced on record by the TPO. It was also pointed out that anti dumping duty levied by the Government was very relevant as it shows that the Government accepted that the price paid by the assesse for the imports was lower. It was argued that order passed by the other departments cannot always be considered irrelevant. He referred to the decision of Tribunal in case of M/s Coastal Energy (P) Ltd. Vs. ACIT In ITA 2099/Mum/07 in which it was held that the custom valuation which was based on scientifically formulated methods can be taken into account for the purpose of comparison of price. As regards the point made by the learned CIT(DR) that the fall in prices had been demonstrated only in case on one product, it was submitted that IRI-100 was the main pigment dealt with by the assessee which accounted for 51.4% pigment turnover. Referring to the details given at page 365 of the paperbook, it was pointed out that in case the profitability of IRI-100 was taken as the one in the year 2002, the net margin of the pigment division would come to 18%. It was thus clear that Page 56 of 71 ITA No. 925/Mum/2007 Merck Limited fall in the margin was because of low selling prices and not because of high cost of import.
23.10 We have perused the records and considered the the rival contentions carefully. The dispute is regarding TP adjustment on account of import of pigments made by assesseee amounting to Rs. 29.66 crore from the associate enterprise. The assessee in its transfer pricing study in relation to the said international transaction adopted the TNMM for bench marking the transaction which has been accepted by the TPO/AO. The assessee selected certain comparables which were functionally similar to distributors as the assessee was also a distributor, which gave arithematic mean margin of 3.12% compared to the 15% margin in case of the assessee. It was therefore requested that no adustment was required to be made. The TPO has not accepted the comparables selected by the assessee. He noted that the assessee had trading operations in respect of products imported from the AE which included pigment and also other products as well as trading of items purchased from non AE parties. The AO, therefore, asked the assessee to separate the AE and non AE transaction and also compute margin seaparately in case of pigments. The margin in respect of pigment was computed at 5% and maring in case of non pigment products imported from the AE was at 15% and in respect of non AE segment, the margin was 16%. The TPO has compared the margin of pigment segment with the Page 57 of 71 ITA No. 925/Mum/2007 Merck Limited margin of non AE segment and made adjustment accordinlgy.
23.11 The view taken by the TPO was that non AE segment was internal TNMM which was more suitable for comparison as the conditions were identical. The assessee gave the comparative case of import of the same product from Berger Paint but the same has been rejected by the TPO on the ground that it was an isolated instance of import by an end customer which was not comparable to the case of the assessee, which was a distributor. The argument of the assessee that the AE had sold the same product to other group entities at a much higher price has also not been accepted. The order of authorities below to reject the argument based on high sale price to other group entities is justified as the sale was in different geographical locations and the transactions being with AE were also controlled.
23.12 However the main argument of the assessee is that the pigment segment of the assessee could not be compared with non AE segment which did not contain any pigment. It has been explained that low margin in case of pigments was not because of high import price but because of low domestic sale price as the market was very competitive. The case of the revenue is that the product difference is not material in TNMM and is important only in case of CUP method. Therefore, it has been argued that comparison with non AE Page 58 of 71 ITA No. 925/Mum/2007 Merck Limited segment was proper. We however do not agree with the view taken by the authorities below. The product characteristic no doubt has very important role in case of CUP method but the same cannot be ignored in case of TNMM. The Rule 10 B(2)(a) clearly provides that characteristics of the property is required to be taken into account while judging the comparability of the international transaction. Further, Rule 10B(2)(d) also provides that the marketing conditions including the geographical locations and size of the market is also required to be taken into account. The marketing conditions in respect of each product may be different. When the marketing conditions are the same, product's characteristic may not have much importance in TNMM but in case of change in marketing conditions, product characteristics cannot be ignored. Threfore, in our view, comparison of margin of pigment segment with non AE segment which did not deal with pigment is not proper.
23.13 The assessee in this case has also produced evidence to show that Government had levied anti dumping duty in respect of pigments imported by the assessee which shows that the AE was selling the pigment to the assessee at a lower price. The authorities below had not accepted the plea based on anti dumping duty on the ground that the notification had been issue in the year 2005 which was subsequent to the period under consideration and assessee had not given details of the submissions made before anti Page 59 of 71 ITA No. 925/Mum/2007 Merck Limited dumping authorities. It has also been pointed out that anti dumping duty had been levied only in respect of two products i.e. IRI-100 and IRI -111. The authorities below have also pointed out that e-mail correspondence dated 28.2.2006 submitted by the assessee also showed that the AE was deliberately following the predatory pricing policy in respect of the product. On careful consideration of the entire material on record, we do not find merit in the approach adopted by the authorities below. The levy of anti dumping duty by the Government on any product imported in India whether by way of predatory pricing policy or otherwise is a clear indication of the fact that the said product is being exported to the country by the foreign parties at a very low price which adversely affects the local business. As regards the period of anti dumping duty notification, it has been pointed out before us by the assessee that though the anti dumping duty order was dated 30.11.2004, the period of enquiry was 1.4.2002 to 30-9-2003 which is supported by the details given at page 380 of the paperbook which had been submitted before the lower authorities. Thus the anti dumping duty order cannot be considered irrelevant to the period under consideration.
23.14 As regards the argument of the revenue that anti dumping duty was only in relation to few products, it has been submitted by the assessee that the product IRI-100 in respect of which anti dumping had been levied was the main Page 60 of 71 ITA No. 925/Mum/2007 Merck Limited pigment dealt with by the assessee which accounted for 51.4% of pigment turnover. The assessee had given further details as placed at page 364 of the paperbook which show that the price of the product in the local market had been falling since December 2001. it fell from Rs. 9825 per kg. in December 2001 to Rs. 7343 per kg in Dec. 2002 and the price was Rs. 6432 in Dec. 2003. It has been pointed out that in case the profitability of IRI-100 was taken as the same as in the year 2002, the net margin of the pigment division would come to 18%. To further support the low margin in case of the pigment the assessee has cited the case of Sudarshan Chemicals on whose complaint the Government had started anti dumping procedure to point out that margin in case of Surdarshan Chemicals was only 8.5% and considering that Sudarshan Chemicals was a manufacturer and the margin in case of manufacture is higher, the margin shown by the assessee at 5% was comparable to the margin in case of Sudarshan Chemicals. In our view the assessee had placed sufficient material on record in support of its plea that low margin in case of pigment was not because of high import price but because of low selling price in the domestic market which was highly competitive. The comparison made by AO of the pigment segment with non AE trading which had no pigment, in our view is not justified on the facts of the case. The best comparison would have been with an independent party importing pigments from the same foreign market and trading in the local market but no such Page 61 of 71 ITA No. 925/Mum/2007 Merck Limited comparative case has been placed on record by the TPO. though it was the TPO who separated the pigment segment for the purpose of transfer pricing study. Considering the entirity of facts and circumtances we are unable to sustain the order of CIT(A) upholding the TP adjustment made by AO in this case. The order of CIT (A) is accordingly set aside and the addition made was deleted.
24. The third adjustment made by AO/TPO is regarding the technical know how fees of Rs. 1.57 crore paid by the assesse to its parent company in Germany. The assessee filed copy of technical consultancy agreement from which the AO noted that as per the clause 3 of the agreement the assessee was to receive assistance from the parent in the following fields.
(i) Support of engineering technology, construction of factory and services.
(ii) Selection or right equipment, sourcing of supplies internationally.
(iii) Support of production and quality control with regard to technical and analytical background.
(iv) International marketing and sales trends.
(v) Access to new products. (vi) Search for licence products.
(vii) Information on engineering and scientific trends and training.
(viii) International trends on finance and administration+ Page 62 of 71 ITA No. 925/Mum/2007 Merck Limited
(ix) International banking contracts and issue of letters of comfort.
(x) Advising on new trends on information technology and its implementation.
(xi) Monitoring the setting up and working of the new project.
(xii) Initiation/implementation of SAP.
24.1 The TPO asked the assessee to produce evidence regarding receipt of services under various heads mentioned in the agreement as well as payment of fees in the subsequent two years. The AO noted from the details filed that the payment of fees in each year was different which showed that the assessee was entering into annual agreement as per which the fees was increasing every year. As regards the evidence for receipt of services, the assessee explained that it received technical guidance whenever it required particularly in respect of new projects undertaken by it. It was pointed out that recently it had received technical assistance in respect of project of Thiamine Disulphide and the project for manufacture of 'Oxinex'. The TPO however noted that asistance on both the occasions had been received during the year 2004 and 2005. The TPO issued show cause notice as to why the arm's length price of services could not be taken as nil as no evidence had been given to substantiate the same. The assessee thereafter vide letter dated 7.3.2006 gave particulars of some services claimed to be received during the year. The assessee also Page 63 of 71 ITA No. 925/Mum/2007 Merck Limited filed E-mails to show correspondences relating to SAP implementation, implementation of IT related software and regarding quality controls. The AO observed that the assessee had produced evidence only in respect of services rendered under three heads out of total tweleve services. He, therefore, appropriated the expenditure incurred only towards the three services at the average rate which gave the figure of Rs. .40 crore. He thus made adjustment of Rs. 1.175 crore in relation to fees paid of Rs. 1.57crore.
24.2 The assessee disputed the decision of AO/TPO and submitted before CIT (A) that the assessee paid fees for consultancy and related services to parent company for various consultancy and related services in the field of engineering technology, sourcing of supplies, information on engineering and scientific trends, international trends on finance and administration and other related services. The consultancy agreement was in respect of list of services which was an ongoing exercise. The services were being received by way of continuous ineraction between the personnel of the assessee and overseas parent by phone calls, e-mails and personal visits. The agreement did not specify that all services mentioned in the agreement will be rendered during the same year. The agreement was only indicative in nature. The TPO therefore, erred in allocating technical services payment based on the number of heads mentioned in the agreement without appreciating the nature Page 64 of 71 ITA No. 925/Mum/2007 Merck Limited of the services received during the year and the value associated with the same. The assessee during the year had received significant support from the AE for implementation of SAP in India and in case the assessee had paid to the AE at man hour rate the technical services fees payble would have been significantly high. It was, therefore, urged that adjustment made by TPO was not justified. CIT (A) was however not satisfied with the explanation given. It was observed by him that the assessee had given general explanation without substantiating the claim. The assessee had given evidence only in respect of three out of twelve heads of services. Even during the appellate proceedings the assessee could not provide evidence in respect of all the services received during the year. CIT (A) therefore, confirmed the adjustment made by AO, aggrieved by which the assessee is in appeal before Tribunal.
24.3 Before us the learned Sernior Counsel assailed the order of CIT(A) confirming the adjustment made by AO/TPO. It was argued that adjustment under transfer pricing regulations had to be made on the basis of one of the prescribed methods only. The TPO had not followed any of the methods. He had made only estimated disallowance of expenses which is not permissible under transfer pricing regulations. It was also submitted that the fees paid by the assessee was not for fixed services. The assessee had the facility to obtain certain services which it availed from time to Page 65 of 71 ITA No. 925/Mum/2007 Merck Limited time depending upon the requirement. The fees paid by the assessee had been taken as part of the cost incurred in trading and marketing segment. For bench marking the transactions the assessee had applied entity level TNMM. The net margin of the assessee was 15% whereas that of the comparable was 13.36%, thus requiring no adjustment. He referred to the decision of Tribunal in case of McCan Ericsson (India) (P) Ltd. VS. ACIT in ITA (5871 Del/ 2011) in which in respect of similar management services and client coordination fees entity level TNMM has been upheld by the Tribunal. In that case also the TPO had taken the value of services as nil. The Tribunal observed that it was for the assessee to decide the legitimate business needs and the AO can not dictate the business needs. Reliance was also placed on the decision of Tribunal in case of Ericsson (India) (P) Ltd. in ITA 5141/Del/2011 in which in similar situation the Tribunal observed that it was for the assessee to decide whether services were required or not and what was the business expediency and enter into arrangement as per the business needs. The Tribunal also observed that it was not for the department to say as to how much should be paid for which service. Moreover it was further pointed out that it was a case of TP adjustment and not normal assessment and, therefore, adjustment can be made only by following the prescribed methods, which has not been done in this case. Therefore, it was urged that the adjustment made should be deleted.
Page 66 of 71 ITA No. 925/Mum/2007Merck Limited 24.4 Learned CIT(DR) on the other hand strongly defended the orders of authorities below. It was argued that there was no evidence for payment of remaining nine services and, therfore, payment to those services had been treated as nil by the TPO as no independent party would be providing any free services. Therefore, it was argued that the TPO had applied the CUP method which was most appropriate on the facts of the case. The learned CIT(DR) also referred to the decision of Bangalore bench of Tribunal in case of Festo Controls (P) Ltd Vs. DCIT in ITA No. 969/BNG/2011 in which in a similar situation where certain services had been provided from the central point to more than one entities, the issue had been restored by the Tribunal to the file of AO. It was thus argued that in this case also the issue may be restored to the file of AO. The learned Senior Counsel however pointed out that the said decision of Tribunal was distinguishable as in that case services had been rendered and the issue was cost allocation which had been restored by the Tribunal. The said decision, therefore, will not apply to the facts of the present case.
24.5 We have perused the records and considered the rival contentions carefully. The dispute raised in this ground is regarding TP adjustment made by AO/TPO in relation to technical know how fess paid by the assessee at Rs. 1.57 crore to its parent in Gernamy. The details of the various Page 67 of 71 ITA No. 925/Mum/2007 Merck Limited services which parent company was required to provide to the assessee have been given in para 24 earlier. There are tweleve such services listed in the said para. The TPO on detailed examination concluded that during the year the parent company had provided services only under the three heads out of total twelve heads of services, which related to SAP implementation and quality control. The TPO has, therefore, held that no fees was required to be paid in respect of nine services and has, therefore, allowed only a sum of Rs .40 crore on average basis in respect of three heads which resulted into adjustment of Rs. 1.157 crore. The case of the assessee is that the parent as per the agreement was required to provide services as mentioned in the agreement from time to time as required by the assessee. The agreement did not specify that all the services mentioned in the agreement have to be rendered during the year. The assessee had the facility under the agreement to obtain certain services as mentioned therein which could be availed from time to time. The assessee has applied entity level TNMM for bench marking the international transaction and demonstrated that in case of comparables, the mean margin was 13.36% whereas the margin of the assessee was 15% and, therefore, no adjustment was required to be made. On the contrary the TPO has not applied any prescribed method.
24.6 We find susbtance in the argument advanced. The law is quite clear on the subject that TP adjustment is Page 68 of 71 ITA No. 925/Mum/2007 Merck Limited required to be made by applying one of the prescribed methods. The TPO has not applied any prescribed method and has only disallowed part of the expenses as done in the normal assessment, which is not permitted under tranfer pricing regulation as per which adjustment on account of any internationl transaction is required to be made as per the method prescribed. The learned CIT (DR) pointed out that the TPO in respect of the nine services not availed by the assessee has treated the payment as nil since no indpendent party would make any payment for services not provided. The TPO thus had applied the CUP method and made adjustment on account of nine services on average basis.
24.7 Such argument in our view is not convincing. The argument would have been valid if fees was fixed in respect of each service, which was compulsorily required tobe provided to the assessee, but it is not so in the present case. The agreement listed certain services on which the assessee requires guidance/assistance from time to time. The assessee was thus entitled to any of the services as and when required. Therefore, applying CUP method to the service not availed by the assessee during the year is not justified. It would have been appropriate if the AO had applied CUP method to the payment made during the year by the assessee for the three services and compared with similar payment for such services by an independent party. No efforts have been made by TPO/AO to determine the market value of services Page 69 of 71 ITA No. 925/Mum/2007 Merck Limited received by the assessee during the year relating to SAP implementation and quality control to show that the assessee had paid more compared to any independent party for the same services. The assessee had submitted that in case the assessee had paid to the AE at man hour rate for the technical services provided during the year in relation to SAP implementation, the fees payable would have been significantly higer. There is nothing produced before us to controvert the said claim. The assessee has applied TNMM which shows that the margin shown by the assessee was higher than the comparable companies. The case of the assessee is also supported by the decision of Tribunal in case of Mc Can Erricson India Pvt. Ltd. (Supra) in which the decision of TPO to take the value of cergain services at nil has not been upheld. Considering the entirity of facts and circumstances, the adjustment made by TPO which is nothing but disallowance of expenses cannot be upheld. We, therefore, set aside the order of CIT (A) on this point and delete the addition made.
25. In the result, the appeal of the assessee is partly allowed.
Order pronounced today i.e 19 /7/2013
Sd/- Sd/-
(B.R. Mittal) (Rajendra Singh)
या यक सद य / JUDICIAL MEMBER लेखा सद य / ACCOUNTANT MEMBER
S.K.S Sr. P.S. Mumbai, Dated 19 /7/2013
Page 70 of 71
ITA No. 925/Mum/2007
Merck Limited
आदे श क त ल प अ े षत/Copy
षत of the Order forwarded to :
1. अपीलाथ / The Appellant
2. यथ / The Respondent.
3. आयकर आयु (अपील) / The CIT(A)-
4. आयकर आयु / CIT
5. वभागीय त न ध, आयकर अपील य अ धकरण, मंुबई / DR, ITAT, Mumbai
6. गाड फाईल / Guard file.
ु / BY ORDER,
आदे शानसार
स या पत त //True Copy//
उप सहायक पंजीकार (Dy./Asstt.
उप/सहायक Registrar)
आयकर
आयकर अपील य अ धकरण,
धकरण मंुबई / ITAT, Mumbai
Page 71 of 71