2024 (2) TMI 1518 - AT - Income Tax

ITAT rejects both assessee's and TPO's transfer pricing methods, remands for fresh determination using TNNM with external comparables

Aurobindo Pharma Ltd Hyderabad Versus ACIT Central Circle 1 (2) Hyderabad

The ITAT Hyderabad ruled on transfer pricing adjustments for raw material transfers between Non-SEZ and SEZ units. Both the assessee's methodology ... TP adjustments - specified domestic transactions of raw material transfer from Non-SEZ Units to SEZ Units - AO made reference u/s 92CA(1) to the TPO for determination of Arms’ Length Price (ALP) - HELD THAT:- TP analysis of the assessee was rejected by the TPO. However, while determining the ALP, TPO has also adopted cherry picking of certain products out of 11 families. When the assessee is selling its formulation under 11 families from one unit to another unit of the assessee, then the entire lot of formulation will be considered as a basket of products and the TPO is not justified in picking only some of the products which are having low price and excluding the products which are having higher prices in comparison to the unrelated transactions of the assessee. Therefore, we find that neither methodology applied by the assessee which excludes 70% of the products while determining the ALP and benchmarking its specified domestic transactions in the TP study is acceptable as resulting a distorted outcome, nor the action of the TPO while cherry picking some of the products out of the total basket of 11 product formulations showing as 11 families of the formulation is a right approach. We further note that in the subsequent A.Y i.e. for the A.Y 2020-21, the TPO himself after rejecting the TP analysis of the assessee has proceeded to conduct an independent search by applying TNNM as the most appropriate method. Assessee has claimed that its specified domestic transactions having operating margin of 25.21% is at arm’s length in comparison to the median margin of the comparable at 20.61%. Accordingly, this issue is remanded to the record of the TPO/Assessing Officer for determination of the ALP by adopting TNNM as the most appropriate method based on the external comparables as well as international comparables of the assessee. If the operating margin of the assessee is found to be within the tolerance range of 3% of ALP, then no adjustment would be called for. Needless to say, before passing the fresh order, the assessee be given an appropriate opportunity of hearing. Disallowance of weighted deduction u/s 35(2AB) - AO has restricted the claim of weighted deduction u/s 35(2AB) only to the extent of the expenditure incurred for in house R&D facility and denied the claim in respect of the expenditure incurred on clinical drug trials outside the inhouse facility - HELD THAT:- When the issue as well as the facts are identical for the year under consideration to that of the A.Y 2017- 18, then to maintain the rule of consistency, we following the earlier order of this Tribunal and allow the claim of the assessee u/s 35(2AB) of the I.T. Act, 1961 for the entire expenditure as referred in the report of the DSIR. Disallowance of additional depreciation - claim was dis-allowed by AO in the draft assessment order by giving the reasons that it was used for less than 180 days - HELD THAT:- DRP after considering all the relevant facts and material has accepted the claim of the assessee and directed the AO to allow additional depreciation u/s 32(iia). In the final assessment order, the AO has not given the effect to the directions of the DRP which is not only uncalled for but also reflects the indiscipline on the part of the AO. Accordingly, we direct the AO to give effect to the directions of the DRP and allow the claim of the additional depreciation as directed by the DRP. Appeal filed by the assessee is partly allowed. ISSUES PRESENTED and CONSIDEREDThe core legal issues considered in this judgment include:Whether the Transfer Pricing (TP) adjustments made by the Transfer Pricing Officer (TPO) regarding specified domestic transactions between SEZ and non-SEZ units were justified.Whether the disallowance of weighted deduction under Section 35(2AB) of the Income Tax Act for expenditure on clinical trials conducted outside approved facilities was appropriate.Whether the disallowance of additional depreciation under Section 32(iia) was justified despite the directions of the Dispute Resolution Panel (DRP).ISSUE-WISE DETAILED ANALYSISTransfer Pricing AdjustmentsThe legal framework for this issue is governed by Section 92CA of the Income Tax Act, which mandates the determination of the Arm's Length Price (ALP) for specified domestic transactions. The TPO rejected the methodology used by the assessee, which applied the cost-plus method and a range concept for benchmarking transactions between SEZ and non-SEZ units.The Court noted that the TPO adopted a selective approach by cherry-picking certain products from the assessee's portfolio, which was not justified. The assessee's methodology, which excluded 70% of products, was also found to be flawed. The Tribunal emphasized that the entire product range should be considered as a basket for determining the ALP.The Court observed that for the subsequent assessment year, the TPO accepted the Transactional Net Margin Method (TNNM) as the most appropriate method. Therefore, the Tribunal remanded the issue back to the TPO/Assessing Officer to determine the ALP using TNNM based on external comparables, ensuring the operating margin falls within the 3% tolerance range.Disallowance of Weighted Deduction under Section 35(2AB)The legal framework involves Section 35(2AB) of the Income Tax Act, which allows weighted deductions for R&D expenditures. The Assessing Officer restricted the deduction to in-house R&D expenses, excluding clinical trials conducted outside approved facilities.The Tribunal referenced previous decisions, including those of the Gujarat High Court, which recognized that clinical trials often occur outside approved facilities and should qualify for deductions. The Tribunal emphasized consistency with its earlier rulings and allowed the deduction for clinical trial expenses, aligning with the principle that such trials are integral to R&D activities.Disallowance of Additional DepreciationThe issue pertains to Section 32(iia) of the Income Tax Act, which provides for additional depreciation on new plant and machinery. The DRP directed the Assessing Officer to allow this depreciation, but the Assessing Officer failed to comply.The Tribunal criticized the Assessing Officer's non-compliance with the DRP's directions, emphasizing the importance of adhering to procedural discipline. The Tribunal directed the Assessing Officer to implement the DRP's decision, allowing the additional depreciation as claimed by the assessee.SIGNIFICANT HOLDINGSThe Tribunal held that the TPO's selective approach in determining the ALP was inappropriate and remanded the matter for reconsideration using the TNNM method. It reiterated the importance of considering the entire product range as a basket for TP analysis.The Tribunal upheld the assessee's claim for weighted deductions under Section 35(2AB) for clinical trials conducted outside approved facilities, aligning with judicial precedents that recognize the necessity of such trials in R&D processes.The Tribunal directed the Assessing Officer to comply with the DRP's instructions regarding additional depreciation, highlighting the need for procedural adherence and consistency in tax assessments.