2025 (8) TMI 954 - AT - Income Tax

Third-party lab payments treated as pass-through excluded from cost base, CSMM margin revised to 13.71%; late s.143(3) challenge disallowed

ACIT-14 (2) (2) Versus M/s. Pfizer Limited, Mumbai And (Vice-Versa)

ACIT-14 (2) (2) Versus M/s. Pfizer Limited, Mumbai And (Vice-Versa) - TMI 1. ISSUES PRESENTED AND CONSIDERED 1.1 Whether payments made by the taxpayer to third-party clinical laboratories for conducting clinical trials qualify as 'pass-through costs' to be excluded from the cost base when computing the taxpayer's operating margin for provision of Clinical Study Management and Monitoring (CSMM) support services. 1.2 Whether the taxpayer's functions (agreements with principal investigators, indemnity obligations, protocol amendments, data compilation/analysis, organization of trial activities) evidence that it is more than an intermediary/agent such that third-party payments are not pass-through costs. 1.3 Whether comparables selected by the Transfer Pricing Officer (TPO) - contract research & development (R&D) companies - were rightly applied to benchmark the CSMM support services instead of business support/consultancy comparables selected by the taxpayer. 1.4 Whether the Assessing Officer (AO)/TPO could validly apply the same set of comparables to benchmark two different services (CSMM and Marketing Support Services) or whether separate benchmarking and comparables are required for the distinct transactions. 1.5 Whether an assessment order passed by an Additional Commissioner lacked jurisdiction because there was no traceable order under the relevant statutory provisions (section 120(4)(b)/127 equivalent) assigning the case, and whether the taxpayer can raise that jurisdictional challenge after a long delay. 2. ISSUE-WISE DETAILED ANALYSIS 2.1 Issue 1 - Treatment of third-party clinical lab payments as pass-through costs Legal framework: Transfer pricing principles and OECD guidance (paras referenced to OECD 2010, including para 7.36) recognize pass-through costs where a taxpayer acts truly as an agent for an associated enterprise (AE) and incurs payments on behalf of the AE without earning a mark-up on those reimbursements. Precedent treatment: Tribunal decisions in earlier years involving the same taxpayer and decisions of the Mumbai Bench (including an earlier favourable order for preceding assessment years) and dismissal of departmental appeal by the High Court in one earlier year supported exclusion of pass-through costs where the taxpayer acted as a facilitator/intermediary. Interpretation and reasoning: The Court examined the character of payments and the substance of the taxpayer's role. Relying on prior Tribunal findings in the taxpayer's own case and the OECD principle that pass-through treatment requires agency-type conduct, the Court accepted that where the taxpayer's role is limited to facilitation and it procures clinical trial services from third parties for the AE, the related payments represent pass-through costs that should be removed from the cost base for margin computation. Ratio vs. Obiter: Ratio - where the factual matrix shows the taxpayer operates as a facilitator/intermediary (does not itself perform the clinical work and merely reimburses third parties), payments to clinical labs qualify as pass-through costs and must be excluded from the cost base. Obiter - discussion of general OECD wording is supportive but the decisive factor is the factual finding of intermediary role in this taxpayer's case. Conclusions: The Court upheld the exclusion of third-party clinical lab payments as pass-through costs for the CSMM margin computation for the assessment year under appeal, dismissing Revenue grounds challenging that treatment. 2.2 Issue 2 - Whether contractual and functional features (agreements, indemnity, protocol control, data activities) demonstrate value addition precluding pass-through treatment Legal framework: Transfer pricing requires functional analysis; where a taxpayer performs substantive functions and bears risks, reimbursements may not qualify as pass-through costs and may attract a mark-up. Precedent treatment: The Tribunal in earlier related proceedings found the taxpayer to be a facilitator; Revenue relied on contractual clauses to argue assumption of risk and performance of substantive functions. Interpretation and reasoning: The Court reviewed the contractual clauses relied upon by Revenue (clause asserting independent contractor status, clauses on protocol amendment control, indemnity, and data handling) but accepted the factual conclusion that the operative commercial model showed the taxpayer obtaining clinical trials from third parties and acting as intermediary/facilitator. The Court treated the prior Tribunal findings and related factual determinations as persuasive for the year under appeal. Ratio vs. Obiter: Ratio - where the evidentiary and functional reality is that the taxpayer procures third-party clinical services and acts as facilitator despite contractual language, such internal clauses do not automatically negate pass-through treatment. Obiter - general remarks that indemnity or contractual obligations may indicate risk assumption only where demonstrated in commercial substance rather than mere documentation. Conclusions: The Court rejected Revenue's contention that contractual provisions and listed functions necessarily convert reimbursements into non-pass-through costs; the factual finding of intermediary role controlled and pass-through exclusion stands. 2.3 Issue 3 - Appropriateness of comparables: contract R&D comparables versus business support/consultancy comparables for CSMM benchmarking Legal framework: Transactional Net Margin Method (TNMM) requires comparables that are functionally similar; exact identity is not required but substantial functional similarity is necessary. Selection and rejection of comparables must be reasoned and supported by functional analysis. Precedent treatment: Tribunal's prior orders for the taxpayer and appellate authorities have held that entities acting as facilitators/support service providers should be benchmarked against business support/consultancy comparables rather than high-end contract R&D firms performing substantive research. Interpretation and reasoning: The Court found substantial force in the taxpayer's functional characterization of CSMM as support/facilitation. The TPO's selection of contract R&D comparables was held to be inappropriate because those comparables perform fundamentally different functions and bear different risks and assets. The Court relied on prior Tribunal findings and on the principle that functional similarity, not mere industry label, governs comparability. The CIT(A)'s direction to adopt taxpayer comparables was sustained because the TPO's rejection lacked cogent reasons demonstrating functional equivalence of contract R&D comparables to the taxpayer's support role. Ratio vs. Obiter: Ratio - comparables must be functionally similar; applying high-end contract R&D comparables to a facilitator/support services provider is improper absent clear functional parity. Obiter - remarks on TNMM requiring functional similarity rather than exact sameness. Conclusions: TPO's comparables were rejected; the comparables selected by the taxpayer for CSMM benchmarking were restored and Revenue's grounds on comparables (grounds 6 & 7) were dismissed. 2.4 Issue 4 - Use of same comparables for two distinct transactions (CSMM and Marketing Support Services) Legal framework: Separate international transactions should generally be benchmarked separately, with comparables appropriate to each transaction's functions, assets and risks. Precedent treatment: The CIT(A) and Tribunal have previously held that materially different activities require different comparable sets; however, parties may use the same comparables where functional profiles align. Interpretation and reasoning: The Court examined whether Marketing Support Services (MSS) and CSMM were functionally distinct in this case. Finding that the activities and functions of MSS differed materially from contract R&D activities, and that the TPO erred by treating MSS as akin to contract R&D, the Court agreed with CIT(A) that the TPO's application of R&D comparables to MSS was inappropriate. The fact that TPO had earlier applied R&D comparables to CSMM did not justify extending those same comparables to MSS where functions diverged. Ratio vs. Obiter: Ratio - the same set of comparables cannot be applied to distinct transactions where functional analysis shows material differences; comparability must be transaction-specific. Obiter - a prior inconsistent procedural approach by the TPO does not validate its application where functional mismatch exists. Conclusions: The TPO's application of R&D comparables to MSS was rejected; CIT(A)'s restoration of taxpayer comparables for MSS was upheld and Revenue's ground on using the same comparables for both transactions (ground 8) was dismissed. 2.5 Issue 5 - Jurisdictional challenge to assessment order passed by an Additional Commissioner after long delay Legal framework: Jurisdictional validity of an assessment depends on statutory assignment/orders vesting authority. Questions of jurisdiction can be raised at any time in principle, but delay, acquiescence and equitable doctrines (estoppel, laches, estoppel of acquiescence) may preclude relief where the challenge is raised after inordinate delay and the party participated in proceedings. Precedent treatment: A co-ordinate Tribunal decision involving similar facts (late challenge after many years where records could not be traced) rejected belated jurisdictional challenges, applying estoppel and laches principles and refusing to admit additional grounds after prolonged participation. Interpretation and reasoning: The Court relied on the co-ordinate Tribunal's reasoning: the taxpayer participated fully in assessment and appellate processes, did not raise jurisdictional objection earlier, and sought to challenge jurisdiction after 14 years. The department explained records were not traceable due to lapse of time and restructuring. Given the inordinate delay, absence of satisfactory explanation, and equitable considerations (estoppel/acquiescence), the Court found the jurisdictional ground inadmissible and refused to quash the assessment on that basis. Ratio vs. Obiter: Ratio - a delayed jurisdictional challenge, raised after many years of active participation and without plausible justification, may be rejected on grounds of estoppel/laches even if documentary proof of proper assignment by the department is unavailable. Obiter - general acknowledgment that jurisdictional points can be raised at any time, but relief depends on factual context and delay explanation. Conclusions: The cross objection challenging AO's jurisdiction was dismissed as barred by inordinate delay and estoppel/acquiescence; the Tribunal refused to entertain the belated jurisdictional plea. 3. OVERALL CONCLUSION 3.1 The Revenue's appeal was dismissed in its entirety: pass-through treatment of third-party clinical lab payments upheld; taxpayer's comparables for CSMM and MSS restored; adjustments computed by AO/TPO set aside as per issues decided above. 3.2 The taxpayer's cross-objection challenging the AO's jurisdiction was dismissed on grounds of inordinate delay and estoppel/acquiescence; the assessment order was not quashed for lack of traceable assignment orders.