TaxTMI 
TaxTMI 
2011 (12) TMI 284
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....ing that its international transaction of 'Contract Research and Testing Services' does not satisfy the arm's length principle envisaged under the Income-tax Act, 1961 ('the Act'). In doing so the Ld. DRP has grossly erred in agreeing with the Transfer Pricing Officer's (Ld. TPO) action of: 2.1 disregarding the arm's length price ('ALP') and the methodical benchmarking process carried out by the appellant in the Transfer Pricing ('TP') documentation maintained by it in terms of section 92D of the Act read with Rule IOD of the Income-tax Rules, 1962 ('Rules'); 2.2 not allowing the use of multiple year data as prescribed under Rule 1OB(4) of the Rules read with the OECD TP Guidelines, and determining the arm's length price on the basis of financial information of the comparables for the year ended March 31, 2007 identified pursuant to a fresh search for comparables performed during the assessment proceedings. The AO/TPO/Ld. DRP erred in rejecting the contemporaneous documentation maintained by the appellant as required under the Indian TP regulations; 2.3 rejecting the set of comparable companies (8 compara....
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....ces to its associated enterprises. 4. During the year under consideration, the assessee had international transactions with following AEs: 1. M/s. Mehpa AG 2. M/s. Merckle GmbH 3. M/s. Ratiopharm GmbH 4. M/s. Ratiopharm Inc. 5. M/s. Laboratorie ratiopharm SA 6. M/s. Ratiopharm BV 7. M/s. Ratiopharm UK Ltd. 8. M/s. Ratiopharm Schweiz AG 9. M/s. Ratiopharm international Gmbh, Germany 5. The dispute in this appeal is with regard to the Arm's Length Price (ALP) of the international transaction of rendering contract testing and Research Services by the Assessee to it's Associated Enterprises (AE's) viz., Mepha AG, Merckle GMBH and Ratiopharma GMBH. The Assessee received a sum of Rs. 39.80 Crores for rendering the above services to its AEs. The breakup of the sum received is as under: (a) Contract Testing : Rs. 12.89 crs. (b) Pharmaceutical Product Development : Rs. 23.28 crs. (c) Analytical Research/Testing : Rs. 3.63 crs Total : Rs. 39.80 crs. The above activities were together considered as Contract Research and test....
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....a reasonable number of comparables and the broad level of comparability allowed under the TNMM, the TPO identified a fresh set of 8 comparables (which includes 2 common comparable with that of assessee), which companies according to the TPO perform functions broadly comparable to the activities of the assessee. The details of PLI of remaining 8 comparables are as under: S. No. Name of the Comparable Company PL1 (%) 1. M/s. Engineers India Ltd(Seg.) 45.16 2. M/s. Alphagea (India) Ltd* 38.21 3. M/s. Agile Electric Technologies Pvt Ltd 6.58 4. M/s. Vimta Labs Ltd* 27.44 5. M/s. IDC (India) Ltd 15.89 6. M/s. Oil Field Instrumentation (India) Ltd 76.46 7. M/s. Celestial Labs Ltd 58.35 8. M/s Mindtree Ltd.(Seg) 14.90 Arithmetic Mean 35.37 *These 2 comparables are common to the set of assessee as well as department. The above arithmetic mean of the PLI of the above comparables was 35.37%. The TPO therefore called upon the Assessee to show cause as to why the ALP of the transaction should be determined by applying the above Arithmetic Mean of 35.37%. 8. In response to the above, assessee made detailed submissions vide letters dated 16.7.201....
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....imilarly the TPO was also justified in including companies having similar type of functions. The TPO was also of the view that while applying the TNMM, functional similarity of comparables is not restricted to include companies within the same industry, in the event of inadequate comparable companies. In this regard the TPO also referred to the OECD TP guidelines which permits comparison even where the comparable is not in the same industry as that of the tested party, where there is inadequate comparable companies. b. In the comparables identified by the TPO, Engineers India Ltd. Was a public sector undertaking. According to the TPO, Public sector undertakings were also in the market for earning profits, similar to private companies and therefore, these companies are also considered as comparable and cannot be discarded on account of Public sector undertakings. c. Year to year variations in profits is not a criterion for determining comparability. Since, the companies are engaged in R&D services in the current year, the same can be taken as comparable, Thus, assessee's arguments of not considering department's comparables were rejected by the TPO. 11. The T....
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..... 3,56,80,542/- (Rs. 43,37,79,313/- minus Rs. 39,80,98,771/-) was proposed to the value of the international transaction in respect of providing R&D services to its AEs. 12. The AO accepted the report of the TPO in its draft assessment order. The DRP accepted the draft assessment order proposed by the AO. The relevant observations of the DRP in this regard were as follows: "1.4 In course of the proceedings before us, the arguments made before the Assessing Officer were reiterated. Citing specific instances, argument was reemphasized that 6 comparables selected by the TPO are functionally not comparable with the assessee's line of transaction. With regard to the rejection of the 2 loss making comparables by the TPO, it was pointed out that Neeman Medical International Asia Ltd. cannot be considered as loss maker and further, even after removing ADS Diagnostic Ltd., the OP/TC margin of comparables is less than that of the assessee. Point was further made that TPO has not interpreted the regulations in a manner that does not cause any undue hardship to the taxpayer. 1.5 We have considered the order of the TPO and the assessee's submissions. Looking into the grounds of rejec....
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.... verifying and searching comparables other than those of assessee. Moreover, in the method followed i.e. TNMM, a strict conformity of business is not a precondition. 1.6 In so far as TPO asking for updated Pit for the Financial Year involved is concerned, this is also in conformity with the provisions of Law. Furthermore, the provision of +/- 5% in respect of ALP is not a provision for a deduction of 5% while making adjustment. This claim has not been accepted by the Revenue while making such adjustments in the past years in other cases as well. 1.7 Premised on the foregoing, we find the TP adjustment in order." 13. The AO passed fair assessment order adopting the adjustment suggested by the TPO as directed by the DRP and made an addition to the total income of the Assessee as suggested by the TPO. Aggrieved by the said order of the AO, the Assessee has raised Gr. No. 1 and 2 before the Tribunal. 14. We have heard the rival submissions. The submissions of the learned counsel for the Assessee were reiteration of the stand of the Assessee as was put forth before the TPO/AO/DRP. The learned D.R. took the stand of the revenue as reflected in the orders of TPO/DRP. We will elaborate....
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....as may be prescribed: Provided that where more than one price is determined by the most appropriate method, the arm's length price shall be taken to be the arithmetical mean of such prices: Provided further that if the variation between the arm's length price so determined and price at which the international transaction has actually been undertaken does not exceed five per cent of the latter, the price at which the international transaction has actually been undertaken shall be deemed to be the arm's length price. (3) Where during the course of any proceeding for the assessment of income, the Assessing Officer is, on the basis of material or information or document in his possession, of the opinion that- (a) the price charged or paid in an international transaction has not been determined in accordance with sub-sections (1) and (2); or (b) any information and document relating to an international transaction have not been kept and maintained by the assessee in accordance with the provisions contained in sub-section (1) of section 92D and the rules made in this behalf; or (c) the information or data used in computation of the arm's leng....
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....ic characteristics of the property transferred or services provided in either transaction; (b) the functions performed, taking into account assets employed or to be employed and the risks assumed, by the respective parties to the transactions; (c) the contractual terms (whether or not such terms are formal or in writing) of the transactions which lay down explicitly or implicitly how the responsibilities, risks and benefits are to be divided between the respective parties to the transactions; (d) conditions prevailing in the markets in which the respective parties to the transactions operate, including the geographical location and size of the markets, the laws and Government orders in force, costs of labour and capital in the markets, overall economic development and level of competition and whether the markets are wholesale or retail. (3) An uncontrolled transaction shall be comparable to an international transaction if- (i) none of the differences, if any, between the transactions being compared, or between the enterprises entering into such transactions are likely to materially affect the price or cost charged or paid in, or the profit arising from,....
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....es guidance regarding the comparability of an international transaction with an uncontrolled transaction which shall include specific characteristics of the property transferred, functions performed, assets employed and risk assumed by the respective parties, contractual terms, and conditions prevailing in the market in which the respective parties to the transaction operate. It was submitted that the Assessee's functional and risk profile was a limited risk contract research service provider. It was submitted that the Assessee conducted search on two reputed and most widely used public information databases (Prowess and Capitaline) by applying appropriate quantitative criteria judiciously to initially short list a set of comparables. Thereafter, a detailed analysis of each short comparable was conducted by reviewing the information reported in the databases, Annual Reports filed with the Registrar of Companies and websites. This finally yielded the set of 10 comparables selected by the Assessee in the TP Study. It was highlighted that since the Assessee was engaged in the provision of contract research and testing services, the Assessee selected comparables engaged in contract....
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.... that the same is not in accordance with Rule 10-B(1)(d), Rule 10-B (2) and (3) of the Rules in as much as the comparable identified by the Assessee were inadequate and that under the TNMM method broad level of comparability is allowed. The correctness of this finding is another matter and will be dealt with while dealing with the other grounds of appeal of the Assessee. Though there is no specific finding in this regard in the order of the AO, the fact that the AO has made a reference to the TPO for determination of ALP and the fact that he has adopted the ALP as suggested by the TPO only shows that the AO was not satisfied with the price charged or paid in the international transaction is at Arm's length and that it has not been determined in accordance with sub-sections (2) of Sec. 92C of the Act. In this regard we are also of the view that there is no requirement of any specific finding to be recorded in terms of Sec. 92C(3) of the Act and if on facts these aspects are spelt out in the order of the TPO and adopted by the AO, then that would be sufficient compliance with the requirements of Sec. 92C(3) of the Act. On the facts of this case, we are satisfied that the objectio....
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....e, it can be seen that if ADS Diagnostic is rejected, the OP/TC of comparable companies is 11.76% as against 16.03% of the assessee. Further, without prejudice, if both Neeman and ADS Diagnostic are rejected, the arithmetic mean is 19.08 as against 16.03% of the Assessee and accordingly on applying the 5% range as provided in proviso to Section 92C(2), the assessee's transaction are at arm's length. If comparable cases considered by the TPO are found to be comparable then we will deal with the question whether loss making comparable cases can be altogether rejected and what would be the criteria for rejecting loss making comparable as laid down in OECD guidelines, analysis for reasons for losses whether should be seen and other relevant considerations. 24. No specific arguments were raised on Gr. No. 2.5 except to say that the data available at the time of assessment ought not to be used. We may in this regard quote the provisions of Rule 10B(4) of the Rules which provides that the data to be used in analysing the comparability of an uncontrolled transaction with an international transaction shall be the data relating to the financial year in which the international transa....
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....nts ('FTE's), including a Manager, Deputy Manager, Senior Research Scientist, Research Scientist, Research Associates, Trainees and Lab Attendants. Assessee provides training for specific functions to fresh/new employees. (b) Test samples and relevant information. Merckle provides all the essential information, particularly testing instructions, specifications, validation documents and other relevant information, along with reference substances for assay and impurity testing whiles providing the order to test medicinal products. In this regard, Merckle ensures that the samples are properly taken and that the test samples are properly packaged and dispatched to the assessee. (c) Obtaining an import license and import of test samples The test sample/reference substances are imported from the associated enterprise. Assessee makes the necessary applications for obtaining the license for importing the study drug on which the stability testing will be carried out. On receipt of approval for import of the study drug, assessee makes arrangements to import the test drug. (d) Provision of service Assessee carries out stability testing on the test samples at it....
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....ations, and test final products for release. The quality of analytical data is a key factor in the success of a drug development program. (b) Quality Control Quality control department comprises of three parts viz ; wet laboratory, instrumentation and microbiology department. Quality control department is mainly involved in validation, inactive API analysis and routine water analysis. Further, it is also involved in microbiological testing of actives, inactive, area monitoring and analysis of analytical and stability control samples. (c) Pharmaceutical Development Pharmaceutical development department is mainly involved in scaling up the production of formulations in the plant using the similar technology I know-how, operating principles and equipments used at the laboratory scale. The successful scale-up and commercial production of the developed formulations are the key responsibilities of the scientists working in this department. These formulations are then subject to stability testing and bio-equivalent study. Product development as a process, largely involves unit operations such as mixing, sifting, granulation, drying, size reduction, compression, coating, pa....
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....ctor involving in activities such as Motor Spirit Quality Up-gradation projects, Up-gradation of refineries, Pipeline projects. Also, EIL's engineering services are in the nature of modeling the plant buildings (i.e. refineries, LNG plants and SPM projects) mainly in the nature of architectural activities. The learned D.R. however pointed out that EIL also does Research and Development and in this regard drew our attention to page-183 of the paper book. (Annual Report of EIL) "EIL is making consistent efforts in developing technologies and strengthening its R&D division. The division is continuously pursuing developmental activities both in-house and in collaboration with other R&D Institutes like IOCL(R&D), IIP, IICT, BPCL(R&D) etc. The developmental activities started earlier have resulted in the commercialization of a number of technologies." As rightly contended on behalf of the Assessee the research and development is not a profit centre. It is part of the research and development done in the course of rendering other professional services. We fail to see as to how this company can be compared with the Assessee who renders contract research and testing of drugs. We agre....
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....and evaluate joint ventures and acquisitions. - Standard research reports: These research documents cover everything in hardware-PCs, peripherals, servers, software services and key industry issues. The research reports provide market intelligence, forecasts, competitive analysis, vendor profiles, information on customer requirements and buying patterns. The frequency of standard research offerings may be monthly, quarterly, half-yearly and yearly. Based on the above descriptions of activities undertaken by IDC it is clear that IDC engaged in providing market research and survey services which is not comparable to the functional profile of the assessee and accordingly ought not to be considered a comparable. 4. Oil Field Instrumentation (India) Limited (Oil field): Oil Field is the largest Mud Logging services provider in India. Oil Field offers Mud Logging services with real time data acquisition and monitoring of data with alarm on critical parameters, data storage option, computerized logs and web enabled transmission. Important parameters measured are Total Depth, Rate of Penetration, Weight on Hook, Heave, Weight on Bit, Rotation per minute, Stand Pipe Press, St....
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....and post-SAP implementation services for its customers. Celestial is engaged in implementing SAP for customers from initial planning, design and implementation to maintenance and ongoing optimization. Celestial helps the company align IT Solutions with business strategies. CelSanjivani Products: CelSanjivani is a part of Celestial Labs Ltd, an ISO 9001-2000 company working in this space of Bio-informatics and Gio-Technology. The goal is to become a primary market place for the herbal products providing quality products to the customers and industrial community. This is an Ayurvedic portal dedicated to B28&C market with online live consulting with our Ayurvedic consultants. It provides excellent platform for trading of herbal products, with identification of raw herbs, scientific data, market & trade data, monographs, policy, laws, good manufacturing practices, DNA finger printing etc. It facilitates contacts with suppliers, manufacturers and dealers of herbal Pharma industry. The activities undertaken Celestial Labs are in the nature of providing host of IT related services and some trading activity which is not comparable to the Assessee. Hence it is clear that it is not compara....
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....lity can be eliminated. By not resorting to such a process of making adjustment, the TPO has rendered this company as not qualifying for comparability. We therefore accept the plea of the Assessee in this regard. 6. Mindtree Limited - R&D Segment (mindtree): Mindtree's R&D segment is engaged in providing domain-specific end-to-end R&D Services to help organizations meet their engineering needs. As per page 11 of the annual report, the segment is engaged in providing R&D Services for various industries like Communication, Industrial Automation, Automotive and Avionics, Storage and Systems etc. The relevant extract has been provided below for ready reference: "The diversified focus in the R&D Services Business into various verticals such As Communication, Industrial Automation, Automotive and Avionics. Storage and Systems, Semi Conductor, Wireless and Consumer Electronics had shown results in 2006-07 as well" As per the website of the company, the services in this segment consist of the following departments: IP Led Services - The department offers research that focuses on creating long term technology innovation and licencable intellectual properties with applicability....
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....h terms are formal or in writing) of the transactions which lay down explicitly or implicitly how the responsibilities, risks and benefits are to be divided between the respective parties to the transactions ; (d) conditions prevailing in the markets in which the respective parties to the transactions operate, including the geographical location and size of the markets, the laws and Government orders in force, costs of labour and capital in the markets, overall economic development and level of competition and whether the markets are wholesale or retail. Rule 10-B(3) lays down that an uncontrolled transaction shall be comparable to an international transaction if- (i) none of the differences, if any, between the transactions being compared, or between the enterprises entering into such transactions are likely to materially affect the price or cost charged or paid in, or the profit arising from, such transactions in the open market ; or (ii) reasonably accurate adjustments can be made to eliminate the material effects of such differences. None of the parameters laid down in the rules have been considered by the TPO either in the matter of comparison or a....
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.... 4. The ld. DRP further erred on fact and in law by wrongly considering an amount of Rs. 20,89,500/- towards computer hardware as disallowance (even though such expenditure was already capitalized by the appellant and not claimed as revenue expenditure at all), and based on this direction of the ld. DRP, the ld. AO added this amount of Rs. 20,89,500/- to the income." 31. The assessee had debited under the head repair and maintenance expenses a sum of Rs. 1,21,16,972/- in the P&L Account. Out of the above the AO was of the view that only a sum of Rs. 27,46,806/- which related to the annual maintenance contracts of equipment was of revenue nature and all other expenses related to either purchase of new assets like wire, switches, screws and majority of the expenses related to extensive renovation of building. In the draft assessment order the AO wanted to treat the sum of Rs. 93,70,166/- as capital expenditure and disallow the claim for deduction to that extent. However, the DRP in its order dated 20/7/11 directed that except expenditure relating to purchase of a Mural for a sum of Rs. 1,38,702.82 and purchase of hardware for its systems amounting to Rs. 20,89,500/- should be allo....
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.... to hold that the sum of Rs. 20,89,500/- is towards purchase of hardware for system (7 items of Rs. 2,98,500/- each). We are of the view that the order of the AO should be set aside on this issue and AO should be directed to consider the claim of the assessee as above afresh. Consequently Ground No. 4 raised by the assessee is treated as allowed for statistical purposes. 35. Ground No. 5 raised by the assessee reads as follow: "5. The Ld. AC erred in not allowing the legitimate claim of Rs. 144,048/- being the profit on sale of cars even thought the capital gain on the sale of cars was already offered to tax by the appellant. Complete details for the same were specifically called for by the Ld. AC, but the same were totally ignored. The appellant prays that the book value of the international transactions of Contract Testing and Research Services should be held to be the arm's length price of the said transactions as per the appellant's Transfer Pricing documentation, and the addition made on account of the above grounds should be deleted. The appellant further prays that the claim of expenditure as repairs, as well as claim for reduction from income due to taxation of ....
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....m of deduction of Rs. 144048/- from the income was requested to be granted and accordingly the income was requested to be reduced to that extent." 37. Pursuant to the directions of the DRP, the AO examined the issue and was of the view that assessee had earlier filed original return and latter the return was revised on 26.6.2009. According to the AO, that revised return was not a valid return in the eyes of law as the same was filed after 31.3.2009. The claim for deduction of Rs. 1,44,048/- was made for the first time vide letter dt. 15 October, 2010. Even at that stage, no working for the same was furnished. In the P&L A/c of assessee in Schedule 10 profit on sale of fixed assets was shown at Rs. 3,42,715/-. The assessee reduced only the sum of Rs. 1,50,000/- in the computation of income. Thus the figures are not reconciling with each other. The AO further held that that Supreme court in Goetze (India) Ltd v. CIT [2006] 284 ITR 323/157 Taxman 1 held that no deduction can be claimed by the assessee at the time of assessment otherwise than by way of revised return. The relief can not be allowed in any other way. Section 143(2) also provides that AO issues a notice u/s. 143(2) only ....