Income Tax Appellate Tribunal - Kolkata
Organon (India) Limited, Mumbai vs Addl. Cit, Circle - 12, Kolkata, Kolkata on 15 May, 2019
ITA No. 1335/KOL/2010
Assessment Year: 2005-2006
Organon (India) Limited
IN THE INCOME TAX APPELLATE TRIBUNAL,
KOLKATA 'C' BENCH, KOLKATA
Before Shri P.M. Jagtap, Vice-President (KZ)
and Shri A.T. Varkey, Judicial Member
I.T .A. No. 1335/KOL/2010
Assessment Year: 2005-2006
Organon (Indi a) Lim ited,............................................................Appellant
Platina, 7 t h Floor, Plot No. C-59,
G Block, Bandra Kurla Complex, Bandra (East),
Mumbai-400 098, Maharashtra
(PAN: AAACI 6949 R)
-Vs.-
Addi tional Commissioner of Income Tax,.. ................................Respondent
Circle-12, Ko lkata,
Aayakar Bhawan,
P-7, Chowringhee Square, Kolkata-700 069
Appearances by:
Shri Puskar G upt a, C.A. and Shri Sh asank Kajat, C.A, for the Appellant
Shri P.K. Srihari, CIT, D.R. , for the Respo ndent
Date of concluding th e hearing : March 15, 2019
Date of pronouncing the order : May 15, 2019
O R D E R
Per Shri P.M. Jagtap, Vice-President (KZ):-
This appeal filed by the assessee is directed against the order of ld. Commissioner of Income Tax (Appeals)-12, Kolkata dated 29.03.2010.
2. Grounds No. 1 to 5 of this appeal involve a common issue relating to disallowance of Rs.41,20,200/- made by the Assessing Officer under section 40(a)(i) of the Act and confirmed by the ld. CIT(Appeals) for the alleged non-deduction of tax at source from the payment made for Microsoft licence fees.
3. The assessee in the present case is a Company, which is engaged in the business of manufacturing, trading and sale of pharmaceutical products as well as manufacturing of ready-to-eat foods products on 1 ITA No. 1335/KOL/2010 Assessment Year: 2005-2006 Organon (India) Limited contract basis for Government. The return of income for the year under consideration was filed by it on 31.10.2005 declaring total income of Rs.24,50,77,530/-. As noted by the Assessing Officer during the course of assessment proceedings, the assessee had paid an amount of Rs.41,20,200/- to its Associated Enterprise at Netherland namely M/s. Organon NV and the same was claimed to be towards reimbursement of expenses. It was claimed on behalf of the assessee-company in this regard that its Netherlands based Associated Enterprise had purchased Software on licence from Microsoft for use by all its Group entities and the licence fees paid by M/s. Organon NV for the software to Microsoft was apportioned at actuals to all the Group entities on the basis of number of employees. It was submitted that the share of the assessee worked out to Rs.41,20,200/-, which was reimbursed to M/s. Organon NV on the basis of actuals. It was contended that the said amount thus represented purely reimbursement of expenses to M/s. Organon NV and since it did not include any income element, the assessee was not liable to deduct tax at source from the payment of the same. The Assessing Officer did not find merit in this contention raised on behalf of the assessee. According to him, the amount in question was paid by the assessee for the use of software and since it was taxable as royalty as per the provisions of the Act as well as the DTAA between India and USA, the assessee was required to deduct tax at source under section 195 of the Act from the payment made to M/s. Organon NV. As the assessee had failed to comply with the said requirement, the Assessing Officer invoked section 40(a)(i) and disallowed the sum of Rs.41,20,200/-.
4. The disallowance made by the Assessing Officer under section 40(a)(i) was disputed by the assessee in the appeal filed before the ld. CIT(Appeals). During the course of appellate proceedings before the ld. CIT(Appeals), the main contention raised on behalf of the assessee- company in support of its case on this issue was that the amount in question represented mere reimbursement of expenditure being a part of 2 ITA No. 1335/KOL/2010 Assessment Year: 2005-2006 Organon (India) Limited licence fees apportioned by M/s. Organon NV as a share of the assessee- company and since the same had not given rise to any income in the hands of M/s. Organon NV, the provisions of section 195 were not attracted and the assessee-company was not required to deduct tax at source from the payment made to M/s. Organon NV. The ld. CIT(Appeals) did not accept this stand of the assessee-company. He agreed with the view taken by the Assessing Officer that the amount in question having been paid by the assessee indirectly to Microsoft through its Netherlands based Associated Enterprise for use of Software was in the nature of royalty and since the same was chargeable to tax in India in the hands of Microsoft, the assessee was liable to deduct tax at source under section
195. He accordingly held that the failure of the assessee to deduct tax at source from the said amount attracted the provisions of section 40(a)(i) and the disallowance made by the Assessing Officer by invoking the said provision was confirmed by the ld. CIT(Appeals). He also took note of the fact that a similar issue was involved in assessee's own case for A.Ys. 2003-04 and 2004-05 and the same was decided by the first appellate authority.
5. The ld. Counsel for the assessee submitted that a similar issue was involved in assessee's own case for earlier years i.e. A.Ys. 2003-04 and 2004-05 and the same has already been decided by the Tribunal in favour of the assesese vide its common order dated September 20, 2017 passed in ITA Nos. 863/KOL/2008 and 978/KOL/2009. He also invited our attention to the relevant portion of the order of the Tribunal as contained in paragraph no. 14 to 18 and submitted that a similar amount paid by the assessee-company to its Netherlands based Associated Enterprise for its share of the expenditure incurred on purchase of Software on licence from Microsoft USA was held to be not liable for deduction of tax at source by the Tribunal and the disallowance made under section 40(a)(i) was deleted.
3 ITA No. 1335/KOL/2010Assessment Year: 2005-2006 Organon (India) Limited
6. The ld. D.R., on the other hand, submitted that even though the Tribunal has decided a similar issue in favour of the assessee for A.Ys 2003-04 and 2004-05 vide its order dated September 20, 2017 (supra), the decision of Hon'ble Calcutta High Court in the case of CIT -vs.- Andaman Sea Food Pvt. Limited (ITAT No. 19 of 2013 dated 23.07.2014) supports the stand of the Revenue taken on this issue.
7. In the rejoinder, the ld. Counsel for the assessee submitted that the decision of the Hon'ble Calcutta High Court in the case of CIT -vs.- Andaman Sea Food Pvt. Limited (supra) cited by the ld. D.R. is distinguishable on facts. He submitted that the transactions involved in the said case were not covered by DTAA while the transactions involved in the present case are not only covered by DTAA but the provisions of DTAA are in favour of the assessee as found by the Tribunal in A.Ys. 2003-04 and 2004-05. He also submitted that even otherwise the non- discrimination clause is applicable in the case of the assessee and the assessee is entitled for relief as per the said clause as held by the Tribunal in A.Ys. 2003-04 and 2004-05.
8. We have considered the rival submissions and also perused the relevant material available on record. It is observed that a similar issue involving identical facts and circumstances was considered by the Tribunal in assessee's own case for A.Ys. 2003-04 and 2004-05 vide its common order dated September 20, 2017 and after considering all the relevant aspects including the provisions of DTAA, the case laws on the points etc. it was held by the Tribunal that the amount in question paid by the assessee was not in the nature of royalty. It was held that since the said amount was paid towards purchase of software, it would have been assessable as business profits in the hands of Netherland based Associated Enterprise and since the said Associated Enterprise did not have a permanent establishment in India, the business profits could not be taxed in India under Article 7 of the Indo Netherland DTAA. It was held 4 ITA No. 1335/KOL/2010 Assessment Year: 2005-2006 Organon (India) Limited by the Tribunal that there was no element of profit involved in the transactions representing remittance made towards purchase of licence software for use by the assessee, which was taxable in India in the hands of the Associated Enterprise and the assessee, therefore, was not required to deduct tax at source from the said payment under section
195. It was further held by the Tribunal that the assessee was entitled for relief on this issue even on the basis of non-discrimination clause contained in Article 24(4) of the Indo-Netherland DTAA. The Tribunal accordingly deleted the disallowance made by the Assessing Officer under section 40(a)(i) of the Act and confirmed by the ld. CIT(Appeals) in both the years i.e. A.Ys. 2003-04 and 2004-05.
9. At the time of hearing before us, the ld. D.R. has not disputed the fact that this issue stands squarely covered in favour of the assessee by the decision of the Tribunal rendered in assessee's own case for A.Ys. 2003-04 and 2004-05. He, however, has relied on the decision of the Hon'ble Calcutta High Court in the case of CIT -vs.- Andaman Sea Food Pvt. Limited (ITAT No. 19 of 2013 dated 23.07.2014) which, according to him, supports the revenue's stand on this issue. However, as rightly contended by the ld. Counsel for the assessee, the said case decided by the Hon'ble Calcutta High Court is distinguishable on facts, inasmuch as, the transactions under consideration in the said case were not covered b y the relevant DTAA, whereas the amount in question paid by the assessee in the present case to its Netherland based Associated Enterprise is not taxable in the hands of the Associated Enterprise in India as per the relevant clause of the DTAA as found by the Tribunal in the assessee's own case for A.Ys. 2003-04 and 2004-05. Moreover, as held by the Tribunal in its order for A.Ys 2003-04 and 2004-05, the assessee was entitled for relief on this issue even as per the benefit conferred under non-discrimination clause of the DTAA. We, therefore, respectfully follow the decision of the Tribunal rendered in assessee's own case for A.Ys. 2003-04 and 2004-05 vide its order dated September 20, 2017 (supra) 5 ITA No. 1335/KOL/2010 Assessment Year: 2005-2006 Organon (India) Limited and delete the disallowance made by the Assessing Officer under section 40(a)(i) and confirmed by the ld. CIT(Appeals). Grounds no. 1 to 5 of the assessee's appeal are accordingly allowed.
10. Grounds no. 6 to 8 involve a common issue relating to disallowance of conversion charges of Rs.35,87,454/- as made by the Assessing Officer and confirmed by the ld. CIT(Appeals) on account of prior period expenses.
11. The assessee-company during the relevant period had entered into an agreement with a third party manufacturer, who was required to manufacture goods on behalf of and under the license of the assessee- company. The assessee-company was liable to pay conversion charges to the said party and as per the terms of the agreement, the assessee- company was committed to pay minimum amount of conversion charges every calendar year to the said party i.e. January to December called as "Minimum Conversion Charges". Accordingly if the actual conversion charges paid on the basis of actual production during the year was short of a minimum conversion charges, then the assessee-company was required to make the short-fall good. There was such a short-fall to the extent of Rs.35,87,454/- pertaining to Financial Year 2004-05 and Rs.4,51,83,246/- pertaining to Financial Year 2005-06. After settling and finalizing these amounts in the F.Y. 2006-07, a total amount of Rs.4,87,70,700/- was debited by the assessee to the Profit & Loss Account of F.Y. 2006-07 on account of prior period expenses. Since the assessee- company was following the mercantile system of accounting, it suo moto offered the entire amount of Rs.4,87,70,700/- in the computation of income for F.Y. 2006-07 relevant to A.Y. 2007-08 being the expenditure of prior period. During the course of assessment proceedings for the year under consideration, i.e. A.Y. 2005-06, the assessee claimed a deduction of Rs.35,87,454/- being the expenditure incurred on conversion charges pertaining to A.Y. 2005-06. Since the said deduction was not claimed by 6 ITA No. 1335/KOL/2010 Assessment Year: 2005-2006 Organon (India) Limited the assessee either in the original return or even in the form of revised return, the Assessing Officer did not entertain the claim of the assessee for the said deduction by relying on the decision of the Hon'ble Supreme Court in the case of Goetze India Limited [284 ITR 323]. On appeal, the ld. CIT(Appeals) upheld the action of the Assessing Officer on this issue by observing that the assessee was not entitled to make any fresh claim, which was not made either in the return of income originally filed or by way of filing a revised return.
12. The ld. Counsel for the assessee submitted that the assessee was liable to make good any short-fall in the minimum conversion charges payable as per the agreement entered into with a contract manufacturer. He submitted that such short-fall pertaining to the year under consideration i.e. A.Y. 2005-06 as well as for A.Y. 2006-07 was settled and finalized in the previous year relevant to A.Y. 2007-08. He submitted that the amount of such short fall accordingly was debited by the assessee to the Profit & Loss account for A.Y. 2007-08 and in the computation of total income for A.Y. 2007-08, the amount so debited was offered to tax being prior period expenses. He invited our attention to the Audit Note given on this issue placed at page no. 380 of the paper book and pointed out that the amount to the extent of Rs.35,87,451/- being pertaining to the year under consideration, i.e. A.Y. 2005-06 was claimed by the assessee as deduction during the course of assessment proceedings He contended that since the said amount undisputedly pertained to the year under consideration and even the debit notes for the same were raised by the concerned party during the year under consideration, the assessee was entitled for deduction of the same and the authorities below were not justified in disallowing the deduction claimed by the assessee merely on the ground that the same was not claimed either in the return of income originally filed or by way of revised return. He contended that since the amount in question was settled and finalized subsequently, it was not 7 ITA No. 1335/KOL/2010 Assessment Year: 2005-2006 Organon (India) Limited possible for the assessee to claim the same either in the original return or by way of revised return.
13. The ld. D.R., on the other hand, submitted that neither the Assessing Officer nor the ld. CIT(Appeals) has decided this issue on merit and the claim of the assessee for deduction of the amount under consideration was disallowed by them on the ground that the same was not claimed either in the return of income originally filed or by way of revised return. He contended that the assessee, however, is not entitled for this deduction on merit because even though the Debit Notes were raised by the concerned party in the year under consideration, there was a dispute about this contractual liability payable by the assessee which was finally settled in the subsequent year relevant to A.Y. 2007-08. By relying on the decision of the Hon'ble Kerala High Court in the case of CIT
-vs.- Seshasayee Bros. (Travancore) [82 ITR 442], he contended that the deduction on account of contractual liability can be claimed by the assessee only in the year in which it is finally settled and crystallized.
14. We have considered the rival submissions and also perused the relevant material available on record including the Audit Note on the issue under consideration as given at page no. 380 of the paper book. It is observed that there was a difference between the actual conversion charges and minimum conversion charges for the year under consideration as payable by the assessee to M/s. ASG Bio Chem Limited in terms of the Loan Licensing Agreement dated 1 s t January, 2005. It is also observed that Debit Notes for such difference were raised by M/s. ASG Bio Chem Limited during the year under consideration on 15.02.2005 and 15.03.2005. However, the amount raised in the said Debit Notes was not accepted by the assessee and the same was in dispute. The said dispute was finally settled in the financial year 2006-07 relevant to assessment year 2007-08 and accordingly the amount of difference payable by the assessee to M/s. ASG Bio Chem Limited was debited to the Profit & Loss 8 ITA No. 1335/KOL/2010 Assessment Year: 2005-2006 Organon (India) Limited Account for the F.Y. 2006-07. It is thus clear that the amount in question payable by the assessee on account of difference between the actual conversion charges and minimum conversion charges for the year under consideration representing contractual liability was in dispute and the same was settled and crystallized only in the F.Y. 2006-07 relevant to A.Y. 2007-08. As rightly contended by the ld. D.R., the assessee, therefore, was not entitled for deduction on account of this contractual liability pertaining to the year under consideration as the same represented disputed liability and since this dispute was settled and the liability was crystallized only in the F.Y. 2006-07, the assessee was entitled for the deduction of the same only in A.Y. 2007-08. We, therefore, find no infirmity in the impugned order of the ld. CIT(Appeals) confirming the disallowance made by the Assessing Officer on this issue and upholding the same, we dismiss Grounds No. 6 to 8 of the assessee's appeal.
15. The common issue raised in Grounds No. 9 to 13 relates to the addition of Rs.1,54,04,816/- made by the Assessing Officer and confirmed by the ld. CIT(Appeals) on account of Transfer Pricing Adjustment.
16. During the year under consideration, the assessee-company had entered into certain international transactions with its Associated Enterprises involving, inter alia, purchase of raw materials from related parties and sale of goods manufactured from the said raw materials to unrelated parties in the domestic market and to the Associated Enterprises in the overseas market. There were thus two segments, one involving purchase of raw material from related parties and sale of the manufactured products to unrelated parties and second involving purchase of raw materials from related parties and sale of manufactured products to the Associated Enterprises. In order to determine the Arm's Length Price of the second segment involving transactions with Associated Enterprises, a reference was made by the Assessing Officer to the Transfer Pricing Officer under section 92CA(1) of the Income Tax Act, 9 ITA No. 1335/KOL/2010 Assessment Year: 2005-2006 Organon (India) Limited 1961. During the course of proceedings before the Transfer Pricing Officer, segmental Profit & Loss Account of these two segments was prepared and furnished by the assessee showing the following results:-
Pa r t ic ul a rs Pu rc ha s e o f R M
Pu rc ha s e of RM fr o m R el a t e d,
fr o m r el a t e d, E xp o rt Ex po rt of M F G
of M F G g oo ds to go ods to
R el a t ed ( R S. un r el a te d
Sa l es / C om m is s i o n e r i n c om e 7,5 0, 96 ,6 54 533 10 94
M a t e ria l c o ns um e d 514 01 79 2 142 56 26
A dj us t m e nt fo r d if f e r e nc e - 182 75 39 7 - 200 39 6
M a t e ria l c o ns um e d 331 26 39 5 122 52 30
Pu rc ha s e fo r t ra di ng N IL N IL
Exc i s e du ty N IL N IL
A dj us t m e nt fo r d if f e r e nc e N IL N IL
Pu rc ha s e s fo r t ra di n g N IL N IL
G r os s M a rg i n 236 94 86 2 390 54 68
Va l u e A d d in g ex p e ns es ( VA E)
M a n ufa c tu ri n g c os t 141 98 32 8 563 33 8
T ra d e d is c ou nt N IL N IL
A p po r ti on e d ex p e ns es
A dv e rt is e m e nt a nd p ro duc t N IL N IL
pr o mo ti o n
A dm i nis t ra t iv e , o th e r N IL 145 18 92
a l l oc a bl e e xp e ns e s
De p r ec i a t io n 961 84 8 682 81
C om m is s i o n N IL 142 23 9
Dis c ou nt N IL N IL
To ta l VA E 151 60 17 6 222 57 50
To ta l c os t 665 61 96 8 365 83 76
R M / T ota l c os t 77% 39%
Op e ra ti n g ma rg i n 853 46 86 167 97 18
N on- o p e ra t in g i nc om es N IL N IL
N on- o p e ra t in g ex p e ns e s N IL N IL
Pr o fi t b ef or e ta x( a s p er N IL N IL
a c c ou nt s )
G r os s ma r gi n t o s a l es ( 0%) N IL N IL
Op e ra ti n g ma rg in t o s a l e s 11. 36 % 31. 51 %
( 0%)
G r os s ma r gi n t o VA E ( 0 %) N IL N IL
G P/ OIC O P N IL N IL
10
ITA No. 1335/KOL/2010
Assessment Year: 2005-2006
Organon (India) Limited
17. From the above segmental Profit & Loss Account, the Transfer Pricing Officer found that administrative and other allocable expenses had not been allocated by the assessee to the segment, wherein sales were made to the Associated Enterprises and the same were entirely allocated to the segments where sales were made to the unrelated parties. He also found that operating margin to sales in case of sale made to unrelated parties was 31.51% as compared to 11.36% in case of sales made to Associated Enterprises. As noted by the Transfer Pricing Officer, if the administrative and other expenses had been allocated to the segment involving sales made to the Associated Enterprise, profit of the said segment would have further gone down. He accordingly required the assessee to explain as to why the transactions of the segment involving sales made to Associated Enterprise should not be considered as not being entered into at Arm's Length since both the purchases and sales were controlled transactions entered into with the related parties. In reply, the following explanation was offered by the assessee:-
"On and from Financial Year 2003-04, Organon India Limited (OIL), apart from having it s own manufacturing facilities, also st arted sub-cont racting manufacturing operations to subcontractors, kno w as 'Lo an Manufacturers' . All the necessary raw materials and technologies are supplied by OIL t o the cont ract manufacturer who does all the necessary processing operations. OIL in t urn pays conversion charges to the loan manufacturers for the processing work carried on by them.
In this regard, the t wo existing manufacturing facilities were disposed off by OIL with effect from financial year4 2004-05 and hence all its manufacturing activit ies are being carried out t hrough the above mentio ned loan manufacturers. Since, OIL subcontract its manufact uring operations to sub-contracto rs, allocation o f administrative overhead would not reflect th e true and co rrect profit abilit y of th e said segment. Allocation of administrative overh ead would disto rt th e profit ability o the abo ve segment .
Based on the above rationale, administrative overhead h as not been allocat ed in Segment 2- Contract Manufact uring Segment . In this regard, reference can also be made to page no. 10 and 11 of the Transfer Pricing Study fo r Fin ancial 11 ITA No. 1335/KOL/2010 Assessment Year: 2005-2006 Organon (India) Limited Year 2004-05 filed as Appendix-5 through our submis sion dated 31 s t June, 2008".
"The manufacturing facilities which were disposed off on 'as is wh ere is' basis to the loan manufact urers with effect from financial year 2 004-05, were engaged in full fledged manufacturing. In th e said unit s, various other product s along with those referred to in Segment 2 were al so being manufactured. However, in respect to segment 2, th e functional profile of the assessee is different fro m that in respect of other manufacturing segments. With respect to segment 2 , th at is t he contract manufacturing segment . Organon India Ltd. (OIL) enters into the following internat ional transactions:-
-Impo rt of raw materials
- Export of manufactured finished goods Though the nature o f t ransact ion for Segment 2 and the other manufacturing segments, i.e. Segments 1, 3 & 4 are simil ar, yet there are significant functional diffe rences, between these segments as st ated in paragraph 4 .2.21 (page 25) of the Transfer Pricing St udy for FY 2004-05 already submitted before your goodself. Such funct ional difference expl ain the reason fo r not allocating administrative expenses to segment 2. To el aborate on such differences, the functions performed by OIL with re spect to the above mentio ned international transactions h as been summarised as under: -
OIL impo rts raw mat erials fro m group co mpanies as well as non group companies, which are used in the manufacturing of the final products, the nature of th e ph armaceutical indust ry is such that the quality of inputs (specially the active ingredients) is of paramount import ance in determining the quality of the end product. Before a raw material can be used in the production process, th e qualit y parameters need to be set. Once the raw materials pass th e quality control procedure, they can be used for the production process. In the case o f OIL, such qualit y testing is generally done by t he associate enterprise from whom the raw materials are purchased. In the case of import s fro m non group entities (i.e. th ird parties) quality testing is done by OIL.
The other general functions performed in the course of purchase of raw materials are receiving an indent, obtaining quotations, placing of 12 ITA No. 1335/KOL/2010 Assessment Year: 2005-2006 Organon (India) Limited purchase orders, making timely sh ipments and payment to the suppliers.
In relat ion to segment 2, OIL does not perform any qualit y cont rol functions and also does not perform any functions in relation to sourcing of raw materials (such as receiving an indent , obtaining quot ations, placing of purch ase orders, making t imel y shipment s) because the active ingredients are supplied by the associated enterprise (after necessary qualit y cont rol) fo r contract manufact uring purposes. Thus, for this segment OIL does not incur any significant administrative expenses in relating to impo rt of raw material s".
In addition to the above explanation, it was also submitted by the assessee that the two segments are not functionally similar since in the segment under question goods had not been manufactured by the assessee itself but were manufactured by a loan manufacturer i.e. a sub- contractor and in the segment which is being compared to, the manufacturing process was done by the assessee-company itself.
18. The Transfer Pricing Officer found the explanation offered by the assessee to be un-acceptable. According to him, there was hardly any difference between the own manufacturing activity of the assessee- company and the contract manufacturing done for the Associated Enterprises. He held that the assessee-company was required to ensure the quality of finished goods manufactured by the contract manufacturing as per the specific requirements of the Associated Enterprise and since it was the liability of the assessee-company, administrative and other expenses ought to have been allocated to the said activity. He held that both these segments were functionally comparable and the only difference was that in one case, the export was to Associated Enterprise and in other case, the export was to unrelated party. He observed that even though in one segment, manufacturing had been done by a sub- contractor but the cost of the manufacture of these goods was debited by 13 ITA No. 1335/KOL/2010 Assessment Year: 2005-2006 Organon (India) Limited the assessee in its books of account as manufacturing expenses. He held that the said activity thus was deemed to be the manufacturing activity of the assessee-company for all practical purposes and there was hardly any difference whether the manufacturing was done by the assessee-company by using its own facility or somebody else's facilities. He also held that there was nothing to show that any risk involved in the transactions was transferred by the assessee-company to the sub-contractors/loan manufacturers. He accordingly rejected the assessee's contention that two segments could not be functionally compared and applying the operating profit margin to sales of 31.51% of the segment involving export of goods to unrelated parties after allowing the adjustment of 1.51% on account of commission/charges paid to the loan manufacturer in lieu of the services, he determined the arm's length operating margin of the assessee-company of the segment involving export to Associate d Enterprise at Rs.2,25,38,783/- as against the operating margin of Rs.85,34,686/- shown by the assessee. Accordingly Transfer Pricing Adjustment of Rs.1,40,04,097/- (Rs.2,25,38,783/- minus 85,34,686/-), was worked out by the Transfer Pricing Officer in respect of these international transactions of the assessee-company with its Associated Enterprise and in the assessment completed under section 143(3) vide an order dated 22.12.2008, an addition to that extent was made by the Assessing Officer to the total income of the assessee on account of transfer pricing adjustment.
19. The addition of Rs.1,40,04,097/- made by the Assessing Officer on account of transfer pricing adjustment was challenged by the assessee in the appeal filed before the ld. CIT(Appeals) and the following submissions were made on behalf of the assessee before the ld. CIT(Appeals) in support of its case that the addition on account of transfer pricing adjustment made by the Assessing Officer was not sustainable:-
14 ITA No. 1335/KOL/2010Assessment Year: 2005-2006 Organon (India) Limited "TPO / AO failed t o communicate to t he Appellant the relevant clause under section 92C(3) o f the Act , wh ich triggers the application of pro visio ns of th e transfer pricing.
B. Reaso ns why segment 2 (Cont ract Manufact uring Segment ) cannot be compared to segment 3 .
- Funct ional profile of segment 2 and 3 not correctl y appreciat ed by the T PO
- Both segment 2 and 3 cannot be co mpared since both the segment h ave relat ed party transact ions.
- The two segments cannot be compared since the volume of transactions for segment 2 is almost 15 times mo re th an segment 3 .
- The T ransfer Pricing Officer and accordingly the Assessing Officer has erro neously took an adhoc view while computing the commission ch arges at 1 .51 % and t hus co mputing the total adjust ment for ' segment 2' at 30% (OP/ Sales) without any basis in low nor any scientific basis of calculation.
C. Interpret ation of internal audit services as shareholder service The appellant, humbly submit s that identical issue h as been decided in favour of the appellant in respect of AY 2004-05, wherein the CIT (Appeals) held that" ..... the fact th at the expenditure has been act ually expended is not disput ed and the assessee h as claimed that it has immensely benefit ed by such audit by way of better control , bett er administration and better funct ioning of the company. Considering the fact th at the CIT(Appeals), in the assessee's own case for AY 2003-04 has held that such expendit ure as allowable, the TPO's observatio n that no tangible benefit h as accrued to the assessee company directly or indirectly by this internal audit is held to be not correct. Th erefore, h e should h ave comput ed the arm' s length price for the said t ransaction. Though, in the preceding year the disallowance was made under th e no rmal pro visions of the Act and in the present year the s ame was done under the provisions relating to T ransfer Pric ing, but in both the years the disallowance was mode following the same principle that there was no apparent purpose or utility of such audit to the assessee. Therefore, I find no me rit in th e decisio ns of the TPO in this respect and hence, the AO. is direct ed to allow the claim .... "
Based on the judgment of the CIT (Appeals), th e appellant humbly submits before your goodself, that , the adjust ment of Rs. 1,400,719 made by the TPO and as accept ed by AO is erroneous and bad in law since the same is in co ntradictio n of 15 ITA No. 1335/KOL/2010 Assessment Year: 2005-2006 Organon (India) Limited the pro visio ns of the Act and against the decisio n of various Tribunal ."
D. Variance of 5% from the arith metical mean as pro vided under the Act has not been allowed by the TPO and the Assessing Officer.
Further, th e Ld. A.R. made submissio ns vide his lett er dt . 24- 09-2009 as under:
"Adhoc allowance by the Transfer Pricing Officer ("T PO") and the Assessing Officer ("AO") of 1.51 % as co mmi ssio n charges payable to th e loan manufact urer 1.0 The appellant would like to reit erate from the submissio n dated 5th June dat ed 2009 (Copy of the same is attached as Appendix 1) th at the TPO has wrongly compared 'segment 2' with 'segment 3' (where purch ases are made from relat ed entities and finished goods are expo rted back to unrelated part ies). The TPO at page 9 para 3 of his order has contended th at "this particular set of transactions have been taken as the benchmark , as functionally this sector resembles the most with th e activit y that has to be adjusted. In both th e cases, the raw materials h ave been purchases fro m relat ed enterprises, and goods have been manufactured and th e manufact ured goods have been exported. Thus funct ionally both the set of transactions are co mparable." (Copy of t he TPO order is attached as Appendix 2) 1.1 In this regard, th e appellant h umbl y submit s that the TPO grossly erred in comparing 'segment 2' with seg ment
3. The TPO while comparing the two segments h as specially co mmented that in both the segment s, the raw materials h ave been purchased from rel at ed enterpri ses and manufactured goods are exported back. The contention of the TPO is against the principles of t ransfer pricing. The Act and the Income-t ax Rules, 1962 (hereinafter referred to as 'Rules') specifically provides that fo r co mparability purposes on international transaction needs t o be co mpared or adjust ed to an uncont rolled transact ions. In th is case bot h the segment s have relat ed party transactions and h ence cannot be compared.
2.0 Based on the above submission, the appellant would also like to submit before your goodself th at the Rules also lays down cert ain specific parameter, which if satisfied,' then only co mpariso n can be possible. Reference can be drawn fro m Rules 10B(2) of the Rules;16 ITA No. 1335/KOL/2010
Assessment Year: 2005-2006 Organon (India) Limited 10B. (2 ) Fo r the purposes of sub-rule (1 ), t he co mparabilit y of an international transactio n with an unco ntrolled transaction sh all be judged with reference to the following, namely: -
(a) the specific characterist ics of th e property t ransferred or services pro vided in either transactio n;
(b) the functio ns performed, t aking into account as sets emplo yed o r to be employed and the risk s assumed, by the respective part ies to t he transactio ns;
(c) the cont ract ual t erms (whether o r no t such terms are formal o r in writing) of the t ransact ions which lay down explicitly or implicitl y how the respo nsibilities, risks and benefit s are to be divided between the respective parties to the transactio ns;
(d) conditions prevailing in the market s in wh ich the respective part ies o t he transactio ns operate, including the geographical location and size of th e mark ets, the l aws and Government orders in force, cost s of labour and capit al in the markets, overall econo mic develo pment and level of competit ion and wh ether the markets are wholesale or retail.
The TPO' and accordingly the AO while comparing th e two segments and also computing the adjustment did not t ak e cognizance to the paramet ers l aid down in Rule 10B of th e Rules.
2.1 Further, the Rules also provides th at an uncont rolled transaction would be co mparable t o an international transaction if 1. None of the differences between the transactions being compared or between the ent erprises entering into such t ransactions materially affect the price of the international t ransaction, o r
2. A. reasonable adjustment could be made to eliminate the effects of such differences.
In this regard, reference, can be drawn from Rules 10B (3) of the Rules, 10B (3) An uncont rolled t ransaction shall be comparable to an international transactio n if -
i) none of the differences, if any, between the t ransact ions being co mpared, o r between th e ent erprises entering into such transactions are lik ely o r materially affect the price or cost charged or paid in, o r the profit arising from, such transactio ns in the open market; o r .17 ITA No. 1335/KOL/2010
Assessment Year: 2005-2006 Organon (India) Limited
ii) reaso nabl y accurate adjust ments can be made to eliminate the material effect s of such differences.
2.2. The pro ducts manufactured under the two segments are significantly different in nature, namel y under seg ment 2, the products manufact ured are Nordion and Allylest renol , while under segment 3, th e products manufact ured are PAVULON 2ML- l'S PVMS, Deca Durabolin 25 mg Old, Deca Durabolin 25 mg, Durabolin 25 mg arid Sust anon 250. Since th e product s manufactured are different in nat ure, th e appellant humbly submits th at th ere cannot be any comparison.
2.3. Based, on the abo ve, we humbly submit before your goodself th at as per the provisions Rules 10B(3)(ii ) no reasonable accurat e adjust ments can be made to Segment to eliminate the materials difference and hence acco rdingly, th e two segment s cannot be compared.
(B) Copy of the Kolkata T ribunal judgment in the case of Development Consult ants Pvt . Lt d. v. DCIT (2008) 115 TTJ 577 (ITAT -Kolkat a) is att ached as Appendix 3".
20. The submissions made by the assessee did not find merit with the ld. CIT(Appeals), who proceeded to confirm the transfer pricing adjustment of Rs.1,40,04,097/- made by the Assessing Officer for the following reasons given in his impugned order:-
"I h ave carefully perused the impugned assessment orders, submissio ns made by the A.R of the appellant and also the judicial decisio ns relied upon by the A.O and the A.R. The appellant furnished form no. 3CEB being Ch artered Accountants report in respect of international t ransact ions which cont ained co mparison of profit margin of different segments of internat ional t ransactions wit h mo st appropriate method in each case and fo und th at price of international transactions are at arm's length price. The TPO, however disregarded the repo rt in fo rm 3CEB and proceeded to mak e two adjust ments to th e value of international transactions. The appellant vehemently opposed the adjust ments made by TPO.
5.3.1. The appellant's first challenge to A.O's action is on the ground that the TPO/AO failed to communicate to the appellant the relevant clause u/s 92C(3) of the Act which triggered the applicat ion of pro visions of th e transfer pricing. But this objection of the appellant has no substance at all as the reference to T PO was made by A.O u/s 9 2CA(1) and not u/s 92C(3). Hence appellant's objection raised vide ground no. 5 is rejected.18 ITA No. 1335/KOL/2010
Assessment Year: 2005-2006 Organon (India) Limited 5.3.2. Th e appellant's other objections to adjust me nt are on the ground of no n-co mparabilit y of both segments on account of FAR differences, involvement of relat ed part y trans actions in both segment s etc. In this connection my observations are as under:
(i) The appellant h as impo rted raw materials fro m its AE and in t urn expo rted goods aft er manufacturing to its AE's and non AE's bo th. The goods expo rted to AE's have been manufactured by- the appellant through the loan licensee (contract manufacturer) and th is segment is hereinaft er called ' segment 2' and the goods expo rted to non AE's have been manufact ured by the appellant itself and this segment is hereinaft er called 'segment 3'. T he A/ O has co mpared these two segment s and h as observed th at the appellant has derived o perating margin to sale of 11.36% from ' segment 2' and 31.51 % from 'segment 3'. It has also been observed th at proportionate administrative expenses of Rs.1,91,42,07 2/- has not been allocated to 'segment 2'. In 'segment 2' the appellant sold go ods to AE's which were resold by the AE's in the internatio nal market and in 'segment 3' the appellant directl y sold goods in the int ernatio nal market . The gross margin of 'segment 2' is very low as co mpared t o gross margin of 'segment 3' which shows t hat the appellant sell goods t o its AE at prices lower th an the market price co mpared to its sale to non-AE, so that on resale most of the profit s would be reported in AE's jurisdiction. Thereby th e appellant avoided th e exposure of its real profits to taxation in India.
(ii) It is beyond do ubt th at the appellant h as performed less function in rel ation to ' segment 2' as co mpared to 'segment 3', but it does no t mean that both segments are functionally different . In both the segments t he appellant import ed raw materials and after manufacturing finish ed goods expo rted them on outright basis to it s AE's and non AE's both. Th e only difference is the outsourcing of manufacturing process in 'segment 2' and in 'segment 3 ' the manufact uring process has been conducted by the appellant company itself. In the field of manufact uring of pharmaceutical business, the o utsourcing of manufacturing process is in vogue and it is cost effective also.19 ITA No. 1335/KOL/2010
Assessment Year: 2005-2006 Organon (India) Limited
(iii) The appellant itself submitted th at 'though the apparent nature of activit ies fo r 'segment 2' and the other manufact uring segment s i.e. 'segments 1, 3, & 4' are similar, 'yet t here are significant functional differences between these segments as st ated in paragraph 4.2 .21 (page 25) of the Transfer pricing Study for FY 2004-2005. Such functional difference explai ns the reasons for not allocating administ rat ive expenses to 'segment 2' while th e same has been all ocated to the other segments. Therefore, it is clear th at the appell ant has already conducted FAR analysis at th e time of TP study and adjustments h ave already been mode to mitigate the FAR differences between 'segment 2' an d 'segment 3'. This implies that after making such adjust ments 'segment 3' had become comparable to 'segment 2'.
(iv) Moreover, the manufact uring cost in case of 'segment 2' represent s cost of job charges paid to loan licensee. It is observed that the ratios of manufacturing costs to raw materials consumed are 42.86% in case of segment 2 being co nt ract manufacturing and 45.98% i n case of segment 3 being own manufacturing, It means the outsourcing of manufacturing facilit y is beneficial in the case of the appellant also. But th e rat ios of gro ss margin to sales are 31 .55% in case of ' segment 2' and 73.26% in case of ' segment 3' which shows that in spite of the fact that the cont ract manufacturing is beneficial the g ross margin to sales in case of 'segment 2' is very low as compared to 'segment 3'. This proves th at the appellant sell goods to it s AE' s at prices lower th an the market price, so th at on resale most of the pro fits wo uld be reported in AE's jurisdiction.
(v) Reliance is pl aced on Ranbaxy Labo ratories Ltd. Vs. ACIT (2008) 110 IT D 428 (Delhi) wherein the Hon'ble Tribunal has dismissed the assessee's co ntention that internal uncont rolled transactio ns carried out by the taxpayer were not comparable with t ransactions with the AE' s on account o f the risk differential between them because it did not undert ake risk of success o r failure of product which were undert aken in t ransactions with its AE's. The Hon'ble T ribunal h eld that if it' s done as per normal business pract ice, no adjust ment is needed. But if it is abno rmal favour to an associated enterprise, this crucial aspect was required to be examined and evaluated as entire t ransfer pricing regulations are concerned with adjustments of favourable t reat ment meted to rel ated (associated) co ncerns. The Hon'ble Tribunal held th at the cont ractual terms fo r both categories of transact ions should have been analysed and 20 ITA No. 1335/KOL/2010 Assessment Year: 2005-2006 Organon (India) Limited the possibility of suit able adjust ment s eval uated in light of the same.
(vi) Further, as per provisions of th e Act, t he net margin of transaction is calculated with reference to an appro priat e base say costs, sales, o r assets. Therefo re, the net margin fro m the uncontrolled transaction is establish ed by reference to net margin earned by the t ax payer fro m co mparable uncont rolled t ransactions o r from net margin th at would be earned in co mparable transactions made by independent ent erprises. In the instant case the net margin earned by the appell ant from comparable uncont rolled sales h as been t aken as benchmark fo r comparing net margin earned by the appellant from cont rolled sales. Therefo re, comparison of the abo ve mentioned segment s made by the AO is as per pro visio ns of the Act and th e plea of the appellant that the raw mat erials in both segments h ave been purchased fro m relat ed party cannot debar the AO/TP O from such co mpariso n since the net margin h as been calculated with reference to sale and not purchases.
(vii) Co ming to the case l aws cited by the appell ant , it is to be ment ioned that the facts of th e appellant case are different from that of the case cited.
(viii) Decision: -
Therefo re, based on the above discussio n the upward adjust ment of Rs.1,40 ,04,097/- made by AO as per re po rt of TPO in respect of internatio nal t ransact ions of goods sold to AE's is proper. The ground no. 6 is not allowed".
21. The ld. Counsel for the assessee submitted that the two segments compared by the Transfer Pricing Officer were functionally different. He submitted that even though the raw material consumed in both these segments was purchased by the assessee-company from the related parties, the products manufactured from one segment and sold by the assessee to Associated Enterprises was classified as active pharmaceutical ingredients or bulk drugs while the products of the other segment manufactured and sold to unrelated parties were formulations. He also invited our attention to the list of such products manufactured in both the segments and submitted that the active pharmaceutical ingredients/bulk drugs produced by the assessee in one segment were in the nature of intermediates which were required to be further processed 21 ITA No. 1335/KOL/2010 Assessment Year: 2005-2006 Organon (India) Limited by the Associated Enterprises to produce the final products for sale to their customers. He submitted that the formulations produced in the other segment by the assessee-company and supplied to the unrelated parties, on the other hand, were final products. By relying on the decision of Ahmedabad Bench of ITAT in the case of Inducother (India) Pvt. Limited -vs.- DCIT, he contended that these two segments, therefore, were not comparable and the Transfer Pricing Officer as well as the ld. CIT(Appeals) failed to appreciate and understand the difference in the functional profile pointed out by the assessee in these two segments. The ld. Counsel for the assessee further submitted that the products of the one segment supplied by the assessee-company to its Associated Enterprises were not manufactured by the assessee-company in its own facility and the same were got manufactured from the contract manufacturers. He contended that the risk undertaken by the assessee- company in respect of this segment, therefore, was limited as compared to the risk undertaken by it in case of the other segment where products were manufactured on its own by the assessee-company and supplied to the unrelated parties under its own brand name. He invited our attention to the details furnished by the assessee in this regard before the authorities below enumerating the different risks undertaken in respect of these two segments. He also invited our attention to the relevant portion of the Transfer Pricing Study Report submitted by the assessee at page no. 64 of the paper book to point out that the additional functions performed by the assessee in respect of segment where goods were manufactured and sold by the assessee-company to unrelated parties as final products under its own brand name than the other segment where the intermediate goods supplied to the Associated Enterprises were got manufactured from the contract manufacturer as per the specific requirement of the Associated Enterprise. He contended that even there was a huge difference in the volume of both these segments making them un-comparable on this ground also. He contended that all these differences pointed out by the assessee in the two segments have been 22 ITA No. 1335/KOL/2010 Assessment Year: 2005-2006 Organon (India) Limited properly appreciated by the Transfer Pricing Officer in A.Y. 2007-08 and the two segments were not compared by him in that year for making any transfer pricing adjustment as done in the year under consideration.
22. The ld. D.R., on the other hand, submitted that there was no difference between two segments compared by the Transfer Pricing Officer, inasmuch as, in both these segments, similar products were manufactured from the raw materials purchased by the assessee from the Associated Enterprises and the same were sold in one segment to unrelated parties and in the other segment to the Associated Enterprises. He contended that there was thus no functional difference in these two segments and even if there was some difference in the nature of products manufactured as pointed out by the ld. Counsel for the assessee, the same is not relevant when the method adopted is TNMM. As regards the difference in risk undertaken in two segments as pointed out by the ld. Counsel for the assessee, he contended that such difference is only marginal and not substantial. He contended that when these two segments are found to be the functionally comparable, some adjustments can be made for the marginal difference in risk undertaken while determining the transfer pricing adjustment.
23. We have considered the rival submissions and also perused the relevant material available on record. It is observed that the segment in which sales were made by the assessee to its Associated Enterprises, the products were in the nature of active pharmaceutical ingredients/bulk drugs, which were intermediates and the said intermediates were required to be further processed by the Associated Enterprises for producing the final products for sale of its customers. In the other segment where sales made by the assessee were to the unrelated parties, products manufactured were in the nature of formulation which constituted final products manufactured and sold by the assessee- company under its own name. It is thus clear that the products sold by 23 ITA No. 1335/KOL/2010 Assessment Year: 2005-2006 Organon (India) Limited the assessee-company to its Associated Enterprises were being used by the Associated Enterprises as their inputs for further manufacturin g while the products sold by the assessee-company in other segment to unrelated parties were final products which were meant for their consumption. In the case of Inducotherm (India) Pvt. Ltd. (supra) cited by the ld. Counsel for the assessee, it was held that a sale to dealer of the same product, much less to a manufacturer of related end product, inherently cannot be equated with the sale to the end-consumer. It was held that the comparability of an international transaction with an uncontrolled transaction under Rule 10B(2)(d) is to be judged with reference to, inter alia, the conditions prevailing in the market in which the respective parties to the transactions operate and the case of sale to the end consumer is not the same thing as sale to the manufacturer or dealer who uses the same as input raw material. It was held that this distinction is so fundamental that the comparison is meaningless.
24. It is observed that besides the difference in the nature of products manufactured in two segments compared by the Transfer Pricing Officer, even the risk undertaken by the assessee-company in these two segments was different. As pointed out by the assessee in this regard before the authorities below as well as before us, a limited risk was undertaken by it in the segment where the products were got manufactured from the third party as per the specific requirement of the Associated Enterprises whereas higher risk was taken in the other segment where products were not only manufactured mainly in the own manufacturing facility of the assessee-company but the same were sold as a final product to the ultimate consumer under its own brand. The risk undertaken in one segment involving sale of Associated Enterprise thus was limited while a full-fledged risk was taken by the assessee in the other segment involving sale to unrelated parties and the extent of such different risk undertaken in these two segments was brought to the notice of the authorities below 24 ITA No. 1335/KOL/2010 Assessment Year: 2005-2006 Organon (India) Limited with reference to each and every risk involved in the relevant transactions.
25. It is pertinent to note here that the two segments compared in the process of transfer pricing analysis done in the year under consideration were also sought to be taken as comparables by the Transfer Pricing Officer in A.Y. 2007-08 and when specific query was raised by him, the difference in business profile of both these segments was explained by the assessee by pointing out that the final products exported to Associated Enterprises were active pharmaceutical ingredients, which were active chemicals with medicinal properties used in the further manufacturing of drugs (formulations), whereas the goods exported to unrelated parties were formulations being the finished products (Drugs). It was also pointed out by the assessee that the nature of risk borne by the assessee in these two segments was different, inasmuch as, the risk undertaken in the manufacturing and export of goods to Associated Enterprises was low while the risk undertaken in manufacturing and export of final products to unrelated parties was high. As pointed out by the ld. Counsel for the assessee from the Transfer Pricing Officer's order dated 28.10.2010 passed for A.Y. 2007-08, this distinction or dissimilarity brought to his notice by the assessee was accepted by the Transfer Pricing Officer and these two segments were not taken by him as comparables inspite of the fact that the PLI (OP/TC) of the segment involving export of goods to unrelated parties was substantially higher than the PLI of other segment involving export of goods to Associated Enterprise.
26. Keeping in view the above discussion, we find that not only the nature of products manufactured in both these segments compared by the Transfer Pricing Officer as well as the risk undertaken by the assessee in these two segments was different, even the business model or business process adopted by the assessee in these two segments was different and 25 ITA No. 1335/KOL/2010 Assessment Year: 2005-2006 Organon (India) Limited the same cannot be taken as comparables for the purpose of transfer pricing analysis in order to determine the arm's length price. We, therefore, delete the addition made by the Assessing Officer and confirmed by the ld. CIT(Appeals) on account of transfer pricing adjustment and allow Grounds No. 9 to 13 of the assessee's appeal.
27. In Ground No. 14, the assessee has challenged the addition of Rs.14,00,719/- made by the Assessing Officer and confirmed by the ld. CIT(Appeals) on account of transfer pricing adjustment made in respect of international transactions of the assessee-company with its Associated Enterprise involving payment of audit fees.
28. During the year under consideration, a sum of Rs.14,00,719/- was claimed to be paid by the assessee for internal audit services received from its Associated Enterprise namely Akzo Nobel South East Pte. Ltd., Singapore. Although the assessee-company during the course of proceedings before the Transfer Pricing Officer furnished the relevant details including the copy of internal audit report, which contained the findings and recommendations of the internal auditors and the comments to the management of the assessee-company on such findings and recommendations, the Transfer Pricing Officer was of the view that no tangible benefit had accrued to the assessee-company directly or indirectly by such internal audit. He accordingly determined the arm's length price of the internal audit services received by the assessee- company from its Associated Enterprise at 'NIL' and proposed a transfer pricing adjustment of Rs.14,00,719/-. When the addition was made by the Assessing Officer on account of this transfer pricing adjustment, the assessee challenged the same in the appeal filed before the ld. CIT(Appeals). During the course of appellate proceedings before the ld. CIT(Appeals), it was submitted on behalf of the assessee-company that it did not have any internal audit department in its organisation and hence internal audit services were availed from external agencies in order to 26 ITA No. 1335/KOL/2010 Assessment Year: 2005-2006 Organon (India) Limited have an internal audit system commensurate with its size and nature of business. The benefits received from such internal audit services were also explained by the assessee before the ld. CIT(Appeals). The ld. CIT(Appeals), however, did not find merit in the case of the assessee on this issue and confirmed the addition made by the Assessing Officer on account of transfer pricing adjustment for the same reasons as given by the Assessing Officer.
29. We have heard the arguments of both the sides on this issue and also perused the relevant material available on record. Although the ld. D.R. has strongly relied on the orders of the authorities below in support of the revenue's case on this issue, it is observed that a similar issue was involved in the assessee's own case for the immediately preceding year i.e. A.Y. 2004-05 and the similar addition made by the Assessing Officer on account of transfer pricing adjustment made in respect of the international transactions of the assessee-company entered into with its Associated Enterprise availing of internal audit services was deleted by the ld. CIT(Appeals) after rejecting the TPO's case that no tangible benefits had accrued to the assessee directly or indirectly by the internal audit. The relevant portion of the ld. CIT(Appeals)'s order giving his conclusion on this issue for A.Y. 2004-05 is reproduced hereunder:-
"In the inst ant case the fact that the expendit ure h as been actually expended is not disputed and the assessee h as claimed that it has immensel y benefited by such audit by way of better cont rol, better administration and better functioning of the company. Considering the fact th at the CIT(Appeals) in assessee's own case fo r AY 2003-04 has held such expendit ure as allowable, the TPO' s observat ion that no intangible benefit h as accrued to the assessee co mpany directl y o r indirectly by this internal audit is held not to be correct . Therefore, h e should have co mputed the arm's length price fo r the said t ransactio n. Though, in the preceding year the disallowance was made under th e normal pro visio ns of the Act and in the present year the same was done under the pro visions relat ing to Transfer Pricing, but in both the years the disallowance was made following the same principle that there was no apparent purpose or utilit y o f such audit to th e assessee. Therefo re, I find no merit in the decisio n of the TPO 27 ITA No. 1335/KOL/2010 Assessment Year: 2005-2006 Organon (India) Limited in this respect and hence, th e AO is directed to allow the claim of Rs.13,61,864/- of t he assessee" .
30. As submitted by the ld. Counsel for the assessee, the decision of the ld. CIT(Appeals) giving relief to the assessee on this issue in A.Y. 2004-05 was challenged by the revenue by filing an appeal before the Tribunal but the said appeal involving low tax effect was dismissed by the Tribunal as not maintainable without going into merit of the issue. It appears that the decision rendered by his predecessor on a similar issue in the immediately preceding year i.e. 2004-05 in assessee's own case was not taken into consideration by the ld. CIT(Appeals) while deciding this issue vide his impugned order passed for the year under consideration. As found by the ld. CIT(Appeals) in A.Y. 2004-05, the assessee-company was benefited by the internal audit by way of better control, better administration and better functioning and keeping in view the same, the Transfer Pricing Officer's conclusions that no tangible benefit had accrued to the assessee-company directly or indirectly by such internal audit was held to be incorrect by the ld. CIT(Appeals) in A.Y. 2004-05. Even in his impugned order passed for the year under consideration, the ld. CIT(Appeals) accepted the fact that the internal audit conducted by the parent company was to ensure that the affairs of the assessee- company are carried out as per the global practices of the group. He, however, held that the parent company was not willingly appointed by the assesese-company to conduct the audit and, therefore, there was no additional benefit that had accrued to the assessee directly or indirectly from such audit. Keeping in view all the facts of the case as well as the decision of the ld. CIT(Appeals) in assessee's own case for the immediately preceding year i.e. A.Y. 2004-05, we are unable to subscribe to the view taken by the ld. CIT(Appeals) in the year under consideration.
31. As already noted, the relevant details of the internal audit services rendered from its Associated Enterprise were furnished by the assessee including the internal audit report which contained findings and recommendations of the internal auditors and the comments to the 28 ITA No. 1335/KOL/2010 Assessment Year: 2005-2006 Organon (India) Limited management of the assessee-company on such findings and recommendations. It was specifically pointed out on behalf of the assessee-company that it did not have any internal audit department and hence the internal audit services were required to be availed in order to have an internal audit system commensurate with its size and nature of business. Even the benefits received from such internal audit services were explained by the assessee by pointing out that the focus of the said audit was on business risk aspect and it provided certain assurance/comfort to the management that the operations of the assessee-company were well managed and efficient. As pointed out on behalf of the assessee-company, key findings and recommendations under various financial and operational areas of the assessee-company were made in the internal audit report and implementation of such recommendations by the management had resulted in better control and functioning of the business of the assessee-company. Having regard to all these facts of the case, we are of the view that certain specific benefits were derived by the assessee-company from the internal audit services rendered by its Associated Enterprise and the authorities below were not justified in making the impugned addition on account of transfer pricing adjustment by taking the arm's length price of the internal audit services rendered by its Associated Enterprise to the assessee at 'nil' on the ground that no benefit, directly or indirectly, was received by the assessee by availing the said services. In that view of the matter, we delete the addition made by the Assessing Officer and confirmed by the ld. CIT(Appeals) by way of transfer pricing adjustment on this issue and allow Ground No. 14 of the assessee's appeal.
32. In the result, the appeal of the assessee is partly allowed.
Order pronounced in the open Court on May 15, 2019.
Sd/- Sd/-
(A.T. Varkey) (P.M. Jagtap)
Judicial Member Vice-President (KZ)
Kolkata, the 15 t h day of May, 2019
29
ITA No. 1335/KOL/2010
Assessment Year: 2005-2006
Organon (India) Limited
Copies to : (1) Organon (Indi a) Lim ited,
Platina, 7 t h Floor, Plot No. C-59,
G Block, Bandra Kurla Complex, Bandra (East), Mumbai-400 098, Maharashtra (2) Addi tional Commissioner of Income Tax, Circle-12, Ko lkata, Aayakar Bhawan, P-7, Chowringhee Square, Kolkata-700 069 (3) Commissioner of Income Tax (Appeals)-12, Kolkata, (4) Commissio ner of Income Tax- , (5) The Depart ment al Represent ative (6) Guard File By order Assistant Registrar, Income Tax Appellate Tribunal, Kolkata Benches, Kolkata Laha/Sr. P.S. 30