Income Tax Appellate Tribunal - Delhi
Eli Lilly & Company (India) Pvt. Ltd., ... vs Assessee on 20 April, 2011
1 I.T.A. No. 5265/Del/2011
IN THE INCOME TAX APPELLATE TRIBUNAL
(DELHI BENCH 'B': NEW DELHI)
BEFORE SHRI U.B.S. BEDI, JUDICIAL MEMBER
And
SHRI SHAMIM YAHYA, ACCOUNTANT MEMBER
ITA No.5265/DEL/ 2011
(Assessment Year: 2007-2008)
Eli Lilly & Company (India) Pvt. Ltd. Vs. ACIT
Plot No.92, Sector-32, Circle -1(1),
Institutional Area, I.P Estate
New Delhi New Delhi.
PAN: AAACE9801F
(APPELLANT) (RESPONDENT)
ASSESSEE BY :Shri Ajay Vohra & Shri Neeraj Jain, Adv.
Shri Abhishek Agrawal, CA
REVENUE BY :Shri Peeyush Jain, CIT.DR.
ORDER
PER U. B. S. BEDI, JM:
This appeal of the assessee is directed against the order passed u/s 143 (3) read with 144C of the Income Tax Act, for the Assessment Year-2007-08 dated 20.04.2011,Whereby, difference in ALP as determined by the TPO and confirmed by Dispute Resolution Panel-1, New Delhi has been challenged as per ground no.2 to 2.6, whereas, ground no.1 is general and ground no.3 is with regard to levying interest u/s 234 B and section 234 C of the Act which is consequential and ground no.4 is not pressed.
2. Facts indicate that assessee filed its return declaring Rs.138,476,801/- as income on 31.10.2007. The case was taken up for scrutiny and notice u/s 143 (2) was issued and served upon the assessee. Further notice u/s 143(2), 142(1) along with questionnaire were issued, which were duly served upon the assessee. Authorized representative attended and filed the required 2 I.T.A. No. 5265/Del/2011 particulars, as per questionnaire and order sheet, which were verified on test- check basis in para 2 to 5 of the assessment order which is reproduced as under:
"2. The Company was incorporated on March 18, 1993 as a Private Ltd. Company with its headquarters in New Delhi with nine branch offices by virtue of 50:50 joint venture among two partners, namely Eli Lilly and Company, Indianapolis, USA, through its wholly owned subsidiary, Eli Lilly Netherland BV and Ranbaxy Laboratories Ltd., New Delhi. Eli Lilly and Company, Indianapolis, USA (hereinafter called 'Lilly Us') is engaged in the business of Research, manufacturing, marketing and sale of formulations that find usage in the treatment of several; disease segments ranging from Oncology, CNS, Cardiovascular, Infectious diseases, Endocrine etc. The company received Foreign Collaboration Permission in April 1993 to manufacture and market products of Eli Lilly and Company under its brand name. The company launched its products in October, 1993 with 3 products namely Dobutrex, Tobrang and Distaclor. In the F.Y 1993-94, Company achieved Sales Turnover of Rs.177 crores with an assessed loss of Rs.4.91 crores.
During the F. Y.2006-07, Lilly India was engaged in the business of trading of formulations and providing services Viz. Clinical Trials and answering medical queries and other support services to other Associated Enterprises.
3) A reference was made to the TFI-I(2) to determine the Arms Length Price u/s 92CA(3) in respect to International Transactions entered into by the assessee during the F. Y. 2006-07. The order of the TPO-I (2) dated 08.10.2010 passed u/s 92CA (3) of the act has been received. Transfer Pricing Officer vide his order has determined the adjustment/ difference on account of ALP in respect of international transactions with associated enterprises at Rs.135,950,375/- as follow.
"8. Based on the discussions in the preceding paras, the gross margin of the assessee is calculated as below.
Opening stock : 414,965,282 Sales : 1,823,107,281
Purchases : 1,758,133,119 Free Samples : 23,276,950
Customs duty : 65,074,378 Closing stock: 566,033,645
Gross Profit: 174,245,097
2,412,417,876 2,412,417,876
Subvention income cannot be taken as part of this calculation because of its character as other income.3 I.T.A. No. 5265/Del/2011
Total Sales : Rs.1,823,107,281/-
Gross margin @47.21% : Rs.860,688,947/-
Gross margin Shown : Rs.174,245,097/-
Arms length value of purchase : Rs.1,071,689,269/-
Purchase value shown : Rs.1,758,133,119/-
Difference : Rs.686,443,850/-
Less: Subvention income : Rs.550,493,475/-
Adjustment u/s 92CA : Rs.135,950,375/-
The arm's length value of the international transaction related to purchase of goods is determined at Rs.1,071,689,269/- as against Rs.1,758,133,119/- determined by the assessee. The downward adjustment of Rs.135,050,375/- is required to bring it to arms length. The assessing officer shall enhance the income of the assessee by Rs.135,950,375/-. The assessee shall not get the benefit of the proviso of Section 92C(2) as the difference of Rs.686,443,850/- is more than 5% of the value of international transaction."
Following the order of the Transfer Pricing Officer the adjustment/ difference on account of ALP amounting to Rs.135,950,375/- is proposed to be added to the returned income.
Accordingly, draft assessment order u/s 144C dated 14.12.2010 was passed by the undersigned.
(4) The assessee filed the objections against the Draft Assessment Order with the Dispute Resolution Panel (DRP), Delhi on 28.01.2011. Hon'ble DRP-I, New Delhi has issued order u/s 144C (5) of the Income Tax Act, 1961 dated 08.08.2011, received in the office of the undersigned on 30.09.2011. The DRP vide his order dated 08.08.2011 has upheld the orders of the TPO/AO (Copy of the orders of DRP dated 08.08.2011 enclosed).
(5) In view of above, I am satisfied that the assessee has concealed the particulars of income to the tune of Rs.135,950,375/- within the meaning of section 271(1)(c) of the Act. Therefore, the assessee is liable to levy of penalty u/s 271(1) (c) of the Act. Proceedings u/s 271(1)(c) of the Act are being initiated separately.
With these remarks, the total income of the assessee is being recomputed as under:
Net taxable income as per the return of income -Rs.138,476,801 Add: Difference in ALP as determined by TPO -Rs.135,950,375
----------------------4 I.T.A. No. 5265/Del/2011
Assessed Income Rs.274,427,176 Assessed. Charged interest u/s 234 'A', 'B',& 'C' if any. Allow credit for prepaid taxes if any. Issue requisite documents."
3. Aggrieved by the order of the AO, the assessee has come up in appeal and challenged the action of Assessing Officer, raising ground no. 2 to 2.6 as under:
"2. That the AO erred on facts and in law in making adjustment of Rs.135,590,375/- to the income of the appellant on account of the difference in the arm's length price of the international transactions of purchase of formulations undertaken during the previous year.
2.1 That the AO/DRP erred on facts and law in rejecting the transfer pricing analysis undertaken by the appellant for benchmarking the transaction of purchase of formulations applying TNMM and instead applied RPM as the most appropriate method.
2.2 That the AO erred on facts and in law in not appreciating that because of restrictions imposed by the drug control authorities of India on fixation of price of medicines, RPM could not be considered as most appropriate method.
2.3 That the AO erred on facts and in law in not appreciating that due to lack of appropriate patent laws in India, generic drugs put additional pressure on price of medicines traded by the appellant.
2.4 Without prejudice, the AO erred on facts and in law in disregarding the internal benchmarking undertaken by the appellant for determining the arm's length price of the international transaction of purchase of formulations applying RPM on the ground that (i) the internal benchmarking was neither available in audited accounts nor in the TP study report (ii) the purchases made from unrelated parties constitutes only 31% of the total purchases.
2.4 Without prejudice, the AO erred on facts and in law in considering following companies as comparables even when they were into manufacturing activities as against the appellant which is solely into trading of formulations:
i. Mankind Pharma Limited
ii. Novartis India Limited
5 I.T.A. No. 5265/Del/2011
iii. TTK Healthcare Limited
2.5 The AO erred on facts and in law in considering sales of formulations of Rs.1,823,107,281/- representing total value of purchase of formulations as against the specific finding of DRP to consider Rs.1,164,303,000/- as sales made from formulations purchased only from associated enterprise.
2.6 The AO erred on facts and in law in not reducing subvention income of Rs.550,493,475/- received from the associated enterprise in the nature of subsidy, from the value of purchase of formulations of the ground that same represents other income earned by the appellant."
4. The Ld. AR while arguing the appeal on ground no.2 to 2.3 has submitted that TNMM method was not accepted by the TPO whereas, it is the most appropriate method. So as to the business of the assessee is concerned, assessee has filed Broad Proposition (B.P) and submitted that assessee deals in drugs and price leased to be directed Drugs Price Control Authority. Only sale prices to be regulated while making reference to page 3 of the B.P. Reference was made to drug price control order 1995 and it was submitted that DRP has applied re-sale price method and while relying upon B.P page 456 para 2, it was submitted that OECD guidelines 2009 are applicable in succeeding year. Department has drafted TNMM method. TPO cannot take methods in two different years and relying upon at pages 510 to 524 of paper book and giving its specific reference making at page 518, para 11 of paper book.
4.1 In order to argue the appeal of the assessee, Ld. A.R. of the assessee filed following "broad proposition" in short referred to as (BP) on the issue raised in the appeal:
"Eli Lilly & Co. (India) Pvt. Ltd. ('the appellant') is engaged in the business of trading of Life saving drugs formulations sourced its associated enterprises ("AEs") as well as from third parties.
During the financial year 2006-07, the appellant entered into the international transaction, inter alia, of purchase of formulations from the associated enterprise, of Rs. 1,24,28,99,954 for reselling/trading in India.
In the transfer pricing documentation, the appellant determined arm's 6 I.T.A. No. 5265/Del/2011 length price of the 'international transaction' of purchase of formulations applying Transactional Net Margin Method ("TNMM"), by comparing operating profit margin with that of five comparable Average OP/ Sales % of 5 comparable companies 2.80% OP/ Sales % of the appellant 5.06% The Transfer Pricing Officer ('TPO") in his order dated 08.1 0.20 1 0, however, rejected TNMM applied by the appellant and instead applied Resale Price Method ("RPM") as the most appropriate method, holding that (i) the appellant does not add any significant value to the goods imported; and (ii) reliable gross margin details are available for comparable companies. The appellant also contended before the TPO that considering that the appellant has purchased similar formulation from related parties as well as unrelated parties, RPM could be applied considering such internal comparables. Accordingly, the appellant had submitted segmented details of profitability in respect of the transactions of sales of formulations purchased from related vis-a-vis unrelated parties. The Gross profit margin (GP/Sales) earned by the appellant on transactions with the associated enterprise was worked out at 50.06%, which was higher than the average gross profit margin earned on similar transactions with unrelated third parties at 21.54%. Accordingly, the international transaction of purchase of formulations was considered to be at arm's length price.
The TPO, however, also rejected internal benchmarking submitted by the appellant, and \himself carried out a fresh search for comparable companies and accordingly considered \following companies with averages Gross Profit/Sales ratio of 47.21 %, as under:
Name of the company Gross profit on sales for FY 2006-07( %) 1 Cosme Farma Laboratories Ltd. 64.46 2 Mankind Pharma Limited 42.97 3 Marksons Pharma Limited 31.70 4 Novartis India Limited 55.76 5 TYTK Healthcare Limited 41.16 Arithmetic mean 47.21 The TPO further, instead of reducing subvention income from the cost of goods sold", considered it as other income and reduced it from the difference between arm's length price and value of international 7 I.T.A. No. 5265/Del/2011 transactions. Accordingly, the TPO computed an adjustment of Rs.
135,9550,375 to the total income of the appellant as under:
Total sales Rs.1,823,107,281 Gross Margin @ Rs.860,688,947 47.21% Gross margin shown Rs.174,245,097 Difference Rs.686,443,850 Less: subvention Rs.550,493.475 income Adjustment u/s Rs.135,950,375 92CA
The adjustment made by the TPO is unlawful and is not sustainable for the reasons submitted as under:
Incorrect application of RPM:
The TPO has erred in applying RPM as the most appropriate method due to following reasons:
(i) Price Control Regulations in India:
The appellant trades in medical formulations and majority of its products are Subject to Price Control Regulations issued by National Pharmaceutical Pricing Authority ("NPPA"),Government of India. Under the Drug Price Control Order, 1995. An entity engaged in trading of formulations is allowed a much lower gross margin on imported formulations vis- a-vis purchase of indigenous formulations. Further, in case of non scheduled drugs, no upper ceiling has been prescribed on the profit margins from sale of such products and a company can determine the price of such products as per the market forces. Hence, gross margin earned by an India company in trading of formulations may vary significantly depending on whether the company is in the business of trading of scheduled drugs or non scheduled drugs and whether such scheduled drugs are imported or manufactured in India.8 I.T.A. No. 5265/Del/2011
(ii) Patent Laws applicable in India:
The appellant also trades in drugs which are registered under patent laws of other country but not in India. If patent laws of India are not applicable on a specific formulation, then other domestic Indian companies can also manufacture similar generic formulations at a lesser price, which ultimately puts a severe pressure on pricing policy of the appellant. For example. Gemcite, a key patented product traded by Lilly India has around 150 generic players in India, who can manufacture these drugs at a lesser price and hence price of a drug may vary substantially from company to company.
Rule 10B(2) of the Income Tax Rules, 1962 ("Rules") provides that while evaluating comparability of an uncontrolled transaction with controlled transaction, due consideration should be given to the market conditions and laws and Government orders in force.
Reference in this regard, can also be placed on the following extract of transfer guidelines issued by Organization for Economic Co- operation and Development ("OECD") under "Revision of chapters I-III of the Transfer Pricing Guidelines" issued on 22nd July, 2010 which states that due consideration should be given to the government restrictions while evaluating uncntrolled transaction with controlled transactions:
"The effect of government policies 1.73 There are some circumstances in which a taxpayer will consider that an arm's length price must be adjusted to account for government interventions such as price controls (even price cuts), interest rate controls, control over payments for services or .. Management fees, controls over the payment of royalties, subsides to particular.
sectors, exchange control, antidumping duties, or exchange rate policy. As a general rule, these government interventions should be treated as conditions of the market in the particular country, and in the ordinary course they should be taken into account in evaluating the taxpayer's transfer price in that market Accordingly, in view of the government restrictions imposed by way of price control and prevailing patent laws, a gross margin comparison would give an absurd result. In the absence of such information in 9 I.T.A. No. 5265/Del/2011 public domain, a net margin analysis using Transactional Net Margin Method would be the most appropriate method.
Further, under the Transfer Pricing regulations, for the purpose of benchmarking analysis applying TNMM, it would suffice if the tested party and the comparable company broadly fall into similar business segment, but what is necessary is that they should be performing similar functions, assuming similar risks and employing similar assets.
Attention is invited in this regard to the paragraph 3.34 of the OECD guidelines, 2009 which in the context of application of TNMM, clearly provides as under:
"3.34 Prices are likely to be affected by differences in products, and gross margins are likely to be affected by differences in functions, but operating profits are less adversely affected by such differences. As with the resale price and cost plus methods that the transactional net margin method resembles, this, however, does not mean that a mere similarity of functions between two enterprises will necessarily lead to reliable comparisons. "
It is also a settled position under the Transfer Pricing regulations that for the purpose of. benchmarking analysis applying TNMM, the functional comparability, i.e., functions performed, assets utilized and risks assumed, is relevant and the benchmarking analysis is less affected by the product differences.
It is further respectfully submitted that TNMM examines net profit margin relative to an appropriate base, (e.g. cost, sales, assets) that the tested party realizes in a controlled situation with that of the uncontrolled comparables. The OECD guidelines, 2009 explain the TNMM method and its strengths in the following paras:
3.27 One strength of the transactional net margin method is that net margins (e.g., return on assets operating income to sales, and possibly other measures of net profit) are less affected by transactional differences than is the case with price, as used in the CUP Method. The net margins also may be more tolerant to some functional differences between the controlled and uncontrolled transactions than gross profit margins.10 I.T.A. No. 5265/Del/2011
Differences in the /functions. performed between enterprises are often reflected in variations in operating expenses. Consequently, enterprises may have a wide range of gross profit margins but still earn broadly similar levels of net profits.
3.28 Another practical strength is that it is not necessary to determine the functions performed and responsibilities assumed by more than one of the associated enterprises. Similarly, it is often not necessary to state the books and records of all participants in the business activity on a common basis or to allocate costs for all participants. This can be practically advantageous when one of the parties to the transaction is complex and has many interrelated activities or when it is difficult to obtain reliable information about one of the parties ..... "
In view of the above, it is respectfully submitted that TNMM being more tolerant and less susceptible of minor functional difference ought to have been applied as the most appropriate method for determining the arm's length price of purchase of formulations undertaken by the appellant made by the assessing officer on account of difference in arms length price of international transaction of purchase of formulations is not sustainable and liable to be deleted.;
2. Res-Judicata - Benchmarking of transaction of purchase of formulations was undertaken by applying TNMM during A Y 2008-09 The TPO has himself benchmarked the transaction of purchase of formulations by applying TNMM in the assessment year 2008-09. There is no change in facts of the current year with respect to the transaction of purchase of formulations vis-a-vis the facts of assessment year 2008-09. In view of the aforesaid, it is respectfully submitted that the transaction of purchase of formulations ought to have been accepted to be at arm's length, applying TNMM in the year under consideration, too. Reliance in this regard is placed on the decision of the Hon'ble Pune bench of the Tribunal in the case of Brintons Carpets Asia Pvt. Ltd vs DCIT (ITA No 1296/PN/2010), wherein it is held as under:
"We have considered this argument and in our opinion, it is a settled law that the principle of res judicate is inapplicable to income tax matters. However, the same is true as long as the facts are different in different AYs. Otherwise, the rule of consistency is relevant to income tax matters and AO cannot be ignore the same. There ought to be 11 I.T.A. No. 5265/Del/2011 uniformity in treatment and consistency when the facts and circumstances are identical"
Since international transaction of purchase of formulations has .. been. benchmarked applying TNMM in the subsequent year, therefore, there is no reason to dispute the application of TNMM as the most appropriate method in the relevant previous year.
3. Incorrect rejection of comparable companies:
During the course of assessment proceedings, the appellant submitted profit margins of the following comparable companies, substantial income from trading activities formulations:
Gross profit on sales for f.y.
Name of the company
2006-07
Aditya Medisales Limited 3.70 %
B A & B Brothers (Eastern) Ltd. 9.40 percent
Cosme Farma Laboratories Limited 64.46 percent
Sharon Bio-Medicines Ltd 18.86 percent
Solumiks Herbaceuticals Ltd. 50.90 percent
Serum International Ltd. 50.53 percent
Arithmetic mean 32.98 percent
The TPO summarily rejected the aforesaid companies holding that these companies have a high level of manufacturing expenditure or the level of personnel expenses is very high. The TPO, further failed to appreciate the fact that the aforesaid companies are functionally comparable to the appellant, and hence, for the purpose of benchmarking the international transaction of 'purchase of formulations' undertaken by the appellant, applying RPM, the above mentioned companies ought to be considered for the purpose of the computation of arm's length price.
Considering the aforesaid companies considered by the appellant with average gross profit margin over sales of 32.98%, no adjustment on account of difference in international transaction of purchase of formulations is warranted, as under:
Particulars Anlount(Rs. )
Total Sales Rs.l,823,107,281
12 I.T.A. No. 5265/Del/2011
Gross Margin @ 32.98% Rs. 601,260,781
Gross margin shown Rs. 174,245,097
Difference Rs.427,015,684
Less: subvention income Rs. 550,493,475
Adjustment u/s 92CA NIL
In view of the aforesaid, the adjustment made by the TPO on account of difference in arms length price of international transaction of purchase of formulations is not sustainable and liable to be deleted.
4.The TPO erred in considering companies as comparable to the appellant having substantial manufacturing activities:
It is respectfully submitted that RPM method is applicable in a situation where property purchased from related party is sold to unrelated entity without adding any significant value addition. Accordingly, in computing arm's length margin, gross margin earned by companies from only trading activities should be considered comparable.
Para 2.22 of the OECD guidelines provides, in this regard, as under:
"2.22 An appropriate resale price margin is easiest to determine where the reseller does not add substantially to the value of the product. In contrast, it may be more difficult to use the resale price method to arrive at an arm's length price where, before resale, the goods are further processed or incorporated into a more complicated product so that their identity is lost or transformed (e.g. where components are joined together in finished or semi-finished goods). "
The TPO, in his order has considered following companies for the purpose of benchmarking the international transaction of Purchase of drug formulation with average Gross Profit/Sales ratio of 47.21 %, as under:
13 I.T.A. No. 5265/Del/2011 Name of the company Gross profit on
sales for FY
2006-07( %)
1 Cosme Farma Laboratories 64.46
Ltd.
2 Mankind Pharma Limited 42.97
3 Marksons Pharma Limited 31.70
4 Novartis India Limited 55.76
5 TYTK Healthcare Limited 41.16
Arithmetic mean 47.21
However, while considering the aforesaid companies, the TPO has erroneously selected following companies engaged in manufacturing activities, as comparable companies:
(i) Novartis India Ltd.
(ii) TTK Healthcare Ltd.
(iii) Mankind Pharma Ltd.
It is also submitted that, for the purpose of application of RPM, the following comparable companies placed on record by the appellant during the assessment proceedings, which are solely engaged in trading activities shall also be considered in the final set of comparable companies:
(i)Aditya Mediasales Limited
(ii) B A & B Brothers (Eastern) Limited
(iii) Cosme Pharma Laboratories Limited
(iv) Solumiks Herbaceuticals Ltd.
(v) Serum International Ltd.
Accordingly, after considering only those companies which are majority engaged in the business of trading of drug formulations, 14 I.T.A. No. 5265/Del/2011 from the final set of comparable companies considered by the TPO as well as the appellant, the average gross profit over sales work out to 35.11 %, as under:
Name of the company Only GP/Sales % Page
trading No.(PB-1)
Companies considered by
the appellant
Aditya Medisales Limited Yes 3.70 137
BA & B Brothers (Eastern) Yes 9.40 138
Limited
Cosme Farma Laboratories Yes 64.46 139
Limited
Sharon Bio-Medicines No 140
Limited manufact
uring
profit
clubbed
with
trading
profit.
Solumiks Herbaceuticals Yes 50.90 141
Limited
Serum International Ltd. Yes 50.53 142
Companies considered by
the TPO
Cosme Farma Laboratoris Yes -
Ltd (Common)
Marksons Pharma Ltd Yes 31.70 312-341
Novartis India Ltd. No. 250/263
Manufac
turing
profit
clubbed
with
trading
profit.
TTK Healthcare Ltd. No. 290/295
Manufac
15 I.T.A. No. 5265/Del/2011
turing
profit
clubbed
with
trading
profit
Mankind Pharma Ltd. No. 208
Manufac
turing
profit
clubbed
with
trading
profit
Average 35.11
Accordingly, it is respectfully submitted that after considering the aforesaid companies having only trading income and functionally comparable to the appellant with average gross profit margin over sales of 35.11 %, no adjustment on account of difference in international transaction of purchase of formulations is warranted, as under;
16 I.T.A. No. 5265/Del/2011 Particulars Amount Rs.
Total Sales Rs.l,823,107,281
Gross Margin @ 35.11 % Rs. 640,092,966
Gross margin shown Rs. 174,245,097
Difference Rs.465,847,869
Less: subvention income Rs. 550,493,475
Adjustment U/S 92CA Nil
The adjustment made by the TPO on account of difference in arms length price of international transaction of purchase of formulations is not sustainable and liable to be deleted.
5. Without prejudice, the transaction of purchase of formulations was at arm's length even after applying RPM with internal comparable:
It is respectfully submitted that the appellant, during the year purchased for resale, similar formulation from the AE as well as unrelated parties. The Gross profit margin (GP/Sales) earned by the appellant on transactions with the associated enterprise was worked out at 50.06%, which was higher than the average gross profit margin earned on similar transactions with unrelated third parties at 21.54%. Accordingly, the international transaction of purchase of formulations was considered to be at arm's length price.
The TPO/DRP, however, disregarded the internal benchmarking undertaken by the appellant for determining the arm's length price of the international transaction of purchase of formulations applying RPM on the ground that (i) the internal benchmarking was neither available in audited accounts nor in the TP study report and (ii) the purchases made from unrelated parties constitutes only 31 % of the total purchases and (iii) the purchases made from unrelated third party is an estimated figure.
The contentions of the TPOIDRP in disregarding internal comparison carried out by the appellant for benchmarking international transactions of purchase of formulations are unlawful and not sustainable for the reasons submitted hereunder:
Rule 10B( 1 )(b) of the Income-tax Rules ("the Rules") provides that 17 I.T.A. No. 5265/Del/2011 for application of RPM, the profit margin realized by an enterprise or by an unrelated enterprise from comparable uncontrolled transaction or a number of such transactions are to be compared with net profit margin realized by the enterprise (tested party) from the international transactions entered into with an associated enterprise. Rule 1OB(1)(b) of the Rules reads as follows:
"10B. Determination of arm's length price under section 92C.
(1) For the purposes of sub-section (2) of section 92C, the arm's length price in relation to an international transaction shall be determined by any of the following methods, being the most appropriate method, in the following manner, namely:-
xxx xxx xxx (b) resale price method, by which, (i) the ..price at which property purchased or services obtained by
the enterprise from an associated enterprise is resold or are provided to an unrelated enterprise, is identified; --
(ii) (ii) such resale price is reduced by the amount of a normal gross profit margin accruing to the enterprise or to an unrelated enterprise from the purchase and resale of the same or similar property or from obtaining. and providing the same or similar services, in a comparable uncontrolled transaction, or .a number of such transactions;
(iii) the price so arrived at is further reduced by the expenses incurred by the enterprise in connection with the purchase of property or obtaining of services;
(iv) the price so arrived at is adjusted to take into account the functional and other differences, including differences in accounting practices, if any, between the international transaction and the comparable uncontrolled transactions, or between -, the enterprises entering into such transactions, which could materially affect the amount of gross profit margin in the open market;
(v) the adjusted price arrived at under sub-clause (iv) is taken to be an arm's length price in respect of the purchase of the property or obtaining of the services by the enterprise from the associated enterprise. "
It is submitted that in the case of the appellant, RPM could appropriately be applied considering internal comparable uncontrolled transactions entered into by the appellant with unrelated parties. Such internal com parables, it is submitted, provide the best guide and ideal benchmark for international transactions. In fact, 18 I.T.A. No. 5265/Del/2011 internal comparables available in case of an assessee are to be preferred for the purpose of benchmarking of international transactions applying RPM, instead of relying on external comparables, as provided in Paragraph 3.26 of the GECD Guidelines which reads as under:
"3.26. The transactional net margin method examines the net profit margin relative to an appropriate base (e.g. costs, sales, assets) that a taxpayer realizes from a controlled transaction or transactions that are appropriate to aggregate under the principles of Chapter 1). Thus, a transactional net margin method operates in a manner similar to the cost plus and resale price methods. This similarity means that in order to be applied reliably, the transactional net margin method must be applied in a manner consistent with the manner in which the resale price or cost plus method is applied. This means in particular that the net margin of the taxpayer from the controlled transaction (or transactions that are appropriate to aggregate under the principles of Chapter 1) should ideally be established by reference to the net margin that the same taxpayer earns in comparable uncontrolled transactions. Where this is not possible. the net margin that would have been earned in comparable transactions by an independent enterprise may serve as a guide. A functional analysis of the associated enterprise and, in the latter case, the" independent enterprise is required to determine whether the transactions are comparable and what adjustments may be necessary to obtain reliable results". (emphasis supplied) As per the OECD Guidelines, the net margin of the taxpayer from the controlled transaction should ideally be established by reference to the net margin that the same taxpayer earns in comparable uncontrolled transactions. Where this is not possible, the net margin that would have been earned in comparable transactions by an independent enterprise may serve as a guide. It is respectfully submitted that the OECD Guidelines on Transfer Pricing recognizes the fact that internal comparables, if available, are to be adopted in the first instance, as the preferred benchmark. Only where such internal comparables are not available, resort can be had to external comparables, which may even otherwise be difficult to obtain and information in respect of which may be incomplete and difficult to interpret. 'The OECD under "Revision of chapters I-III of the Transfer Pricing Guidelines" issued on 22nd July, 2010, too, recommended the use of internal comparable data for benchmarking analysis, as under:
C.3.4.4 Reliance on data from the taxpayer's own operations ("internal data"): ] 19 I.T.A. No. 5265/Del/2011 2.141 "Where comparable uncontrolled transactions 0/ sufficient reliability are lacking to support the division 0/ the combined profits, consideration should be given to internal data, which may provide a reliable means of establishing or testing the arm's length nature of the division of profits "
***** ***** A.4.2 Internal com parables:
3.27 "Step 4 of the typical process described at paragraph 3.4 is a review of existing internal comparables, if any. Internal comparables may have a more direct and closer relationship to the transaction under review than external com parables. The financial analysis may be easier and more reliable as it will presumably rely on identical accounting standards and "practices for the internal comparable and for the controlled transaction. In addition, access to information on internal comparables may be both more complete and less costly. "
***** ***** A.4.3 External comparables and sources 0/ information:
Para 3.29 -."There are various sources of information that can be used to identify potential external comparables. This sub-section discusses particular issues that arise with respect to commercial databases, foreign comparables and information undisclosed to taxpayers. Additionally, whenever reliable internal comparables exist, it may be unnecessary to search for external ones, see paragraphs 3.27-3.28. "
***** ***** 3.32 "It will be unnecessary to use a commercial database if reliable information is available from other sources, e.g. internal comparables, Reliance is also placed on the decision of Hon'ble Mumbai Bench of the Tribunal in the case of UCB India (P) Ltd. v CIT.,30 SOT 95 (Mumbai). wherein, the TPO sought to undertake the benchmarking analysis applying TNMM by considering segI?3nted results by comparing operating profit margin earned from transactions of associated enterprises and unrelated parties. The TPO required the assessee to submit such segmented profitability of transactions with associated enterprises and unrelated parties. The appellant contended before the Tribunal that segmental reporting requirements were not attracted and the assessee in terms of 20 I.T.A. No. 5265/Del/2011 the Accounting Standard was not required to maintain separate segmental profitability in respect of transactions with associated enterprises and unrelated parties. The assessee, on that basis, insisted that the benchmarking analysis applying TNMM be undertaken at entity level by comparing operating profit margin earned by the assessee with operating profit margin of comparable uncontrolled enterprises.
The Tribunal in the aforesaid background held that notwithstanding that there was no requirement for the assessee to report segmented results in the audited accounts, the assessee was required to provide working for operating profit marginfrom transactions undertaken with associated enterprises and unrelated parties. Such comparison of profitability on transaction to transaction basis was, according to the Tribunal,to be preferred over entity level comparison for application of TNMM under the Transfer Pricing regulations. Further, in the case of Gharda Chemicals Limited Vs DCIT, 130 TTJ 556, the Hon'ble Income Tax Appellate Tribunal ("IT AT"), too, held that internal comparable should be preferred over external comparables. The relevant extract of the judgment is reproduced below: "Internal CUP method envisages comparing the uncontrolled transactions of the appellant itself with other unrelated parties so as to determine the ALP with the AE. However the E~e.rnaL.CJ1P-'l1£Jho.d disregards the price charged or paid by the appellant to or from its unrelated parties and contemplates the comparison of the price so charged from or paid to its AE with some external independent reliable price data under similar circumstances of transactions with AE. Ordinarily the internal CUP method should be preferred over the External CUP method as it neutralizes several distinguishing factors, such as the local factors and the economies available or unavailable to the appellant in particular, having bearing over the comparison of price charged from unrelated parties and AE."
The Hon'ble Tribunal in the case of Birlasoft (India) Ltd. vs. ACIT- .1.3.6TIJ 505, too, upheld the internal benchmarking analysis undertaken by the appellant while justifying the international transactions of provision for software development services as at arm's length applying TNMM as against. External benchmarking referred by the TPO Further, the revenue is not before the High Court on the issue of internal comparability.
On the same lines, the co-ordinate bench of Delhi Tribunal in the case of Destination of the World vs. DCIT [ITA No 5534/pe1l20101too, held that transfer pricing analysis should be done by taking recourse to internal uncontrolled transactions.
21 I.T.A. No. 5265/Del/2011In view of the above, without prejudice to the submission that TNMM is to be applied as the most appropriate method in the present case, RPM analysis is to be carried out considering internal data, as aforesaid, and should be preferred over external comparable data.
Further, it is submitted that, in the transfer pricing study, the appellant benchmarked distribution business applying TNMM with operating profit on operating revenue as the profit level indicator. It is respectfully submitted that the appellant has the same distribution network and marketing force and administrative staff etc. for both products purchased from both related and unrelated parties. Hence, separate cost level details from related and unrelated segment beyond gross margin level were not available. Allocation of cost into related and unrelated party segment would have resulted in significant assumptions. Further, AS-17 requires reporting of financial information about the different types of products and services that the business segment produces which includes different geographical areas in which it operates. It is not the case that the appellant is not selling similar products to AEs and non AEs and hence, there were no requirement of providing the segmental in the audit report of the appellant Accordingly, the contention of the TPO for rejecting the segmented profitability submitted by the appellant on the ground that segmental profitability were available neither in audited accounts of the assessee nor in its TP study is erroneous, palpable and overriding errors of fact and procedural unfairness.
It is further respectfully submitted that the appellant did not undertake benchmarking analysis considering internal comparables in the Transfer Pricing study, would not estoppel the appellant from making such a claim in the course of proceedings before the TPO. In any case, the appellant has submitted the aforesaid benchmarking analysis pursuant to the proposal of the TPO to undertake the benchmarking analysis applying RPM. The contention of the TPO, therefore, in this regard, is not sustainable.
Further, in terms of clause (b) of Rule 1 OB(1) of the Income-tax Rules, RPM could be applied considering a comparable uncontrolled transaction. In any transaction in the appellant's case constitute a sizable volume of 31 % of the total purchases. The TPO has disregarded the internal benchmarking proposed by the appellant on flimsy and unlawful grounds.
Further, the contention of the TPO that the appellant has derived the figures of purchases made from unrelated third parties on an estimated basis is also incorrect, in view of the fact that the appellant has submitted the segmented account duly audited and certified by an 22 I.T.A. No. 5265/Del/2011 independent Chartered Accountant, wherein, the procedures related to purchases and sales made by the appellant has been mentioned as under;
2. We obtained the list of products being purchased by the company. In respect for each of the products, following information was included in the list:
a)Unique item code of the product
b)Whether purchased from AE or other enterprise or both.
3. For products purchased from both Associated enterprise and Other enterprise, we obtained batch numbers against each purchases made during the year.
4. We obtained listing of purchases during the year ended March 31, 2007 containing:
a.Unique item code of the product b.Name of the supplier c.Base value of purchases d.Other expenditures.
We furnish our findings below:
4. with respect to point no. 6, we fond that the purchases was correctly categorized between associated enterprise and other enterprises.
It would be appreciated from the above that the amount of purchases made from associated enterprises and unrelated third parties were derived on actual basis and the segmented accounts placed on record were duly audited and certified, the allegations of the TPO finds no place.
In view of the aforesaid, it is respectfully submitted that since the Gross profit margin (GP/Sales) earned by the appellant on transactions with the associated enterprise was worked out at 50.06%, which was higher than the average gross profit margin earned on similar transactions with unrelated third parties at 21.54%. Accordingly, the international transaction of purchase of formulations was considered to be at arm's length price.
6.Arms length principle to be applied on international transaction with associated enterprise:
The appellant during the proceedings before the TPO as well as DRP 23 I.T.A. No. 5265/Del/2011 submitted the audited segmental profitability on the basis of purchase made from related enterprises vis-a-vis unrelated third parties. It is respectfully submitted that the TPO while computing Gross Profit margin of the appellant for the purpose of benchmarking the international transaction of 'purchase of formulations' considered the entire sales of the appellant of Rs. 1,82,31,07,281 (comprising of sale of products sourced from AE of Rs. ,16,43,03,000 and from unrelated parties of Rs.65,88,04,000).
Without prejudice, it is respectfully submitted that, even if RPM has to be applied, arms length principle should be restricted to international transactions undertaken by the appellant with its associated enterprise.
Reliance in this regard was placed on the decision of Mumbai Bench of Tribunal in the case of IL Jin Electronics (I) P ltd. vs. ACIT (ITA 438/D/2004), wherein, the Hon'ble Tribunal has directed to restrict the adjustment to the extent of transactions undertaken by the assessee with its associated enterprise, as under:
"The Appellant has also taken one alternative ground out of the total raw materials consumed by the Appellant for manufacturing print circuit boards, only 45.51 percent of the total raw materials were imported through Appellant's associate concerns, and, therefore, any adjustment, if any called for, can only be made to the 45.51 percent of the total turnover, and not to the total turnover of the Appellant. After considering the facts of the case, we do not find any difficulty in accepting this contention of the Appellant that at best only 45.51 per cent of the operating profit can be attributed to imported raw material acquired form Appellant's associate concerns. In the present case, the Assessing Officer has calculated the operating profit on the entire sales of the Appellant, which in our considered opinion is not justified when it is admitted position that only 45.51 per cent of raw material has been acquired by the Appellant form its associated concerns for the purpose of manufacturing items------------We therefore direct the assessing officer to modify the assessment and make the adjustment only to the extent of difference in the arm's length operation profit with adjusted profit with reference to the 45.51 per cent of the turnover, and not to the total turnover of the Appellant. Therefore to this extent, the addition made by the Assessing Officer and further confirmed by the CIT (A) is reduced, We order accordingly. " [Emphasis Supplied} Attention is also invited to the decision of Hyderabad Bench of Tribunal in the case of Four Soft Ltd. vs. DCIT [ITA No. 1495/HYD/201O], wherein the Hon'ble Tribunal held that for 24 I.T.A. No. 5265/Del/2011 computing the net margin of the assessee for the purposes of transfer pricing, only the cost @ 460PB-I I related to the transaction with the associated enterprises has to be considered, as under:
"In our considered view, for computing the net margin of the assessee for the purposes of transfer pricing, only the cost related to the transaction with the Associated Enterprises has to be considered and accordingly, we approve that segmental financials is to be considered for the purpose of arriving at the net margin on the international transaction with the assessee's enterprise in respect of software development services. "
On the similar lines, the Mumbai Bench of Tribunal in the case of Technimount ICB India P. Ltd. vs. ACIT [ITA No. 7098/Murnl2010], held as under:
"Coming to the main issue as to whether the segmental results are to be taken into consideration or profit margin at entity level is to be considered, it is seen that Chapter-X incorporates special provisions relating to avoiding of tax in regard to international transactions and income from international transactions has to be determined at arm's length price. Therefore. as per the provisions contained under sections 92 to 94. international transactions are to be taken into consideration. Therefore, segmental results are to be considered and not the profit at entity level" Reliance may also be placed in this regard on the following decisions:
- ACIT vs. Twinkle Diamond: ITA No. 5033/Mum/07
- ACIT vs. T Two International Pvt. Ltd. : ITA No. 5644/Mum/2008
- Addl, CIT vs. Tej Diam : 130 TTJ 570 (Mum)
- Abhishek Auto Industries Ltd. vs. DCIT: ITA No. 1433/Del/2009
- Starlite vs. DCIT: ITA No. 925/Mum/2006
- SMCC Construction India Ltd v. Addl, CIT: 44 SOT 63 (Delhi) (URO)
- Genisys Integrating Systems (India) Pvt. Ltd. vs. DCIT [ITA No. 1231/Bang/2010] In view of the aforesaid decisions, no adjustment on account of difference in arms length price of international transaction of purchase of formulations would survive after considering the segmental profitability of the appellant, as under:25 I.T.A. No. 5265/Del/2011
Particulars Computation of Computation of gross profit gross profit margin by the margin TPO sales 1,82,31,07,281 1,16,43,03,000 Cost of goods sold 1,64,88,62,184 1,10,07,93,000 Gross margin shown 17,42,45,097 6,35,10,000 Gross margin 9.56% 5.45% Arm's length gross 86,06,88,947 54,96,67,446 margin as computed by she TPO @ 47.21% Shortfall in profits 68,64,43,850 48,61,57,46 Less Subvention 55,04,93,475 55,04,93,475 income Balance Adjustment 13,59,50,375 nil Further, the DRP has considered the segmental profitability of the appellant and accordingly given a specific finding that for the purpose of computing the gross profit margin of the appellant, transactions which were undertaken with associated enterprise only shall be considered, as under:
"The correct calculation of the gross profit as per the segmentation given by the assessee now would be Net Sales Rs.1,16,43,03,000 ~.
Cost of goods sold Rs. 1, 10,07,93,000
Gross profit Rs. 6,35,10,000'/
GP/Sales 5.45%
However, the assessing officer, while passing the final order dated 24- 12-2011 failed to take note of the specific direction of the DRP and proceeded with the adjustment proposed by the TPO. The appellant had filed a rectification application before the RP, which is pending disposal. Accordingly, the adjustment made by the TPO would be deleted after considering the direction of the DRP."
4.2 Ld. Counsel for the assessee while reiterating such broad proposition in the light of case law, has pleaded for deletion of the difference in ALP as determined by the TPO and as confirmed by Dispute Resolution Penal-1, New Delhi.
26 I.T.A. No. 5265/Del/20115.Ld. D.R. filed his written submissions to support the order of the A.O. based on the difference in ALP as determined by the TPO and confirmed by Ld. Dispute Resolution Panel -1(DRP), New Delhi as under:
"I place reliance on the direction of the Hon'ble DRP, the TPO and the A.O. as relevant. I have placed these arguments to bolster the directions/orders of the authorities below. These submissions are merely a brief note on the line of arguments, as directed by the Hon'ble Bench. The detailed and comprehensive arguments have already been made.
A. Grounds 2.1 till 2.4 relating to use of RPM over TNMM claim of the assessee that there are drug control restrictions and lack of patent laws in India, and rejection of internal benchmarking and the three entities being in manufacturing activities also. It has been noted in the order of DRP, paragraph 4.1 and 4.2, that even the comparables were affected by Govt. Policies such as drug control regulations, and patent laws in India. It is the TPO's case that the assessee did not demonstrate that the comparables were unaffected by this while the assessee only was affected. All the entities chosen in the analysis were subject to India legislation/laws/business environment.
It is a fact that the assessee did 11IIt make sufficient profits in its purchases from the AEs. The tested party being the Indian entity. the assessee needed to have been concerned only with the bench mark margins required to be earned ill India. The assessee is the tested party as chosen by the assessee himself. There is no justification for the assessee to bend backwards to accommodate its AF. What effectively the assessee, wishes to convey is that the US entity will not compromise on its profits or prices, though in this process the Indian assessee may earn less than bench mark profits in India.
The assessee did not specify as to how were the prices fixed by the AE.
With regard to assessee's claim that TNMM is a better method over RPM, it is pointed out that the assessee is in a resell situation. It has been specified by the assessee in its own TP study report that RPM would have bee I! the ideal method for bench marking in a situation similar to the assessee. Yet the assessee chose In. ignore RPM. on a plea that the data was not available (please see paragraph 2. on pages 2 and of the TPOs order). Reliance is placed upon order of MIs Scrdia Pharmaceuticals, 136 IT1 129. Mumbai, which prescribes a primacy of methods (please see paragraphs 54 till 66 of this order). In paragraph 66 of this order it has been specifically noted that a traditional method such as RPM is preferred over pm lit method, i.c. a method such as RPM is preferred 27 I.T.A. No. 5265/Del/2011 over TNMM. Further, it has been noted in this order that it is the duty of the A.O./TPO to choose most appropriate method Further, in the case of M/s Star Diamond Group VS DDIT Mumbai, in ITA No. 39231Mumbai/2008, A Y 04-05 28.01.2011, it has been noted that RPM is the most suited method in case of a resell situation, such that of the assessee It is noted that the three comparables specifically pointed out by the assessee In its grounds of appeal viz. M/s Mankind Pharma Ltd. M/s Novartis India Lid and M/s.TTK Healthcare Ltd. have very less manufacturing Even the assessee' sown comparable, M/s Sharon Bio- Medicines Ltd. is into manufacturing. The assesse's plea that whereas it is into trading and these entities are into manufacturing, also does not hold good as the percentage of manufacturing is very less viz. a viz. the over all sale of these entities. The TPO has covered this issue on page 9. I (J .urd II of his order. Moreover, even the assessee's own comparable M/s Sharon Bio Medicines Ltd. is also into manufacturing.
It is also pointed out that the submissions made by the assessee supposedly as Broad Propositions before the Hon'ble ITA T in the form of a 20 page write up is at variance with the submissions detailed in TP study report. These variations are pointed out in the form of table below :-
S.No. Name of the Business description as per Business description as per entity page 159/160 of the paper assessee's broad book and forming annexure 3A propositions, page 9 to the TP study report being thereof page 110/111 of TP study report 1 Sharon The company is engaged in The company is also into Biomedicines trading of medicines/bulk manufacturing Ltd. drugs/formulations, only 2 Serum On page 160 of the paper The assessee has claimed International book, the assessee claims that that this entity is only into Ltd. this entity is into trading and trading. No mention of also has revenue from revenue from wind power windmill power.
3 Solumiks On page 160, the assessee The assessee has claimed Herbaceuticals claims that more than 75% of that this entity is only into Ltd. the revenue only was derived trading.
from trading of drugs and formulations 28 I.T.A. No. 5265/Del/2011 B. The asscssee's claim, made in ground No. 2.6 that subvention income of Rs.55,04,93,475/- is needed to be reduced from the value of purchases from the AE.
The assessee has wrongfully reported the figure of Rs 1,04.93,475/- as 'subvention Income. As per assessee's O' v n annual audited accounts. ill transactions with related parties, page 20 I of paper hook. the assessee has shown subvention income at Rs. 53.21 crores only. There is market research income shown at Rs. 1.83 crores. Both these transactions needed to be separately benchmarked. The assessee has wrongly dubbed these two transactions and has not carried out bench marking of these items separately. In fact, the assessee ought to have charged a mark up upon market research income which it has failed.
In fact Market Research and Subvention Income are other incomes. which are distinct and clearly distinguishable different international transactions. which needed separate bench marking. the assessee has not carried out any separate bench marking for these activities. (Please refer to pages 35,36, 37 and 38 of paper book). The TPO has discussed in detail that subvention income was other income reported by the assessee in its own audited annual accounts.
Furthermore, cross subsidisation is not allowed. The subvention income and the market research income were received for separate purposes, and cannot be reduced from purchase price of the formulations. There was no specific agreement that these amounts were given for reduction from purchase price. [hey were for a separate purpose and need to be got bench marked separately. The assessee failed to do so. That every transaction needs to be separately benchrnarked is supported by the following orders:
1.UCB India (P) Ltd. Vs. ACIT (200s)) 30 SOT 95/121 n o : 3 1124 TT J 2X9
2.Addl. err Vs. Tej Diamond (2010) 37 SOT 341/130 TTJ 570
3.Dy. err vs. Starlite (2010) 40 SOT 4211133 n-J 425
4.Global Vantedge (P) Ltd. Vs. Dy.CIT(2010)}7 SOT (Delhi Trib.) CIT(A)
5.Dy CIT Vs S Narendra (2010) 41 SOT 1
6.Dy: CIT Vs. Sterlite (2010) 40 SOT .421 (Mum.)
6.Asstt CIT Vs. Twinkle Diamond (~()II, 45 SOT 115 (Mum) (URO)
7.Bcucuon India (P) Ltd. Vs. ITO (2012) 134 ITD 229 Delhi Tribunal 29 I.T.A. No. 5265/Del/2011 The assessee's arguments that the entities chosen by the TPU were functionally not comparable. does not hold water. In fact, as noted, even the assessee's comparables are not exactly comparable functionally. It is noted in the case of M/s Symantec, 46 SOT 48, para 16 thereof, that exact functional comparability is never established. It has been further noted in this order that this is the reason why the plus minus 5% benefit is allowed to the assessee.
With regard to the segmentation done by the assessee, reliance is placed on the case of M/s Cell. paragraph 71B, 317 ITR 292 that the assessee needed to evaluate? transaction on a standalone basis, even though there was no statutory requirement to maintain segmental data, The assessee has provided a report by M's SR Batliboi & Co. to supposedly bolster its case. This report is dated August R, 2011, and pages 366 till 370 of paper book. This report does not inspire confidence, as noted from the concluding paragraphs of this report, viz, "Because the above procedures do not C011Sti!UfC either an audit or (I review mad" in accordance with generally accepted auditing standards In India, we do not express any assurance 011 the margin for the financial year 2006 07.
Had we performed additional procedures or had we performed an audit or review of the financial statements in accordance with generally accepted dud/ring standards in India. other matters might have come to our attention that would have been reported to you.
Our report is solely for the purpose as se t forth in the first paragraph of this report and for your information and is not to be used fur any other purpose or to be distributed to any other parties. This report relates only to the accounts and items specified above and do not extend to any financial statements of Eli Lilly and Co. (India) (P) Ltd. taken as a whole."
It is also pointed out that in the case of M/s ACIT Vs. Genome Biotech (P) Ltd., ITA No. 5272/Mumbai/2007 dated 16-05-2012. (para 10.8 thereof )that mere fact that the expenses were audited is not a ground on which a TP adjustment could be deleted by an appeal authority.
C. The assessee's plea regarding consistency / res judicata The assessee has, in its broad propositions, being written submissions has noted that the department has in the subsequent years accepted 30 I.T.A. No. 5265/Del/2011 assessee's bench marking using TNMM and therefore in this prior year also it should have accepted the same, is not acceptable.
Reliance is placed upon the orders of Hon'ble Tribunal in the cases of M/s John Mathey of Hon'ble Delhi Tribunal-delivered by Hon'hle Sh. U.B.S Bedi and Sh. B.C. Meena, dated 29-03-2012, ITA 344/De1l2010, para 9 thereof, and M/s Li & Fung India (P) Ltd. Vs. DCIT dated 30-09-2011, 2012-143 IT.T 20 I, para 8 thereof. Further in the case of M/s Fulford Vs. DeIT - 140 ITJ 183 it has been held that the TPO needs to apply his mind afresh every year. Reliance is also placed on the: order of M/s Carraro India Ltd. Vs. DCIT - 2008- TIOL-519-IT A T-Del, as noted in the case of M/s John Mathey, copy already submitted.
D. Miscellaneous The assessee has put forward a proposition that internal comparables needed to be preferred over external comparables, In.this matter the assessee has relied upon certain cases, which however do not help the assessee.
The case of M/s Birla Soft relates to services, whereas the assessee's products arc pharmaceuticals. In this case the method chosen was TNMM however in the case of the assessee the method chosen h) the TPO is RPM. In the case of Gharda Chemicals the choice was between Internal Cup Vs. External cup in the assessee's case the dispute is RPM over TNMM. Similarly, the case of Destination of the World also involved TNMM. Therefore, all these cases have facts, different from the assessee.
The assessee while carrying out the internal bench marking has conveniently not provided for the bulk discount/favourable credit terms that would have been available to it, when buying from the AE. The assessee itself has claimed that buying in India and selling in India cannot be compared to an At: situation. Reliance upon case or M/s Gharda Chemicals (1 :1() "1"1.1 )50) is countered by pointing out, from assessee's own submission. ( page 14 middle part) the local factors and economies need to he accounted for.
E. With regard to ground relating to section 234B and 234C, il is noted that these are compensatory in nature and full compensation ought to have been provided to revenue, which means full compensation vis. a vis. finally assessed income."
31 I.T.A. No. 5265/Del/20115.1 While noting the order of the A.O. and reiterating the written submissions filed by Ld. D.R. pleaded for confirmation of the impugned order.
6. Ld. counsel for the assessee filed rejoined to the arguments of the Ld. D.R. as under:
"1. Resale Price Method is to be applied as the most appropriate method. DR's contentions:
(i) The Ld. Departmental Representative (DR), rejecting the appellant's contentions, contended that since the appellant was engaged only in trading, i.e., purchase and resale of drug formulations without any value addition at its end, for benchmarking of international transactions of purchase of drug formulations from the associated enterprise, Resale Price Method was to be applied as the ost appropriate method. The Ld. DR placed reliance in this regard on decisions of the benches of the Tribunal in the case of Gharda chemicals Ltd. vs. DCIT (130'1'TJ 556) and Serdia pharmaceuticals India P. Ltd. vs. ACIT (44 SOT 391).
(ii) The Ld. DR, referring to page 42 of the Transfer Pricing study contended that the appellant had itself, in the Transfer Pricing study, stated that RPM was the ideal method for determining the arm's length price, but disregarded the same on frivolous grounds.
(iii) The appellant had applied Transactional Net Margin Method ("TNMM") as the most appropriate method for benchmarking the international transactions of import of drug formulations, in order to take into account subvention income as part of the operating profit margin. In the submission of the Ld. DR, TNMM in the present case was not the most appropriate method, but the most convenient method.
Appellant's rejoinder:
There is no dispute with the contention of the TPO that, ideally, in case of transactions of resale, it would be appropriate to apply RPM. However, RPM has not been considered as the most appropriate method since gross profit argin of the comparable companies cannot be reliably determined for the reasons stated at page 42 of the Transfer Pricing study; as under:
• Absence of reliable data on functional comparability (same or similar services) of comparable companies, i.e., the degree of comparability existing between the international transaction and the uncontrolled transactions and between the enterprises entering into such transactions; and Absence of reliable gross margin data of comparable companies necessary for application of the method. "32 I.T.A. No. 5265/Del/2011
It is submitted that, considering the following special circumstances, the gross profit margin earned by the appellant from international transactions of import of drug formulations cannot be compared with gross margin earned by unrelated parties engaged in manufacturing or from trading in indigenously manufactured pharmaceuticals:
(a) Competition with smaller players not subject to Patent Laws:
It is respectfully submitted that the patent law in India. does not allow product specific patents, which essentially means that companies can manufacture cheaper generic drugs. The same puts severe price pressure on the patented products sold by the appellant in India, which have to compete with cheaper locally manufactured drugs. With stronger patent laws, the products sold by the appellant in India could have fetched much higher prices .The competitive scenario regarding appellant's products is summarized as follows:
S.No. Lilly India's No. of Generic Name of Generic Product Product Players 1 Huminsulin Total 7 Wosulin (WOC), Reconsulin (Vial + Carts) (Shreya), Insucare (Rbx) 2 Distaclor 453 Phexin (GSK), Ceftum (GSK), Zifi (FDC) 3 Gemcite 149 Famorubicin (PIRAMAL), Daxotel (DBF), Geftinat (NATCO) 4 Humatrope 2 LG Eutropin (LG LIFE), Saizen (SERRI, & INST.) 5 Reopro 7 Aggramed (GERMAN REM), Aggribloc (Piramal), Aggritor (Torrent), Terofib (Intas), G) 2 BAN (Gland Pharma), COROMAX (USV) To reiterate, the appellant, it would be appreciated, has been facing strong competition from generic drug manufacturers which has put significant pressures on pricing of its products resulting in lower gross profit margin earned by the appellant .
/(b) (b) Price Control Regulations:
55% to 60% of the sales values of the dugs traded by the appellant are 33 I.T.A. No. 5265/Del/2011 from trading of scheduled drugs, which are subject to price control regulations by the National Pharmaceutical Pricing Authority (NP AA) constituted under the Drugs (Price Control) Order 1995.
However, in case of comparable companies. the proportion of sale of schedule drugs would be significantly lower, which make them earn more pro tits as the price control regulation of NPPA do not apply to non-scheduled drugs. The relevant portion of the Drug (Price Control) Order, 1995 providing for calculatiun of retail price of drug formulations, read as follows:
7. Calculation of retail pric~ulation ,:
The retail price of a formulation shall be calculated by the Government in accordance with the folio w ing formula namely:
R.P.=(M.C.+C.C.+P.M.+P.C.)x(1+<A{E/100)+ED. Where "R.P." means retail price:
"M.C." means material cost and includes the cost of drugs and other pharmaceutical aids used including overages, if any, plus process loss thereon specified as a norm from time to time by notification in the Official Gazette in this behalf;
"C.C. means conversion cost worked nut In accordance with established procedures of costing and shall be fixed as a norm every year by notification in the Official Gazette in this behalf;
"P.M" means cost of the packing material used in the packing of concerned formulation, including process loss, and shall be fixed as a norm every year by, notification in the Official Gazette in this behalf;
"P.C.." means packing charges worked out in accordance with established procedures of costing and shall be fixed as a norm every year by notification in the Official Gazette in this behalf.
"MAPE" (Maximum Aflowable Post-manufacturing Expenses) means all costs incurred by a manufacturer from the stage of ex-factory cost to retailing and includes trade margin and margin for the manufacturer and it shall not exceed . One hundred per cent for \ indigenously manufactured Scheduled formulations .
Provided that in the case of an imported formulation. the landed cost shall form the basis for fixing its price alongwith such margin to cover selling and distribution expenses including interest and importer's profit which shall not exceed/fifty percent of the landed cost., Explanation - For the purpose of this proviso, "landed cost" means the cost of import of formulation inclusive of customs duty and clearing 34 I.T.A. No. 5265/Del/2011 charges.
The appellant, on the other hand, vide reply dated 05-10-2010 to show cause notice dated 14-09-20 10 (placed at pages 118 to 134) submitted that, pursuant to price control regulations issued by the National Pharmaceutical Pricing Authority under the Drug (Price Control) Order, 1995, lower gross margin is permitted from trading of imported drug formulations, vis-A-vis, purchase of indigenous drug rmulations. It would be appreciated that TPO, however, in his order passed under ection 92CA(3), at page 6, has referred to para 3 of the Drugs (Price Control) Order 1995 dealing with power to fix the maximum sale price of bulk drugs specified in the First Schedule. The TPO, it is respectfully submitted, did not reproduce or deal with para 7 of the Drugs (Price Control) Order 1995, dealing with manner of calculation of retail price of formulations, which specify the maximum allowable post manufacturing expense in case of scheduled drugs manufactured in India and price margin available in respect of imported formulations, Pursuant thereto, the appellant before the Dispute Resolution Panel reproduced relevant paragraph 7 of Drug (Price Control) Order, 1995 dealing with manner of computation of retail price prescribing profit margin from trading of imported drug formulations.
In terms of the Drug (Price Control) Order, a manufacturer of drug formulations in India is entitled to a mark up of 100% from the stage of ex-factory. cost to retailing, i.e., the maximum retail price. On the other hand, in case of imported formulations, a mark up of 50% only is permitted on the landed cost of imported drugs. The allocation of the above mark up to the channel partners in the business of trading of scheduled drug formulations in the aforesaid three situations is tabulated as follows:
Particulars Imported drugs (as in Drugs
the case of appellant) manufactured
in India
Ceiling limit of mark- 50% 100%
up
Less: Retailers and 35% 48%
Stockiest
Importer/manufacturer 15% 52%
margin
Less Distribution Cost 5% 5%
Gross Profit 10% 47%
* Marin of retailers is fixed at 16% of retail price and margin of stockiest is fixed at 8% of retail price.
35 I.T.A. No. 5265/Del/2011It would be appreciated from the aforesaid that in case of import of rugs from the AE, the appellant only earns gross profit margin of 10% and after taking into account other establishment costs / expenses, the appellant would invariably incur a loss. In order to compensate the appellant for loss, which would inevitably be incurred by the appellant, pursuant to the price control regulations in India, the AE compensates the appellant by way of subvention payment. It may be pointed out that the aforesaid compensation in the form of subvention income is paid by the A R to remain present in the Indian market, in anticipation of earning profit in later years in a relaxed price control regime, when the AE would be able to sell its patented drug ormulations in the domestic market at greater profit.
Considering the special circumstances, viz., (i) price control regulations in India in respect of medical formulations and majority of products traded by the appellant and the tact that such regulations do not apply to company(ies) trading in on scheduled drugs and (ii) competition with smaller domestic manufacturers producing generic drugs in India, the gross profit margin earned by the appellant from international transactions of import of drug formulations cannot be compared with margin earned by unrelated parties, engaged in manufacture / trading in indigenously manufactured generic drugs. The bench marking analysis is required to be undertaken at net profit level by applying TNMM, in order to capture the compensation received by the appellant by way of subvention payment from the AE, to mitigate the aforesaid special circumstances.
Further the decision of Mumbai bench of Tribunal III the case ~:t:,cS~rsU~,_== in the case of Serdia Pharmaceuticals 136 TTJ 129, relied upon by the Ld. DR, is concerned with application of elJP method which requires comparison of price in a controlled transaction with price in an uncontrolled comparable transaction and for that reason is considered to be the most direct method. The Hon,ble Tribunal in that case, therefore, held that CUP method being a price based method is to be preferred over profit method. it is respectfully submitted that the aforesaid decision does not advance the case of the Ld. DR. RPM and TNMM are profit based methods and not price based methods. Further, RPM and TNMM being profit based methods operate in the same manner as opined in Para 3.26 of the OEeD guidelines, which reads as under:
"3.26. The transactional net margin method 36 I.T.A. No. 5265/Del/2011 examines the net profit margin relative to an appropriate base (e.g. costs, sales, assets) that a taxpayer realizes from a controlled transaction or transactions that are appropriate to aggregate under the principles of Chapter I). Thus, a transactional net margin method operates in a manner similar to the cost plus and resale price methods. This similarity means that in order to be applied reliably, the transactional net margin method must be applied in a manner consistent with the manner in which the resale price or cost plus method is applied.(emphasis supplied) The decision in Serdia Pharmaceuticals india P. Ltd. (supra) does not, therefore, support the proposition that TNMM should be substituted by RPM, on the ground that RPM ranks higher in terms of priority.
II. Res judicata does not apply and each year is to be benchmarked separately.
DR's contentions:
The appellant had submitted that TNMM was accepted as the most appropriate method by the TPO for assessment year 2008-09. The Ld. DR has placed reliance on the decisions of benches of the Tribunal in the cases of Johnson and Mathey India Pvt.
Ltd. vs. DCIT (ITA no. 344IDeIl2010), Li & Fung India Pvt. Ltd. vs. DC IT (ITA No. SIS6/DeIl20 1 0), Carroro India Ltd. vs. DCIT 120 TTJ 77, Fulford India Ltd. vs. DCIT (140 TTJ 183) for the proposition that there is no res judicata and transfer pricing exercise had to be undertaken each year.
Appellant's rejoinder:
There is no quarrel with the proposition laid down in the aforesaid decisions relied upon by the Ld. DR. that benchmarking analysis for determining the arm's length price of the international transactions is to be undertaken having regard to the facts and circumstances of each year. For undertaking benchmarking analysis of international transactions of each year, it is also not disputed that profit margin of compurubles for that year are to be considered. However, considering the settled rule regarding consistency, there ought to be uniformity in the treatment and consistency in approach and/or methodology adopted for undertaking the benchmarking analysis when facts and circumstances in different 37 I.T.A. No. 5265/Del/2011 years are the same. (Refer Brintons Carpets Asia Pvt. Ltd vs. DCIT (ITA No. 1296IPNI2010).
In our respectful submission, the Ld. DR did not appreciate the settled position that principle of resjudicata is not applicable to income-tax matters as long as facts are different in different assessment years. However, if the facts permeating through different years are the same, the same treatment or approach needs to be adopted, ie. the tax authorities, in our respectful submission, are to be consistent in their approach.(ref Radha Swami Satsang vS.CIT.' 193 ITR 321 @page 329).
Reliance is also placed on the recent decision of the Hon 'ble Tribunal in the case of McCann Erickson India Pvt. Ltd. vs. Addl, CTT (TTA No. 5871/Del/2011), wherein, alter considering the aforesaid decision in the case of Li & Fung India Pvt. Ltd. and Johnson Mathey India Pvt. Ltd. (supra), relied upon by the Ld. DR, the Hon'ble Tribunal held that "although the principle of res judicata is not applicable to the income-tax proceedings, however, something material or adverse in nature, which is having direct bearing on the peculiar facts and circumstances of the case, has to be brought on record to draw the adverse inference".
The Ld. DR, it is respectfully submitted, did not point out as to whether facts and circumstances surrounding the international transactions in the relevant previous year are different than in assessment year 2008-09.
In view of the aforesaid, in order to maintain consistency, TNMM only is to be adopted as the most appropriate method for undertaking international transactions for import of drug formulations by the appellant in the relevant previous year.
111. Without prejudice. determination of RPM.
DR's contentions:
The Ld. DR referred to financials of Mankind Pharma Ltd., Novartis India Ltd. and contended that these companies have very less manufacturing activities. The Ld. Dk contended that the assessee's own comparable Mis. Sharon Bio Medicines Ltd. is also engaged in manufacturing. The Ld. DR also referred to page 160 of the paper book, wherein, at paragraph 1.4 of annexure 4 of the Transfer Pricing documentation, it was stated with respect to Sharon Bio-Medicines Ltd., that the company is engaged in the 38 I.T.A. No. 5265/Del/2011 trading of medicines / bulk drugs / formulations trading of formulations and derives whole of its revenue from this activity only.
The Ld. OR relying upon the decision of the benches of the Tribunal (46 SOT 48) contended that since it is not possible to find exact comparable for undertaking benchmarking analysis, Novartis India Ltd., TTK Healthcarc Ltd. and Mankind Pharma Ltd. were to be considered as comparable companies for undertaking benchmarking analysis.
Appellant's rejoinder:
It is not disputed that Novartis India Ltd., TTK HeaIthcare Ltd. and Mankind Pharma Ltd., considered as com parables by the TPO, have manufacturing operations in addition to trading operations. On the other hand, Sharon Bio-medicines Ltd. and Cosmo Pharmaceutical Laboratories Ltd., considered as part of comparable companies by the assessee, too, have manufacturing operations along with trading operations.
It would be appreciated that the appellant has undertaken benchmarking analysis applying TNMM in the Transfer Pricing documentation, wherein the comparison is made with reference to net profit margin earned by the assessee, the tested party, from the international transactions with net profit margin of the comparable companies. The TPO, on the other hand, sought to apply Resale Price Method, whereby comparison is made of the gross profit margin earned from international transactions of import of drug formulations by the appellant with gross profit margin earned by the comparable companies, including the aforesaid companies, which are engaged in manufacturing operations in addition to trading of pharmaceuticals. Comparison of gross profit margin earned from international transactions by the appellant with gross profit margin in respect of the above mentioned companies, viz., Novartis Tndia Ltd., TTK Healthcare Ltd. and Mankind Pharrna Ltd., Sharon Bio-medicines Ltd. and Cosmo Pharmaceutical Laboratories Ltd., which are engaged in manufacturing as well as trading, would provide a distorted comparison.
In case of the above companies, Novartis India Ltd., TTK Healthcare Ltd. and Mankind Pharma Ltd., Sharon Bio-medicines Ltd. and Cosmo Pharmaceutical Laboratories Ltd., which are also engaged in manufacturing, gross profit margin would be computed by reducing from the turnover of cost of goods sold, which 39 I.T.A. No. 5265/Del/2011 includes cost of finished goods for the trading turnover and also cost of raw materiul, for turnover of manufactured goods. However, in case of manufacturing operations, direct manufacturing expenses / costs incurred is included in the respective account head in the profit and loss account and does not, get considered while computing the gross profit margin. It would be appreciated that, for the aforesaid reasons, correct gross profit margin cannut be computed in respect of the above said companies, which are also engaged in manufacturing, apart from trading operations and the same would be significantly higher than gross profit margin of companies (including the appellant), which are solely engaged in trading operation.
The aforesaid fallacy in the comparison made at gross profit level by considering companies engaged in manufacturing operations also apart from trading, is illustrated as follows:
Particulars Case-I Case-II
Trading + Only
Manufacturing Trading
Sales (Rs.110*11 units) 1,210 1,210
Cost of trading goods
(Rs.100*10 units) 1,000
(Rs.100*10 units) 1,100
Cost of raw material (Rs.25*1 unit) 25 -
Total cost of goods sold 1,025 1,100
Gross profit 185 110
GP/Sales Ratio 15.28% 9.09%
'" To make a similar scenario as in the present case, we have taken the manufacturing business to be only 1 0% of the trading business. We have considered the total no. of goods sold in the both the cases to be 11. In Case 1, 10 units are trading goods and 1 unit is raw material. In case 2. all 11 units are traded goods.
The cardinal principle of the transfer pricing regulations is to compare like with like and to eliminate differences, if any. by suitable adjustment. The said 40 I.T.A. No. 5265/Del/2011 regulations clearly provide for adjustments in margins of the enterprise entering into international transactions for any differences between such international transactions and the transaction of the com parables or between the enterprise entering into international transactions and comparable companies.
It would, therefore, be appreciated that considering companies engaged in manufacturing, apart from trading operations for application of Resale Price Method, provides a distorted comparison of gross profit margin. It would be appreciated that, when comparison is made at net profit level (while applying TNMM), the entire cost including manufacturing cost incurred in manufacturing operation, is taken into account, which provides parity for comparison at net margin level.
For that reason, the appellant had, it is respectfully submitted, considered Sharon Bio-
medicines Ltd., which is engaged in trading as well as manufacturing operation, as comparable company in the Transfer Pricing documentation, wherein TNMM was applied as most appropriate method.
In view of the aforesaid, it is respectfully submitted that for undertaking benchmarking analysis at gross profit level by applying RPM, the above companies, viz. Novartis India Ltd., TTK Healthcare Ltd. and Mankind Pharma Ltd., Sharon Bio-medicines Ltd. and Cosmo Pharmaceutical Laboratories Ltd., engaged in manufacturing as well as trading operations, would be required to be excluded from the set of comparables in order to facilitate comparison of like to like.
Inconsistencies pointed out by the DR Further, our response to various inconsistencies pointed out by the Ld. DR is summarized as follows:
S. Name of Business Business Appellant's No the description as per description as per comments 41 I.T.A. No. 5265/Del/2011 . entity page 159/160 of assessee's broad the paper book propositions, and forming page 9 thereof annexure 3A to the TP study report being page 110/111 of TP study report
1. Sharon The company is The company is That company is Bio- engaged in also into engaged into medicin trading of manufacturing manufacturing es Ltd. medicines/bulk activity is evident drugs/formulation from pages 8,9,18 & s, only 31 of its annual report, wherein, the company has shown the new products manufactured by it, the manufacturing expenses debited in the profit and loss account, the plant address etc. (refer page 80, 81, 90 and 103 of the paper book). Sharon Bio-
Medicines Ltd. has both manufacturing and trading operations and, is, therefore, required to be excluded for benchmarking analysis applying RPM
2. Serum On page 160 of The assessee has The company is into Internati the paper book, claimed that this trading of preventive onal the assessee entity is only into and curative medical Ltd. claims that this trading No products. The entire entity is into mention of sales of the company trading and also revenue from during the year, are has revenue from Wind Power from sale of traded windmill power goods, as evident form page 4 (notes to accounts) of its annual accounts.
(refer page 148 of the
paper book). Serum
International Ltd.,
having only trading
operations, is,
therefore, required to
be considered for
42 I.T.A. No. 5265/Del/2011
benchmarking
analysis applying
RPM
3. Solumik On page 160, the The assessee has From Point 8 of
s assessee claims claimed that this Schedule 13: Notes to
Herbace that more than entity is only into Accounts of the
uticals 75% of the trading. company's annual
Ltd. revenue was accounts, it is evident
derived form that the total turnover
treading of drugs of the company is
and formulations from sale of traded
goods (refer page
125 of paper book).
Solumiks
Herbaceuticals Ltd.,
having only trading
operations, is,
therefore, required to
be considered for
benchmarking
analysis applying
RPM.
After excluding the companies which are engaged in manufacturing as well as trading the final set of comparable companies, would be as follows:
Name of the company Only GP/Sales (%)
trading
Companies considered by the appellant
Aditya Medisales Limited Yes 3.70
B A & B Brothers (Eastern) Limited Yes 9.40
Solumiks Herbaceuticals Limited Yes 50.90
Serum International Ltd. Yes 50.53
Companies considered y the TPO
Marksons Pharma Ltd. Yes 31.70
Average 29.25%
It would be appreciated that, since gross profit margin of the appellant at 39.75% is higher than that of the above comparable companies at 29.25%, the international transactions of import of drug formulations by the appellant is to be considered being at arm's length applying Resale Price Method (RPM).
IV. Without prejudice-Internal benchmarking:
DR's contentions:
The Ld. D.R. dispute the contention of ht appellant that, if RPM was 43 I.T.A. No. 5265/Del/2011 to be considered as the most appropriate method, without prejudice to the submission that on the facts of the case, TNMM was the most appropriate method, benchmarking analysis is to be undertaken considering internal comparables and accordingly gross profit margin form import of drug formulations from the AE is to be compared with the gross profit margin from import of drug formulations form unrelated party.
The Ld. D.R. referring to page 3 of the broad propositions submitted by the appellant, contended that in view of the special circumstances, viz., price control regulations under the Drugs (Price Control) Order, 1995 in India with respect to scheduled drugs and competition form small local manufacturers of generic drugs in absence of application of patent law, gross profit margin from domestic purchases cannot be compared with gross profit margin from import of drugs, for undertaking internal benchmarking analysis.
The Ld. DR further contended that the certificate from the Chartered Accountant dated 08.08.2011 placed on record before the TPO does not correctly determine the gross profit margin from international transactions of import of drugs from the AE as well as gross profit margin from import of drugs from unrelated party.
Appellant's rejoinder:
It is respectfully submitted that the appellant, during the year purchased for resale, similar formulations from the AE as well as unrelated parties. The Gross profit margin (GP/Sales) earned by the appellant on transactions with the associated enterprise was worked out at 50.06%, which was higher than the average gross profit margin earned on similar transactions with unrelated third parties at 21.54%.
Accordingly, the international transaction of purchase of formulations was considered to be at arm's length price.
The TPO/DRP, however, disregarded the internal benchmarking undertaken by the appellant for determining the arm 's length price of the international transaction of purchase of formulations applying RPM on the ground that (i) the 44 I.T.A. No. 5265/Del/2011 internal benchmarking was neither available in audited accounts nor in the TP study report and (ii) the purchases made from unrelated parties constitutes only 31 % of the total purchases and (iii) the purchases made from unrelated third party is an estimated figure.
The contentions of the TPOIDRP in disregarding internal comparison carried out by the appellant for benchmarking international transactions of purchase of formulations arc unlawful and not sustainable for the reasons submitted hereunder:
Rule 1OB(1)(b) of the Income-tax Rules ("the Rules") provides that for application of RPM, the profit margin realized by an enterprise or by an unrelated enterprise from comparable uncontrolled transaction or a number of such transactions are to be compared with profit margin realized by the enterprise (tested party) from the international transactions entered into with an associated enterprise.
Rule 10B(1 )(b) of the Rules reads as follows:
"10B Determination of arm's length price under section 92C.
(1) For the purposes of sub-section (2) of section 92C, the arm's length price in relation to an international transaction shall be determined by any of the following methods, being the most appropriate method, in the following manner namely:-
Xxx xxx xxx
(b) resale price method, by which,
i) the price at which property purchased or services obtained by the enterprise from an associated enterprise is resold or are provided to an, unrelated enterprise, is identified;
(ii) such resale price is reduced by the amount of a normal gross profit margin accruing to the enterprise or to an unrelated enterprise from the purchase and resale of the same or similar property or from obtaining and providing the same or similar services, in a comparable uncontrolled transaction, or a number of such transactions;
(iii) the price so arrived at is further reduced by the expenses incurred by the enterprise in connection with the purchase of property or obtaining of services,'
(iv) the price so arrived at is adjusted to take into account the functional and other differences, including differences in accountingpractices, if any, uncontrolled transactions, or between the enterprises entering into such ransactions. which could materially affect the amount of gross profit margin in the open market;
(v) the adjusted price arrived at under sub-clause (iv) is taken to be an arm's length price in respect of the purchase of the property or obtaining of the services by the enterprise from the associated enterprise. "
It is submitted that in the case of the appellant, RPM could appropriately be applied considering internal comparable uncontrolled transactions entered into by the appellant with unrelated 46 I.T.A. No. 5265/Del/2011 parties. Such internal comparables, it is submitted, provide the-best guide and ideal benchmark for international transactions. In fact, internal comparables available in case of an assessee are to be preferred for the purpose of benchmarking of international transactions applying RPM, instead of relying on external comparables, as provided in Paragraph 3.26 of the OECD Guidelines which reads as under: _ "3.26. The transactional net margin method examines the net profit margin relative to an appropriate base (e.g. costs, sales, assets) that a taxpayer realizes from a controlled transaction or transactions that are appropriate to aggregate under the principles of Chapter I). Thus, a transactional net margin method operates in a manner similar to the cost plus and resale price methods. This similarity means that in order 1'0 he applied reliably, the transactional net margin method must be applied in a manner consistent with the manner in which the resale price or cost plus method is applied. This means in particular that the net margin of the taxpayer from the controlled transaction (or transactions that are appropriate to aggregate under the principles of Chapter I) should ideally be established by reference to the net margin that the same taxpayer earns in comparable uncontrolled transactions. Where this is not possible, the net margin thC;,t would have been earned in comparable transactions by an independerd enterprise may serve as a guide. A functional analysis of the associated enterprise and. in the lauer case. the independent enterprise is required to determine whether the transactions are comparable and what adjustments may be necessary to obtain reliable results ". (emphasis supplied) As per the OECD Guidelines, the net margin of the taxpayer from the controlled transaction should ideally be established by reference to the net margin that the same taxpayer earns in comparable uncontrolled transactions. Where this is not possible, the net margin that would have been earned in comparable transactions by an independent enterprise may serve as a guide. It is respectfully submitted that the OECD Guidelines on Transfer Pricing recognizes the fact that internal comparables, if available, are to be adopted in the first instance, as the preferred benchmark. Only where such internal comparables are not available, resort can be had to external comparables, which may even otherwise be difficult to obtain and information in respect of which may be incomplete and difficult to interpret.
47 I.T.A. No. 5265/Del/2011The OECD under "Revision of chapter I-III of the Transfer Pricing Guidelines" issued on 22nd July, 2010, too, recommended the use of internal comparable data for benchmarking analysis, as under:
C.3.4.4 Reliance on data from the taxpayer's own operations ("internal data''):
2.141 "Where comparable uncontrolled transactions of sufficient reliability are lacking to support the division of the combined profits, consideration should be given to internal data, which may provide a reliable means of establishing or testing the arm's length nature of the division of profits............
A.4.2 Internal com parables:
3.27 "Step 4 of the typical process described at paragraph 3.4 is a review of existing internal comparables, if any. Internal com parables may have a more direct and closer relationship to the transaction under review than external com parables. The financial analysis may be easier and more reliable as it will presumably rely on identical' accounting standards and practices for the internal comparable and for the controlled transaction. In addition, access to information on internal com parables may be both more complete and less costly ...
A.4.3 External com parables and sources of information:
Para 3.29 "There are various sources of information that can be used to identify potential external comparables. This sub-section discusses particular issues that arise with respect to commercial databases, foreign comparables and information undisclosed to taxpayers. Additionally, whenever 48 I.T.A. No. 5265/Del/2011 reliable internal comparable e:dst. it may be unnecessary to search for external ones. see paragraphs 3.27-3.28 .:' 3.32 "It may be unnecessary to use a commercial database if reliable information is available from other sources, e.g. internal comparables Reliance is placed on the following decisions, wherein it is held that internal comparables are to be preferred over the external com parables tor undertaking benchmarking analysis for determining the arm's length price of international transactions:
•UCB India (P) Ltd v ArrT.10 S()T 95 (Mumbai). •Gharda Chemicals Limited Vs Dell', 130 'ITJ 556 (Del) •Birlasoft (India) Ltd. vs. ACIT 136 ITJ 505 (Del) •Destination of the World vs. DCIT [ITA No 55341De11201O] (Del) The Ld. DR, in our respectful submission, sought to distinguish the aforesaid decisions as under:
"The case of M/s. Birla Soft relates to services, whereas the assessee's products are pharmaceuticals. In this case the method chosen was TNMM, however in the case of the assessee the method chosen by the TPO is RPM In the case of Gharda Chemicals the choice was between Internal FCup Vs. External cup. In the assessee's case the dispute is RPM over TNMM Similarly, the case of Destination of the World also involved TNMM"
The Ld. DR also contended that internal benchmarking was relevant only for TNMM and not for RPM and claimed that the decisions relied upon by the appellant for the proposition that internal comparables needed to be preferred over the external comparables were distinguishable and do not advance the case of the appellant.49 I.T.A. No. 5265/Del/2011
The Ld. DR, while contending as aforesaid, did not appreciate that Rule lOB of the Income-tax Rules providing for manner of application of the various methods for determining the arm's length price prov ides for internal benchmarking analysis in respect of CUP method, Cost Plus Method, Resale Price Method, Transactional Net Margin Method and Profit Split Method. The Hon 'ble Tribunal in the case of the Destination-of the World vs. ACIT (ITA No. 5534/De1l2010) also held that "Further, in the ease of Birlasoft (India) Ltd. (supra), it has been clearly held that the assessee was justified in undertaking internal comparison on stand alone basis by placing on record working of operative profit margin from international transactions with AEs and transactions with uncontrolled parties undertaken in similar functional and economic scenario. Such internal comparison is valid in all the methods. Therefore, it is held that in the first instance, the attempt should be made to determine arm '8 length price ~f controlled transactions by comparing the same with Internal uncontrolled transactions undertaken in same or similar economic scenario. "
It is respectfully submitted that the certificate dated 08-08-2011 from the Chartered Accountant determining profitability from transactions of purchase of drug formulations from associated enterprise as well as from unrelated parties, was placed before the TPO in response to show cause notice, wherein TNMM applied by the appellant, was sought to be disregarded and RPM was sought to be applied by the TPO.
Further, it is respectfully submitted that the Ld. DR has sought to 50 I.T.A. No. 5265/Del/2011 dispute / reject the aforesaid benchmarking analysis undertaken by the appellant on the basis of a valid benchmarking analysis considering internal comparables on flimsy grounds, i.e., the certificate from the Chartered Accountant contains certain disclaimer and that the gross profit margin in respect of import of drug formulations from the AE and import from unrelated party has not reliably been determined in the certificate of the Chartered Accountant on account of the following:
(i) In the certificate of the Chartered Accountant, it is stated that it is not possible
to determine profit margin in respect of the scheduled drugs and unscheduled drugs.
(ii) The certificate of the Chartered Accountant contains disclaimer that "because the above procedures do not constitute either an audit or a review made in accordance with generally accepted auditing standards in India, we do not express any assurance on the margin for the financial year 2006-07".
In the certificate of the Chartered Accountant, the profitability from international transactions of import of drug formulations from AE and drug formulations from unrelated parties have been worked out on the basis of defined allocation keys, after examination of books of accounts and records of the appellant. The Ld. DR, it is respectfully submitted, did not point out any error in the computation of operating margin from transactions with AE and from unrelated parties. The first disclaimer in the certificate of the Chattered Accountant as to impossibility of determining the profit margin in respect of scheduled drugs and unscheduled drugs has no bearing on internal benchmarking analysis applying RPM in as much as the appellant is 51 I.T.A. No. 5265/Del/2011 purchasing both, scheduled drugs and unscheduled drugs from the AR as well as from unrelated parties and the difference in mix of scheduled and unscheduled drugs does not have significant bearing on comparison of the gross profit margin from transactions with AE and unrelated parties. Para 2.17 of the OECD guidelines, too, provide in this regard as follows:
"2.17 In a market economy, the compensation for performing similar functions would tend to be equalized across different activities. In contrast, prices for different products would tend to equalize only to the extent that those products were substitutes for one another. Because gross profit margins represent gross compensation, after the cost of sales for specific functions performed (taking into account assets used and risks assumed), product differences are less significant..................
Attention is further invited in this regard to the paragraph 3.34 of the OECD guidelines which in the context of application of TNMM, clearly provides as under:
"3.34 Prices are likely to be affected by differences in products, and gross margins are likely to be affected by differences in functions, but operating profits are less adversely affected by such differences. As with the resale price and cost plus methods that the transactional net margin method resembles, this, however, does not mean that a mere similarity of functions between two enterprises will necessarily lead to reliable comparisons."
The Ld. DR, it is respectfully submitted, is seeking to blow hot and cold in the same breadth, contradicting his own stand. The Ld. DR, on the one hand, is seeking to 52 I.T.A. No. 5265/Del/2011 contend that the special circumstances, which exist in the domestic market for trading of imported drug formulations in India on account of (i) price control regulations and
(ii) absence of product specific patent laws would render such, internal benchmarking analysis made by the assessee, unreliable, while, on the other hand, the Ld. DR, at the same time, is seeking to disregard the aforesaid peculiar circumstances as not relevant to reject application of RPM instead of TNMM.
The second disclaimer in the certificate of the Chartered Accountant that the above procedure for determination of profit margin from the transactions with associated enterprise and from unrelated parties does not constitute an audit or review made in accordance with the accounting standard in India, is in order. It would be appreciated that the above exercise for determination of profit margin from the transactions with associated enterprise and unrelated parties cannot be equated to audit of the entire financial results, viz., profit and loss account and balance sheet, in terms of auditing standard. Though the Chartered Accountant in their certificate have confirmed the correctness of the profit margin determined from transactions with associated enterprise and unrelated parties, no opinion is expressed on the profit margin of the company for the financial year 2006-07, which is the domain of auditor's report issued along with the audited accounts already placed on record.
Another basis for disregarding internal benchmarking by the TPO (though not alluded to Ld. DR) is that the transaction of purchase of drugs with unrelated parties is only 31% of the total turnover of the appellant. Apart from the submission that transaction with unrelated parties to the tune of 31 % is sizeable quantum and the internal 53 I.T.A. No. 5265/Del/2011 benchmarking undertaken on that basis cannot be disregarded, it is respectfully submitted that, in terms of Rule 10B(1)(b)(ii) of the Income-tax Rules, benchmarking analysis could be undertaken with reference to a comparable uncontrolled transaction.
In other words, even a single comparable uncontrolled transaction can be considered as comparable undertaking benchmarking analysis applying RPM.
In view of the aforesaid, it is respectfully submitted that benchmarking analysis has wrongly been sought to be disregarded by the Ld. DR and the same is to be preferred over the external comparison, even while applying RPM.
Re.: Subvention Income:
DR's contentions:
The Ld. DR referred to the subvention agreement placed at page No. 484 to 497 to contend that it was not clear as to why the amount by way of subvention income was paid by the associated enterprise to the appellant. According to the Ld. DR the purpose of subvention was to extend corporate financial support, for building the brand and for undertaking market research, etc., and was in the nature of other income. The Ld. DR also referred to the annual accounts, placed at pages 485 - 486 of the paper book, to contend that subvention income was treated by the appellant as other income itself in the annual accounts.
The Ld. DR also submitted that subvention income received from the AE is to be separately analyzed or benchmarked. The Ld. DR placed reliance on the decision uf the benches of the Tribunal in the cases of 134 ITD 229, DO TIJ 570 and 133 TTJ 425 in support of the contention that each transaction is to be 54 I.T.A. No. 5265/Del/2011 separately benchmarked.
The further submission of the Ld. DR was that cross subsidization could not be permitted by treating subvention income as part of sales.
The Ld. DR further observed that as per the books of accounts, subvention income is only Rs 53.21 crores and the balance of Rs. 1.83 crores is marketing research income.
it was alternatively contended by the Ld. DR that the appellant had incorrectly reduced subvention income from AE transactions only and the same should, at best, be allocated to the entire sale.
Appellant's rejoinder:
The term 'subvention' is defined in Oxford Dictionary, as "an amount of money that is given by a government, etc. to help an organization". The subvention agreement dated 04.04.1994 entered into between the appellant with its associated enterprise also provides that the subvention is in the nature of financial support provided to the appellant to meet the consequence of very low end-selling prices of Lilly goods due to absence of product patent protection brought about by an amendment in the Indian Patent Act, 1970 as would be evident from the said agreement as extracted below:
LN BV to position ELR as a high quality organization to establish its branaimage7ii Indian market. ELN B V, nevertheless, is aware the factors listed below may result in significant losses to ELR in the near term:
(a) That LILLY as a pharmaceutical company and its specialty prescription products are relatively unknown to India;
(b) That ELR will be actively competing in the market with
al2Proximateiv ,
16.000 other manufacturers; and
55 I.T.A. No. 5265/Del/2011
(c) Of the very low end-selling price; that prevail in the market place due.
to absence of product patent protection brought about by an amendment in the Indian Patent Act, 1970.
ELN B V is aware of the long term importance of the Indian market place for LILLY products. In order that ELR continue in its efforts to establish its presence in the Indian market despite the apprehended losses that it may suffer in the initial years, ELN BV hereby assures a corporate financial support through this specific subvention agreement for a period of one calendar year being 1994 only."
It would be appreciated that the compensation by way of subvention income is paid by the associated enterprise to the appellant in terms of the agreement considering the fact that drug formulations or drugs purchased by the appellant from the associated enterprise are relatively unknown in India. Further, the appellant for sale of such drugs in Indian market is required to compete with approximately 16,000 other manufacturers and because of the price control regulations in India (as elaborated supra) providing for very low end-selling prices, permitted in the Indian market with respect to imported scheduled drugs (which forms significant portion of the drug formulations traded by the appellant).
In view of the aforesaid, it would be appreciated that the amount paid by way of subvention income is nothing but price support provided to the appellant in view of the loss which is otherwise incurred on resale / distribution in India of drug formulations purchased from the AE. In other words, the subvention income is the compensation received by the appellant from its associated enterprise to compensate the lower profit earned on resale of goods in India imported from the 56 I.T.A. No. 5265/Del/2011 associated enterprise.
For that reason, while applying TNMM in the transfer pricing documentation, operating profit margin was computed by the appellant after taking into consideration receipt of subvention income from associated enterprises. Reliance in this regard may be placed on TP Guidelines for Multinational Corporations and Tax Administrations by the Organization for Economic Co-operation and Development (OECD Guidelines) which provides fur aggregation of transactions as under:
"1.42 Ideally, in order to arrive at the most precise approximation of arm 's length conditions, the arm's length principle should be applied on a transaction-by-transaction basis. However, there are oftnl situations where separate transactions are so closely linked or continuous that they cannot be : / evaluated adequately on a separate basis. Examples may include 1.
some I ~ long-term contracts for the supply of commodities or services, 2.
rights to use intangible property, and 3. pricing a range of closely-linked products (e.g. in a product line) when it is impractical to determine pricing for each individual product or transaction Another example would be the licensing of manufacturing know-how and the supply of vital components to an associated manufacturer; it may be more reasonable to assess the arm's length terms for the two items together rather than individually. Such transactions should be evaluated together using the most appropriate arm's length method. A further example would be the routing of a transaction through another associated enterprise; it may be more appropriate to consider the transaction of which the routing is a part in its entirety. rather than consider the individual 57 I.T.A. No. 5265/Del/2011 transactions on a separate basis. "
1.43 While some separately contracted transactions between associated enterprises may need 10 be evaluated together in order to determine whether the conditions are arm's length, other transactions contracted between such enterprises as a package may need to be evaluated separately. An MNE may package as a single transaction and establish a single price for a number of benefits such as licenses for patents, know-how, and trademark'>, the provision of technical and administrative services, and the lease of production facilities.
This type of arrangement is often referred to as a package deal. Such comprehensive packages would be unlikely to include sales of goods, however, although the price charged for sales of goods may cover some accompanying services. In some cases, it may not be feasible to evaluate the package as a whole so that the elements of the package must be segregated. In such cases, after determining separate transfer pricing for the separate elements, the tax administration should nonetheless consider whether in total the transfer pricing for the entire package is arm's length."
Reliance may also be placed on the guidance given by the US and Australian TP Regulations on this issue. US Regulations 4.482-1 (f)(2)(i) also provide in this regard as under:
"The combined effect of two or more separate transactions (whether before, during, or after the taxable year under review) may be considered. if such transactions, taken as a whole, are so interrelated that consideration of 58 I.T.A. No. 5265/Del/2011 multiple transactions is the most reliable means of' determining the arm's length consideration for the controlled transactions. Generally, transactions will be aggregated only when they involve related products or services."
Similarly, the Australian Transfer Pricing Regulations in TP. 97/20 provide in this regard " ideally, dealings between associated enterprises should be priced on a transaction by transaction basis. However, it is also recognized that if it is impractical to assess individual transactions (e.g., if such an approach would not address all the relevant aspects of the dealings between the parties that affect comparability), it may be more appropriate to consider a combination of transactions.
Grouping may be appropriate in the following situations:
(1) Transactions / components of transactions:
Dealings between associated enterprises in a particular product may involve separate transactions for the product, the intangibles associated with the product, technical advice, management services and any other related matters.
In dealings with independent parties, the various aspects may be rolled into a package deal with all the associated costs being included in the transfer price of the product.
The various aspects may need to be considered together to account properly for the cost and to prevent double counting.
If the independent dealings being considered as possible comparable cannot be desegregated, it would generally be appropriate to group all the relevant transactions between associated enterprises so comparability to the uncontrolled party package deal transaction can be properly determined.
Care is need to identify the value of any component of the package 59 I.T.A. No. 5265/Del/2011 that is subject to different domestics tax treatment, e.g., items subject to interest or royalty withholding tax.
(2) Integrated operations:
If it is decided to route the transaction through an associated enterprise, it may be more appropriate to consider the dealing in its entirely rather than consider the component transactions on a separate basis. There could be practical difficulties in determining the true value added by any intermediate company if it is considered in isolation.
For example, a company may be licensing intangible and supplying vital components to an associated as part of a highly integrated global manufacturing process.
Further, it is necessary to consider incremental dealings that may have the effect of gradually eroding profitability. The most appropriate approach in such cases may be to apply the statutory test of whether independent enterprises would have entered into the package of transactions, rather than analyzing each individual transaction separately.
If it cannot be demonstrated in a particular case that the intermediate company bears a real risk or performs a function adding economic value in the chain that has produced the value of the goods or services, it might be appropriate to attribute any profit element, claimed to be attributable to the activities of the intermediate company, elsewhere in the MNEs group. Independent enterprises operating independently might not be expected to have allowed such a company to share in the profits from the dealing."
In terms of the OECD guideline, too, it is possible to undertake benchmarking analysis of different controlled transactions on an aggregate basis provided such transactions are closely inter linked and cannot be evaluated adequately on a separate basis. It is also provided to undertake combined evaluation of transactions which involves in international set-off. The relevant portion of the OECD guidelines read as under:
"(viii) International Set Off 60 I.T.A. No. 5265/Del/2011 1.60 An intentional set-off is one that associated enterprises incorporate knowingly into the terms of the controlled transaclions. It occurs when one associated enterprise has provided a benefit to another associated enterprise within the group that is balanced to some degree by different benefits received from that enterprise in return. These enterprises may claim that the benefit each has received should be set off against the benefit each has provided as full or part payment for those benefits so that only the net gains 01' loss ar any) on the transactions needs to be considered for purpose of assessing tax liabilities. For example, an enterprise may license another enterprise to use a patent in return for provision ot' know-how in another connection and claim that the transactions result in no profit or loss to either party. Such arrangements may sometimes be encountered between independent enterprises and should be assessed in accordance with the arm's length principle in order to quantify the value of the respective benefits claimed as set-
offs.
1.61 International set-offs vary in size and complexity. Such set-offs may range from a simple balance of two transactions (such as a favourable selling price for manufactured goods in return for a faburable purchase price for the raw material used in producing the goods) to an arrangement for a general settlement balancing all benefits accruing to both parties over a period. Independent enterprises would be very unlikely to consider the faller type of arrangement unless the benefits could be accurately quantified and the contract created in advance. Otherwise, independent enterprises normally would prefer to allow their receipts and disbursements to flow independently of each other, taking any profit or loss resulting from normal trading ... "
The Indian transfer pricing regulations also provide for the evaluation of combined transactions. The term "transaction" has been defined in clause (v) of section 92F of the Act to include the arrangement, understanding or action in concert whether or not 61 I.T.A. No. 5265/Del/2011 such arrangement, understanding or action is formal or in writing.
Rule lOA(d)of the Rules, too, provides that "transaction" includes a number of closely linked transactions.
On an analysis of the OECD guidelines, transfer pricing regulations/practices in other jurisdiction as outlined hereinabove, and considering the mandate of provisions of Rule 10A(d) of the Rules, the following position emerges:
(a) It is possible to conduct combined evaluation of interlinked transactions.
(b) It is possible for the associated enterprise involved in the controlled transaction to undertake/provide benefit in one controlled transaction to compensate for the benefit received in the other controlled transaction. In such situation the benefit received should be set off against the benefit provided, i.e., such transactions are required to be evaluated together.
(c) The combined effect of two or more separate transactions may be considered if such transactions taken as a whole are so interrelated that consideration of multiple transactions is the most reliable means for determining the arm's length consideration.
It would be appreciated that the subvention income received by the appellant pursuant to the agreement with the associated enterprise is for compensating the appellant for low profit margin or loss incurred pursuant to trading in such drug formulations purchased form associated enterprise, considering peculiar regulatory, economic and market scenario in India. The amount received by the appellant by way of subvention income from the associated enterprise is, therefore, closely and inextricably linked to the transaction of import of drug formulations and, therefore, is required to be benchmarked together, the same is not amenable to separate benchmarking analysis as contended by L. D.R. There is no quarrel with the decisions relied upon by the Ld. D.R. for the proposition that each international transaction is to be benchmarked separately. IN the facts of the case, however, the contention of the Ld. D.R. that subvention received from the AE is to be benchmarked separately, is not tenable in as much as subvention 62 I.T.A. No. 5265/Del/2011 income is nothing but compensation received from the AE for the lower profit earned from resale in India of drug formulation purchased form the AE. The said subvention income has, therefore, first degree nexus and is inextricably linked to the international transactions of import of drug formulations. The same is, in fact, compensation for the transfer pricing adjustment already paid by the AE and is regarded as such by thethe TPO, when the TPO himself reduces the subvention income from the transfer pricing adjustment at page 30 of the TPO's order reproduced below:
Total sales Rs.1,823,107,281
Gross margin @ 47.21% Rs.860,688,947
Gross Margin shown Rs.174,245,097
Arms length value of purchases Rs.1,071,689,269
Purchase value shown Rs.1,758,133,119
Difference Rs.686,443,850
Less: subvention income Rs.550,493,475
Adjustment u/s 92CA Rs.135,950,375
Without prejudice to the aforesaid, it would be appreciated that even if RPM is to be applied, the adjustment should be restricted to international transactions undertaken by the appellant with its associated enterprise as accepted by the DRP at paragraph 4.5 of its decision. Reliance is also placed in his regard on the following decisions:
IL Jin Electronics (I) P ltd. vs. ACIT (ITA 438/0/2004) (Mum) Four Soft Ltd. vs. DCIT [ITA No. 14951HYD/2010] (Hyd) Technimount res India P. Ltd. vs. AClT TTA No. 7098IMum/2010] (Mum) •ACIT vs. Twinkle Diamond: ITA No. 50331Mum/07 •ACIT vs. T Two International Pvt. Ltd. : ITA No. 5644IMumJ2008 •Addl. CIT vs. Tej Diam : 130 TTJ 570 (Mum) •Abhishek Auto Industries Ltd. vs. DCIT: ITA No. 1433/DeV2009 •Starlite vs. DCIT: ITA No. 9251Mum/2006 •SMCC Construction India Ltd v. Addl. CIT: 44 SOT 63 (Delhi) (URO) •Genisys Integrating Systems (India) Pvt. Ltd. vs. DCIT [ITA No. 1231IBang/201O] 63 I.T.A. No. 5265/Del/2011 It would be appreciated that adjustment on account of the alleged difference in the arm's length price of international transactions for purchase of drug formulations computed by the TPO, would not survive if the benchmarking analysis is restricted only to international transactions or related party segment as follows:
Particulars Computation of Computation of gross profit gross profit margin by the margin (Related TPO (total party segment turnover) only) Sales 1,82,31,07,281 1,16,43,03,000 Cost of goods sold 1,64,88,62,184 1,10,07,93,000 Gross margin shown 17,42,45,097 6,35,10,000 Gross margin 9.56% 5.45% Arm's length gross margin 86,06,88,947 55,96,67,446 as computed by the TPO @ 47.21% Shortfall in profits 68,64,43,850 48,61,57,446 Less: subvention income 55,04,93,475 55,04,93,475 Balance Adjustment 13,59,50,375 nil Further, regarding market research income of Rs. 1.83 crores, it is stated in Para 6 of the notes to Form 3CEB that "in respect of purchase of formulations and service kits from the associated enterprises (receipt of promotional grants, viz, subvention income and market research income from Eli Li/~v Netherlands, 13. V. have been taken as a closely linked transaction to the purchase of formulations and service kits), the assessee has determined that the Transaction Net Margin Method (FNMM) is the most appropriate method. Accordingly, the market research income has also been considered as grant received by the appellant from its associated enterprise and treated similar to subvention income.
It is further respectfully submitted that, in terms of the agreement, the subvention income as also market research income has been paid by the associated enterprise in relation to sale of its own products by the appellant and is, therefore, directly attributable to the international transactions of purchase of drug formulations from the associated enterprise. The entire subvention income of Rs.55,04,93,475, is therefore, in our respectful submission, required to be reduced from the value of purchases from the associated 64 I.T.A. No. 5265/Del/2011 enterprise as directed by the DR WP and adjustment would, even . otherwise, on the facts of the case."
1. 6.1 While relying upon the written submissions in the shape of broad proposition, rejoinder in response to written submission of ht department, Ld. counsel for the assessee pleaded for deletion of impugned addition made on account of difference in arm's length price as determined by the TPO and confirmed by DRP-I, New Delhi which was adopted by the A.O. to make the impugned addition.
7. We have heard both the sides, considered the material on record as well as broad proposition and rejoinder filed by the Ld. A.R. and submission made by Ld. D.R. in the light of case law cited by the rival sides in such submissions and find that all the points as raised before the TPO, DRP-I and the A.O. have not appropriately been considered before passing the impugned assessment order. Therefore, considering the facts, circumstances and material on record, in the light of the case law cited by the rival sides, we find it just and appropriate to set aside the order of the A.O. and restore the matter back to his file for reconsidering the issue raised in the appeal assessment afresh after giving due opportunity to the assessee. We hold and direct accordingly.
8. As a result, appeal of the assessee gets accepted for statistical purposes.
9. Order pronounced in the open court on 21st Nov., 2013.
Sd./- Sd./- (SHAMIM YAHYA) (U.B.S.BEDI) Accountant Member Judicial Member Date: 21st Nov., 2013. Sp. Copy forwarded to: 1. Appellant 2. Respondent 3. CIT 4. CIT(A)-XXV, New Delhi AR, ITAT, 5. CIT(ITAT), New Delhi NEW DELHI