Income Tax Appellate Tribunal - Hyderabad
Dr. Reddy'S Laboratories Limited, Hyd, ... vs Acit, Circle-17(1), Hyderabad, ... on 28 April, 2017
1
ITA.Nos.294/H/2014, 458 & 463/H/2015
Dr. Reddy's Laboratories Limited, Hyderabad.
IN THE INCOME TAX APPELLATE TRIBUNAL
HYDERABAD BENCHES "A" : HYDERABAD
BEFORE SHRI D. MANMOHAN, VICE PRESIDENT
AND
SHRI S. RIFAUR RAHMAN, ACCOUNTANT MEMBER
ITA.No.294/Hyd/2014
Assessment Year 2009-2010
Dr. Reddy's Laboratories Addl. Commissioner of Income
Limited, Hyderabad - 500034 vs., Tax, Circle-1(2), Hyderabad.
PAN AAACD7999Q
(Appellant) (Respondent)
ITA.No.458/Hyd/2015
Assessment Year 2010-2011
Dr. Reddy's Laboratories Addl. Commissioner of Income
Limited, Hyderabad - 500034 vs., Tax, Circle-17(1), Hyderabad.
PAN AAACD7999Q
(Appellant) (Respondent)
ITA.No.463/Hyd/2015
Assessment Year 2010-2011
Addl. Commissioner of Income Dr. Reddy's Laboratories
Tax, Circle-17(1), vs., Limited, Hyderabad - 500034
Hyderabad. PAN AAACD7999Q
(Appellant) (Respondent)
For Assessee : Shri K.R. Sekhar
For Revenue : Shri P. Chandrasekhar
Date of Hearing : 23.03.2017
Date of Pronouncement : 28.04.2017
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ITA.Nos.294/H/2014, 458 & 463/H/2015
Dr. Reddy's Laboratories Limited, Hyderabad.
ORDER
PER D. MANMOHAN, V.P. These appeals are directed against the orders passed by ACIT, Circle-17(1), Hyderabad under section 143(3) r.w.s.144C(5) of the I.T. Act, 1961. The first two appeals are filed by assessee for the A.Y. 2009-2010 and 2010-2011 whereas ITA.No.463/Hyd/2015 is a cross- appeal filed by Revenue for the A.Y. 2010-2011 on the following grounds:
1. "The order of DRP is erroneous both in law and facts of the case.
2. Whether on the facts and in the circumstances of the case, the DRP is correct in law in holding that the profit-sharing ratio of 50:50% between the taxpayer and the A.E, DRL Inc USA is reasonable without appreciating the analysis made by the TPO and arriving at the conclusion merely on the assessee's legal and marketing expenses incurred which have no basis and is without any empirical evidence.
3. Whether on the facts and in the circumstances of the case, the DRP is correct in law in holding that expenditure towards stock-
based compensation (ESOPs) is Revenue expenditure when the Tribunal in the case of Medha Servo Drivers Private Limited versus upheld the addition on account of ESOPs as being capital in nature.
4. Any other ground that may be urged at the time of hearing the appeal."
1.1. Similarly for the A.Y. 2010-2011 assessee company raised 21 grounds and also filed additional grounds. In the cross-appeal by Revenue only two grounds were raised. Facts available/referred to in A.Y. 2009-10 are sufficient to project the rival contentions for both the years. We, therefore, refer to the record of A.Y. 2009-2010.
2. Both parties admitted that major issues are common for both the years and the Learned Counsel for the Assessee prepared a 3 ITA.Nos.294/H/2014, 458 & 463/H/2015 Dr. Reddy's Laboratories Limited, Hyderabad.
chart referring to the relevant pages in the draft order, TPO's order, DRP's order as well as the final assessment order, issue-wise. We, therefore, feel it appropriate to refer to the chart filed for each year separately. Wherever it is warranted, we shall refer to the record pertaining to A.Y. 2010-2011 also.
3. At the outset, it may be stated that in respect of the A.Y. 2009-2010, assessee raised as many as 29 grounds, arising out of the order passed by Addl. CIT, Range-1, Hyderabad dated 26.12.2013, consequent to the receipt of the directions of DRP, dated 26.11.2013. Assessee has also raised additional set of grounds which are mentioned as additional grounds but in fact the grounds are identical to the grounds originally raised; There is modification of the language employed in the original grounds. Similarly, there are 21 grounds for A.Y. 2010-2011 and four grounds in the appeal filed by Revenue.
4. Assessee is engaged in the manufacture and sale of bulk drugs, APIs, Formulations and other pharmaceutical products. The company declared income of Rs.78,38,27,560 on 30.09.2009. However, as per the provisions of Section 115JB of the Act, the profit worked out at Rs.767.80 crores. The return was accordingly processed under section 143(1) of the Act. Subsequently, assessee-company filed revised return declaring income of Rs.17.59 crores only under the normal provisions, and the same was also processed by the A.O. In the original return assessee claimed loss on hedging contracts amounting to Rs.22.7 crores in computation of income whereas in the revised return this claim was withdrawn. Similarly, assessee claimed deduction of Rs.333.01 crores under section 10B of the Act which is enhanced to Rs.416.53 crores. The enhanced claim of deduction was on account of the fact that assessee- company took into account export proceeds received upto 31.03.2010 4 ITA.Nos.294/H/2014, 458 & 463/H/2015 Dr. Reddy's Laboratories Limited, Hyderabad.
whereas in the original return the export proceeds received upto 30.09.2009 were considered.
4.1. In the meantime, the case was selected for scrutiny under CASS. During the scrutiny proceedings the A.O. noticed that assessee- company entered into international transactions with it's A.E. and the amount of transactions were more than Rs.15 crores as per 3CEB report. Consequently, the case was referred to the Transfer Pricing Officer ("TPO"), with the prior approval of CIT-I, Hyderabad, for determining the Arms Length Price ("ALP") of the international transactions entered into by assessee-company. While passing the order under section 92CA of the Act, the TPO observed that assessee had a full-fledged in-house research and development division, engaged in research on new products and on process development of existing products. As per 3CEB report, assessee aggregated the transactions pertaining to purchase, sales, royalty income, interest, fees etc., by applying TNMM method. The transactions put together works-out to 45.38% of the total revenue and in the absence of suitable CUPs available for transactions pertaining to purchase, sales, reimbursements of royalty income etc., TNMM method was found to be most appropriate method. For suitable comparables, information was taken from PROWESS and CAPITALINE database, by taking into account current year data only. The following filters were adopted by the TPO for rejecting certain companies.
(a) Companies whose data is not available for F.Y. 2008-09.
(b) Companies whose software services are less than Rs.1 crore
(c) Companies whose revenue from manufacture and pharmaceuticals is less than 75% of the total operating revenues.
(d) Companies who have more than 25% related party transactions (income sales expenditure combined) of the operating revenues.5
ITA.Nos.294/H/2014, 458 & 463/H/2015 Dr. Reddy's Laboratories Limited, Hyderabad.
(e) Companies having different financial year ending or data of the company which does not fall within 12 months period i.e., 01.04.08. to 31.03.2009.
(f) Companies that are functionally different from the tax payer.
4.2. Since the operating margin on sale (Profit Level Indicator) of the tax payer falls within plus or minus 5% of the arms length range the transactions pertaining to purchase and sale were accepted by the TPO without any adjustment.
5. The TPO noticed that assessee-company entered into loan transactions with it's A.Es and charged interest. According to the assessee, all the above loans (including rate of interest) was within the regulatory frame work and was approved by the Reserve Bank of India. Such approvals serve as an appropriate yardstick for determining the arms length.
5.1. The TPO observed that merely because interest is charged by the tax payer on loans given to it's A.Es in accordance with the provisions of FEMA/RBI regulations, it does not automatically imply that the interest charged by the tax payer is within the arms length range. In this regard, the TPO referred to the decision of the ITAT, Mumbai Bench in the case of Serdia Pharmaceuticals wherein the Bench observed that merely because another arm of the Government considers the interest charged by the assessee as reasonable i.e., at arms length, assessee cannot be relieved of the burden of establishing that it is at arms length, for the purpose of transfer pricing requirements. The TPO, therefore, proceeded to consider each loan independently. It may be noted that out of the loan transactions with 5 A.Es, in the case of three loan transactions, the interest charged was 6 ITA.Nos.294/H/2014, 458 & 463/H/2015 Dr. Reddy's Laboratories Limited, Hyderabad.
higher. The loan transactions with Falcon Mexico and Lacock Holdings are subject matter of dispute for A.Y. 2009-2010.
5.2. Loan to Lacock Holdings Limited : It is wholly owned subsidiary of the tax payer which was established for the purpose of acquisitions from the funds received by the A.E, - in the form of loan given by the tax payer as well as equity. Lacock Holdings Ltd., Cyprus gave loan to its wholly owned subsidiary i.e., Reddy Holding GmBH, Germany @ 6.5%. Since the loan was given in Euros, TPO sought to compare the transactions with the prevalent Euribor rate which was 4.37% and added suitable risk premium and finally arrived at arms length rate of 6.5% as against 5% charged by assessee and accordingly adjustment was made.
5.3. Similarly, with regard to A.E. Falcon Mexico, the loan was given in Mexican Peso by charging interest at 9.56%. It is not in dispute that the average lending rate prevalent in Mexico was 8.30%. However, the TPO observed that the aforementioned rate is applicable to only prime customers who have good credit rating whereas the taxpayer herein has weak finance and low creditworthiness. According to the TPO, the World Bank lending rate cannot be applied to such cases. In his opinion, interest @ 12% p.a. should be taken into consideration.
5.4. When the same was put to the assessee, it was replied that the loan was advanced to overseas subsidiaries based on commercial relationship. The loan given to these subsidiaries are risk free and is recoverable after stipulated period. It was further contended that the domestic rates would have no application when the transaction between the assessee and the A.E. is in foreign currency. The transaction being an international transaction, LIBOR rate would come into play and it should be looked upon based on commercial principles. The contention 7 ITA.Nos.294/H/2014, 458 & 463/H/2015 Dr. Reddy's Laboratories Limited, Hyderabad.
of the assessee was that LIBOR+ 2% should be adopted as arms length interest.
5.5. The TPO did not accept the contention of assessee. In his opinion, the correct approach would be to benchmark the interest charged by taxpayer with the interest rates prevalent in relevant foreign markets. According to the TPO, interest on loan to the Mexican A.E. was properly benckmarked using the prime lending rate prevalent in Mexico. He thus, adopted 12% as ALP and accordingly made the adjustment.
CORPORATE GUARANTEE :
6. The TPO noted that the assessee did not file any submission regarding the corporate guarantees which were outstanding as on 31st March, 2009. The TPO also noted that the guarantees are given to subsidiaries. In response to the questionnaire issued by the TPO the assessee, vide letter dated 09.01.2013, furnished particulars of corporate guarantee given by it in 2006 i.e., from February to December, 2006. The TPO noticed that the rate of interest on loan with recourse was Euribor + 0.7% whereas the rate of interest on loan without recourse is Euribor + 2%. In otherwords, A.E. derives benefit in the form of lower interest rate by 1.3%. TPO had referred to the guidelines issued by OECD to state that the parent company raised funds on behalf of another group Member to acquire a new company which would generally be regarded as providing of service to the group Member. In otherwords, it can be termed as 'Intra Group Services' which needs to be properly benchmarked. In order to find the corporate guarantee fee at arms length, the most common method used is "Yield Approach" or "Benefit to the Owner Approach" which is popularly used by Canadian Tax Authorities. The other approach is of using interest rates on "Credit Defaults Swaps" for which it is difficult to obtain reliable data. He 8 ITA.Nos.294/H/2014, 458 & 463/H/2015 Dr. Reddy's Laboratories Limited, Hyderabad.
therefore, proposed to adopt "yield approach" for determining the arms length fee for the corporate guarantee given by the tax payer to the lender bank of the A.E. 6.1. It is not in dispute that the A.E. enjoyed lower interest rate to the tune of 1.3 percentage points but the tax payer did not receive any benefit either tangible or intangible. The main contention of the assessee is that there is no expenditure or loss in this year on account of guarantee provided to A.E. and hence it cannot be considered as international transaction. In the alternative, assessee submitted that during the A.Y. 2008-09 DRP has adopted 0.7% of guarantee commission based on risk adjusted internal CUP. Reliance was also placed upon the decision of ITAT, Mumbai Bench in the case of Everest Kanto Cylinders Ltd., vs. DCIT (ITA.No.542/Mum/2012) wherein the Bench observed that various factors have to be evaluated while pricing guarantee commission. The company requested the TPO to adopt 0.7% as guarantee commission.
6.2. The TPO observed that the assessee has not advanced any arguments on merits but merely relied upon the DRP's direction for the earlier year which is not binding on the TPO while deciding the case of the subsequent year. Since the A.E. has received the benefit of lower interest rate by 1.3 percent points, solely due to corporate guarantee given by the tax payer, the ALP of the fee for the corporate guarantee was determined at 1.3% p.a. of the loan amount and observed that on this count adjustment of Rs.24.45 crores need to be made under section 92CA of the Act.
7. Upon receiving the order of the TPO, a draft assessment order was passed by the A.O. by determining the total income at 9 ITA.Nos.294/H/2014, 458 & 463/H/2015 Dr. Reddy's Laboratories Limited, Hyderabad.
Rs.327,63,42,635. In the draft assessment order the A.O. made the following additions :
1. Claim of ESOP Rs.19,16,80,304.
2. Claim of depreciation on goodwill of Rs.1,97,63,349
3. Weighted deduction u/s.35(2AB) of Rs.169,34,19,392
4. Disallowance of maintenance expenditure Rs.50,20,503
5. Expenditure on sponsorship Rs.28,46,48,099.
6. Allocation of corporate overheads u/s.10B, 80IB and 80IC of Rs.63,82,40,666.
8. With regard to expenditure referable to ESOPs, A.O. observed that it is incurred in connection with the issue of fresh lot of shares to increase share capital and hence it is capital in nature, not allowable as deduction.
9. With regard to claim of depreciation of goodwill, the A.O. observed that in the books of account the differential amount was adjusted in the general reserve account and it was not shown separately as an item of intangible asset. In the earlier years also it was held that goodwill simpliciter was not entitled for depreciation and accordingly even in this year the claim of depreciation on goodwill was rejected.
10. The assessee company claimed weighted deduction under section 35(2AB) of the Act. As per Rule-6(7A), the Prescribed Authority has to submit its report, in relation to the approval of "Inhouse Research and Development Facility" within 60 days of its granting approval. Since no such report was furnished by DSIR (Department of Scientific and Industrial Research) to D.G. (Exemptions) assessee was held to be not entitled to weighted deduction. However, assessee was held to be entitled to 100% deduction in respect of both the capital and revenue expenditure under section 35(1) of the Act, as the expenditure was 10 ITA.Nos.294/H/2014, 458 & 463/H/2015 Dr. Reddy's Laboratories Limited, Hyderabad.
incurred on scientific research relating to the assessee's business. In otherwords, excess claim i.e., 50% of the expenditure representing weighted deduction was disallowed.
11. Assessee claimed certain expenditure which according to the A.O. was capital in nature. It was claimed under the head "Repairs and Maintenance of Plant and Machinery" and "Repairs and Maintenance Others". Out of the total expenditure of Rs.66,32,629, an amount of Rs.50,20,503 was disallowed by the A.O. after allowing depreciation at Rs.16,12,126.
11.1. The A.O. however observed that even in earlier years certain capital expenditure was disallowed and depreciation was only allowed. Therefore, the depreciation claimed on these items also was allowed.
EXPENDITURE INCURRED ON DOCTORS' MEETINGS ETC., :
12. Assessee debited expenditure in the nature of sponsorships for meetings of Doctors and other guests which was held to be purely personal in nature. The case of the assessee was that the expenditure was referrable to travel, conveyance, lunch/dinner, gifts and complimentaries to Doctors for promoting its products and such expenditure falls under the category of business promotion.
12.1. The A.O. observed that as per the Medical Council of India, there is a prohibition from taking any gifts, travel facility, hospitality, cash or monthly grant from the pharmaceutical and other allied health sector industries. Reliance was placed upon the circular issued by the CBDT vide Circular No.5/2012 wherein it was clarified that any expenditure incurred, in providing abovementioned or similar freebies, is in violation of the provisions of Indian Medical Council Regulations, 11 ITA.Nos.294/H/2014, 458 & 463/H/2015 Dr. Reddy's Laboratories Limited, Hyderabad.
2002 and therefore, inadmissible by virtue of Explanation to Section 37(1) of the Act.
12.2. It may be noted that assessee's case was that the guidelines issued by the Medical Council is applicable to medical practitioners and not to pharmaceutical companies because the medical Council seeks to regulate the conduct of the Medical practitioners but the same do not prohibit the pharmaceutical industry from promoting its products. So far as the assessee is concerned, the expenditure was incurred wholly and exclusively for the purpose of business.
12.3. The A.O. placed reliance upon an unreported decision of the Hon'ble High Court of Himachal Pradesh to hold that once the activity is prohibited by Indian Medical Council, under the powers vested in it, Section 37(1) of the Act comes into play and expenditure incurred on the medical practitioners cannot be allowed as deduction.
12.4. The next contention of the assessee was that the circular issued by the CBDT in 2012 was prospective in operation and not applicable to the year under consideration. The A.O. on the other hand, was of the opinion that Explanation to Section 37(1) is even otherwise applicable since any expenditure incurred for any purpose, which is prohibited by law, shall not be deemed to have been incurred for the purpose of business or profession. Accordingly, the expenditure claimed on this count was disallowed by the A.O.
13. The assessee claimed deduction under section 80G of the Act referring to donations made to several organisations. But during the course of proceedings proof could not be furnished with regard to the donations given to "MANAVA SEVA DHARMA SAMVARDHINI TRUST 12 ITA.Nos.294/H/2014, 458 & 463/H/2015 Dr. Reddy's Laboratories Limited, Hyderabad.
AND INDIAN RED CROSS". Therefore, the claim referable to those two donations was not accepted.
ALLOCATION OF CORPORATE OVERHEADS :
14. The assessee claimed deductions under section 10B, 80IB and 80IC without apportioning corporate overheads. In this regard, the A.O. observed that the overheads incurred in the corporate office cannot be viewed in isolation of the special units. Proper allocation has to be made for determining the correct income of the eligible units. In otherwords, the A.O. was of the opinion that the allocation of overheads to each unit is mandatory for the purpose of arriving at the profits under those sections. He accordingly determined the eligible deductions under sections 10B, 80IB and 80IC of the Act.
TAX CREDIT RELATING TO INTEREST INCOME FROM CYPRUS :
15. During the course of draft assessment proceedings, assessee submitted that it should be allowed tax credit amounting to Rs.14.88 crores being 10% of the interest income earned by the Company from its subsidiary i.e., M/s. Lacock Holdings Ltd., Cyprus. This credit was not claimed in the return. However, similar claim was accepted by the DRP in the proceedings for the A.Y. 2008-09. Having regard to the circumstances, the A.O. allowed the claim of the assessee.
16. The assessee filed objections to the draft assessment order before the DRP on the following points :
1. "Proposed adjustment of Rs.8,11,30,972 by the Assessing Officer/Transfer Pricing Officer (TPO) u/s.92CA(3) of the I.T. Act, 1961 in respect of interest of loan provided to Associated Enterprises (AE).
2. Proposed adjustment of Rs.24,45,30,000 by the Assessing Officer/Transfer Pricing Officer (TPO) u/s.92CA(3) of the Act in 13 ITA.Nos.294/H/2014, 458 & 463/H/2015 Dr. Reddy's Laboratories Limited, Hyderabad.
respect of corporate guarantee fee not charged on loan provided by Lender to A.E.
3. Proposed action of the Ld. A.O. in disallowing the expenditure of Rs.19,69,80,304 incurred by the assessee on the Employee Stock Option Plan (ESOP).
4. Proposed action of the Ld. A.O. in disallowing Rs.1,97,63,349 towards claim for depreciation on goodwill.
5. Proposed action of the Ld. A.O. of not allowing weighted deduction of 150% u/s.35(2AB) in respect of expenditure on scientific research amounting to Rs.169,34,19,392 incurred by the assessee.
6. Proposed treatment of Ld. A.O. in disallowing maintenance expenditure amounting to Rs.50,20,503 (net of depreciation).
7. Proposed treatment of Ld A.O. in disallowing certain expenditure amounting to Rs.28,46,48,099 towards sponsorship of meet of doctors, gifts to doctors and other guests as expenses unrelated to business.
8. Proposed treatment of Ld. A.O. in apportioning corporate overheads to the respective computation for exemption/ deduction allowable u/s. 10B, 80IB and 80IC units total amounting to Rs.63,82,40,666."
16.1. After hearing the detailed submissions of the assessee's Authorised Representative, the panel analysed the issues to give its opinion point-wise.
17. The first issue is with regard to the loans given to Lacock Holdings and Falcon D. Mexico. With regard to the contention of the assessee that the interest charged on loans to A.E. is within the arms length range since it was approved by the RBI, the Panel observed that the RBI examines the matter from the perspective of FEMA Regulations and not from arms length perspective. In fact, the TPO found that the loan to A.E. i.e., Lacock Holdings has been given in EUROs whereas loan to Falcan D. Mexico was given in Mexican Peso and therefore, the 14 ITA.Nos.294/H/2014, 458 & 463/H/2015 Dr. Reddy's Laboratories Limited, Hyderabad.
interest rates prevalent in respective countries would be the correct indicator. In the case of Lacock Holdings it was noticed that funds were received from the assessee-company through equity and loans whereas the A.E. has given the loan to its subsidiary @ 6.5% p.a. as against 5% p.a. charged by the assessee. Similarly, the TPO determined the arms length price of the interest on loans to Mexican A.E. as 12% p.a. This was also based upon the rate applicable in Mexico. Therefore, the DRP observed that the TPO's approach is in line with the principle laid down by the Hyderabad Bench of ITAT in the case of Foursoft Ltd., 142 TTJ 358 (Hyd.).
17.1. With regard to corporate guarantees, the Panel observed that in assessee's own case for the A.Y. 2008-09 A.O. was directed to adopt 0.7% of the loan amount as ALP and therefore, similar direction was given for this year also.
17.2. As regards disallowance on account of ESOPs the Panel followed the decision of ITAT, Special Bench, Bangalore in the case of Biocom Ltd., and directed the A.O. to work-out the deduction accordingly. For A.Y. 2010-2011 assessee-company debited Rs.19,29,83,505 to the P & L A/c as expenditure on ESOP. According to A.O. it is not an allowance deductible since it is notional and capital in nature. DRP however followed the decision of ITAT, Bangalore Special Bench in the case of Biocon Ltd., vs. DCIT to hold that expenditure incurred towards ESOPs is an ascertained liability and thus, the allowance is revenue expenditure.
17.3. As regards the disallowance of claim of depreciation on goodwill, the DRP followed the order passed by them in the assessee's own case for the A.Y. 2008-09 and rejected the contention of the assessee.
15ITA.Nos.294/H/2014, 458 & 463/H/2015 Dr. Reddy's Laboratories Limited, Hyderabad.
17.4. With regard to claim of weighted deduction under section 35(2AB) of the Act, the assessee furnished certificate in Form 3CL issued by DSIR to contend that as per the said certificate the assessee is entitled to deduction. The Panel accordingly directed the A.O. to consider Form 3CL and allow weighted deduction as per Law.
17.5. As regards the disallowance of maintenance expenses (net of depreciation) the Panel observed that though the assessee contends that the expenditure is on account of repair and maintenance undertaken on a routine basis and did not result in any enduring benefit, details of the expenditure having not been filed the objection of the assessee was rejected.
17.6. As regards the expenditure incurred on the Doctors meetings etc., the Panel observed that identical issue was decided for the A.Y. 2008-09 wherein it was held that expenditure incurred by the assessee is against public policy and therefore hit by Explanation to Section 37(1) of the Act. Accordingly, the addition proposed by the A.O. was confirmed.
17.7. With regard to computation of deduction under section 10B, 80IB and 80IC of the Act, the Panel noticed that identical issue was decided by the DRP for the A.Y. 2008-09 which was in line with the proposed action of the A.O. in this year and thus the plea of the assessee for this year was rejected.
PROFIT SHARING BETWEEN ASSESSEE AND DRL SWITZERLAND :
18. During the DRP proceedings, vide letter dated 16.09.2013, the A.O. intimated to the Panel that there has been remittance to Switzerland by the assessee without deduction of tax at source and requested the Panel to consider the information suitably to issue 16 ITA.Nos.294/H/2014, 458 & 463/H/2015 Dr. Reddy's Laboratories Limited, Hyderabad.
necessary directions to remedy the escapement of the income of assessee. The Additional CIT (Transfer Pricing) vide letter dated 07.11.2013 reported that assessee i.e., Dr. Reddy Laboratories, along with it's A.Es (DRL, USA) developed a generic drug for the patented drug (Sumatripton) of Glaxo Smithkline USA (hereinafter referred to as "GSK"). A suit was filed by the GSK against DRL disputing the rights of DRL to sell the generic drug in the USA territory. Through an out of Court settlement in 2006, before the US District Court, DRL and GSK agreed that Sumatripton will be manufactured by GSK but marketed by DRL USA with all the support from DRL (India). In lieu of its contribution, it was agreed that the profit shall be shared between the DRL USA and DRL India equally. Another A.E. i.e., DRL, Switzerland agreed to bear certain risks like post-sales liabilities of DRL USA, as per MOU with DRL India, in May, 2008 and in consideration thereon, the assessee agreed to part 50% of its share of profit to DRL, Switzerland. According to the assessee, the payment represents profit share with Swiss A.E. Hence, DRL USA passed-on 50% of share of DRL India to DRL Switzerland. Under these circumstances, assessee had offered only net profit in marketing and distribution, received from DRL USA. The TPO as well as the A.O. observed that business arrangement between the assessee and the DRL, Switzerland was not discussed properly in 3CEB report or in the T.P. documentation. Since such remittances fall under the definition "International Transaction", under section 92B of the Act, the same ought to have been Benchmarked in order to show that the same was within the arms length range but the assessee had nowhere mentioned about the modus of payment.
18.1. Based on the information available on record, the DRP vide letter dated 08.11.2013 issued a show cause notice to the assessee as to why 25% of the total profit paid to DRL Swiss, by DRL USA, should 17 ITA.Nos.294/H/2014, 458 & 463/H/2015 Dr. Reddy's Laboratories Limited, Hyderabad.
not be brought to tax in the hands of the assessee since no deduction is allowable on such payments, under section 37(1) of the Act.
18.2. In its reply, assessee raised a preliminary ground objecting to the jurisdiction of the DRP to deal with any variation which is not part of the draft assessment order. It was also contended that the power of DRP to enhance the variation includes power to consider any matter arising out of the assessment proceedings relating to the draft order, notwithstanding such matter was raised or not. In the instant case, the matter having not been considered at any stage, the DRP has no jurisdiction to deal with the issue.
18.3. Without prejudice to the technical ground the assessee contended that by virtue of an agreement dated 05.10.2006 with GSK assessee had to purchase finished product i.e., Sumatripton from GSK during 180 days exclusivity period, to market in USA on a pre-agreed quantity and price and the product was accordingly launched in November, 2008. Marketing the product and necessary license was carried out through DRL India. In otherwords, the product purchased was sourced and warehoused in USA, marketed and sold in USA. DRL Switzerland undertook significant risk that arose on account of price fall and based on the functions performed and risks undertaken, the Switzerland A.E. was entitled to 25% of the profit share (50% of DRL India share). It was also submitted that DRL, Switzerland bore 50% of development and legal cost incurred in defending suit concerning Sumatripton litigation and Swiss AE had also undertaken the price fall impact of Rs.75 crores over the years. It was thus contended that profit share of 25% was based on the above functions and risks assumed by Swiss AE.
18ITA.Nos.294/H/2014, 458 & 463/H/2015 Dr. Reddy's Laboratories Limited, Hyderabad.
18.4. It was also contended that the provisions of Section 37 are not applicable because profit share is not an expenditure as per Section 37, the amount received from DRL USA is paid to DRL Switzerland towards their share of profit based on the functions and risks undertaken. In short, Dr. Reddy's India has not incurred any expenditure under the ambit of Section 37 of the Act.
18.5. The Panel considered the issue in great detail. With regard to the preliminary objection concerning the power of DRP, it referred to the provisions of section 144C of the Act to point out that the DRP is empowered to confirm, reduce or enhance the variation in the draft order and the "variation shall include any matter arising out of the assessment proceedings relating to the draft order notwithstanding that such matter was raised or not by the eligible assessee". Thereupon, the Panel observed that the issue which is the subject matter of the show cause notice has arisen out of the assessment proceedings of the assessee and therefore, it has power to consider the issue which had come to their notice. Thus the objection of the assessee, challenging the jurisdiction of the DRP, was rejected.
18.6. With regard to the sharing of profit between the DRL India and its Swiss A.E. the DRP considered the matter in extenso to hold that the sharing of 50% of profits received from DRL, USA is not on account of any commercial expediency but shifting of profits to lower tax regime. The Panel referred to the 'Tripartite Agreement' by and between 'DRL USA, DRL India and GSK' as well as the date of agreement with DRL Switzerland to highlight that the Switzerland A.E. would not have taken risk on account of litigation between U.S. District Court which was concluded in 2006; the agreement between Swiss A.E. and assessee was entered into on 1st May, 2008.
19ITA.Nos.294/H/2014, 458 & 463/H/2015 Dr. Reddy's Laboratories Limited, Hyderabad.
18.7. Having regard to the detailed reasons given in its report, the Panel concluded that by virtue of share of 25% of profit with Switzerland A.E. the profit which was taxable in India was diverted to Switzerland. In otherwords, the amount diverted to Switzerland is assessable to tax in India.
19. Based on the final report of the DRP, the A.O. completed the assessment by arriving at the total income, after T.P. adjustment, at Rs.287,46,89,931.
20. In so far as the A.Y. 2010-2011 is concerned, this issue was considered by the TPO elaborately based on the information supplied by the assessee. In this regard, he observed that DRL USA was incorporated in Switzerlnad in 2007 to cater to European customers, liaise with major Pharma Innovators situated in Europe. Thus it has no specific competence to bear the risks of so-called "Post Sale Liability"
for a drug to be sold in USA during exclusivity period of six months after the expiry of patented drug. Though it was shown that Swiss AE undertook price fall impact over the years and it also made payments towards developmental and legal charges, the TPO rejected the contention of the assessee on the premise that the claim is not supported by facts; mainly on the ground that the payments are made in 2009 whereas the settlement took place in 2006. The Swiss Company came into existence in 2007 and by then i.e., in 2006 DRL India had already developed generic drug and also entered into an out of Court settlement with GSK along with DRL USA. Under these circumstances, it was concluded that the amount paid by the assessee to its Swiss AE, in the form of profit, from marketing and distribution of Sumatripton generic drug, cannot be allowed as deduction. In otherwords, the amount payable to Swiss AE was determined as NIL and the amount 20 ITA.Nos.294/H/2014, 458 & 463/H/2015 Dr. Reddy's Laboratories Limited, Hyderabad.
already paid by the assessee was treated as excess payment to the A.E. Adjustment was accordingly made. According to the A.O/TPO the share of the tax-payer company should be 60% of the gross profit earned from the marketing and distribution of Sumatripton generic drug.
20.1. The same was objected before the DRP. Since identical issue was considered by the TPO/A.O. in the immediately preceding assessment years, the Panel directed the A.O. to treat only 50% of the share as profit of the assessee-company instead of 60% sought to be adopted by the A.O. 20.2. Further, the claim of the assessee that the payment made to Swiss AE was on account of commercial expediency, was rejected by the Panel.
21. With regard to other issues also DRP adopted the same approach for the A.Y. 2010-2011. Accordingly assessment was completed for the A.Y. 2010-2011 by determining total income at Rs.779.33 crores after T.P. adjustments.
22. Aggrieved by the order of the DRP, Revenue preferred an appeal contending that the DRP erred in law in holding that the profit sharing ratio between DRL India, DRL USA is 50% - 50% overlooking the fact that TPO has made detailed analysis in arriving at the conclusion that the assessee had a major role in development of generic drug and therefore, it is entitled to 60% share of profit. The Revenue also contended that the DRP is not correct in holding that expenditure towards stock based compensation (ESOPs) is Revenue in nature when the Tribunal in the case of Medha Servo Drivers P. Ltd., held that such expenditure is capital in nature.21
ITA.Nos.294/H/2014, 458 & 463/H/2015 Dr. Reddy's Laboratories Limited, Hyderabad.
23. Assessee also preferred appeals for both the years by raising various grounds which are taken-up item-wise.
24. It deserves to be mentioned that the case was heard on day- to-day basis and on the final day the Authorised Representative of assessee as well as Revenue were directed to furnish written submissions which may include the counter arguments to meet the points urged by the other party. On behalf of the assessee 41 pages synopsis, of the arguments, was filed along with two annexures. Similarly, the Ld. CIT-D.R. filed his written submissions running into 40 pages.
25. Ground Nos. 2 to 8 for the A.Y. 2009-2010 and ground Nos. 5 to 11 for the A.Y. 2010-2011 are directed against the issue referable to corporate guarantee provided by assessee company to it's A.Es.
26. The first issue is with regard to the bank guarantee extended by the assessee for a loan availed by Lacock Holdings. According to the tax authorities the ALP of the corporate guarantee should be taken as 0.7% of the value of the loans given by Citi Bank to the assessee's A.E. In the draft order, the A.O. adopted 1.3% as corporate guarantee charges assessable in the hands of the assessee-company whereas the DRP directed the A.O. to limit it to 0.7%. The case of the Revenue is that identical issue was considered in assessee's own case for the A.Y. 2008- 09 wherein the DRP has fixed the corporate guarantee charges at 0.7% on which assessee has not preferred any appeal. It was further contended that the issue of corporate guarantee provided by the assessee, for the purpose of availing loans by the A.E. from Banks, emanated from the A.Y. 2008-09 since the loans were actually availed in the earlier A.Ys. and the guarantee provided was carried forward to the current A.Y. To be precise the Company has not provided any 22 ITA.Nos.294/H/2014, 458 & 463/H/2015 Dr. Reddy's Laboratories Limited, Hyderabad.
corporate guarantee during the financial year relevant to the A.Y. 2009- 2010. It was therefore, contended that the assessee cannot raise same issue in the current year. At any rate, it is not correct on the part of the assessee to raise an additional ground by stating that corporate guarantee is not covered under the definition of "International Transaction", under section 92B of the Act. It was also submitted that it is an international transaction within the meaning of Explanation (c) to Section 92B, introduced by the Finance Act, 2012 with retrospective effect from 01.04.2002. The Explanation merely elaborates the legislative intent to bring into fold the "Corporate Guarantee" as international transaction it is not necessary to incur any expenditure in the year under consideration to treat it as an international transaction. Detailed submissions were made by the D.R. by referring to various case law on this aspect.
27. On the other hand, the Learned Counsel, appearing on behalf of the assessee, submitted that principles of resjudicata are not applicable to income tax proceedings and each year being a separate unit, what is decided in one year need not be applied in the following year. He submits that it is a pure legal issue, on a proper analysis of all the provisions of the Act, which can be raised at any point of time to highlight that the transaction of corporate guarantee cannot be considered as an 'International Transaction' and as a consequence the tax authorities were not justified in making an ALP adjustment. The transaction of corporate guarantee finds a mention in clause (c) of Explanation to Section 92B of the Act but it can be considered as an international transaction only when it has a bearing on profit or loss of the assessee. In the instant case, assessee has not incurred any cost to provide such guarantee and thus it will not have any impact on the profits or costs of the assessee. By providing such guarantee the 23 ITA.Nos.294/H/2014, 458 & 463/H/2015 Dr. Reddy's Laboratories Limited, Hyderabad.
subsidiary can enjoy loan at low interest rates with no cost to the assessee. It was also submitted that the amendment made to Section 92B has no retrospective operation and cannot be applied to the period falling prior to the previous year relevant to the A.Y. 2013-2014. In fact, no new guarantees were provided in this year. Apart from several case law, the Learned Counsel for the Assessee strongly relied upon the decision of the ITAT, Delhi Bench in the case of Bharati Airtel Limited 161 TTJ 428 to submit that even after the amendment in Section 92B a corporate guarantee, for the benefit of the A.Es, which does not involve any costs to the assessee and does not have any bearing on profits, income, loss or assets of the enterprise, would not fall within the ambit of "International Transaction" to which ALP adjustment can be made. In the alternative, it was contended that international bank charges 0.5% which can at best be considered as ALP.
28. The main contention of the assessee is that the case law relied upon by the D.R. did not make any analysis on the issue as to whether corporate guarantee falls under the definition of "International Transaction" or not. No doubt the assessee has not appealed against the DRPs order before ITAT for the A.Y. 2008-09 but it cannot be considered as a covered issue in favour of the Revenue since a legal issue can be raised at any stage, each year being distinct and separate and right of appeal is provided to the assessee for each year independently.
29. We have carefully considered the rival contentions and perused the record. The ITAT, Delhi Bench in the case of Bharati Airtel Ltd., (supra) has considered an identical issue which was re-affirmed in the case of Siro Clinpharma Pvt. Ltd., vs. DCIT (order dated 31st March, 2016). The Bench observed that transfer pricing is a legislation seeking 24 ITA.Nos.294/H/2014, 458 & 463/H/2015 Dr. Reddy's Laboratories Limited, Hyderabad.
the tax-payers to organise their affairs in a manner compliant with the norms set-out. In short, it is an anti abuse legislation which tells you as to what is the acceptable behaviour but it does not trigger levy of tax in a retrospective manner because no party can be asked to do an impossibility. Analysing further the Bench observed that though Explanation to Section 92B is stated to be clarificatory, it has to be necessarily treated as effective from the A.Y. 2013-2014 and in this regard, relied upon the observations of the Hon'ble Delhi High Court in the case of Skies Satellite. We have also analysed the case law relied upon by the Ld. D.R. and also the provisions of the Act. In our considered opinion, the view taken by the Delhi Bench of ITAT in the case of Bharati Airtel Ltd., (supra) is one of the possible views on the matter and so long as there is no binding decision of any other Higher Forum taking a contrary view, the one which is favourable to the assessee has to be adopted even though other Benches have taken a different view. We, therefore, hold that the Explanation to Section 92B cannot be applied retrospectively and for the years under consideration the assessee having not incurred any costs in providing corporate guarantee it would not constitute "International Transaction" within the meaning of Section 92B of the Act and consequently, ALP adjustment is not warranted on this aspect.
30. Since we are of the opinion that it falls outside the ambit of "International Transaction" the alternative contention urged before us need not be taken into consideration. Suffice to say, that each year being independent, merely because the assessee has accepted in the earlier year it would not come in the way of the assessee to urge the same issue in a subsequent year.
25ITA.Nos.294/H/2014, 458 & 463/H/2015 Dr. Reddy's Laboratories Limited, Hyderabad.
31. The next issue is with regard to the attribution of additional interest on loans given to A.Es. This issue is raised vide ground Nos. 9 to 12 for the A.Y. 2009-2010 and ground Nos. 1 to 4 in the A.Y. 2010- 2011. In so far as A.Y. 2009-2010 is concerned, ALP adjustments are only with reference to inter-corporate loans to it's A.E. namely Lacock Holdings, Cyprus and Falcon Mexico wherein the interest was charged by the assessee at 5% and 9.5% respectively. The TPO benchmarked interest rates at 6.5% and 12% by taking into account Euribor rate + 2.5% and Mexican rates respectively. The loans advanced, interest charged from A.Es as well as rate adopted by DRP are tabulated below:
A.Y. 2009-2010 Name of Interest ALP interest Differential DRP ruling borrower charged by determined by interest (Rs.) (AE) appellant TPO (%) (%) Lacock 5% 6.5% 4,71,26,437 Confirmed Holdings, (EURIBOR+2.5%) TPO's ALP Cyprus Falcon, 9.5% (MXN 12% 3,40,04,535 Confirmed Mexico TIIE 28d TPO's ALP plus 1.5%) Total 8,11,30,972 A.Y. 2010-2011 Name of Interest ALP interest Differential DRP ruling borrower (AE) charged by determined interest (Rs.) appellant (%) by TPO (%) Lacock 4.57% 7% EURIBOR 8,26,24,373 Confirmed Holdings, + 200 BPS TPO's ALP Cyprus DRL Swiss 1.3% 7% 9,45,98,323 Confirmed LIBOR + 200 TPO's ALP BPS DRL Brazil 1.64% 7% LIBOR + 3,61,20,148 Confirmed 200 BPS TPO's ALP Total 21,33,42,845 26 ITA.Nos.294/H/2014, 458 & 463/H/2015 Dr. Reddy's Laboratories Limited, Hyderabad.
31.1. Before us, the Learned Counsel for the Assessee contends that as per the decision of the ITAT, Hyderabad Bench in the case of Four Soft Limited 164 TTJ 561 whenever a loan was given in foreign currency LIBOR interest rate should be considered for benchmarking the interest and not local interest rates of the respective countries. Reliance was placed upon the decision of the Coordinate Bench in assessee's own case for the A.Y. 2006-07 (ITA.No.1605/Hyd/2010 read with M.A.No.217/H/13) wherein the Tribunal accepted LIBOR+ 2% as the comparable rate for benchmarking the interest. The DRP for the A.Y. 2008-2009 has accepted LIBOR+ 2% as ALP.
32. On the other hand, the Ld. D.R. submitted that in assessee's own case for the A.Y. 2008-2009, the Tribunal directed the TPO/A.O. to adopt LIBOR+ 2% or 7% whichever is higher as the ALP interest and thus the interest rate adopted by the TPO at 6.5% in respect of Lacock Holdings, Cyprus is reasonable. As far as the interest charge at 12% on the loan advanced to Falcon Mexico, it was submitted that assessee itself has charged interest at 9.5% and therefore, it cannot raise a ground to reduce it to LIBOR+2% rate. It was also submitted that the adoption of 12% rate on loan to the Mexican A.E. is proper since prime lending rate prevalent in Mexico was taken into consideration. Similarly for A.Y. 2010-2011 TPO was of the opinion that PLR is not a correct tool for calculating interest and assessee should have charged interest on the basis of rate of interest received on deposits made with Banks and public companies. It was also stated that in assessee's own case for the A.Y. 2006-07 the ITAT held, following the decision in the tax-payers case for the A.Y. 2004-2005, that 7% p.a. is an appropriate ALP. Thus the A.O. adopted 7% in this year also. Reliance was placed upon several decisions on this aspect.
27ITA.Nos.294/H/2014, 458 & 463/H/2015 Dr. Reddy's Laboratories Limited, Hyderabad.
33. Joining the issue, the Learned Counsel for the Assessee submitted that DRP has erroneously mentioned that the ITAT, Hyderabad Bench has held that respective countries foreign currency lending rate should be considered instead of LIBOR. It was strongly contended that LIBOR is a comparable rate for benchmarking interest and not local interest rates in the respective countries. It was also contended that for the A.Y. 2006-2007 the Tribunal, in principle, accepted LIBOR + 200 basis points which works-out to 7% in that year and therefore, it was accepted by the assessee. For the A.Y. 2007-08 though LIBOR + 2% is accepted as ALP, it was wrongly mentioned that LIBOR + 2% or 7%, whichever is higher, to be considered, while following the order of the Tribunal in the assessee's own case for the earlier year. It was also submitted that the assessee is in the process of filing M.A. against the ITAT order for the A.Y. 2007-08. Even otherwise various Benches of the Tribunal consistently held that for benchmarking ALP LIBOR + 2% should be adopted. Reliance was also placed upon the decision of the ITAT, Chennai Bench in the case of Siva Industries Ltd., 145 TTJ 497 and also the decision of the Tribunal in Northgate Technologies Ltd., vs. DCIT (2014) 148 ITD 433 Hyd); in both the cases the matter was remitted to the file of the A.O. to verify the actual average LIBOR prevailing in the financial year relevant to the assessment year under consideration.
34. The case of the Revenue on the other hand was that the assessee having accepted 7% in the earlier years, it cannot now claim that the rate of interest charged by the assessee, which is below 7% is appropriate. It was further submitted that the assessee has charged higher rate in the case of Falcon Mexico which shows that the LIBOR + 2% rate is not an appropriate method for benchmarking. Further, the TPO/A.O. was justified in taking into consideration prime lending rate 28 ITA.Nos.294/H/2014, 458 & 463/H/2015 Dr. Reddy's Laboratories Limited, Hyderabad.
prevalent in the respective countries. Reliance was placed upon the following decisions :
1. Cheil India (P) Ltd., vs. DCIT (2014) 46 Taxmann.com 90 (Del.) (Tribu.)
2. Mylan Laboratories Ltd., vs. ACIT (2015) 63 Taxmann.com 179 (Hyd.) (Tribu.)
3. Tricom India Ltd., vs. ITO (2014) 51 Taxmann.com 405 (Mum.) (Tribu.)
35. The case of the assessee on the other hand was that the decision in the case of Cheil India (P) Ltd., (supra) is with regard to levy of interest where there is delay in receiving inter-company receivables. Thus, there is no comparison between the facts pertaining to Cheil India (P) Ltd., (supra) and the assessee. Similarly, in the case of Mylan Laboratories Ltd., (supra) assessee was ready to accept adjustments at LIBOR + 2%/Euribar + 2% since no interest was charged in the books of account whereas in the assessee's case it has been charging interest on loans on regular basis and it was the consistent stand that LIBOR + 2% should be considered as ALP.
36. We have carefully considered the rival submissions and perused the material on record. The principle that emerges from the decisions cited by the Learned Counsel for the Assessee particularly in assessee's own case for the earlier years, show that benchmarking of ALP should be LIBOR + 200 basis points and TPO should not determine the ALP by taking into consideration the market rate prevailing in the respective countries. Even for A.Y. 2008-2009, the Hyderabad Bench accepted in principle that LIBOR + 200 basis points can be adopted as ALP. Under these circumstances, we set aside the matter to the file of the A.O. who is directed to adopt the LIBOR rate applicable for the years 29 ITA.Nos.294/H/2014, 458 & 463/H/2015 Dr. Reddy's Laboratories Limited, Hyderabad.
under consideration + 200 basis points to arrive at the ALP. This issue is disposed of accordingly.
37. Ground No.21 for the A.Y. 2009-2010 is with regard to allowability of claim of depreciation on goodwill. Brief facts are that American Remedies Ltd., got merged with the assessee w.e.f. 01.04.1999. Upon merger the difference between the consideration and the net worth was considered as goodwill and depreciation was claimed on such goodwill. A.O. disallowed the claim on the ground that it is not an intangible asset. This view was confirmed by the DRP. It is not in dispute that this very issue was considered by the ITAT in assessee's own case for the A.Y. 2007-08 (ITA.No.229/Hyd/2011 and ITA.No.84/Hyd/2013 dated 02.01.2017) wherein the Bench allowed the plea of the assessee by observing as under :
"40. Having regard to the rival contentions and the material on record and respectfully following the decision of the Hon'ble Supreme Court in the case of CIT vs. Swifs Securities Ltd., (supra), we direct the A.O. to allow depreciation on goodwill. Accordingly, ground Nos. 7 to 7.2 are allowed whereas ground No.7.3 is rejected."
38. Consistent with the view taken therein, we direct the A.O. to allow depreciation on goodwill.
39. Vide ground Nos. 22 for the A.Y. 2009-2010 and ground No.16 for the A.Y. 2010-2011, the assessee contends that the treatment of repairs and maintenance expenditure as capital expenditure is not in accordance with law. During the course of hearing, Learned Counsel for the Assessee submitted that assessee-company is not interested in pressing this ground as the A.O. has allowed depreciation apart from the fact that in assessee's own case for the A.Y. 2007-08 this issue was decided and it was treated as capital expenditure. Under the 30 ITA.Nos.294/H/2014, 458 & 463/H/2015 Dr. Reddy's Laboratories Limited, Hyderabad.
circumstances, grounds urged by the assessee for both the years are dismissed.
40. Vide ground No.23 for the A.Y. 2009-2010 and ground No.17 for the A.Y. 2010-2011 the assessee challenges the order of the A.O. with regard to disallowance of expenditure incurred towards travel, stay, participation fee in the pharmaceutical conferences etc., The case of the assessee was that the expenditure was incurred during the conference of the Doctors which is necessary to improve the knowledge of the Doctors on the latest development in medicine field, therapeutics areas etc., which benefits the business of the assessee company. The submission of the assessee company is that Doctors are the backbone of the medicine world who spread/awareness about the latest, molecures in the medicinal field. Thus the participation of the Doctors in conference is for bonafide business purposes and therefore, the expenditure incurred towards such meetings is wholly and exclusively for the purpose of business which should be allowed as deduction under section 37 of the I.T. Act.
41. The case of the Revenue, on the other hand, was that sponsorship of meetings of Doctors, gifts to doctors and other guests is unrelated to the business of assessee and an identical issue was considered by the Tribunal in the A.Y. 2007-08 wherein the Bench observed that the expenditure falls within the proviso to Section 37. Since the expenditure was not allowed in the immediately preceding year, the Ld. D.R. contended that even for this year the facts being same, it cannot be allowed as deduction. Ld. D.R. adverted our attention to the decision of ITAT, Mumbai Bench in the case of ACIT vs. Liva Health Care 161 ITD 63 wherein it was held that expenditure incurred by a pharmaceutical company on overseas tours of Doctors to increase their sales and profitability was not an allowable expenditure inasmuch 31 ITA.Nos.294/H/2014, 458 & 463/H/2015 Dr. Reddy's Laboratories Limited, Hyderabad.
as overseas trips were directed towards leisure and entertainment of Doctors and their spouses rather than focussing on the product information dissemination. Ld. D.R. relied upon the Circular issued by the CBDT (No.5/2012 dated 01.08.2012) to submit that any freebies provided by Health Sector Industries to medical practitioners is in violation of the Regulations issued by Medical Council of India falling within the ambit of Explanation-1 to Section 37(1) of the Act. The said Circular refers to the prohibition imposed on the medical practitioners from taking any gift, travel facility, hospitality, cash or monetary grant from the pharmaceutical and allied Health Care Industries.
42. Learned CIT (DR) submits that the validity of the CBDT circular was subject matter of challenge before the Hon'ble High Court of Himachal Pradesh in a writ petition filed by Confederation of Pharmaceutical Industry wherein it was held that the Circular issued by the Board is valid and disallowance can be made for violation of Circular issued by Indian Medical Council. He has also relied upon the following decisions.
(1) CIT vs. KAP Scan and Diagnostic Centre Pvt. Ltd., 25 taxmann.com 92 (P & H) (HC) (2) CIT vs. Pt. Viswanath Sharma 182 taxman 63 (All.) (HC).
42.1. The case of the Learned Counsel for the Assessee, on the other hand, is that the issue is squarely covered in favour of the assessee in assessee's own case for the A.Ys. 2007-08 and 2008-09 wherein the Tribunal remitted the issue to the file of the A.O. with a direction to verify the nature of expenditure and disallow only such expenditure which is not incurred for the purpose of business. Learned Counsel for the Assessee relied upon the decision of the ITAT, Mumbai Bench in the case of DCIT vs. PHL Pharma P. Ltd., 32 ITA.Nos.294/H/2014, 458 & 463/H/2015 Dr. Reddy's Laboratories Limited, Hyderabad.
(ITA.No.4605/Mum/2014 dated 12.01.,2017) wherein reference was made to the decisions of Liva Health Care as well as the decision rendered by Hon'ble Himachal Pradesh High Court (supra) and distinguished those case law on the ground that the payments therein are genuinely opposed to public policy and such payments should be discouraged as it is not a fair practice. Elaborating further the Bench observed that physicians samples are necessary to ascertain the efficacy of the medicine and introducing it in the market for circulation and for such purpose, a conference of Doctors may be necessary. No doubt, that any claim of expenditure towards gift, hospitality etc., is in violation of the Indian Medical Council Regulations, 2002 but, in the instant case, there is no infraction of any law. It was also contended that the code of ethics issued by Medical Council of India are applicable to the Medical Practitioners/Doctors and not the pharmaceutical companies. It was also contended that the CBDT issued circular on 1st August, 2012 which cannot be applied retrospectively. It was clarified by the ITAT in PHL Pharma (supra) that CBDT circular which creates new impairment and impose disallowability not envisaged in any of the Act or Regulation cannot be reckoned to be retrospective.
43. We have carefully considered the rival contentions and perused the material on record. An identical issue has come-up before the ITAT in assessee's own case for the A.Y. 2008-09 wherein the Bench set aside the issue to the file of the A.O. by observing as under :
"53. Respectfully following the same, we set aside the issue to the file of the A.O. with a similar direction to verify the nature of the expenditure and disallow only such expenditure which is not incurred for the business purposes of the assessee. This ground is accordingly treated as allowed for statistical purposes."33
ITA.Nos.294/H/2014, 458 & 463/H/2015 Dr. Reddy's Laboratories Limited, Hyderabad.
43.1. The facts and circumstances being identical, we hereby direct the A.O. to verify the nature of the expenditure and disallow only such expenditure which was not incurred for the purpose of business of the assessee. This ground is accordingly treated as allowed for statistical purposes.
44. The next issue is with regard to the allocation of corporate overheads expenses to tax holiday units (Ground No.24 in A.Y. 2009- 2010 and Ground No.18 in A.Y. 2010-2011).
45. Facts in brief are as follows. During the year under consideration assessee claimed certain amount of exemption under section 10B of the Act on the eligible undertaking. A.O. allocated the corporate overheads on adhoc basis to undertaking claiming exemption under section 10B and thereby, reduced the amount of exemption available. It is not in dispute that only the profits and gains "derived" from "undertaking" is eligible for deduction., According to the assessee section 10B unit is independently functional with separate/identified set of employees and hence the expenditure which is not directly related to the undertaking should not be allocated to such undertaking on adhoc basis. The A.O. observed that for the A.Y. 2003-04 the ITAT upheld the apportionment of corporate overheads since the overhead expenditure incurred in corporate office cannot be viewed in isolation of the special units. Instead of incurring such overheads in each of the special units, the assessee, through the establishment of corporate office, incurred the expenditure centrally. Therefore, the allocation of corporate overheads has to be made for determining the correct income of the eligible units. Accordingly, eligible deduction was re-worked out.
46. Ld. D.R. on the other hand submits that this issue was considered in assessee's own case for the A.Y. 2007-08 and the Tribunal 34 ITA.Nos.294/H/2014, 458 & 463/H/2015 Dr. Reddy's Laboratories Limited, Hyderabad.
held that in the absence of identifying expenditure of export division, there is no basis other than allocating the total indirect cost on the basis of the turnover and accordingly directed the A.O. to apportion the expenditure on the basis of turnover of various units. The ITAT has considered the matter again for the A.Y. 2006-07 wherein the A.O. was directed to apportion the expenditure on the basis of turnover of various units. A Miscellaneous Petition was filed by the assessee against the order of the ITAT for the A.Y. 2006-07 on the issue of apportionment of corporate/head office expenses but the same was dismissed; which implies that the head office expenditure should be allocated amongst all the units based on the turnover of respective units.
47. Notwithstanding the above, the Ld. D.R. made the following further submissions.
"As per the provisions of Income Tax Act, tax holiday undertakings are required to maintain separate books of account. The cost directly attributable to individual undertakings are assigned / charged to such undertakings. However, there are certain common head office expenses which would benefit all the units of the assessee in general. These expenses could be in the nature of general administration expenses such as travelling and conveyance expenses, marketing and selling expenses, legal and professional expenses, accounting and finance expenses, internet and communication expenses, research and development expenses etc. Under the circumstances, in order to arrive at the correct amount of profits eligible for tax exemption, it is important to consider method of allocation of such head office expenses against tax holiday units. While doing so,
a) All common expenses are to be allocated on a reasonable and scientific basis i.e. turnover. head count etc.;
b) Even if the expenses are in the nature of interest & finance charges, human resources expenses which do not directly relate to tax holiday units, they should be reasonably allocated to the tax holiday undertakings on the premise that the head office does not exist for its own sake, but its existence is relevant for all activities undertaken by various units/profit centers; and 35 ITA.Nos.294/H/2014, 458 & 463/H/2015 Dr. Reddy's Laboratories Limited, Hyderabad.
c) Non-allocation of common head office expenses might lead to inflation of profits of tax holiday undertakings and consequent excess claim of tax exemption and deflation of income in the hands of head office, leading to erosion of domestic tax base.
In this regard, reliance is placed on the following decisions as detailed below :
a. Controla & Switchgear Co. Ltd. Vs . DClT in ITA No.1155/2011 dated 14.11.2011 (Del.HC) b. Prestige Foods Ltd., vs. CIT (2012) 81 CCH 31 (MP)"
48. Learned Counsel for the Assessee on the other hand submitted that identical issue was set aside to A.O. for allocation of corporate overheads on the basis of turnover of eligible units and requested for similar direction even in this year. Without prejudice, it was also contended that only the net expenditure of corporate entity (i.e., corporate overhead (-) income) should only be allocated amongst all the units based on the turnover.
49. We have considered the rival contentions and perused the record. In assessee's own case for the A.Ys. 2007-08 and 2008-09 (supra), the Tribunal vide para 64 set aside the matter with the following observations :
"64. The Learned Counsel for the Assessee submitted that it is only the net expenditure and not the gross expenditure which should be allocated amongst all the Units. We agree with the contention of the assessee and direct the A.O. to allocate the only net expenditure of the corporate entity amongst all the units on the basis of the turnover. Thus, the alternate contention of the assessee is allowed."
50. Facts being identical in this year also, we direct the A.O. to allocate net expenditure of the corporate entity amongst all the units on the basis of turnover. This ground is disposed of accordingly.
36ITA.Nos.294/H/2014, 458 & 463/H/2015 Dr. Reddy's Laboratories Limited, Hyderabad.
ISSUE ON PROFIT SHARE TO DRL SWISS :
51. Ground Nos. 13 to 20, 25 and 26 for the A.Y. 2009-2010 and ground Nos. 12 to 15 for the A.Y. 2010-2011 and ground No.2 in the appeal filed by Revenue are directed against the issue of profit sharing between DRL Swiss and DRL India. We have already set-out the facts culminating into disallowance made by the A.O. and the view taken by the DRP. Both Assessee as well as Revenue filed detailed written submissions on this aspect. For the sake of convenience, we extract the detailed written submissions filed by Learned Counsel for the Assessee as well as Ld. CIT-D.R. as under :
Submissions of Learned Counsel for the Assessee :
Background:-
1. Dr. Reddy's Laboratories Limited ('DRL India' or 'Appellant') is engaged in the manufacturing and trading of pharmaceutical products mainly generic drugs. Generic drugs are finished pharmaceutical products which are ready for consumption by the patient. These drugs are required to meet the United States Food and Drug Administration (U.S. FDA) standards for selling the product in USA. All the manufactures that sell products in United States are subjected to extensive regulation by U.S. Federal Government and U.S. FDA.
2. DRL India filed an Abbreviated New Drug Application ('ANDA') for the drug namely "Sumatriptan" (which is used in the treatment of migraine headaches) before the U.S. FDA for selling the drug in United States. Subsequently, DRL India has got approval to manufacture the developed product in India and sell product in USA.
3. However, GlaxoSmithKline (GSK) is already having patent rights as original Innovator for similar kind of product and marketing the drug under the brand name 'Imitrex' in USA.
4. As the patent period has not expired, GSK has filed a patent infringement petition against DRL India before the US Federal Courts. Subsequently, GSK and DRL India and its group have entered into a settlement agreement to settle matter out of Court to 37 ITA.Nos.294/H/2014, 458 & 463/H/2015 Dr. Reddy's Laboratories Limited, Hyderabad.
avoid litigation in USA vide agreement dated 5 October 2006 (Please refer Page No.622 to 650 of Paper Book Volume - II).
5. As per the settlement agreement, GSK, DRL India and Dr. Reddy's Laboratories Inc., US (DRL US) entered into supply and distribution agreement of the drug "Sumatriptan" (Please refer Page NO.651 to 723 of Paper Book Volume - II). Pursuant to this agreement GSK authorized DRL US to launch the product as an authorized generic agent during the unexpired patent period.
6. Pursuant to the court settlement GSK will exclusively manufacture the drug for DRL India. Further, DRL India is required to undertake the product liability insurance for not less than USD 25 million and price fall risk as per the settlement agreement.
7. As DRL India does not have marketing network in USA, DRL India entered into agreement with DRL US which is having a strong distribution network in United States as Distributor, which in turn markets the product manufactured by GSK in United States (Please refer Page NO.724 to 727 of Paper Book Volume - II). As per the said agreement, DRL US retain 50% of the profits earned on marking the product in USA and the balance 50% profit would be transferred to DRL India as a compensation for losing the manufacturing facility of the drug developed by DRL India, which would have been otherwise manufactured by DRL India.
8. Further DRL India has approached DRL Swiss to take product liability insurance and shelf-stock adjustment risk (i.e. risk of price fall after completion of exclusive period) because of its inability to take insurance from Indian Insurance Companies for an amount of USD 25 Million and entered into agreement with DRL Swiss (Please refer Page NO.728 to 730 of Paper Book Volume - II). As against this agreement, DRL India paid compensation of 25% of the profits to DRL Swiss for undertaking the Insurance for product liability and shelf-stock adjustments ('SSA') risk. The details of profits earned and SSA during the period under consideration i.e. AY 2009-10 and AY 2010-11 are given below:-
Profit Statement for A.Y. 2009-2010 (Rupees in Cr.) Particulars Total profit share DRL US DRL India DRL Swiss earned share share share Profit share before price fall adjustment 636 318 159 159 Price fall adjustment (SSA) - - - -
Total 636 318 159 159 38 ITA.Nos.294/H/2014, 458 & 463/H/2015 Dr. Reddy's Laboratories Limited, Hyderabad. Profit Statement for A.Y. 2010-2011 (Rupee in Cr.) Particulars Total profit share DRL US DRL India DRL Swiss earned share share share Profit share before price fall adjustment 260 130 65 65 Price fall adjustment (SSA) (114) (57) - (57) Total 146 73 65 8
9. During the Assessment Proceedings u/s 143(3) for the AY 2009-10, the Assessing Officer ('AO') has not questioned the transaction of profit share transferred to DRL Swiss. However, the AO has requested the DRP vide a letter 16/09/2013 to Disputes Resolution Panel ('DRP') requiring the DRP to look back into the transaction again (please refer para 14.0 of DRP order). Accordingly, DRP issued a show cause notice u/s 37(1) (sic.) of the Income-tax Act, 1961 ('the Act') and made an addition of ₹ 159 crores towards disallowance u/s 92CA and u/s 37(1) of the Act on the amounts transferred to DRL Swiss.
Our Submissions
10. The Appellant submits that as per the agreement between DRL India, DRL US and GSK provides for product liability insurance (means an insurance that indemnifies the Manufacturer, Distributors against third party liability arising out of the sale of products) for a minimum sum assured of USD 25 million is undertaken by DRL Group and GSK will not be responsible for any product liability claims except for manufacturing defects.
11. The Appellant submits that the risk of SSA (means the price fall risk after the exclusive period) will be equally undertaken by DRL US and DRL Swiss.
12. The Appellant submits that as per para 1, & 2 of agreement between the DRL India and DRL Swiss, the product liability claim is to be undertaken by DRL Swiss (refer page 728 of Paper book Volume -II). Product liability claim is the claim arising from a third party on manufactures or distributors on selling of products by which any loss is incurred to the consumer. To mitigate the risk the companies will take product liability insurance, wherein the insurer will indemnify the policy holder against third party liability arising out of the sale of products.
13. DRL Swiss paid an amount $ 2.2 million towards 50% of legal and development cost incurred by DRL India. DRL Swiss 39 ITA.Nos.294/H/2014, 458 & 463/H/2015 Dr. Reddy's Laboratories Limited, Hyderabad.
undertook the liability of SSA and product liability. It has borne SSA to the extent of $ 13 million towards SSA.
14. As per the settlement agreement, DRL group should take product liability insurance for a minimum sum assured of USD 25 million.
15. In this regard, the Appellant submits that undertaking of product liability insurance with an Indian Insurance Company for a product to be sold in USA is not possible as the insurance amount is USD 25 million. Further, as per the FEMA Regulations no persons resident in India shall take any general policy issued by Insurer outside India without specific approval from Central Government.
16. Therefore, the Appellant submits that as there is no Insurer available in India for undertaking an insurance for a sum insured of USD 25 million, DRL India has entered into an agreement with DRL Swiss, wherein DRL Swiss will undertake the product liability insurance. Further, DRL Swiss will also undertake the SSA risk of 50%. To compensate the risk and costs undertaken by DRL Swiss, the profits received from DRL US will be shared between DRL India and DRL Swiss in the ratio of 50:50.
Technical issues (applicable only for A.Y. 2009-2010)
17. The Appellant submits that the DRP has no power to enhance the income or reduce the loss of the Appellant at the behest of AO during the DRP proceedings.
18. In this regard, we draw yours Honour's kind attention to section 144C of the Act which is reproduced below:-
"144C. (1) The Assessing Officer shall, notwithstanding anything to the contrary contained in this Act, in the first instance, forward a draft of the proposed order of assessment (hereafter in this section referred to as the draft order) to the eligible assessee if he proposes to make, on or after the 1st day of October, 2009, any variation in the income or loss returned which is prejudicial to the interest of such assessee.
(2) .....
(3) .....
(4) .......
(5) The Dispute Resolution Panel shall, in a case where any objection is received under sub-section (2), issue such directions, as it thinks fit, for the guidance of the Assessing Officer to enable him to complete the assessment.
(6) The Dispute Resolution Panel shall issue the directions referred to in sub-section (5) after considering the following, namely:--
(a) draft order;40
ITA.Nos.294/H/2014, 458 & 463/H/2015 Dr. Reddy's Laboratories Limited, Hyderabad.
(b) objections filed by the assessee;
(c) evidence furnished by the assessee;
(d) report, if any, of the Assessing Officer, Valuation Officer or Transfer Pricing Officer or any other authority;
(e) records relating to the draft order;
(f) evidence collected by, or caused to be collected by, it; and
(g) result of any enquiry made by, or caused to be made by, it.
(7) The Dispute Resolution Panel may, before issuing any directions referred to in sub-section (5),--
(a) make such further enquiry, as it thinks fit; or
(b) cause any further enquiry to be made by any income-tax authority and report the result of the same to it.
(8) The Dispute Resolution Panel may confirm, reduce or enhance the variations proposed in the draft order so, however, that it shall not set aside any proposed variation or issue any direction under sub-section (5) for further enquiry and passing of the assessment order.
Explanation.--For the removal of doubts, it is hereby declared that the power of the Dispute Resolution Panel to enhance the variation shall include and shall be deemed always to have included the power to consider any matter arising out of the assessment proceedings relating to the draft order, notwithstanding that such matter was raised or not by the eligible assessee."
19. We submit that Section 144C of the Act specifies that the DRP can only give directions for confirming/enhancing/reducing the disallowances proposed in the draft assessment order by the AO after considering the objections raised, documents filed and reports obtained from the experts. However, in the present case the DRP has disallowed on its own on the issue which are not subject matter of draft assessment order and that too on the request of the AO.
20. In this regard, we place reliance on the Mumbai Tribunal Judgement in the case of Dredging International NV vs ADIT(Intl. Tax), 1(2), Mumbai. In the said judgement, the Hon'ble Tribunal has held "applying the principles laid down by the Karnataka High Court in the case of M/S GE India Technology Centre Pvt. Ltd. (Writ Appeal No. 1010 of 2011, dated 5th July 2011), it is clear that in the proposed draft order vide objection No. 2, the variation proposed was only with reference to disallowance of future losses claimed whereas the DRP suo moto considered 20% of the total contract as completed during the year (which is in fact was not correct as assessee 41 ITA.Nos.294/H/2014, 458 & 463/H/2015 Dr. Reddy's Laboratories Limited, Hyderabad.
has offered more turnover in its books of account) and proposed bringing to tax the net profit at 8% of the above determined turnover. This direction of the DRP is wholly without jurisdiction and suffers from inherent lack of jurisdiction as it is not in conformity with the powers under section 144C(5) r.w.s. 144C(8). Therefore assessee's ground No. 1 is to be upheld as the DRP has varied from the proposed draft order and took up a new issue and issued directions which are at variance with the proposed draft order. In view of this, ground No. 1 raised by assessee is upheld. Consequently ground No. 2, 3 & 4 which are raised as alternate grounds without prejudice, are also deemed to have been allowed".
21. We pray before your Honours that in the present case, the issue relating to profit share to DRL Swiss was not discussed in the draft assessment order and therefore, the DRP has no jurisdiction to consider the new issue. Further, we submit that if the DRP allows AO, then there would be no end to the assessment proceedings which was not the intention of the DRP.
22. The Appellant submits before your Honour that in the present case the DRP has issued notice under section 37(1) of the Act for disallowing profit share to DRL Swiss, but they have disallowed under section 92CA of the Act.
23. Section 92CA(1) of the Act provides as under:-
"Where any person, being the assessee, has entered into an international transaction or specified domestic transaction in any previous year, and the Assessing Officer considers it necessary or expedient so to do, he may, with the previous approval of the [Principal Commissioner or] Commissioner, refer the computation of the arm's length price in relation to the said international transaction or specified domestic transaction under section 92C to the Transfer Pricing Officer."
24. The Appellant submits that on a perusal of section 92CA(1) of the Act it is clear that the power to determine Arm's Length Price ('ALP') in an international transactions is vested with Transfer Pricing Officer ('TPO') only and not with DRP. The DRP has not referred the matter to TPO as per section 92CA(1) of the Act for determining the ALP of the transactions, but they have done suo motto.
25. In this regard, we draw your Honours kind attention to Instruction No.3/ 2003 dated 20.05.2003 issued by the Central Board of Direct 42 ITA.Nos.294/H/2014, 458 & 463/H/2015 Dr. Reddy's Laboratories Limited, Hyderabad.
Taxes [reported in 261 ITR 51 (St.)] and the relevant extracts of the said instruction are given below:
(i)The power to determine arm's length price in an international transaction is contained in sub-section (3) of section 92C. owever, section 92CA provides that where the Assessing Officer considers it necessary or expedient so to do, he may refer the computation of arm's length price in relation to an international transaction to the TPO.
Sub-section (3) of section 92CA provides that the TPO after taking into account the material available with him shall, by an order in writing, determine the arm's length price in accordance with sub-section (3) of section 92C.
26. Therefore, the Appellant submit that as in the present the DRP has not referred the international transaction to TPO, the determination of ALP is without jurisdiction.
27. Without prejudice to the above, we submit before your Honours that even if the DRP has jurisdiction to consider the new issues, then the ALP for the said transaction determined by the DRP should not be 'Nil'. In this regard, we rely on the following jurisdictional judgements.
• Kirby Building Systems India Ltd. Vs. Addl. CIT, Range -8, Hyd.
[(ITA No.1651/Hyd/2010 (AY 2006-07) and ITAT No.1975/Hyd./2011 (AY 2007-08)] • IWM construction (P) Ltd. Vs. ACIT, Circle-2(1), Range-2, Hyd. [2016] 72 taxmann.com 104 (Hyderabad - Trib.) We pray before your Honours that the ALP of the said transaction should not be determined as 'Nil'.
28. The Appellant submits before your Honour that in the present case the DRP has issued notice under section 37(1) of the Act for disallowing profit share to DRL Swiss.
29. The Appellant submits that the AO cannot decide how much is the reasonable expenditure under section 37(1) of the Act. In this regard, we place reliance on the following judgments:
In the case of S.A. Builders Ltd. Vs. CIT(A), Chandigarh [2007] 288 ITR 1 (SC), the Hon'ble Supreme Court held that at para no.34 as under:
"We agree with the view taken by the Delhi High Court in CIT v. Dalmia Cement (Bharat) Ltd. [2002] 254 ITR 377 that once it is established that there was nexus between the expenditure and the purpose of the business 43 ITA.Nos.294/H/2014, 458 & 463/H/2015 Dr. Reddy's Laboratories Limited, Hyderabad.
(which need not necessarily be the business of the assessee itself), the Revenue cannot justifiably claim to put itself in the arm-chair of the businessman or in the position of the board of directors and assume the role to decide how much is reasonable expenditure having regard to the circumstances of the case. No businessman can be compelled to maximize its profit. The income tax authorities must put themselves in the shoes of the assessee and see how a prudent businessman would act. The authorities must not look at the matter from their own view point but that of a prudent businessman. As already stated above, we have to see the transfer of the borrowed funds to a sister concern from the point of view of commercial expediency and not from the point of view whether the amount was advanced for earning profits."
In the case of CIT Vs. Dalmia Cement (P.) Ltd [2002] 254 ITR 377 (Delhi), the Hon'ble High Court of Delhi held that at para no. 7 as under:
"It is to be noted that, in the present case, the question that has been raised by the revenue is not one relating to the expenditure being not for the purposes of the business. It is the question of an appropriate amount which would have been paid as commission. In fact, the Assessing Officer himself has allowed to the extent of Rs. 4,35,854 holding, inter alia, "the payment of Rs. 1.75 per M.T. to Cement Distributors Ltd. is very much on the excessive side". This in our view was impermissible within the framework of section 37. The jurisdiction of the revenue is confined to deciding reality of the expenditure, namely, whether the amount claimed as deduction was factually expended or laid down and whether it was wholly and exclusively for the purpose of the business. The reasonableness of the expenditure could be gone into only for the purpose of determining whether, in fact, the amount was spent. Once it is established that there was a nexus between the expenditure and the purpose of business, the revenue cannot justifiably claim to put itself in the armchair of a businessman or in the position of the board of directors and assume the said role to decide how much is a reasonable expenditure having regard to the circumstances of the case. We need not go into any hypothetical issue in this case in view of the accepted position that the factum of services rendered by CDL has not been refuted by the revenue. It needs no reiteration that the settled position in law is that no businessman can be compelled to maximise his profits. The obvious answer to the first question is in the affirmative, in favour of the assessee and against the revenue."
Further, the above view has been upheld by Hon'ble Supreme Court in the case of S.A. Builders (Supra).
In the case of Hero Cycles Private Limited Vs. CIT [2015] 379 ITR 347 (SC), the Hon'ble Supreme Court held in para no. 13 & 14 as follows:-
"13. In the process, the Court also agreed that the view taken by the Delhi High Court in CIT v. Dalmia Cement (P.) Ltd. [2002] 254 ITR 377/121 Taxman 706 wherein the High Court had held that once it is established that there is nexus between the expenditure and the 44 ITA.Nos.294/H/2014, 458 & 463/H/2015 Dr. Reddy's Laboratories Limited, Hyderabad.
purpose of business (which need not necessarily be the business of the assessee itself), the Revenue cannot justifiably claim to put itself in the arm-chair of the businessman or in the position of the Board of Directors and assume the role to decide how much is reasonable expenditure having regard to the circumstances of the case. It further held that no businessman can be compelled to maximize his profit and that the income tax authorities must put themselves in the shoes of the assessee and see how a prudent businessman would act. The authorities must not look at the matter from their own view point but that of a prudent businessman.
14. Applying the aforesaid ratio to the facts of this case as already noted above, it is manifest that the advance to M/s. Hero Fibres Limited became imperative as a business expediency in view of the undertaking given to the financial institutions by the assessee to the effect that it would provide additional margin to M/s. Hero Fibres Limited to meet the working capital for meeting any cash loses."
30. In the present case the DRP has disallowed profit share to DRL Swiss on the ground disqualification as an 'expenditure' u/s 37(1) of the Act is not sustainable.
31. We also submit that DRL India does not have marketing network in USA, DRL India entered into agreement with DRL US which is having a strong distribution network in United States as Distributor, which in turn markets the product manufacture by GSK in United States. As per the said agreement, DRL US retain 50% of the profits earned on marking the product in USA and the balance 50% profit would be transferred to DRL India as a compensation for losing the manufacturing facility of the drug developed by DRL India, which would have been otherwise manufactured by DRL India.
32. It is to be noted that the entire functions and operations during the "exclusivity period", Viz- the ANDA filing, Para IV challenge, Patent Infringement, Settlement with Innovator, Manufacture of the product, purchase of product, logistics relating to the product, warehousing/storage of product, inventory channel relating to the product, marketing of the product, the field force relating to marketing of the product, sale of the product, consumers (institutional or otherwise) of the product and replacement of the product have all happened in USA and hence net profit out of the product sold in USA was a US sourced income.
45ITA.Nos.294/H/2014, 458 & 463/H/2015 Dr. Reddy's Laboratories Limited, Hyderabad.
Prayer In view of the above we pray before your Honours that the disallowance made under section 37(1) of the Act relating profit share to DRL Swiss should be deleted.
52. The L.d. D.R. in its written submissions strongly urged that the view taken by TPO is correct and in this regard contended as under:
The appellant has argued that the DRP has no power to enhance the income or reduce the loss of the appellant at the behest of the AO during the course of DRP proceedings. Further, it is submitted by the appellant that DRP can only give directions for confirming/enhancing/reducing the disallowances proposed in the draft assessment order by the AO after considering the objections raised etc. It is also highlighted by the appellant that in the instant case, the ORP has disallowed on its own on the issue which is not subject matter of draft assessment order. In this regard, appellant placed reliance on the decision of Mumbai Tribunal in the case of Dredging International NV V5. ACIT in ITA No. 8035/Mum/2010 dated 16.09.2011 [2011] 48 SOT 430 (Mumbai) and also on the decision of Hon'ble Karnataka High Court in the case of GE India Technology Centre Vs. DRP (2011) 338 1TR 416.
2. The objections raised by the assessee in regard to powers of DRP are not tenable in view of the following submissions:-
As per the provisions of Sec. 144C(8), the DRP is vested with the powers of enhancement of variations proposed in the draft assessment order, apart from others. Further, the power of DRP with regard to enhancement of income has been further widened by virtue of Explanation to Sec. 144C(8), to all the matters arising out of assessment proceedings relating to draft order passed irrespective of the fact whether such issues raised or not by the assessee. This explanation has been inserted by Finance Act, 2012 with retrospective effect from 01.04.2009. The relevant portion of the Statute is reproduced for ready reference:
Explanation.- For the removal of doubts, it is hereby declared that the power of the Dispute Resolution Panel to enhance the variation shall include and shall be deemed always to have included the power to consider any matter arising out of the assessment proceedings relating to the draft order, 46 ITA.Nos.294/H/2014, 458 & 463/H/2015 Dr. Reddy's Laboratories Limited, Hyderabad.
notwithstanding that such matter was raised or not by the eligible assessee. (Emphasis supplied) As seen from the above, the hitherto limited scope of enhancing the variations proposed in the draft order has been expanded to encompass any matter arising out of the assessment proceedings relating to the draft order. Further, the said explanation is applicable w.e.f. 01.04.2009 i.e. to all cases filed before the DRP or on after 01.04.2009, irrespective of the assessment year. This is clarified by the Board vide Circular No. 3/2012 dated 12.06.2012 (copy enclosed). Accordingly, in the instant case, as the assessee has filed reference to DRP after 01.04.2009, the DRP was right in principle to embark upon the question of enhancement of the assessment with regard to disallowance of amount paid to DRL SA. The expanded powers of enhancement of variation / income by the DRP subsequent to insertion of explanation to sub-section (8) of Sec. 144C has been subject matter of appeal before Hon'ble ITAT, Bangalore and Hon'ble ITAT, Mumbai, wherein it is judicially held that the DRP is fully empowered to enhance the income of the assessee beyond the variations proposed in the draft assessment order. The relevant case laws with gist of the decision are mentioned below:
1. Himalaya Drug Co. Vs. DClT (2014) 48 Taxmann.com 65 (Bang.
Trib) dated 13.06.2014 (copy of the order submitted during the course of hearing):
In this case, it is held that in view of explanation to Sec. 144C(8), DRP is empowered to take cognizance of any new issue which comes to its notice during the course of proceedings before it. The relevant portion of the decision is reproduced below:
"9.2. We have carefully considered the rival submissions on the issue and also perused the relevant materials as well as the Circular No.3 of 2012 dated 12th June, 2012.
9.2.1. At the outset, we would like to clarify that as per the Circular No.3 of 2012 dated 12.6.2012 which was the ITA Nos.1634 to 1639 of 2012 The Himalaya Drug Company Bangalore Page 63 of 78 supplementary memorandum explaining the Official amendments moved in the Finance Bill, 2012 as reflected in the Finance Act, 2012, it has been made explicit that "The date of effectivity of the provision mentioned in clause 63 of the Finance Bill, 2012 and the Notes on clauses (clause 60) thereof is 1st April, 2009, i.e., the provision would 47 ITA.Nos.294/H/2014, 458 & 463/H/2015 Dr. Reddy's Laboratories Limited, Hyderabad.
apply to all cases filed before the DRP on or after 1st April, 2009, irrespective of the assessment year .... II In view of the above clarification, we are of the view that the DRP was within its domain and also justified in exercising the powers conferred under Explanation to s. 144C (8) of the Act. Moreover, it was the contention of the assessee that the DRP has power only to enhance or reduce the adjustment that has already been carried out u/s 92CA. In other words, it was the learned AR's submission that the DRP has no power to treat transactions in respect of which either no adjustment was proposed by the learned TPO or such transaction does not form part of the report u/s 92E. This submission of the learned AR is devoid any merits, in view of the Memorandum explaining the intention behind introduction of explanation below s. 144C (8) which read as under:
"Power of the DRP to enhance variations Dispute Resolution Panel (DRP) had been constituted with a view to expeditiously resolve the cases involving transfer pricing issues in the case of any person having international transactions or in case of a foreign company. It has been provided under sub-section (8) of section 144C that DRP may confirm, reduce or enhance the variations proposed in the draft order of the assessing officer. In a recent judgment, it was held that the power of DRP is restricted only to the issues raised in the draft assessment order and therefore it cannot enhance the variation proposed in the order as a result of any new issue which comes to the notice of the panel during the course of proceedings before it. This is not in accordance with the legislative intent. It is accordingly proposed to insert an Explanation in the provisions of section 144C to clarify that the power of the DRP to enhance the variation shall include and shall always be deemed to have included the power to consider any matter arising out of the assessment proceedings relating to the draft assessment order. This power to consider any issue would be irrespective of the fact whether such matter was raised by the eligible assessee or not. This amendment will be effective retrospectively from the 1st day of April, 2009 and will accordingly apply to assessment year 2009-10 and subsequent assessment years."
9.2.2. In view of Explanation to s. 144((8), it is clear that DRP is empowered to take cognizance of any new issue which comes to the notice of the panel during the course of proceedings before it. Therefore, in the light of the aforesaid reasoning, the issue raised 48 ITA.Nos.294/H/2014, 458 & 463/H/2015 Dr. Reddy's Laboratories Limited, Hyderabad.
by the assessee is decided in favour of the Revenue. It is ordered accordingly." (Emphasis supplied) ii. Hamon Shriram Cottrell Pvt. Ltd. Vs. ITO (2013) 34 Taxmann.com 162 (Mum. Trib) dated 19.04.2013 (copy of the order submitted during the course of hearing) :
It is held by the Hon'ble ITAT that there is no embargo on the power of DRP, on a reference made by the assessee seeking relief against proposed adjustment, to enhance transfer pricing adjustments made by the Assessing Officer pursuant to TPO's order. It is also held by the ITAT that on the cursory look at the language of the 144C(8) shows that the power of enhancement of the DRP has been further widened to all the matters arising out of the assessment proceedings relating to draft order, irrespective of the fact whether they were raised or not by the assessee. With this, amplification of the scope of power of DRP, now even the matters not agitated by the assessee before the DRP can also be considered for the purposes of enhancement.
" 6. Adverting to the facts of the instant case it is noticed that the TPO proposed adjustment in respect of Management fee, Tender cost reimbursed and R&D expenses totalling 63.69Iakh and the DRP enhanced this variation of 63.69 lakh to '1.17 crore. As the subject matter of enhancement in the present case continues to remain the same, being the adjustment flowing from the TPO's order, we find no force in the contention that the DRP ought not to have ventured to increase the variation to the prejudice of the assessee in a reference made by the assessee for reduction of the amount of adjustment made in the draft assessment order.
7. The Id. DR pressed into service Explanation ta sub-section (8) of section 144C for bolstering his submission in support of the enhancement. At this juncture, it would be prudent to note the Finance Act, 2012 has inserted this Explanation with retrospective effect from 01.04.2009 which provides as under.- "For the removal of doubts, it is hereby declared that the power of the Dispute Resolution Panel to enhance the variation shall include and shall be deemed always to have included the power to consider any matter arising out of the assessment proceedings relating to the draft order, notwithstanding that such matter was raised or not by the eligible assessee."
8. A cursory look at the language of the Explanation divulges that the power of enhancement of the DRP has been further widened to all the matters arising out of the assessment proceedings relating to draft 49 ITA.Nos.294/H/2014, 458 & 463/H/2015 Dr. Reddy's Laboratories Limited, Hyderabad.
order irrespective of the fact whether they were raised or not by the assessee. With this amplification of the scope of the power of the DRP, now even the matters not agitated by the assessee before the DRP can also be considered for the purposes of enhancement. In other words, the hitherto limited scope of enhancing the variations proposed in the draft order has been expanded to encompass any matter arising out of the assessment proceedings relating to the draft order irrespective of the fact whether or not such a matter was raised by the assessee. However, it is pertinent to note that the insertion of the Explanation has been made with retrospective effect from 01.04.2009. Since we are dealing with the A. Y. 2007-08, the question as to whether such Explanation would also be applicable to the A. Y. 2008-09 or earlier years is left open to be decided on a suitable occasion.
9. Be that as it may the facts prevailing in the extant case are fully covered by the mandate of sub-section (8) of section 144C de hors the Explanation inserted retrospectively inasmuch as the enhancement has been directed by the DRP in respect of the variations proposed in the draft order. We, therefore, hold that the DRP was right in principle to embark upon the question of enhancement of the TP adjustments made by the A.O. in the draft order. II (Emphasis supplied)
3. It is also submitted that Rule-l0 of the Income Tax Act (Dispute Resolution Panel) Rules, 2009 stipulates that the DRP has the power to consider any matter arising out of the assessment proceedings. The relevant portion of the same is submitted below for ready reference:
"10(1) : On the date fixed for hearing or on any other date to which the hearing may be adjourned, the eligible assessee or his authorized representative do not appear or when they appear, upon hearing the objections, the panel may, within the specified time, issue such directions as it deems proper. (2) While hearing the objections, the panel shall not confine to the grounds setforth in the objections but shall have power to consider any matter or grounds arising out of the proceedings. {emphasis supplied) (3) On conclusion of hearing, the panel may issue directions within the specified period."
4. In this regard, it is submitted that reliance placed by the appellant on the decision of Dredging International NV Vs. ACIT (supra) which in turn relied upon the decision of Hon'ble Karnataka High Court in the case of GE India Technology Centre Pvt. Ltd. Vs. DRP (supra) was rendered prior to insertion of Explanation to sub-section (8) of Sec. 144C.
50ITA.Nos.294/H/2014, 458 & 463/H/2015 Dr. Reddy's Laboratories Limited, Hyderabad.
Accordingly, those decisions have no relevance to the facts of the case on hand and law applicable thereof. Further, the Hon'ble ITAT in the case of Himalaya Drug Company (supra) has considered the decision of GE India Technology Centre (supra) and differentiated the same on account of facts as well as amended provisions of Sec. 144C(8).
5. Accordingly, it is humbly submitted that in view of newly inserted Explanation to sub-section 144C(8), the DRP is empowered to take cognizance of any new issue, which comes to the notice of the DRP during the course of the proceedings either suo-moto or on account of reference made by the Assessing officer/TPO. Accordingly, on the basis of such new issue, the DRP is empowered to enhance the variations arising from the income of the assessee. Further, such new issues cannot be confined to TP issues alone, but all the issues including regular additions and disallowances under Chapter IV of I.T. Act i.e. Computation of Business Income and Book Profits u/s. 115JA/115JB etc.
6. During the course of arguments, the Ld. Counsel has raised an objection that the AO has no power to make a request to DRP after the completion of assessment proceedings to examine any issue during the course of proceedings pending before the DRP. It is also contended that in order to raise any objection before the DRP, there should be legislative sanction for the same and in accordance with the provisions of Sec. 144C of the Act, it is only the appellant who can raise objection before the DRP. In this regard, it is submitted that as mentioned in the preceding paras, by virtue of Explanation to Sub-Section (8) of Section 144C read with Rule- l0 of Income Tax Act (Dispute Resolution Panel) Rules, 2009 (supra), it is the prerogative of the DRP to consider any matter arising out of the assessment proceedings relating to the draft order, notwithstanding such matter has been raised or not by the assessee. In the instant case, the DRP has invoked such powers and embarked on enhancement of variations proposed by the TPO/AO, though the assessee has not raised the issue before the DRP. In this regard, it is pertinent to note that the consideration of any other matter arising out of the assessment proceedings relating to the draft order by the DRP would come into picture by way of -
i. Suo-moto DRP identifying the issues from the details furnished by the assessee or calling for details from the Assessing officer/TPO in connection with the proceedings conducted by the TPO/AO which culminated in the form of draft order;
ii. DRP can take note of any information received from the TPO or AO which has a bearing on the computation of income of the assessee / variations to the value of international transactions proposed in the draft order.
51ITA.Nos.294/H/2014, 458 & 463/H/2015 Dr. Reddy's Laboratories Limited, Hyderabad.
iii. Any other issue or matter that comes to the notice of DRP from whichever source having bearing on the proceedings pending before the panel.
7. In the instant case, during the course of pendency of proceedings before the DRP, the AO submitted certain details having bearing on the computation of the value of international transactions proposed in the draft assessment order or change in the variations proposed to the international transactions in the draft assessment order. Accordingly, the DRP has considered such information and made available of the same to the assessee for its comments. After having afforded adequate number of opportunities of hearing to the assessee and admitting the arguments and evidences furnished by the assessee, the DRP enhanced the variation proposed in the draft assessment order.
8. The argument of the assessee's counsel that the AO has no power to furnish information to DRP is not tenable inasmuch as there is no provision in Income Tax Act preventing the Assessing Officer from sharing the information with the DRP in connection with draft assessment order pending for adjudication on the basis of objections raised by the assessee. For this purpose, the demand for legislative sanction is overstretching the argument beyond limitation. As explained above, it is the prerogative of the DRP either to consider such information or reject the same. But, at the same time, there is no prohibition as far as AO sharing the information with DRP.
9. In continuation of Ground No.19 i.e. "Not undertaking any economic analysis and determining the price of the transaction at Rs. Nil", during the course of arguments, the AR of the assessee has raised an issue that "even if the DRP has jurisdiction to consider the new issues, then the ALP for the said transaction determined by the DRP should not be Nil" .
With regard to this ground, it is submitted that as per the Transfer Pricing provisions of Income Tax Act, 1961 i.e. u/s. 92B, there is no restriction in so far as determination of ALP as Nil. Further, it is submitted that the DRP has decided the issue of disallowance of payment made to the DRL SA on the basis of allowability of such expenditure u/s. 37(1) of the I.T. Act. Accordingly, the DRP had come to a conclusion that the transaction between DRL India and DRL SA is nothing but an arrangement for profit shifting from India to Switzerland. There is no legitimate need to avail purported services from DRL SA. Also, the assessee has failed to adduce any evidence to establish that DRL SA has actually offered any such services warranting payment of 50% of its profit share. Also, since the payment made to DRL SA, Switzerland falls under the definition of international transaction u/s. 92B and as the assessee 52 ITA.Nos.294/H/2014, 458 & 463/H/2015 Dr. Reddy's Laboratories Limited, Hyderabad.
had not reported the same, either in the TP documentation or in Form - 3CEB report, the DRP analyzed the issue from transfer pricing perspective and arrived at Nil ALP. While doing so, the DRP has given a finding of the fact that DRL SA has not contributed in any way in earning of the profits by the assessee and it has not rendered any services nor bore any risk or product liability in return.
10. The decisions of Hon'ble ITAT, Hyderabad bench in the cases of Kirby Building Systems India Ltd. Vs. Add/.CIT in ITA No. 1651/H/2010 for AY 2006-07 and ITA No. 1975/H/2011 for AY 2007- 08 and IWM Constructions Pvt. Ltd. Vs. ACIT 72 Taxann.com 104 (Hyd. Trib.) relied upon by the appellant in support of its claim that the ALP of the transaction should not be determined as Nil are not applicable to the facts of the case. In the case of IWM Constructions(supra), the ITAT gave a finding of the fact that the assessee has received some services from its AE and, accordingly, set aside the matter to AO/TPO for re- determination of ALP. Same is the case in respect of Kirby Building Systems India Ltd. wherein the issue was regarding payment of royalty and technical knowhow fees and the ITAT held the issue in favour of the assessee on the ground that the TPO failed to bring information on record that payment of royalty @ 7.5% on net sales was not at ALP. While doing so, the ITAT observed that royalty agreements were periodically approved by RBI and Ministry of Industry and the assessee was paying the amounts as per the agreements.
11. On the other hand, in the instant case, a clear cut finding has been recorded by the DRP that no services had been rendered by the AE warranting payment of 50% of profit share to DRL SA due to peculiar set of facts and circumstances of the case. Similarly, the agreement entered into by the assessee with DRL SA was not approved either by the RBI/ Ministry of Industry or any other Government Authority / Agency to vouch the genuineness and legitimate requirement of the transaction with the AE - DRL SA. Accordingly, the reliance placed by the appellant is not applicable to the case on hand.
12. In continuation to Ground No. 26 i.e. "The AO erred in disallowing the amount of profit share to DRL SA under section 37 of the Act", during the course of argument, the AR of the assessee has contended that the AO cannot decide that how much is the reasonable expenditure u/s. 37 of the I.T. Act .
Regarding this ground, it is submitted that the issue was discussed elaborately in the order of the DRP and also order of the TPO for the subsequent assessment year i.e., AY 2010-11, wherein all the facts involved in the case have been brought on record and arrived at a conclusion that there is no necessity on the part of the assessee to enter 53 ITA.Nos.294/H/2014, 458 & 463/H/2015 Dr. Reddy's Laboratories Limited, Hyderabad.
into an agreement with DRL SA, but for diversion of its profits from Indian shores to Switzerland, wherein tax rate is 9.99%. In view of this, the reliance placed by the assessee on various case laws i.e. S.A. Builders Vs. CIT(A), (2007) 288 ITR 1 (SC), CIT Vs. Dalmia Cements (Pvt.) Ltd. (2002) 254 ITR 377 (Delhi High Court) and Hero Cycles Pvt. Ltd. Vs. CIT (2015) 379 ITR 347 (SC) are not applicable. Further the main issue of payment made to DRL SA is discussed as under:
i. It is submitted that the appellant has not reported the transaction between the assessee and the AE Le. DRL SA either in the return of income filed before the Assessing officer or in the TP study or in Form-3CEB report filed before the TPO.
ii. It is interesting to note that even the original agreement between the assessee and its AE Le. DRLI USA which is the basis for the generation of income amounting to Rs.318,97,44,080/- is also not reported either in the TP study or in the 3 CEB report. iii. However, only 50% of the transaction value amounting to Rs.159,48,72,040/- is reported in the TP study as amount received from DRLI USA.
iv. Further, the assessee has not remitted 50% of the amount i.e. Rs.159,48,72,040/- to the DRL SA during the FY 2008-09 relevant to the AY under reference. The said amount was remitted only during the FY 2011-12 relevant to AY 2012-13.
v. In the normal course, the assessee should have reported the entire amount received from DRL USA amounting to Rs.318,97,44,080/- as forming part of its transfer pricing documentation and claimed 50% of the payment to DRL SA along with giving the justification for determination of Arms Length Price at Rs.159,48,72,040/- by adopting one of the methods stipulated u/s. 92B rws 92C i.e. Comparable Uncontrollable Price Method, Resale Price Method, Cost Plus Method, Profit Split Method, Transactional net Margin Method etc. However, the appellant chose not to disclose such transaction. vi. It is also submitted that the gross amount of Rs.318,97,44,080/- is not credited to the P&L account and there is no debit to the P & L account of Rs.159,48,72,040/-. Only the net amount of Rs.159,48,72,040 is disclosed in the P & L account under the head "License fees, net''(please refer to page Nos. 103 & 127 of assessee's paper book Vol. I).
vii. As per statutory Audit report u/s 44AB of IT Act., in Form No. 3CD, it is mandatory to report the details of related party transactions i.e., particulars of payments made to persons specified u/s 40A(2)(b). In the instant case, the auditor/assessee ought to 54 ITA.Nos.294/H/2014, 458 & 463/H/2015 Dr. Reddy's Laboratories Limited, Hyderabad.
have reported the transactions the assessee had with both the AEs i.e DRLI USA and DRI SA. However, the said transactions have not been reported in Annexure 6 of the report (please refer to page Nos. 217 & 234 of assessee's paper-book Vol. I).
viii. As per statutory Audit report u/s 92E of IT Act, in Form No 3CEB, it is mandatory to report particulars relating to all international transactions. In the instant case, the auditor/assessee have failed to report the transaction with DRLI USA & DRI SA in annexure 4A of the report( please refer to page no 252 & 264 of assesse's paper-book).Only the net amount received from DRLI USA is reported in auditors TP Memorandum (please refer to page No. 292 of assessee's paper-book Vol. 1 at 51 no 14- Profit share of marketing and distribution).
ix. As such, in the return of income filed as well as in the TP study, assessee has not disclosed fully and truly, the details of income received from DRLI USA and amount paid or payable to DRL SA. In view of the above, this issue could not be considered either by the AO or the TPO before finalizing the draft assessment order. Later, during the course of pendency of proceedings before the DRP, it came to light that the assessee had actually received an amount of Rs.318,97,44,080/- from DRLI USA and diverted 50% of the same to DRL SA.
x. It is submitted that the in the month of September 2006, the litigation pending between the assessee and GSK in the United States District Court, Southern District Of New York was dismissed in view of out of court settlement of the case (please refer to Page Nos. 647 to 650 of assessee's paper-book Vol. II). Accordingly, the assessee group and GSK entered into a settlement agreement and also Supply & Distribution Agreement on 05.10.2006. As per these agreements, the assessee group had agreed to buy the finished product viz., Sumatriptan from GSK during the 180 days exclusivity period to market in the USA.
xi. On the other hand, DRL SA Switzerland was actually incorporated in the FY 2007- 08 and thereafter entered into an MoU with assessee on 01.05.2008 to assume the risk on account of post sale liability of the product 'Sumatriptan' and the risk concerning with the final determination of the Para-4 litigation pending in Civil Case filed by the assessee group before the District Court of the Southern District of Newyork, USA, with Glaxo Group Ltd., UK. It is also mentioned in the MoU that DRL SA would assume the risk on account of any change in the net realization value, shelf stock adjustments and other provisions on the inventory of the product i.e. Sumatriptan, charged to Dr. 55 ITA.Nos.294/H/2014, 458 & 463/H/2015 Dr. Reddy's Laboratories Limited, Hyderabad.
Reddy's by DRLI. In consideration for the same, it is stated in the MoU that the assessee shall pay DRL SA 50% of the gross profits / profit share royalty accrued to it from DRLI USA. xii. In this regard, it is submitted that after having dismissed the court case (supra) and consequent entering into settlement agreement by the assessee group with GSK in the year 2006 itself, there is no scope of any risk relating to the litigation pending in the Civil Case. However, in the said MoU, it is stated that DRL SA has undertaken to take risk on account of legal issue pending in the case. Under the circumstances, it is submitted that DRL SA has no role to play in the litigation with GSK as it came into existence only in the FY 2007-08 and the settlement with GSK was completed in the month of May, 2006.
xiii. Further, in the written submissions filed by the appellant before the Hon'ble ITAT, it is stated that DRL SA has undertaken product reliability risk, fall in price risk and also share of cost of development of the product and legal cost. As such, there is a difference between what is mentioned in the MoU and what is stated by the appellant in the written submissions with regard to scope of the agreement between the assessee and DRL SA. In this regard, it is submitted that at the time of development of the product by the assessee group Le. prior to FY 2006-07, DRL SA was not in existence. Accordingly, there is no truth in the assessee's submission that DRL SA has shared development cost of the product. Similarly, there is no scope on the part of DRL SA to share the legal cost involved in settlement of the case with GSK inasmuch as the legal dispute was settled in the FY 2006-07 itself and the DRL SA came into existence only in FY 2007-08.
xiv. In regard to product liability risk, it is important to note that any liability on account of manufacturing defect is borne by the manufacturer i.e. GSK. This is clearly mentioned in the agreement entered by the assessee with GSK dated 05.10.2006 i.e. The Supply and Distribution Agreement, wherein at Page No. 43 & 44 of the agreement (Please refer to assessee's Paper Book Page Nos. 696 & 697), it is stated that GSK shall indemnify, defend and hold Dr. Reddy's and its affiliates harmless-free and against any and all losses, liabilities, damages etc. result or arise from in connection with a claim, suit or other proceedings made or brought by a third party against Dr. Reddy's based on, resulting from, or arising in connection with product claims only to the extent arising out of a manufacturing defect of GSK supplied product, apart from others. Accordingly, the assessee need not incur any liability on account of manufacturing defect of the product.
56ITA.Nos.294/H/2014, 458 & 463/H/2015 Dr. Reddy's Laboratories Limited, Hyderabad.
xv. The relevant portion of the agreement is reproduced below:
"Article VIII-INDEMNIFICATlON, INSURANCE AND DISPUTE RESOLUTION Section 8.1 Indemnification.
(a) GSK Indemnification Obligations. GSK shall indemnify, defend and hold Dr. Reddy's, its Affiliates, and its and their officers, directors, trustees, agents and employees (individually and/or collectively referred to herein as an "Dr. Reddy's Party/l) harmless from and against any and all losses, liabilities, damages (inclusive of indirect, incidental, special or consequential (but excluding punitive) losses or damages), fees (but only reasonable attorneys fees and expenses and costs of litigation pertaining to such Dr. Reddy's Claim), and expenses paid or payable by Dr. Reddy's or a Dr. Reddy's Party to a Third Party (collectively, "Dr. Reddy's Losses") to the extent that such Dr. Reddy's Losses result [rom or arise in connection with a claim, suit or other proceeding made or brought by a Third party against Dr. Reddy's or a Dr. Reddy's Party (a "Dr. Reddy's Claim") based on, resulting from, or arising in connection with:
(i) The breach of any obligation, covenant, agreement, representation or warranty of GSK or a GSK Party contained in this Agreement;
(ii) Any violation of applicable Law by GSK, or a GSK Party, in connection with the performance of GSK's or its Affiliates; obligations under this Agreement; or
(iii) Product Claims only to the extent arising out of a manufacturing defect of GSK Supplied Product."
(emphasis supplied) Further, in the same agreement under Section 8.4 : Insurance, at c1ause(b), it is once again stated that GSK shall take full responsibility with regard to insurance for product liability and general liability. The relevant portion of the same is reproduced below:
"Section 8.4 Insurance.
(a) For the Term, and for a period of five (5) years after the expiration of this Agreement or the earlier termination thereof, Dr. Reddy's shall maintain at its sale cost and expense, product liability and other insurance for itself in amounts, respectively, which are reasonable and customary in the United States Pharmaceutical industry for companies of comparable size and activities at the 57 ITA.Nos.294/H/2014, 458 & 463/H/2015 Dr. Reddy's Laboratories Limited, Hyderabad.
respective place of business of Dr. Reddy's, provided in no event shall the product liability insurance amounts be less than Twenty- Five Million US. Dollars (US. $ 25,000,000) per occurrence (or claim) and Twenty-Five Million US. Dollars (u.s.$ 25,000,000) in the aggregate limit of liability per yar, with a self-insured retention of Five Million US. Dollars (u.s.$5,000,000). Such insurance shall insure against all liability, including personal injury, product liability, physical injury, clinical development liabilities, or property damage arising out of the development, manufacture (including packaging and labeling), sale, distribution, or marketing of GSK Supplied Products. Dr. Reddy's shall provide written proof of the existence of such insurance to GSK upon request.
(b) GSK hereby represents that it is self-insured for product liability and general liability, and that it has and will maintain such coverage for the Term and for a period of five years after the expiration of this Agreement or the earlier termination thereof. Such self-insurance is in an amount which is reasonable and customary in the United States pharmaceutical industry for companies of comparable size and activities at the respective place of business of GSK. GSK shall provide a written statement of the existence of such insurance to Dr. Reddy's upon request." (Emphasis supplied) Accordingly, the assessee need not incur any liability towards insurance on account of product liability and general liability. xvi. Notwithstanding that, it is well known fact that the Pharma companies normally enter into insurance contract with the insurance companies to insure their drug products, rather than enter into agreement with their sister concerns or AEs. It is an admitted fact that DRL SA has no experience or expertise in insuring the drug / products as it came into existence only in FY 2007-08 and it has no wherewithal to take the risks involved with regard to product liability. Further, the said company is located in Switzerland rather than in USA. As such, the assessee should have entered into an agreement with renowned insurance companies or any of the companies located in USA rather than assigning the insurance functions to its AE i.e. DRL SA.
xvii. Similarly, the assessee's contention that the agreement with DRL SA includes fall in price risk is also not tenable inasmuch as any fall in price post 180 days exclusivity distribution period would have been compensated by the assessee directly to the distributors / consumers rather than assigning the same to a fledgling such as DRL SA which has no exposure to this kind of activities.
58ITA.Nos.294/H/2014, 458 & 463/H/2015 Dr. Reddy's Laboratories Limited, Hyderabad.
Further, it is very important to note that, there was no impact on price during the FY 2008-09 under reference inasmuch as the end of the exclusivity period of 180 days happened in subsequent FY 2009-10 relevant to AY 2010-11. Accordingly, there is no cost attributable to price risk born by the assessee in the AY 2009-10 in order to assign the same to DRL SA.
xviii. Further there is a violation of the terms and conditions mentioned in the Settlement agreement between GSK and the assessee dated 06/10/2006 wherein at page 6, para 11 at of agreement, it is stated that "This Agreement and the rights herein shall not be assigned or otherwise transferred without the written consent of all Parties Each of the Parties represents and warrants that it has not sold or conveyed or otherwise transferred any claim, demand or cause of action related to the District Court Case that it has or had against any Party." As such, the assessee has assigned certain rights emanating from the agreement to DRL SA without the written consent of GSK.
xix. In view of this, it would appear that the MoU has been drafted in a routine and casual manner in order to create a facade as to the genuineness of the transaction. As such, the assessee is required to show the details of liability on account of marketing, distribution and selling of the product. Further, it should have been clearly mentioned in the MoU that risk on account of post sale liability attributable to product defect / manufacturing defect is not forming part of the risk assigned to ORL SA. Also, the assessee should have given a detailed and clear working with scientific basis for the purpose of arriving at the amount of consideration paid or payable to DRL SA towards the various risks mentioned above. Though there are four different functions said to be assigned to the AE, the method of allocation of consideration paid in respect of each function/activity and actual amount of expenditure incurred in respect of each function/activity have not been spelt out in such agreement or adduced during the course of proceeding before DRP. It is also interesting to note that an adhoc percentage of 50 % has been fixed in respect of all the four functions/activities exposing the hollowness in the stand of the assessee on this issue.
xx. It is submitted that for the purpose of allowing any deduction, the assessee is required to prove the genuineness of the transaction, business/legitimate requirement of entering into such transactions, actual incurring of expenditure in connection with such transaction and reasonableness of the expenditure incurred thereof. All these conditions should be fulfilled cumulatively. Further, these conditions are stipulated 59 ITA.Nos.294/H/2014, 458 & 463/H/2015 Dr. Reddy's Laboratories Limited, Hyderabad.
as per the provisions of Sec. 37(1) and Sec. 40A(2)(b). However, in the instant case, the assessee has not fulfilled any of these conditions. To be precise, the assessee has failed to disclose the transaction itself either before the AO or before the TPO. Further, there is no evidence to show that the assessee had incurred any liability towards post sale liability, development of product, legal cost, fall in price etc. in connection with marketing, distribution and sale of the products.
xxi. Accordingly, the assessee has not fulfilled the above mentioned conditions envisaged u/s. 37(1) and Sec. 40A(2)(b) in order to claim deduction towards payment made to DRL SA. However, it has created a legal framework by way of entering into an agreement in writing and thereafter transfer of money to DRL SA. Also, the assessee has failed to produce any evidence in regard to actual expenditure incurred during the financial year relevant to assessment year under reference in connection with risks assigned to the DRL SA i.e.-
1) what is the amount of post sale liability attributable to marketing, distribution and selling functions of the assessee group;
2) What is the amount of legal expenses incurred in connection with Civil Case pending, if any, subsequent to entering into agreement during the financial year under reference; and
3) What is the amount of expenditure incurred in connection with fall in price after the termination of exclusivity period. In this regard, it is pertinent to note that as the exclusivity period is falling during the financial year 2009-10 relevant to subsequent assessment year, neither assessee nor its AE should have incurred any expenditure.
4) Any other expenditure incurred in connection with the transactions referred to above. Further, it is clearly brought out that DRL SA is not capable of performing the said functions in view of its lack of experience and expertise.
By considering all the above factors, it is clearly evident that assessee has diverted its 50% of the profits from the sale and distribution of product 'Sumatriptan' amounting to Rs.159,48,72,040/- with the sole purpose of evasion of tax in India.
13. Coming to the assessee's reliance placed on the cases of S.A. Builders Vs. CIT and CIT Vs. Dalmia Cements and Hero Cycles Pvt. Ltd. Vs. CIT (supra), it is submitted that the issue involved in the case of S.A. Builders is with regard to transfer of the borrowed funds to the sister concern i.e. diversion of interest bearing funds. In this regard, the Hon'ble Supreme Court has held that transfer of such funds should be looked into 60 ITA.Nos.294/H/2014, 458 & 463/H/2015 Dr. Reddy's Laboratories Limited, Hyderabad.
from the commercial expediency point of view rather than earning profits. However, in the instant case, the issue is with regard to disallowance of the transaction and requirement of incurring the expenditure. As such, the said decision is not applicable to the facts of the case.
14. Similarly, in the case of Dalmia Cements (supra), it is held that the AO cannot go into reasonableness of the expenditure once nexus between the expenses and the purpose of business is proved. However, in the instant case, the assessee has not proved the genuineness of the expenditure incurred and the nexus between the expenditure incurred for the purpose of business. Hence, the said decision is not applicable.
15. In the case of Hero Cycles Ltd. (supra), the issue is once again with regard to the reasonableness of the expenditure wherein the Hon'ble Supreme Court held that the authorities must not look at the matter from their point view, but that of prudent businessman. In the instant case, from the view point of a prudent business man itself, it is crystal clear that there is no requirement of incurring 50% of the profit share as the AE has not performed any of such functions mentioned in the MoU. Further, the assessee has not submitted any details with regard to the basis for quantifying the value/price of the said services rendered by DRL SA @ 50% of their profit share received from DRL USA. No Scientific methodology adopted in this regard with supporting documentary evidences have been furnished by the assessee. Similarly, no breakup of expenditure incurred by the AE towards various functions assigned to it is furnished, but simply 50% of their income share from DRL USA has been earmarked towards such services payable to DRL Switzerland.
16. On the other hand, it is submitted that in the case of Dalmia Cements (supra) itself, it is held by Hon'ble High Court of Delhi that contractual payment relating to business need not be disallowed unless it suffers from "the vice of collusiveness or colourable device". The relevant portion of the same is reproduced below:
"For the allowance under section 37(1), the following conditions are to be satisfied, i.e. : (a) there must be expenditure, (b) such expenditure must not be of the nature described in sections 30 to 36, (c) the expenditure must not be in the nature of capital expenditure or personal expenses of ,the assessee, (d) the expenditure must have been laid out or expended wholly and exclusively for the purposes of the business or profession. The word "wholly" refers to the quantum of expenditure, while the word "exclusively" refers to the motive, objective and purpose of the 61 ITA.Nos.294/H/2014, 458 & 463/H/2015 Dr. Reddy's Laboratories Limited, Hyderabad.
expenditure. An expenditure to which one cannot apply an empirical or subjective standard is to be judged from the point of view of a businessman and it is relevant to consider how the businessman himself treats a particular item of expenditure. The term "commercial expediency' Is not a term of art. It means everything that serves to promote commerce and includes every means suitable to that end. In applying the test of commercial expediency for determining whether the expenditure was wholly and exclusively laid out for the purpose of the business, the reasonableness of the expenditure has to be judged from the paint of view of the businessman and not the revenue (see CIT v. Walchand and Ca. (P) Ltd. (1967) 65 ITR 381 (5C), J. K. Woollen Manufacturers v. CIT (1969) 72 ITR 612 (SCI, Aluminium Corporation of India Ltd. v. CIT (1972) 86 ITR 11 (SCI and CIT v. Panipat Woollen and General Mills Co. Ltd. (1976) 103 ITR 66 (5C). But it must not suffer from the vice of collusiveness or colourable devices. " (emphasis supplied)
17. In the instant case, in view of the facts narrated above, it is proved beyond doubt that there is a collusion between the assessee and the AE and the facade of the written agreement has been used as a colourable device for the purpose of diversion of its taxable profits.
18. Also, the Hon'ble Supreme Court pointed out in the case of Madhavo Prasad Chetio Vs. CIT (IIB/TR 200) and in the case of Lochminarayan Madan Lal Vs. CIT (B6/TR 439) (copies enclosed) that merely because the assessee established the existence of an agreement between him and his agents and an actual payment therein, it Would not take away the jurisdiction or the discretion of the Assessing officer to consider whether the expenditure was genuinely and exclusively incurred for the purpose of the business and whether the expenditure was commercially expedient. The relevant portion of the same is reproduced below:
"The question whether on amount claimed as an expenditure Was laid out or expended wholly and exclusively for the purpose of the business has to be decided on the facts and in the light of the circumstances in each case. The mere existence of an agreement between the assessee and its selling agents or payment of certain amounts as 'commission, assuming there was such payment, did not bind the Income-tax Officer to hold that the payment was made exclusively and wholly for the purpose of the assessee's business. Although there might be such on agreement in existence and the payments might have been mode, it was still open to the Income- tax Officer to consider the relevant factors and determine for himself 62 ITA.Nos.294/H/2014, 458 & 463/H/2015 Dr. Reddy's Laboratories Limited, Hyderabad.
whether the commission said to have been paid to the selling agents or any part thereof was properly deductible under section 37. Prima facie, all the findings of the Tribunal were findings of fact and, therefore, the Tribunal was justified in not stating a case for opinion of High Court under section 256(1) and High Court was justified in not calling for a statement of case under section 256(2)."
19. Further, the Hon'ble Supreme Court in a recent decision in the case of Ganapati & Co Vs. CIT (2016) 381 ITR 363 (copy enclosed) has held that failure on the part of the assessee to produce proof of service rendered during the assessment year in question with regard to service charges paid to firm having common partners would attract disallowance of such service charges u/s. 40A(2) rws 37(1). Further, the Hon'ble Gujarat High Court in the case of Jayesh Roychand Shaw Vs. ACIT (2014) 360 ITR 387 (copy enclosed) has held that in view of finding recorded that payments were not made exclusively for the purpose of business, the salary paid to relatives cannot be treated as business expenditure u/s. 37(1) and accordingly disallowance made by the AO is justified.
20. The Hon'ble Kolkata High Court in the case of Prakash Engineering Works Vs. CIT (2015) 373 ITR 246 has held that conversion charges paid to sister concern cannot be treated as business expenditure as the assessee has failed to prove the rate paid for conversion of materials is reasonable and not excessive having regard to legitimate need of business and market value.
21. Further, the Hon'ble High Court of Delhi in the case of Denso India Ltd. Vs. CIT (2016) 388 ITR 324 (Del. He) (copy enclosed), while dealing with the TP issue, held that where purchaser, manufacturer as well as intermediary are all AEs and components purchased which constituted 86% of total raw material is imported from intermediary not their manufacturer, job of TPO extends to critically evaluating materials and onus is clearly on assessee to offer a convincing and reasonable explanation.
Reliance is also placed on the following decisions (copies enclosed) i. Vishnu Agencies Pvt. Ltd., vs. CIT (1979) 117 ITR 754 (Cal.HC) ii. Vibhooti Glass Works Vs. CIT (177 ITR 439) (Hon'ble SC) iii. Premier Breweries Ltd. Vs. CIT (372 ITR 180) (Hon'ble SC) iv. Prakash Engg. Works Vs. CIT (2015) 373 ITR 246 (Cal. HC) 63 ITA.Nos.294/H/2014, 458 & 463/H/2015 Dr. Reddy's Laboratories Limited, Hyderabad.
53. Counter arguments of the Learned Counsel for the Assessee are as under :
a. The Ld. DR claimed that the Appellant has failed to disclose the said transaction with DRL Swiss in the financials, Income-tax Return filed by the Appellant and Form 3CEB for the year under consideration. Further in the written submissions filed by the DR, it is stated that that the payment of profit share to DRLSA has not been reported in the report issued u/s 44AB as it was made to persons covered u/s 40A(2)(b).
b. With respect to the above contention of Ld. DR, we request your honours kind attention to :-
• Page no 103 of Paper Book Volume-I - Profit & Loss account for the AY 2009-10 the amount is disclosed under licence fees, net. • Page no. 127 of Paper Book Volume-I - Related Party Disclosures V. Licence fees, net Dr. Reddy's Laboratories Inc., USA 1,597 • Page no. 130 of Paper Book Volume-I - Related Party Disclosures(Continued) iii. Due to related parties ( included in current liabilities) Dr. Reddy's Laboratories SA, Switzerland 1,464 • Page no. 272 of Paper Book Volume-I to for the AY 2009-10 wherein the transaction with DRL Swiss is made available in the Transfer Pricing report of the Appellant.
c. We submit that the transaction has been disclosed in the financials as well as Transfer Pricing report filed before the AO. Hence, we submit that there is no failure on the part of the Appellant in disclosing the transaction. The reason for disclosing the transaction on net basis is the share of profit to DRL Swiss is connected with the share of profit received from DRL USA as these are originating from the marketing and sale of product - Sumatriptan in USA. From the above, it may be observed that there is no intention on the part of Appellant not to disclose the said transaction with DRL Swiss.64
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d. Further, with respect to the contention of the Ld. DR on non-
disclosure of the transaction in report u/s 44AB of the Act, we submit that clause 18 of tax audit report (Form 3CD) requires the tax auditor to report particulars of payment made to persons specified under section 40A(2)(b). Section 40A(2) provides that expenditure for which payment has been or is to be made to certain specified persons listed in 40A(2)(b) are to be reported in tax audit report. In the present case, we submit that the transaction is disclosed on net basis is the financials as share of profit to DRL Swiss is connected with the share of profit received from DRL USA as these are originating from the marketing and sale of product - Sumatriptan in USA. Clause 18 of the tax audit report requires expenditure to be reported and in the present case the transaction relating to profit share is resulted in income and not expenditure and hence the same is not disclosed in the report u/s 44AB of the Act. Hence, we submit that there is no failure on the part of the Appellant in disclosing the transaction in tax audit report.
e. Further, the Ld. DR contented that the Agreement between DRL Swiss and DRL India are void-ab-inito by referencing para no. 11 of pg. 627 (Settlement Agreement between DRL India, DRL USA & GSK) of Volume-II to paper book filed for the AY 2009-10, wherein it specifies that "the Appellant cannot assign or transfer rights of the agreement to any third party without written consent of all the parties of the agreement".
f. In response Ld. D.R's contention, we submit that the word assignment/ transfer as referred in the agreement refers to the transfer/assignment of product patent/marketing and distribution rights but not with reference to assignment of Insurance and shelf-stock adjustment. Hence, we submit before your honours that there is no restriction on part of the Appellant to enter into an agreement with other parties to assign/transfer the liability of insurance. Further it may be noted that if there is an assignment, it is not an assignment of rights but assignment of liability only.
g. The Ld. DR contended that the there is no requirement on the part of Appellant to undertake product liability insurance by referencing para 8.1 of pg. 697 of (Supply & Distribution agreement between DRL India, DRL US & GSK) of Volume-II to paper book filed for the AY 2009-10 wherein it specifies that GSK is responsible for product claims arising out of a manufacturing defect of GSK supplied products.
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h. In response to the above, we draw your honours attention to para 8.4 of Pg. 701 of volume-II of paper book, where in it is mentioned that DRL is sole responsible to undertake Insurance. The relevant paragraph from the supply and distribution agreement between DRL India, DRL USA and GSK is reproduced below for your ease reference:-
Insurance.
For the Term and for a period of five (5) years after the expiration of this Agreement or the earlier termination thereof, Dr. Reddy's shall maintain at its cost and expense, product liability and other insurance for itself in amounts, respectively, which are reasonable and customary in the United States pharmaceutical industry for companies of comparable size and activities at the respective place of business of Dr. Reddy's, provided in no event shall the product liability insurance amounts be less than Twenty- Five Million U.S. Dollars (U.S. $ 25,000,000) per occurrence (or claim) and Twenty-Five Million U.S. Dollars ( U.S. $ 25,000,000) in the aggregate limit of liability per year, with a self-insured retention of Five Million U.S. Dollars (U.S. $5,000,000). Such insurance shall insure against all liability, including personal injury, product liability, physical injury, clinical development liabilities, or property damage arising out of the development, manufacture (including packing and labelling), sale, distribution, or marketing of GSK Supplied Products. Dr. Reddy's shall provide written proof of the existence of such insurance to GSK upon request."
i. We submit before your honours that DRL India being the approved holder of Abbreviated New Drug Application ("ANDA") and IP holder of the generic drug Sumatriptan is responsible for paying for any liabilities arising out of product defects. Even as per the supply and Distribution agreement between DRL India, DRL USA and GSK (para 8.4 of Pg. 701 of paper book para 8.4 of Pg. 701 of volume-II ) the DRL India is responsible for taking insurance for USD 25 Million towards product liability. (emphasis supplied) j. We are herewith enclosing a write up on product liability risk to pharmaceutical companies about the product liability risk exposure (Source:http://www.imc-seminars.com/uploads/ papers/Johannes Klose.pdf) as Annexure-1.66
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k. Because of restrictions of the RBI and inability of Indian insurance providers for such huge sum, DRL India has approached DRL Swiss to undertake product liability risk and to bear 50% of costs towards shelf-stock adjustment. In this regard, the DRL India and DRL Swiss has entered into an agreement dated 1st May, 2008 (refer page No.729 of paper book Volume-II filed for A.Y. 2009-10).
l. Further, the Ld. D.R. pointed out that the DRL Swiss is getting compensated at 50% of the profit received from DRL US for 4 services availed from DRL Swiss i.e. share for product development costs, share for legal expenses, share for undertaking the insurance and share of 50% of shelf stock adjustment. He also pointed out that the 50% of shelf stock adjustment assigned to DRL Swiss is bogus, as no adjustment was made for shelf stock costs in the AY 2009-10.
m. In this regard, we would like to submit before your good self that the DRL Swiss is compensated only for rendering two services namely share for undertaking the insurance risk and shelf stock adjustment. Further, we also submit that the adjustment for shelf-stock adjustment will only arise after the end of exclusive period of 6 months which has ended in the year AY 2010-11 and hence no adjustment has been made on amount payable to DRL Swiss in the AY 2009-10. In this regard, we request your honours attention to page no. 3 of our written submission made on profit share on 24 January 2017, wherein the 50% price fall adjustment was borne by DRL Swiss and not by DRL India.
n. Further, the Ld DR argued that the Appellant has not submitted any evidence towards post sales liability, development of product, legal cost, fall in price in connection with marketing, distribution, and sale of the product.
o. In this connection, we submit that the post sales liability towards price fall occurred in AY 2010-11 and DRL Swiss has already undertaken the liability amounting to Rs.57 Crs. This matter was duly examined by the AO and necessary effect was duly given in the assessment order of AY 2010-11. Similarly, legal and development cost details are duly furnished and recorded in the T.P. order for A.Y. 2009-10. (Please refer para 8 at page 23 above).67
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As per the assessment order passed by the AO for Ay 2010-11, "The assesses also submitted that as per clause 1.3 of the agreement with Dr.Reddy's USA and DRL India, the gross profit means Net sales reduced the price fall adjustment etc., and as per clause 2 of the agreement, 50% of the profit i.e. after price fall adjustments, has been shared with DRL India. In effect, what DRL India has received as profit share after price fall adjustment from Dr.Reddy's USA is only Rs.72,93,09,429 (Rs.129,84,03,185 -
Rs.56,90,93,756) out of which Rs.64 crs was retained by DRL India and the balance of about Rs.8 crs has been transferred to DRLSA. Therefore, the assesse submitted that due credit has to be given to this price fall adjustment and only an amount of Rs.8,01,07,837 had to be considered for the adjustment by the TPO.
Considering the submissions, made by the assesse, the adjustment on account of profit share of DRL, Switzerland on marketing and distribution of Sumatriptan is taken at Rs.8,01,07,837 as against Rs64,92,01,592 after giving set off for the price fall adjustment "
From the above stated submission it is clear that the tax department has accepted the fact the DRL Swiss has borne price fall adjustment of Rs.57 crs i.e. one of the risk DRL Swiss had taken in pursuance of the agreement dated 1st May 2008. This lends credence to the argument of the appellant that arrangement of profit share payment to DRL Swiss is bona fide and is not colourable as alleged by the learned DR.
Similarly, legal & development cost details are duly furnished and recorded in the TP order for AY 2010-
11. p. Further the case law Ganapathi & Co. (381 ITR 363) relied on by the DR is not applicable to the facts of the case as in the Appellants case there is no failure on the part of the Assesse to produce proof of service rendered. The Appellant has 68 ITA.Nos.294/H/2014, 458 & 463/H/2015 Dr. Reddy's Laboratories Limited, Hyderabad.
produced relevant agreements, proof of payment were filed before the AO in support of its claim.
q. In the written submissions filed by the DR before the ITAT, it is stated that the agreement has not been approved by RBI/ Ministry of Industry or any other Government Authority. r. In this regard, we submit that there is no obligation/any regulatory requirement on the part of the Appellant to get approval from any Government bodies to enter into an agreement with the AE. However, it may be noted that the Appellant has transferred the funds only after getting the approval from RBI through the Authorized Dealer banks. The proof for approval and transfer of the funds are filed before your honours vide petition for additional evidence dated 23 January 2017, which is enclosed herewith for ready reference Annexure -2 s. In the written submissions filed by the DR before the ITAT, it is stated that the Appellant should have entered into an agreement with renowned insurance companies or any companies located in USA rather than assigning the insurance functions to its AE.
[[ t. In this regard, we submit that the decision of the Appellant should be viewed in the contest of business expediency and the AO cannot step into the shoes of the Appellant. It may be noted that the DRL Swiss has not only undertaken the insurance liability but also has undertaken the 50% of Shelf-stock adjustment risk. If there was no such arrangement, DRL India would have borne the entire costs towards shelf-stock adjustment, which was borne by DRL Swiss in the AY 2010-11. We reiterate that in addition to business reason that the undertaking of product liability insurance with an Indian Insurance Company for a product to be sold in USA is not possible as the insurance amount is USD 25 million, as per the FEMA Regulations no person resident in India shall take any general policy issued by an Insurer outside India without specific approval from Central Government.
u. In the written submissions filed by the DR before the ITAT, the DR alleged that the Appellant has used the agreement as colourable device to evade tax in India.
v. The Appellant has entered into agreements as per the out of court settlement with GSK. Share of Profits from sale of the 69 ITA.Nos.294/H/2014, 458 & 463/H/2015 Dr. Reddy's Laboratories Limited, Hyderabad.
generic drug Sumatriptan in US market brought to India and offered for tax in India. The share of profit to DRL Swiss for undertaking insurance and shelf-stock risk has been transferred after obtaining RBI's approval through Authorised Bank. Hence, we submit that the argument of the DR that the Appellant has used these agreements as colourable device is not acceptable.
Technical arguments - Whether DRP has jurisdiction
(i) With regard to technical issue on excess jurisdiction by DRP, the Ld. DR has placed reliance on the following judgements:-
• Himalaya Drug Company Vs. DCIT, where in it was held that DRP is empowered to take cognizance of any new issue which comes to its notice during the course of proceedings before it.
• Hemon Shriram Cottrell (Pvt.) Ltd. Vs ITO, where in it was held that DRP has power to even enhance the amount of adjustment made by AO.
(ii) And contented that DRP has power to examine the issue whether or not raised before the DRP if the issue is arising from the Assessment Order.
(iii) In this regard, we request your honours kind attention to para no. 14 of the DRP order, wherein it was mentioned that the AO vide letter dated 16 November 2013 requested the panel to examine the matter relating to profit share to DRL Swiss.
(iv) We submit before your honours that the attempt made by the AO by way of requesting the panel to examine the issue is against the law. There is no power to the AO to make such request to DRP after the completion of assessment proceedings under any provisions of the Act. We submit that every action of AO should have legislature sanction and in the absence of legislative sanction AO cannot exercise any power. It should also be noted that DRP does not have any provisions for cross objection and only assesse has a right to appeal and AO has no right of whatsoever to make a plea or raise cross objection or to request DRP for enhancement. In the absence of such provisions enhancement by DRP at the behest of AO is null and void.
(v) In this regard we rely on the judgement of Jauamal Jayantilal Thakore Vs Chief Commissioner of Income- tax [230 ITR 142], where in the Hon'ble High Court of Gujarat held 70 ITA.Nos.294/H/2014, 458 & 463/H/2015 Dr. Reddy's Laboratories Limited, Hyderabad.
that " It will, thus, be seen that the Assessing Officers have important statutory functions to discharge. It can never be said that their powers to make assessment or to ascertain whether there has been full and true disclosure are powers which are not coupled with duty, to discharge those functions. The Assessing Officers must in accordance with the statutory provisions discharge their functions and it cannot be said that an Assessing Officer can refuse to discharge his function even when the statutory provisions require him to act in a particular way. In the very nature of the things empowered to be done and in the very nature of the object for which the provisions of the Act are enacted as also the conditions in which the powers are to be exercised by the Assessing Officers under the Act, it is clear that these powers are coupled with a duty to exercise them when the statutory provisions warrant their exercise. If a statute invests a public officer with an authority to do an act in a specified set of circumstances, it is imperative upon him to exercise his authority in a manner appropriate to the things when a party interested and having a right to apply, moves in that behalf, and circumstances for exercise of that authority are shown to exist. Even if the words used in the statute are prima facie enabling, the Courts will readily infer a duty to exercise power which is invested in aid of enforcement of a right, public or private, of a citizen or for the safeguard of public revenue."
(vi) We also submit that, the DRP is not equivalent to a Tribunal. We submit that to raise any objection before DRP there should be legislative sanction for the same. We submit that as per section 144C of the Act, it is only the Appellant who can raise objection before the DRP. We also submit that matter which are covered under section 147/148 and 263, the AO cannot bring the matters before DRP.
(vii) Without prejudice to the above, if the AO's request considers valid, the DRP has no power to determine ALP as 'nil' of the said transaction on its own instead of referring the matter to TPO, who is the Competent Authority to determine the ALP of the international transaction with AE's as per section 92CA of the Act. In this regard reference is made to Instruction No. 3/2003 dated 20 May 2003 issued by CBDT [ 261 ITR 51(St) ] wherein it specifies that only the TPO has power to determine ALP with respect to international transactions. The relevant paras are reproduced below:-
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(i) Reference to Transfer Pricing Officer (TPO):- The power to determine arm's length price in an international transaction is contained in sub-
section (2) of section 92C. However, section 92CA provides that where the Assessing Officer considers it necessary or expedient so to do, he may refer the computation of arm's length price in relation to an international transaction to the TPO. Sub-section (3) of section 92CA provides that the TPO after taking into account the material available with him shall, by an order in writing, determine the arm's length price in accordance with sub-
section(3) of section 92C.
(viii) Further, it may be noted that the DRP has not given an opportunity of being heard before making addition under section 92CA as show-cause notice was issued under section 37(1) of the Act.
(ix) Considering all the above, the appellant submits that the entire adjustment made by DRP is not sanctioned any provisions of Income-tax Act and hence the appellant submits that adjustment made by DRP should be considered as null and void.
53. We have carefully perused the rival contentions and perused the record. In respect of A.Y. 2009-2010 assessee raised a preliminary objection with regard to the jurisdiction of the DRP in considering the matter of allowability of deduction referrable to profit share with DRL Swiss. The case of the assessee is that the DRP can only consider the matters which emanate from the orders passed by A.O./TPO.
54. The Ld. D.R. on the other hand pointed out that the provisions of section 144C were amended w.e.f. 01.04.2009, by inserting Explanation to Section 144C(8) by Finance Act, 2012, whereby the DRP was given wider powers i.e., to consider "Any matter arising out of the assessment proceedings relating to the draft order"
notwithstanding that such matter was raised or not by the eligible assessee. In otherwords, even the matters not agitated by the assessee 72 ITA.Nos.294/H/2014, 458 & 463/H/2015 Dr. Reddy's Laboratories Limited, Hyderabad.
before the DRP can be considered for the purpose of enhancement. In fact, the DRP had issued a notice to assessee in 2013 by which time the Explanation to section 144C(8) was already in force. The case of the Revenue is also supported by the decisions of Tribunal referred to by the Ld. D.R. in the written submissions. Under the circumstances, we uphold the plea of the Ld. CIT-D.R. and hold that the DRP is well within its competence to consider the issue pertaining to profit sharing between DRL India and DRL SA.
55. This leaves us with the substantial issue i.e., correctness of disallowance of the claim of sharing of profits. We have extracted detailed arguments of the Learned Counsel for the Assessee as well as the Ld. CIT-D.R. which are furnished before us in the form of written submissions. In brief, the case of the Revenue is that the transaction between DRL, India and DRL, SA is nothing but an arrangement for profit shifting from India to Switzerland and there is no legitimate need to avail purported services from DRL, SA. In addition thereto, assessee failed to adduce any evidence to establish that DRL, SA has actually offered any services warranting payment of 50% of its profit share.
56. We have carefully perused the material on record. It is not in dispute that DRL, India was instrumental in bringing out a generic drug by name Sumatripton and filed an abbreviated new drug application ("ANDA") before the U.S. FDA for selling the drug in US. In fact, DRL India obtained approval for manufacture of the said product. However, GSK had patent rights as original inventor and hence it filed a patent infringement petition against DRL India before the US Federal Court and thus the matter was settled "Out of Court" and a " Tripartite Agreement" was entered into in October, 2006 whereby GSK authorised DRL, US to launch the product as an authorised generic agent. Further, Dr. Reddy's Laboratories were required to undertake the product 73 ITA.Nos.294/H/2014, 458 & 463/H/2015 Dr. Reddy's Laboratories Limited, Hyderabad.
liability insurance for not less than USD 25 Million and price fall risk as per the agreement.
57. The main plea of the assessee is that it does not have any marketing net work in USA whereas DRL US has a strong distribution net work and therefore, they market the product manufactured by GSK. Therefore, DRL, USA was entitled to 50% share of profit. Assessee i.e., DRL, India was allowed to get a compensation of 50% profit for loosing the manufacturing facility of the drug developed by it. However, to protect itself from running into losses DRL, India approached DRL, Swiss to take product liability insurance and Shelf Stock Adjustment (in short "SSA") risk. It is not in dispute that assessee entered into an agreement with DRL Swiss whereby DRL Swiss had undertaken the insurance for product liability and SSA risks. It is also not in dispute that DRL Swiss paid an amount of 22 Million Dollars towards 50% of legal and development cost incurred by DRL, India. DRL, SA had also incurred expenditure to the extent of 13 Million dollars towards SSA. As rightly pointed out by the Learned Counsel for the Assessee there are restrictions for an Indian Company to take any General Insurance Policy outside India unless there is specific approval from Central Government. Since DRL, SA had undertaking the product liability insurance as well as SSA risk of 50% it cannot be said that DRL SA had not rendered any service to earn 25% share out of profits.
58. The contention of the Revenue is that DRL, SA has come into existence in 2007 and there is no reason as to why it should reimburse 50% costs of R & D expenditure to DRL, India. It is also the case of the Revenue that the litigation with regard to who should manufacture the product and market in USA ended in a settlement in 2006 by which time DRL, USA was not even in existence and therefore, there was no 74 ITA.Nos.294/H/2014, 458 & 463/H/2015 Dr. Reddy's Laboratories Limited, Hyderabad.
need to share 50% of the costs by DRL SA, referrable to the litigation and R & D; Thus, it is a colourable device.
58.1. However, it is not denied that DRL, SA made such payments. R & D expenditure is ordinarily claimed by the assessee as a Revenue expenditure and as and when it is reimbursed the same would be treated as revenue expenditure in the hands of the assessee in the year of receipt; In the instant case, there is no dispute that DRL, SA has made the payment to the assessee apart from undertaking product liability insurance and liability of SSA. It is not necessary that decision taken by entrepreneur in the interests of business should always result in higher benefit to the assessee. If it is proved that payment is made in the interests of the business, though the benefit is not proximate, an assessee is entitled to claim deduction of expenditure.
58.2. Ld. CIT-D.R. submitted that the A.O. has a duty to consider the genuinity of the expenditure and he need not merely be persuaded by the agreements entered into between parties.
58.3. However, the consideration shall be objective and not subjective. It is for the assessee to manage his affairs in a way which protects/shields it's business interests. Here is a case where the expenditure incurred by the assessee on R & D and obtaining manufacturing licence is nominal whereas there is a chance of making good profits during exclusivity period by marketing the product in USA. DRL SA had come forward to share 50% of R & D and legal expenses and was also prepared to undertake consideration. As a business entity assessee had taken a decision to enter into an agreement with DRL SA for sharing of profits. Such being the case, Revenue is not entitled to analyse the business decision from it's perspective.
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58.4. In the case of S.A. Builders Limited (supra), the Hon'ble Supreme Court observed that the Revenue authorities should not sit in the arm chair of businessman to decide as to how much is reasonable expenditure having regard to the circumstances of the case. This principle was reiterated in number of cases which were referred to by the Learned Counsel for the Assessee.
59. The Ld. D.R. has relied upon several decisions but the same are rendered in the peculiar set of facts emanating in those cases. Whether the expenditure is genuine or not, has to be considered by taking into consideration the facts in its entirety. In the instant case, in the later part of the exclusivity period there was price fall which resulted in sharing of loss between DRL, US and DRL, India and because of the understanding between DRL, India and DRL, SA, the liability amounting to Rs.57 crores was adjusted by DRL, SA which could be noticed from the following observations of the A.O. in the assessment order for the A.Y. 2010-2011.
1.1. "The assessee vide letter dated 14.03.2014 submitted that the TPO while determining the ALP in respect of the profit share on marketing and distribution of Sumatriptan - Switzerland made an adjustment Rs.64,92,01,592 which is the Gross Profit share of the marketing & distribution of the above product and ignored the price fall adjustment amounting to Rs.56,90,93,756/-. However, as per the agreement of M/s. DRL India with M/s. DRL Switzerland, M/s. DRL Switzerland has undertaken to bear the risk of price fall adjustment as a result of which only an amount of Rs.8,01,07,837 was transferred as profit share to M/s. DRL Switzerland. The assessee also produced copies of the Debit Notes & Credit Notes issued by Dr. Reddy's US and the copies of the agreement between Dr. Reddy's US and M/s. DRL, India in support of its claim. The assessee also submitted the chronicle of events for the launch of Sumatriptan and entering into agreement with Dr. Reddy's US and DRL, Switzerland and also proof that the Sumatriptan (imitrex) was launched only in November, 2008 which is 76 ITA.Nos.294/H/2014, 458 & 463/H/2015 Dr. Reddy's Laboratories Limited, Hyderabad.
subsequent to the entering into agreement with DRL, Switzerland i.e. in May, 2008. The assessee also submitted that as per the clause 1.3 of the Agreement with Dr. Reddy's US and DRL India the Gross Profit means Net Sales reduced the price fall adjustment etc., and as per clause 2 of the Agreement 50% of the profit i.e. after price fall adjustment has been shared with DRL India. In effect, what DRL India has received as profit share after price fall adjustment from Dr. Reddy's US is only Rs.72,93,09,429/-(Rs.129,84,03,185 - Rs.56,90,93,756) out of which Rs.64 crores was retained by DRL India and the balance of about Rs.8 crores has been transferred to DRL SA. Therefore, the assessee submitted that due credit has to be given to this price fall adjustment and only an amount of Rs.8,01,07,837/- had to be considered for the adjustment by the TPO.
1.2. Considering the submissions made by the assessee, the adjustment on account of profit share of DRL, Switzerland on marketing and distribution of Sumatriptan is taken at Rs.8,01,07,837/- as against - Rs.64,92,01,592 after giving set-off for the price fall adjustment."
60. The above findings indicate that the agreement between DRL, India and DRL, SA is taken notice of by the tax authorities and therefore, it may not be proper to treat the agreement as bogus. DRL, SA is compensated for rendering two services i.e., for undertaking insurance and SSA. In fact, legal and development costs were also shared by DRL, SA and those details were duly furnished and recorded in the T.P. order for the A.Y. 2010-2011.
61. It is not out of place to mention that the 'Tripartite Agreement' between DRL, US, GSK and DRL, India took place in 2006 but the need to enter into an agreement with DRL, SA arose only during the period of introduction of the drug i.e., before November/December, 2008. There is no dispute with regard to the fact that prior to that date the assessee already entered into an agreement with DRL, SA. It is thus seen that there is sufficient evidence to show that the assessee entered 77 ITA.Nos.294/H/2014, 458 & 463/H/2015 Dr. Reddy's Laboratories Limited, Hyderabad.
into an agreement with DRL, SA in the interests of business and once it is established that an expenditure is incurred for the purpose of business it is not always necessary to prove that assessee is assured of getting more profit than what is expended. In the instant case, assessee had not actually incurred any expenditure. On the contrary, DRL, SA come forward to share R & D expenditure and legal costs and also agreed to undertake the insurance liability and SSA risk. If there is no such arrangement, DRL, India would have borne the entire costs towards SSA which, in the instant case, was borne by DRL, SA in the A.Y. 2010-2011.
62. Having regard to the overall circumstances of the case, we are of the firm view that the sharing of profits between DRL, India and DRL SA is for bonafide business purposes and therefore, assessee is entitled to claim deduction on this count. It may not be out of place to mention that the A.O. was of the view that the assessee has a major role in product development and therefore, in the process of sharing profits between DRL US and DRL, India, assessee is entitled to larger share i.e., 60%. It is not in dispute that the DRL, US has undertaken the responsibility of warehousing and marketing the product in US territory which is the main role that requires to be played in selling a drug during the exclusivity period. Despite that assessee having initially done the Research and filed an abbreviated new drug application for the drug namely "Sumatripton" and got approval to manufacture and develop the product in India and to sell the same in USA, there was an agreement between DRL, US and DRL, India to share the profits equally. Under these circumstances, we are of the view that the DRP was justified in holding that the sharing of profits between India and US at 50%-50% cannot be questioned.
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63. As we have already stated herein above, out of 50% share that the assessee earned it had to part with a portion of the profit with the DRL SA for the detailed reasons set-out in the above paras. Having regard to the circumstances of the case and in the backdrop of the principles laid down by the Hon'ble Supreme Court in the case of S.A. Builders, we are of the firm view that the agreement between DRL, India and DRL SA cannot be doubted. We direct the A.O. accordingly.
64. In so far as the A.Y. 2009-2010 is concerned, ground No.1 is general in nature whereas Ground Nos. 27, 28 and 29 are general and consequential in nature and therefore, need not be addressed independently. Similarly, for the A.Y. 2010-2011 ground Nos. 19 to 21 are general and consequential in nature and therefore, the same are not discussed in the order. In so far as the Revenue's appeal is concerned, ground Nos. 1 and 4 are general in nature and with regard to ground No.2, this issue is already considered by us along with the appeals filed by the assessee for both the years on the said issue. In otherwords, we hold that distribution of 60% profit to DRL India is not correct and thus we affirm the view taken by DRP in this regard.
65. Vide ground No.3, the Revenue contends that the expenditure incurred towards stock based compensation should be treated as capital expenditure. This issue is squarely covered by the decision of the ITAT, Special Bench, Bangalore (supra). In fact, Ld. D.R. has not placed before us any decision of a superior Forum wherein a contrary view is taken. Under these circumstances, we uphold the view taken by the DRP.
66. In the result, appeals filed by the Assessee for the A.Y. 2009- 2010 and 2010-2011 are partly allowed whereas appeal filed by the Revenue for the A.Y. 2010-2011 is dismissed.
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Order pronounced in the open Court on 28.04.2017.
Sd/- Sd/- (S. RIFAUR RAHMAN) (D. MANMOHAN) ACCOUNTANT MEMBER VICE PRESIDENT Hyderabad, Dated 28th April, 2017. VBP/- Copy to
1. Dr. Reddy's Laboratories Limited, 8-2-337, Road No.3, Banjara Hills, Hyderabad - 500 034.
2. Addl. Commissioner of Income Tax, Circle-1(2), 4th Floor, Aayakar Bhavan, Hyderabad.
3. The Disputes Resolution Panel, 2nd Floor, I.T. Towers, 10-2-3, A.C. Guards, Hyderabad - 500 004.
4. Director of Income Tax (Transfer Pricing), Chennai and Member DRP, Hyderabad.
5. CIT(A)-IV, Hyderabad
6. Addl. Commissioner of Income Tax (Transfer Pricing), Hyderabad.
7. CIT-1, Hyderabad.
8. D.R. ITAT "A" Bench, Hyderabad
9. Guard File