AI Drafter 
TaxTMI 
TaxTMI 
2013 (11) TMI 468
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....grounds raised by the Revenue are as under: "The ld. CIT(A) has erred in law and on facts reducing the adjustment of TPO to Rs.2,20,80,690/- against the addition rate order u/s. 143(3) of Rs.2,69,06,690/- which is correctly workout by the AO. The ld. CIT(A) has erred in law and facts reducing the adjustment of purchase of goods from AE Rs. 2,68,986/-" The grounds raised by the assessee for the assessment year 2005-2006 are also reproduced below because the grounds raised by the assessee are interconnected with the grounds raised by the Revenue. 1. (a) The Ld. CIT (A) grossly erred In facts and in law, in upholding/ recomputing the upward transfer pricing adjustment to the extent of Rs.47,26,000/- in respect of international transactions of sale of goods to associated enterprises, by taking operating profit margin to be 5% on operating cost and by comparing the same with the operating profit margin earned by the appellant in prior years rather than by comparing the operating profit margin of comparable entity (ies) for the year under review. (b) The method of recomputation of adjustment is contrary to his own findings in the order in detail and is also contrary to the....
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.... from them, and bills are raised for the same on the "AE". The assessee had filed its return of income for the present year i.e. A.Y.2005-2006, declaring total income of Rs. 100.79 lakhs. The assessment in this case was made by the AO, by determining the income at Rs. 3,69,85,950/- wherein the additions were made by the AO on account of the Transfer Pricing adjustment under Section 92 of the IT Act. The TPO had rejected the assessee's Transfer Pricing report, and has proposed adjustment of Rs. 2,65,37,704/- on the basis of adopting the "AE" as tested party and IDA, Switzerland as comparable. The TPO has worked out the adjustments on the basis of those transactions, in which, the margin percentage on sale reported by the "AE" was more than 11.94%, being the margin percentage on sales earned by the comparable i.e. IDA, Switzerland ("IDA" for short), and he has ignored those transactions where the margin percentage on sale of the "AE" was less than 11.94%. In addition to this, the TPO has also recommended the addition of Rs.3,68,986/- on account of purchase of goods by the assessee from the "AE" by adopting the margin rate of 15.74%, by way of mark up of the cost of goods purchased by....
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....for this year and the same are reproduced below: "A: Facts of the Case: i. Mission Pharma Logistics (I) Pvt Ltd (MPL) is a manufacturer of medicine kits. The kits are manufactured by the company by sourcing generic medicines from established suppliers, preparations of kits which contain desired medicines and other items packaged to avoid deterioration of the products in extreme circumstances and ensure safety during movement. ii. The entire manufacturing is done as per the orders of its AE and parent company M/s Mission Pharma AS (MPAS), Denmark, which is engaged in obtaining orders from multilateral agencies, government bodies and NGOs for such supply of medical kits on a global in various under-developed/epidemic affected countries. MPAS competes with other similarly placed suppliers like IDA, Netherlands and secures such orders which are then passed on to MPL which then prepares the necessary kits and supplies them dispatches to the ultimate destination to the end-user in the name of MPAS. As claimed by MPL in earlier years of its functioning, it has been able to create an efficient sourcing and logistic system for prompt and efficient response to emergency orders. The ....
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.... goods to the ultimate third party, is handled by the Indian entity. ii. Reliance placed by CIT(A) on the orders of AY 2003-04 and 2004-05: The CIT(A), at para 5.27, has wrongly placed reliance on the earlier year TP orders to accept the selection of tested party. Perusal of the TP documentation of the assessee company reveals that the assessee has tried to change the character of the activity in India from that of a manufacturer in AY 2004-05 (Ref page 15 of the TP document placed at annexure III) to that of an assembly unit in AY 2005-06 inspite of the fact that there is prima facie no change in the functioning or pattern of the appellant. Wrong characterization of the functions of the appellant renders it liable to rejection of the TP documentation. The CIT(A) has failed to appreciate this fact and has relied on the acceptance of assessee's characterization of its functions in earlier years by the department as a valid reason for retaining the tested party. iii. Rejection of Tested Party The CIT(A) has failed to appreciate that the transaction which needs to be benchmarked here is the kit manufacturing business of the assessee. Hence, the other turnover of the AE is immate....
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....f commodities or services 2. Right to use intangible property and 3. Pricing a range of closely linked products (eg. a product line) which is impractical to determine pricing for each individual product or transaction." It is clear, in the current case, that the preferred method would be transaction by transaction method unless the compelling circumstances mentioned above are present. In the current case, it is perfectly possible to delink the transactions. The Indian party is operating as a independent manufacturer. Hence, the CIT(A)'s decision that the transactions are interlinked, is without any basis. The very fact that the TPO has been able to deal with the transactions independently reveals that it is possible to handle them separately. At para 6, the CIT(A) has wrongly concluded that since there is a long term relationship between the two parties, aggregation is essential. The OECD talks about long term contract for supply of commodities or services and not long term relationship. There is no such contract between the two parties and the pricing of the products is not being done on the basis of any contract. In the case of Tara Ultimo Pvt Ltd 47 SOT 401 (Mum), it has been....
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....that goods have been purchased by MPL from MPAS at cost and no margin has been charged. However, it has been noted that the medicines have been purchased from MPAS at high cost and sold to MPAS at lower cost in some instances. ii. The TPO has applied the arm's length margin determined by him on these transactions to arrive at the correct price which should have been charged by the assessee. iii. In spite of there being a clear evidence of wrong pricing of products while purchasing it from AE as well as misrepresentation of facts, the CIT(A) has wrongly resorted to estimation of arm's length price without basis. The TPO has adopted a reasonable approach in trying to arrive at a reasonable arms length price based on the average net margin being earned by the appellant. E: Benefit of 5% price range: i. The price band is allowable to the assessee only if there is determination of average price based on a number of comparables where the arm's length prices determined is different in each case. Since in the current case, there is only one comparable, there is no averaging of the arm's length prices. The subsection 2A refers to arithmetic mean of the various prices determined.....
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....s accepted, of adopting the "AE" as tested party, and IDA as comparable. He submitted that this submission is without prejudice to the claim of the assessee that the assessee should be considered as a tested party, and IDA is to be excluded from the list of comparable. Regarding this claim that the profit margin of the "AE" for this year in respect of the transactions with the assessee is 11.68%, he submitted that the same is 11.68%, and in support thereof, he will file a certificate of Chartered Accountant very shortly. 8. We have considered rival submissions and perused the material on record and gone through the orders of the authorities below and judgments cited by both the sides. We find force in the submissions of the learned AR of the assessee that, even if, it is accepted that the "AE" of the assessee is a tested party, and IDA is comparable, then also, no addition is justified in this year, if the margin for the aggregate transactions is considered. Because, the profit margin of the IDA i.e. comparable is considered on yearly average basis, the profit margin of the tested party should also be adopted on similar basis, i.e. yearly average in respect of all the transactio....
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....d, and the ground no.2 of the assessee is allowed. 10. In the result, the appeal of the Revenue for A.Y.2005-2006 is dismissed and the appeal for the assessee for A.Y.2005-2006 is allowed. 11. Now, we take up the appeal of the assessee for A.Y.2006-2007. The grounds raised by the assessee are as under: On the facts and in the circumstances of the case and in law, the Assessing Officer ('AO') grossly erred, in conformity with the directions of Hon'ble Dispute Resolution Panel ('DRP'). Ahmedabad under section 144C(5) of the Income-tax Act, 1961 ('the Act'), in making the upward transfer pricing adjustment of Rs. 84,580,4861/- in respect of appellant's international transaction of sale of medical kits (comprising genericLpharmaceutical products, hospital supplies and disposables) to its associated enterprise ('AE') Missionpharma AIS. Denmark ('MPAS'). The appellant submits that no transfer pricing adjustment is warranted in its case and wishes to raise the following grounds of appeal, which are without prejudice to each other: (i) The Hon'ble DRP erred in upholding the transfer pricing adjustment made by the Ld. Transfer Pricing Officer ('TPO) without appreciating that suc....
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....utical distributors, as defective and rejecting the comparables identified by the Appellant. ix. The Hon'ble DRP/Ld,TPO/Ld. AO erred, in law and In facts, by attributing the excess profits retained at the level of the AE (i.e. MPAS). to the Appellant. x. The orders of the Hon'ble DRP/Ld.TPO/Ld. AO are untenable in law because they suffer from factually incorrect statements, observations and conclusions." 12. In this year, the basic facts are similar, because, in this year also, the assessee has undertaken similar activity, and the TPO proposed the addition in respect of sales by the assessee to the "AE" by adopting the "AE" of the assessee as tested party, and adopting IDA as comparable. The only difference is this that, in this year, the assessee has provided various other comparables, also before the DRP, but the same were rejected by the DRP. For rejecting some of the comparables, the basis given by the DRP is this that, such comparable are engaged in the manufacturing activity, and therefore cannot be considered as comparable. In respect of some of the comparables, the basis given by the DRP is this that, comparable had no export sales, whereas the assessee's transacti....
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....tment under T.P. rules is called for. 14. As against this, the learned DR of the Revenue submitted written submission in respect of the appeal of the assessee for A.Y. 2006-2007. The written submissions of the learned DR are reproduced below: "Defects in the TP study carried out by the assessee: FUNCTIONAL DIFFERENCE Without prejudice to the fact that the FAR analysis carried out by the assessee is incomplete and faulty, as pointed out in the order made by the TPO, it is seen that, even after assuming the assessee's own FAR analysis to be correct, the following pertinent defects are noted: i. The assessee does not perform any of the critical functions being carried out by a "wholeseller", as per its own FAR analysis. The relevant function which can be identified are : * Development of market and/or distribution chain; * Procurement of material; * Development of procurement chains including the negotiations related to identification of purchaser, quantity to be sourced and the price of the product; * Management of funds; * Development of efficient supply chain including logistics ;etc As a matter of fact, it is claimed that these function are being p....
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....e by the honourable special bench, Chandigarh in the case of M/s Quark Systems Pvt Limited, the limited observation made by the honourable bench can never be of universal applicability divorced from the facts of the case. The honourable bench in the case of Interra Information Technologies (India) Pvt. Ltd. I.T.A. Nos.5568/Del/2010 & 5680/Del/2011 has even cautioned that the applicability of a decision in the case of transfer pricing proceedings depends upon the particular facts of the case and the ruling in one may not be blindly followed in the other. The discussion on this issue is made in para 64 to 66 of the order. 3.1 As already discussed above, since the functional profile, on the basis of which the search process is carried out by the assessee, is erroneous from the beginning, even the remaining entities, after removing the loss makers, are not comparable. This becomes clear from the statement made by the assessee in para 5.2.2 on page 5 of the summary provided to the honourable members, and whereby it is claimed that the transactions between the assessee and the AE are so priced that it is ensured that the assessee did not suffer any operational loss. EXPORT EARNINGS....
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....t, it will lead to comparison of revenues and corresponding margins earned by entities rendering services within India with the entities rendering services outside India. Since the margins earned by exporting services outside India is bound to be more than the margins earned by rendering services within India, due to the higher price of service in the export sector by using the same low costs, it is clear that non application of this filter will lead to inadequate comparison. 4.3 The assessee's argument is that the geographical source of the revenues will not have any impact on the prices charged or the margins earned. However, as per Sub-Rule (1) of Rule 10B, the comparability of an international transaction with an uncontrolled transaction shall be judged with reference to conditions prevailing in the markets, the geographical location, the size of the market, costs of labour, overall economic development, level of competition etc. In this regard, the relevant portion of Rule 10B is reproduced as under : "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....
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....terprise involved in the transactions in order for the controlled transactions to be comparable; there are various factors other than products and functions that can significantly influence net margins." The OECD Draft Guidelines also support above quantitative criteria. The relevant portion is reproduced as under:- "B.4 Economic circumstances 28. The question arises as to how to determine if economic circumstances are indeed comparable. In practice, both quantitative and qualitative criteria can be used to include or reject third party transactions depending on whether or not they are carried out under comparable economic circumstances. The most common quantitative criteria are: - Size criteria in terms of Sales, Assets or Number of Employees: they are used to test whether or not companies, due to their size, are in significantly different economic situations; - Intangible-related criteria such as Net Value of Intangibles/Total Net Assets Value, or ratio of R&D/Sales where available: they make it possible for instance to exclude companies with significant intangibles or R&D activities when the tested party is a contract manufacturer which does not own significant ma....
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....e should be no comparability of transactions in the domestic and export segment, a proposition held by Hon. ITAT in the case of Chiron Behring Vaccines Pvt Ltd 2011-TII-30-ITAT-MUM-TP). This issue was also involved the recent judgment delivered by Hyderabad tribunal in the case of Deloitte Consulting India Pvt. Ltd wherein the use of this filter was approved by the Hon. Tribunal in para 39 of the judgment, reproduced below: 39. The next ground is with regard to rejection of independent comparable companies by TPO/CIT (A) on the basis that they do not have any foreign exchange revenue. We find that the TPO, in the case of back office services segment, has rejected the following five companies on account of the fact that these companies do not generate foreign exchange revenue. (i) C.S. Software Enterprise Limited (ii) Ideaspace Solutions Limited (iii) MCS Limited (iv) Tata Share Registry Limited (v) Vakrangee Softwares Limited We find that the domestic BPO is much smaller business segment than the export BPO. The productivity and return in domestic segment is also much less than the export segment. The TPO clearly demonstrated in his order at page-9 that the ear....
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....ction, it has been mentioned in the TPO's order that the assessee raised objection and it was submitted that this company is carrying out business of vending information, i.e., customer support or a contract centre. This business is similar to the BPO business. The TPO rejected the submission by mentioning that vending of information and rendering services to call centre are activities different from running a call centre. Therefore, the functional profile of the two companies were different. 15.1 Before us, the ld. counsel mentioned that the information vending is nothing but customer support or a contract centre. Thus, Shreejal Info Hubs Ltd. is imparting information of supplier of goods and services to prospective customers. As per director's report, it is carrying out the business of information vending by employing calling agents under the brand name "Ask Me", which is essentially a call centre/contract service centre. Therefore, functional profile is same i.e., to furnish information about the client-company. On the other hand, the case of the ld. DR is that Shreejal Info Hubs Ltd. is working for the clients in India while the assessee is providing services in USA, thus, b....
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....ments of the pharmaceutical sector as compared to the assessee. The issue becomes academic in nature if the functional profile submitted by the assessee is found to be incorrect. The entire selection of the comparables made by the assessee is based on the assumption that it's activities can be compared to "wholesale drug distributors". TURNOVER DIFFERENCE 6. In this respect it is to be stated that the use of turn over criteria is important element to select the comparables in line with FAR analysis of the assessee. The use of such turn over criteria is approved in a number of cases by the Hon. Tribunal. The relevant judgments delivered in this respect are reproduced below: i. Quark Systems Pvt Ltd. 2010-TIOL-31-ITAT-CHD-SB- In this case the turnover of the assessee company was Rs 13.96 crore and in this context it was held by the Hon'ble Tribunal that a broad turnover basis of Rs 1 crore to infinite is not correct. The relevant portion is reproduced below: "25................In our considered view, it is improper to proceed on the basis that the turnover of Rs. 1 crore to infinite is a reasonable classification as turnover base....................". ii. Egain Communi....
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....ributor turnover is immaterial is absolutely erroneous. The use of turnover criteria is an important comparability factor, even if the search process carried out by the assessee is considered. ADJUSTMENTS 7. The assessee has simplistically assumed that the only adjustments that are required to be made are adjustments on account of risk and working capital. As discussed above, the adjustments are required to be made in respect of all the differences listed above in respect of the assessee and the alleged comparables. TESTED PARTY 8. Even though the there cannot be any dispute on the proposition that tested party should be considered to be the entity for which reliable information is available and the reliable information about the comparables are also easily available. However, the selection of the tested party cannot be made by sacrificing the requirement of matching of FAR of the tested party and the comparables. By selecting itself as the tested party, the assessee tried to carried out a search using the comparables available in the Indian market. For the reasons detailed above, such selection of comparables carried out by the assessee was faulty and incorrect. Furthe....
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....uge single customer risk. In case of associated enterprise going into liquidation due to unviable economic conditions, the business of the assessee comes to stand still. Therefore, there is neither any guarantee of assured business/turn over nor of any turn over. Therefore, there is more risk in the case of the assessee who is dependent of single group's concerns while there is no such risk in the case of the comparables. Hence, it is not that the assessee will get eternal business from its AE and also that its revenues will increase year by year is not borne by the above provisions of the agreement. If the parent company goes into liquidation or bankruptcy due to unfavourable economic or other conditions, the business of the assessee comes to stand still. The agreement can be terminated unilaterally by the AE without any cause. Even the assessee is not protected with any compensation if the agreement is terminated unilaterally. Thus, there is neither the guarantee of assured business/turnover nor of the tenure. The only guarantee is of no operating loss. So, there is more risk in the case of assessee who is dependent on a single customer when compared to comparables who may not de....
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....nnel and relations built up with suppliers/manufacturers, MPAS considering the requirements, identifies the supplier and negotiates & finalizes prices and all other terms of supply of goods.then it advises MPL to place order. Therefore, critical and important part of this function is carried out by MPAS. Yes. Reason: As mentioned in the website. (v) Preparation of medical kits Technical assistance is provided by way of supervision of kit assembly by deputing skilled and experienced personnel to the plant in India. Yes. Reason: As it has to bid for tenders and fulfil the requirements of tenders (vi) Warehousing and inventory management Based on the production planning of medical kits, MPAS monitors inventory level of major products and MPL assist in maintaining proper inventories. They also provide necessary system support and its expertise developed over last thirty years. Yes. (vii) Logistics MPAS develops logistic framework and engages third party agencies. It also undertakes or arranges for logistic functions outside india and within India. Expert guidance is provided on account of its expertise in logistics developed over more than thir....
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....ed with faulty design or development of kit is with MPAS. Yes. The tendering process has stringent quality requirements which are required to be fulfilled by IDA also. (iv) Financial risks The borrowings are made by MPAS to finance the operations and therefore it incurs borrowing and its cost also. Foreign exchange rate fluctuation risk is with MPAS. Yes. (v) Entrepreneurial Risk On account of changes in business cycles , new entrants in the market, inherent business risk, etc. which is fully on MPAS , there is risk of capital investment Yes. Consequently, the action of the TPO in considering IDA as comparable to MPAS is correct. * Comparison of IDA with the MPAS (Objections). ○ Not for profit-As per the details in website it is not as if no profit is made by this entity but the profit so made is channelized back to the customers. ○ The final sale price is fixed as it also participates in tenders as with the MPAS. Thus profit potential in both the cases is the same. Being stated as "not for profit" does not mean no profit is being made. As stated the profit is being channelized back. ○ No marketing required by ID....
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....issionpharma A/S, Denmark (hereinafter referred to as 'MPAS' or the 'AE'). MPL is primarily engaged in the wholesale trading of generic pharmaceutical products packed in the form of medical kits and all of its sales are to MPAS, its AE. 2. International Transactions with its AE during the AY 2006-07 During the financial year under consideration, the Appellant has entered into the following international transactions with its AE: Sr. No. Nature of international transaction Value (in Rs.) 1 Sale of various pharmaceutical products (in the form of medical kits) by MPL to MPAS 780,764,326 2 Purchase of capital goods by MPL from MPAS 761,178 3 Recovery of expenses and services charged by MPL 586,811 4 Purchase of pharmaceutical products and packing materials by MPL from MPAS 12,209,096 3. Approach adopted by the Appellant in the Transfer Pricing Study In the Transfer Pricing study undertaken by the Appellant for the subject financial year, the following approach was adopted: * MPL was considered as the tested party. * Indian companie....
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....h impugned assessment order, the appellant is in appeal before this Hon'ble ITAT in the present appeal. The summary of broad issues involved in the present appeal and appellant's submissions are as follows: 5. Selection of Tested Party The concept of "Tested Party" in the context of Transfer Pricing would mean the Associated Enterprise from whose perspective the international transaction is tested for the purpose of determination of the Arms Length Price. Although the Indian regulations do not lay down any specific procedure or guidelines for the choice of tested party, Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations 2010 issued by the OECD ("OECD Guidelines") and US Treasury regulations have provided some guidance on this subject. Based on the above, the following principles would need to be kept in mind in selecting the tested party: * The party that is the least complex in terms of functions performed, assets employed and risks undertaken should be selected as the 'tested party' i.e., the party to the international transaction whose functions are simpler to evaluate, which does not own valuable non routine intangible assets and....
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....mployed criteria, the TPO has mentioned that he has gone through the balance sheet of MPAS and has not noticed any intangible assets reported therein. The Parent Company MPAS may be having unreported intangibles in the form of knowledge on distribution lines, registration as supplier, etc. However, MPL is also having intangibles in the form of buying list of generic pharmaceuticals manufacturers containing cheap and best source of generic drugs, logistics system, etc. Under the circumstances as both companies are having intangibles, it will be difficult to state which one will be the least complex. * The TPO has further observed that the various product registrations with Governmental and non-Governmental organisations, licenses/approvals held by MPAS cannot amount to intangibles as these registrations and licenses are required to be obtained as a matter of procedure. Hon'ble DRP reiterated and confirmed these observations of the TPO. 5.2 Submissions of the Appellant The Appellant submits that the Hon'ble DRP/TPO has erred in considering MPAS as the tested party and makes following submissions on various aspects of Functions, Assets and Risks:- 5.2.1 Functions Perfor....
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....s in foreign currencies. Appellant receives its revenues in foreign currency and correspondingly pays in foreign currency. Hence, as such there is no foreign exchange risk for appellant. The Appellant being an Indian Company is required to comply with Accounting Standards in preparation of its financial statements and therefore, recognizes the exchange gain or loss as required under the Accounting Standards. * Further, as per the long term business arrangement and the implied agreement with MPAS, the transactions between the Appellant and MPAS are so priced that, in addition to compensating the Appellant at a level commensurate to the functions it performs it is ensured that the Appellant does not suffer any operational loss. Therefore, although the Appellant incurs a profit or loss arising due to the fluctuation in the foreign exchange rate, it is compensated for the same through the inter company pricing policy followed. Therefore, the Appellant does not bear the foreign exchange fluctuation risk. * The Appellant, since the commencement of its operations in India, has been making profits irrespective of the performance of the pharmaceutical industry in India. The Appellant ....
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....s relationship with such local suppliers has been developed by MPAS even before MPL was set up and goes against the statement of the TPO that MPL has created intangibles in terms of local supplier list. * The TPO has attempted to justify his contention of the Appellant owning huge intangibles in the form of cheap suppliers list, by drawing reference to service charges paid by MPL to MPAS for visits of expatriate personnel to India. In this regard, Appellant highlights the fact that most of these personnel visited India to provide operational support to MPL (for e.g., training of MPL's employees, assistance in establishment of accounting and other controls, formulation of operational guidelines, resolving cultural issues, etc.). During the subject financial year MPL has not made any payment to MPAS for visits of expatriates. * As regards product registrations and licenses, the Appellant highlights the fact that MPAS is registered as a supplier with various Governments, UN agencies, NGOs, etc as well as product registrations in various customer countries has taken number of years and has been made possible by consistent and reliable supply of quality products in addition to inc....
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....ions in the chain of entire business functions, deploys variety of assets including intangible assets (such as brand name, trademarks, goodwill, product and entity registrations in various countries) and bears most of the risk of entire business. In contrast to that, the functions, assets and risks of Appellant are simpler to analyse. Further, the complete financial and non-financial information related to the Appellant are readily available and can be reliably verified. IDA Foundation also lacks functional and economic comparability with AE (MPAS). The adjustment required to make the two entities comparable are not easily/readily quantifiable. It has been judicially held that if differences between the entities being compared are such that could not be quantified then such potential comparable entity shall be ignored. Therefore, in these circumstances, the AE (MPAS) cannot be considered to be the "tested party" and the IDA Foundation, Netherland cannot be held comparable to AE. Further, the reliable information that is required for carrying out requisite analysis under transfer pricing is more readily and easily available in respect of the Appellant as compared to its AE.....
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.... * As per the financial statements, it is also found that IDA Foundation does undertake market development, marketing, business promotion and selling, etc similar to that of MPAS. Further, IDA Foundation participates in all tendering processes and gets business on similar terms as MPAS. In view of the above, the "functional profile" of MPAS and IDA Foundation are similar and there is need for making any adjustments to arrive at comparable results. 6.2 Submissions of the Appellant The Appellant submits that IDA Netherlands could not be considered as a comparable company to MPAS or to MPL on account of the following reasons: * While undertaking a search for identifying comparable companies, a "deductive" approach should be adopted in order to ensure that such an approach is fair with a reasonable degree of objectivity and transparency. The quality of comparability analysis can only be assessed if it is reproducible i.e., in particular, the process followed to identify the comparables and criteria used to select or reject comparables is reproducible by the person who wishes to assess it. The TPO has made a vague reference to Google search conducted on internet for identifyin....
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....r, the TPO has mentioned in the TP Order that even IDA undertakes selling, marketing and distribution, business promotion, etc. However, Appellant expresses its inability to find the associated sales and distribution expenses in the consolidated financial statements of IDA Foundation as provided to the TPO. It is brought on record that if the TPO has considered warehouse/sales cost appearing in the consolidated financial statement to be in the nature of marketing expenses, such expenses constitute merely only 1% of cost of goods sold of IDA Foundation. The above variation in distribution/marketing expenses clearly shows the difference in functional profile and commercial objectives of MPAS and IDA Foundation. * The Appellant also contends that IDA Foundation cannot be considered as a comparable company on account of its persistent operating losses. This is evident from the statement made by the directors in the Annual Report of IDA placed at pages 255 to 282 (this statement appears on page 257 of paper book). * The location of both these entities in the same geography does not have any bearing on their economical comparability for the purpose of transfer pricing evaluation....
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.... as comparable companies by the Appellant is negative (1.56%) which itself shows that these companies cannot be used as comparable companies. * The Appellant has selected companies which are engaged in domestic market where as the Appellant is primarily engaged in export of goods. * The comparable companies selected by the Appellant are associated/related companies of major pharmaceutical companies like Sun Pharma, Pfizer Limited, Cadila Healthcare, etc having huge related party transaction and therefore, cannot be used for comparison purpose. * Comparable companies are dealing in different product segments of pharmaceutical sector as compared to the Appellant. * The Appellant has not carried out any adjustments to the results of comparable companies as per Rule 10B to account for difference in FAR of these companies. 7.2 Submissions of the Appellant 7.2.1 Comparability with Indian wholesale distributors The Appellant is primarily engaged in procuring pharmaceutical products from various suppliers and reselling them on a wholesale basis, packed in different types of kits as per the requirements of the AE. Medical Kit preparation process broadly involves procure....
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....y simply cannot be rejected without any cogent reasons" 7.2.2 Reference to service provider As regards the statement of the TPO that the Appellant has considered itself to be a service provider, the Appellant submits that the analogy to "service provider" was merely drawn by the Appellant to highlight the fact that it performs limited functions and works in a risk mitigated environment. In this context, TPO has taken the aforementioned analogy out of context and has conveniently ignored numerous instances/documents which demonstrate that the Appellant is a "whole sale trader" such as license given by SEZ authorities for undertaking trading activities, disclosures in the financial statements, transfer pricing documentation and certificate (Form 3CEB) furnished by the Appellant before the TPO. In fact, the above issue was already addressed by the Appellant before the TPO. 7.2.3 Negative arithmetic mean of comparable companies As regards the comment of the TPO on negative arithmetic mean of comparable companies, the Appellant contends that functions/business activities undertaken, the risks borne and the assets employed are the broad determinants of comparability and no....
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....transactions could be with a "resident" or "non-resident". This view has been upheld by Delhi Bench of ITAT in the case of M/s. Wringley India Pvt. Ltd. v. ADIT (ITA No. 5224/Del/2010). (c) There is also a similarity in geographical market etc. AE MPAS sells the products in African market. In terms of economic development, Indian and African countries are on par. Both are developing countries. Therefore, Indian domestic market is quite comparable to African market where the AE is selling its products. (d) In the business arrangement with its AE, Appellant's role and responsibility ends once products are delivered to shipping agent of AE in India. Appellant's function does not extend beyond Indian Territory. Further, as mentioned earlier, appellant is also not exposed to foreign exchange risk as it is located in SEZ. Hence, appellant's situation is akin to an Indian wholesaler operating in a domestic market. (e) It is not the case that all the Indian comparable companies selected by the appellant are not having export sale. Some of them are also having export sale. For Example, companies (i) Rajat Pharmachem Ltd; (ii) Indosol Drugs Limited; (iii) Sharon Bio-medicine does ha....
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....nies placed in the additional paper book at pages 1 to 256, all these companies are primarily dealing in pharmaceutical products/drugs and a number of them are dealing in products like tablets, injections, capsules, syrups, etc., which are the same type of products procured by the Appellant from various manufacturers/ suppliers. The Appellant further highlights that it has applied the TNMM to determine the ALP nature of the international transaction. The TNMM is more tolerant to the functional differences such as differences in products, etc., vis-à-vis the other methods of Comparable Uncontrolled Price, Cost plus Method and the RPM. The TPO/Hon'ble DRP also alleged that all of companies selected as comparable by the appellant are engaged in manufacturing operations and are thus not trader. The appellant submits that all of these comparable companies are wholesale trader only and not manufacturer. This fact is evident from published audited annual reports of these companies which are placed at pages 1 to 256 of the additional Paper Book. All these comparable companies being listed entities, their Annual reports are publically available. Hence, Hon'ble DRP's observation....
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.... 5 2008-09 1,30,52,70,172 Similarly, turnover of the comparable companies also varies substantially year on year. This is true for wholesale trading industry. So, it can not be the case that in one year a company is comparable but in other year it is not comparable just because level of its turnover has changed, more so when level of turnover does not have any material impact on the profits. (f) Unless it is undisputedly demonstrated that level of turnover does have material impact on the profitability of tested party or comparables, such filter can not be applied. For this proposition, we rely on following judgment: M/s. Symantec Software Solutions Private Limited v. ACIT (ITA No.7894/MUM/2010) [refer to para nos. 15 and 15.1, pg 22-23] 7.2.8 Adjustments for differences in FAR of comparable companies The TPO has rejected the comparables selected by the Appellant stating that the Appellant has not carried out any adjustments to the net operating margins of the comparable companies which is required as per Rule 10B(e)(iii) for differences in the FAR analysis of each of these companies. In this regard, the Appellant's contends that the TPO has not de....
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....n its AE or any other uncontrolled Indian wholesaler, despite the fact that AE carries out larger share of functions, deploys and is owner of all the intangibles involved in this business and also bears almost all the risk of this business. This is an absolutely absurd result and also a non arm's length proposition. iii. Without prejudice to the above, the Appellant wishes to submit that even if TPO's contention that MPAS has excess profits is assumed to be correct, it would be incorrect to attribute the entire excess profits to the Appellant's transactions with MPAS due to the following reasons: a. The Appellant's sales to MPAS do not constitute a substantial portion of the AE's purchases. Therefore, it is incorrect to assume that all the profits earned by AE are attributable to the Appellant's transaction with its AE. b. MPAS has a number of subsidiaries in different parts of the world. The profits earned by MPAS at the consolidated level may be due to the efforts of the other subsidiaries as well. Given this, it is incorrect to attribute all the excess profits (if any), of MPAS at the consolidated level to its transactions with the Appellant. c. Apart from MPL, MPAS ....
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....know how which has been continuously updated, the benefit of which is passed on to MPL. (iii) Market Development and sales execution No function in this area is carried out. These activities are carried out by MPAS including registration with governments and international agencies. (iv) Material Procurement and Purchases MPL places orders on suppliers for purchase of goods on the terms and conditions finalized by MPAS. Suppliers are identified and finalised by MPAS. MPL's role in this function is very limited which include placing of orders as per the instruction of MPAS and to receive, inspect and warehouse the goods for packing. Therefore, only routine function is carried out by MPL. On account of its expertise developed over the years in sourcing of goods from across the globe, its technical personnel and relations built up with suppliers/manufacturers, MPAS considering the requirements identifies the supplier and negotiates & finalizes prices and all other terms of supply of goods. Then it advises MPL to place order. Therefore, critical and important part of this function is carried out by MPAS. (v) Preparation of medical kits. The facilities ar....
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....matters of accounts and finance are also given by the MPAS. MPAS borrows funds from banks in Denmark and fund MPL's operations by making advance payments for orders as entire inventory is only for MPAS. Risk Assumed Nature and particulars of risk MPL, INDIA MPAS, DENMARK (i) Market risks - Development of market, promotional expenses, fluctuation in prices, changes in business cycle, etc. As discussed above, development of market including spending for business promotion is the sole responsibility and function of MPAS. In all these areas, there is no risk attached to MPL. In terms of the pricing policy described hereunder, MPL is ensured of markup over the costs of kit preparation and therefore is not affected by price variances in the international market. All risks connected with market are entirely assumed by MPAS only. All the expenses for business development, procurement, registration and for promotion are fully borne by MPAS. Loss on account of reduction in market share, reduction in prices and depressed market conditions are mainly attached to the MPAS. (ii) Credit risk All the payments for goods supplied by MPL to MPAS are received....
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....ly more important, particularly in Pharmaceutical Industry in which suppliers' credentials, knowledge, reputation for supply of quality products in accordance with contractual parameters and global scale of its operations is vital. An understanding of the assets employed by MPL and its associated enterprise MPAS provides an insight into the resources deployed by parties in the international transaction and their relative contribution to the business process/economic activities. * The investment in Medical Kit packaging facilities has been made by MPL. This includes packaging plant building, plant and machinery, equipments, electrical installation, etc. The infrastructure for this activity has been fully set up by MPL. For setting up this facility and its continuous maintenance, it receives expert guidance & supervision from MPAS. * As regards human resources, the packaging operations are carried out with contract labour and certain supervisory personnel employed by MPL. Additionally, certain executives have been employed to look after other function including warehousing and inventory management, accounts and administration. * MPAS deploys tangible assets in the form of wa....
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....anufacturer/supplier for more than three decades i.e. even prior to setting up of the assessee-company. It has also been submitted before us that only to ensure timely delivery and savings in transportation time, the assessee-company was set up in the year 2001 by the "AE" to serve as logistic platform and provide efficient service to its customers. It is also submitted that entire procurement department is situated in Denmark right from inception of the "AE" and all contracts to old/new manufacturers/suppliers are established by Procurement Officers sitting in Denmark office of the "AE", using various tools like the internet, the Indian Pharmaceutical Directory, Member of Indian Pharmaceutical Associations, by attending seminars like CPHI, etc. It is also submitted that there is no factual basis for the TPO to claim that the assessee has developed intangible assets in form of supplier base. It was also submitted before us that the assessee obtained confirmations from some of the key local suppliers that they have been doing business with the "AE" of the assessee-company even prior to incorporation of the assessee-company in India, and the same were submitted before the DRP, and ar....
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....in the present year. 20. In this regard, we would like to discuss the applicability of the Tribunal decision cited by the learned DR of the Revenue having been rendered in the case of Interra Information Technologies (India) (P.) Ltd. (supra). We find that in para 65 of this judgment, it is held by the Co-ordinate Bench of the Tribunal while adjudicating the TP issues that there is no legal binding precedence on the issue of selection of most appropriate method, selection of comparable companies, selection of comparables transactions for benchmarking etc, as these are facts based and vary from company to company. Hence this Tribunal decision cited by the learned DR of the Revenue in fact does not help the Revenue, and as per this Tribunal decision, we have to decide on the basis of the facts of the present case, without looking in to the precedents cited by both the sides. 21. We have already discussed that in the facts of this present case, the least complex party is the assessee-company in comparison to its "AE", and therefore, in our considered opinion, the assessee should be accepted as tested party, whereas the TPO had decided for adopting the "AE" of the assessee-compan....
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....ite of having some surplus by the IDA Foundation, the IDA is not a profit motive organization, and therefore, for the purpose of T.P. study, IDA cannot be accepted as comparable. Regarding this aspect that the assessee himself has considered the IDA as comparable initially, the Tribunal's decision, is already cited by the learned AR of the assessee and noted by us hereinabove, that in subsequent proceedings, the assessee can request for omission of such comparable, if same was earlier considered by the assessee by way of inadvertent mistake. We, therefore, accept and hold that the IDA cannot be considered as comparable in the present case. 23. Now, we have to examine the acceptability of comparables cited by the assessee before the DRP. Out of these nine comparables, the assessee has accepted before us that three of them can be excluded i.e. (i) Sharon Bio-Medicine Ltd., because this is a manufacturing company, (ii) Zydus Pharmaceuticals Ltd., for the reason that it has RPT exceeding 25% of sales and (iii) and Earnest Healthcare Ltd., which is also having manufacturing operations. After exclusion of these three parties, the assessee has worked out that arithmetic mean margin ("A....
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.... each case. Whether a comparable can be considered or not on the basis of existence or non-existence of export turnover, has to be decided on the basis of present case, and it cannot be decided on this basis alone that, because of higher turnover and non-existence of export turnover, the comparable cannot be accepted. In the present case, the facts are that, although, the goods are crossing the territorial jurisdictional of India, but whether it can be said that the assessee-company is carrying out such functions and undertaking such risks, that will entitle the assessee-company to expect extra profit which a normal exporter can expect, as compared to the domestic turnover. In the present case, now we have seen that functions of the assessee-company is limited to accept the supply from such suppliers, which are determined by the "AE" and then get goods packed and despatch as per the directions of the "AE". Neither supplier is being selected by the assessee, and nor overseas customers. Even what is to be exported is also not decided by the assessee-company and everything is decided by the "AE". The "AE" participates in the global tender and whatever order it gets, it selects supplie....
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....owing this Tribunal decision, we hold that for the purpose of selecting a comparable, we are not compulsorily proceed on the basis of precedence cited by both the sides, and we have to decide the case, as per the facts of the present case, as discussed by us above. It is seen that in spite of these facts that the material supplied by the assessee-company is crossing the territorial jurisdiction of India, but still, the assessee company is not in a position to command extra profit, which is generally commanded by an exporter, and therefore, in the facts of the present case, this aspect is not relevant as to whether comparable is having export sales or not. So this objection of the DRP is rejected. 27. Regarding one more objection of the learned DRP that the turnover of the comparable is very high, we would like to mention that, for the same reasons as discussed above, regarding export sales, this aspect is also not relevant in the present case, because, whether there is a high turnover or low turnover in the present case, will not alter profit margin, hence this objection of the learned DRP is also rejected. Since there is no other objection for this comparable, we hold that the ....