TaxTMI 
TaxTMI 
TaxTMI 
2014 (5) TMI 882
X X X X Extracts X X X X
X X X X Extracts X X X X
....which are used in the production of anti-ulcerant drug, namely Pantaprozole. It is a joint venture company with 50% stakes of Cadila Health Cab Ltd., India and other 50% of Atlanta Pharma AG, Germany. It also organizes clinical trial for Atlanta Pharma AG. In the returns of income filed for the years under consideration, deduction u/s 10B of the Act was claimed by the assessee. The said claim came to be first examined by the A.O. in the scrutiny assessment u/s 143(3) of the Act for A.Y. 2004-05 wherein deduction u/s 10B of the Act was claimed by the assessee to the extent of Rs. 135,25,31,353/-. On such examination, he found that the deduction u/s 10B of the Act was claimed by the assessee in respect of its export sales entirely made to M/s Atlanta Pharma AG, Germany in respect of two items with code names KSM -6 and KSM -14. In this regard, he required the assessee to furnish, inter alia, the copies of joint venture agreement, supply agreement and license and distribution agreement for his verification. On analyzing the said agreement, he found that as per the supply agreement, the assessee was to exclusively sale the intermediates to APAG, Germany. He also analysed the manufactur....
X X X X Extracts X X X X
X X X X Extracts X X X X
....., the assessee, however, was not able to provide any basis for determining the exact value addition. According to him, the profit earned by the assessee in the A.Y. 2004-05 thus was not an ordinary profit as compared to the profit earned by the assessee in the initial year i.e. A.Y. 2002-03. He noted that the assessee in this connection could not provide any basis for determination of such higher profits nor it could substantiate the stand that the profits so earned in A.Y. 2004-05 was an ordinary profit. He noted that as per the relevant terms of the supply agreement, the basis of calculation of profit should have been based on the lowest supply price of KSM- 6 and KSM-10 charged by third party suppliers to APAG, Germany and this mechanism of determination of profits was required to be documented by the assessee. The assessee, however, could not produce any such documentation maintained by it. The assessee also could not produce the cost audit report in order to enable the A.O. to ascertain the value addition. According to the A.O., the element of technical know-how and patent was also not taken into account by the assessee company in the calculation of profits which ought to hav....
X X X X Extracts X X X X
X X X X Extracts X X X X
..... 147 of the Act, he disallowed the assessee's claim for deduction u/s 10B also in A.Y. 2003-04 to the extent of Rs. 55.92 crores being the excess profit @ 195.68% of the cost of production of Rs. 28.58 crores for that year. In A.Y. 2005-06, the A.O. however adopted a different course for making addition on this issue. He held that the higher ratio of 318.51% between the turnover and cost of production of A.Y. 2005-06 than that of A.Y. 2002-03 was as a result of less cost of sales shown by the assessee and this difference amounting to Rs. 73,55,61,604/- was treated by him as unexplained expenditure adding the same to the total income of the assessee u/s 69-C of the Act. 7. The disallowance made by the A.O. u/s 10B r.w.s. 80IB(10) of the Act was challenged by the assessee in the appeals filed before the ld. CIT(A). Before the ld. CIT(A), it was pointed out on behalf of the assessee that the entire basis of working made by the A.O. to draw an adverse inference against the assessee on this issue was grossly erroneous and the conclusion arrived at by him on the basis of such erroneous working to restrict the claim of the assessee for deduction u/s 10B of the Act was totally unjustifie....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... the purpose compiled as Annexure-I to the Statement of Facts. (iii) Moreover, the expected amount of cost of raw materials as worked out by the learned A. 0. in the chart on page 31 has been so computed on the basis of the total quantity of sales of the two intermediates, instead of working out the same on the basis of respective quantities of production of the two concerned intermediates viz. KSM-14 and KSM-6 and applying the appropriate rate of cost of raw materials per Kg. for each of the intermediate separately. The correct computation in this regard also stands duly reflected in the revised and corrected chart prepared by the appellant and enclosed hereto as Annexure-I above. (iv) Moreover, while adopting the rate of the respective raw-materials utilized in the production of the two intermediates KSM-14 and KSM-6, the learned A. O. ought to have adopted the average rate per Kg. on the basis of the Accounts duly certified under Schedule- VI of the Companies Act and forming part of the Final Accounts as duly available on record with the learned A. 0. himself Considering the cumulative impact of the aforesaid four aspects, the ....
X X X X Extracts X X X X
X X X X Extracts X X X X
....d modality for obtaining Tax Credit in the context of the Double Tax Avoidance Treaty between India and Germany. It is pertinent to note that as per the terms of the Joint Venture Agreement, there was no obligation on the part of the appellant company to make any payments on the above account as alleged by the learned A.O., in respect of the production of the two intermediates KSM-6 and KSM-14, the production of which was to be exclusively supplied by the appellant to Altana Pharma AG, Germany. To support his conclusion that the appellant has not included such cost attributable to value addition, royalties and other charges, the learned A. 0. has as discussed in para 38 of his order relied upon the chart reproduced by him on page 31 of the assessment order. As pointed out hereinbefore, the very basis of discrepancy as sought to be highlighted by the learned A.O. in the expected amount of cost of raw materials and actual cost of raw materials as reflected in the P&L A/c. does not survive and hence the allegation by the learned A.O. on this count holds no ground whatsoever." 9. It was also brought to the notice of the ld. CIT(A) by the assessee that while m....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... 3.94% 86,555,783 5.14% 12,510,173 1.02% Net Profit before tax 134,847,172 52.96% 901,658,156 77.41% 1,352,745,389 80.25% 1,035,524,264 84.54% 10. It was also brought to the notice of the ld. CIT(A) by the assessee that A.Y. 2002-03 was its first year of production comprising of only seven months of working wherein the capacity utilization was only 38.62% whereas A.Y. 2004-05 was comprising of twelve months of manufacturing activity wherein capacity utilization was 96.51%. In this regard, a comparative chart was prepared and furnished by the assessee to show that there was higher capacity utilization, higher average sales realisation and lower cost of raw material consumption in A.Y. 2004-05 as compared to A.Y. 2002-03. the working so furnished by the assessee before the ld. CIT(A) was as under:- COMPARISION OF CERTAIN PARAMETERS OF A.Y. 2002-03 WITH A.Y. 2004-05 PARTICULARS A.Y. 2002-03 A.Y. 2004-05 ACTUAL WORKING IN NO OF MONTHS 7 12 CAPACITY UTILISATION 38.62% 96.51% PRODUCTION IN KG KSM-6 11,328 49,820 KSM-14 13,975 46,693 TOTAL PRODUCTION 25,303 96,513 AVERAG....
X X X X Extracts X X X X
X X X X Extracts X X X X
....ppeal wherein the revised corrected chart for the purpose has been duly worked out by the appellant. (iii) I also find force in the appellant's contention that as pointed out in the above referred chart at Annexure-I, the expected amount of cost of raw materials ought to have been worked out on the basis of respective quantity of production of the two intermediates KSM-14 and KSM-6 and applying the appropriate rate of cost of raw material per Kg. for each of intermediates separately. I find that the Assessing Officer has computed the cost of raw material on the basis of the total quantity of the sales of the two intermediates together which is not the correct method of computation. (iv) The appellant is also justified in pointing out that while adopting the rate of the respective raw materials utilized in the production of the two intermediates KSM14 and KSM-6, the Assessing Officer ought to have adopted the average rate per Kg. on the basis of the accounts duly certified under Schedule-VI to the Companies Act and forming part of the final accounts instead of adopting hypothetical rates, which were already available on record with....
X X X X Extracts X X X X
X X X X Extracts X X X X
....Y.2002-03 to Rs.488 per unit in A.Y.2004-05 which means 40% savings on this account. (b) On account of increased capacity utilization from first year i.e. A.Y.2002-03 to the current year i.e. A.Y.2004-05 further savings in cost of production have been achieved. Yet another reason is increased economy in production process enabling them to re-use the spent solvents in A.Y.2004-05 which was not possible in the first year of production i.e. A.Y.2002-03. (c) Yet another reason is that on account of increase in production, further economies in other manufacturing expenses like Power & fuel, Repairs in Plant and Machinery etc. have been achieved as per chart (reproduced on pages 5 to 7 of this order) have been achieved. (d) It is obvious that depreciation on Plant and Machinery as a percentage of sales will also go down in succeeding years, firstly because WDV will decrease and secondly because sales are also going-up. (e) So far as increase in net profit rate is concerned, it is obvious that there will be savings in administrative and selling expenses over the years as a percentage of....
X X X X Extracts X X X X
X X X X Extracts X X X X
....rect in contending that the sale price had remained the same for all the three years under consideration. Thus the allegation of the Assessing Officer on page 25 of the assessment order that the appellant had calculated different profit margins in contravention with the Articles as contained in the Joint Venture Agreement does not stand justified. When the sale price was constant, but the appellant fetched higher rupee realization on account of the strengthening of the Euro, it was bound to earn higher profits. Moreover, as explained by the appellant, the cost per unit of production had also decreased in A.Y. 2004-05 on account of cheaper availability of raw material, rupee appreciation against dollar, better production and also effective solvent recovery. The average manufacturing cost of production had also decreased on account of greater stabilization of manufacturing process and economy of scale as explained by the appellant. In view of the above, the rise in the margin of profit for the year under consideration as compared to that of A.Y. 2002-03 is both logical and convincing. In fact, it is quite surprising that although the appellant had earned much higher profit in A.Y. 20....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... finished product. (xiv) So far as the provisions of section 80-IA(10) and 10B(7) are concerned, the application of the same is warranted only in a case when the profits are more than the ordinary profits. The A.O. has taken the profits of A.Y.2002-03 to be the ordinary profits and compared the same with the current year's profits. However, in doing so, he committed arithmetical mistakes and hence, arrived at wrong conclusions. Had he not committed arithmetical mistakes and not used wrong figures, he would have seen that the figures of P&L account match with the analysis and there would be no such vast discrepancy as described in the table on page-3 1 of the assessment order. (xv) Yet another observation of the A.O. in the assessment order is regarding supply agreement and basis for export pricing with Byke Gulden group. Article 5.1.2 of the supply agreement as well as Article 21.2 (c) JV agreement stipulates that the initial supply price applicable to first calendar year shall correspond to the lowest supply price charged by third party suppliers. In future calendar years, the supply price shall be fixed as per the method provide....
X X X X Extracts X X X X
X X X X Extracts X X X X
....y profits which was expected to arise in such eligible business. He contended that the A.O. accordingly proceeded to compute the profits and gain of such eligible business for the purpose of allowing deduction u/s 10B of the Act by taking the amount of profits as might be reasonably deemed to have been derived there from. He submitted that it was found by the A.O. in this context that the profit of Rs. 135.27 crores was shown to have been earned by the assessee in A.Y. 2004-05 from the export turnover of Rs. 165.58 crores which was certainly more than the ordinary profits. He invited our attention to the working given by the A.O. in the assessment order for A.Y. 2004-05 to point out that the ratio between the turnover of the assessee and cost of production was substantially higher at 498% in A.Y. 2004-05 as against 211% shown by the assessee company itself in the first year i.e. A.Y. 2002-03. He contended that the A.O. therefore adopted the profit of the assessee company for A.Y. 2002-03 as normal profits of the eligible business and the difference of 286% was treated by him as profit which is more than ordinary profits within the meaning of section 80IA(10) of the Act. He contende....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... mistakes and errors committed by the A.O. in the working made in this regard. He invited our attention to such working given in the assessment order for A.Y. 2004-05 and also to the relevant portion of the ld. CIT(A)'s order wherein the factual mistakes and errors committed by the A.O. in the said working were pointed out and discussed. He submitted that such errors were not only committed by the A.O. in the working of cost of raw material but the same were there even in the comparative working of profitability made by the A.O. to allege that the profits as shown by the assessee in A.Y. 2004-05 was 498% as against 211% shown in A.Y. 2002-03. He contended that the said percentage was worked out by the A.O. by taking the ratio between the turnover of the assessee company and cost of production which by no means can be regarded as profitability ratio. He contended that even the cost of production was worked out by the A.O. by taking the figures of office and administrative expenses, depreciation etc. which was patently wrong. He contended that the ld. CIT(A) quite correctly appreciated these factual mistakes and errors committed by the A.O. as pointed out by the assessee and proceede....
X X X X Extracts X X X X
X X X X Extracts X X X X
....t there was no adverse comments made in the said report by the auditors and it was duly certified therein that cost account records were properly kept by the assessee so as to give a true and fair view of cost of production and margin of product. 15. We have considered the rival submissions and also perused the relevant material available on record. In the returns of income filed for all the three years under consideration, deduction u/s 10B of the Act was claimed by the assessee in respect of the profits derived from the eligible export business, the turnover of which was entirely made by the assessee company to APAG, Germany, one of the joint venture partners in the assessee company. There is no dispute that the assessee is entitled to deduction u/s 10B of the Act in respect of the profits of the said eligible business. The claim of the assessee for deduction u/s 10B of the Act however was restricted by the A.O. for all the three years under consideration by invoking the provisions of section 80IA(10) of the Act which are made applicable in relation to the deduction u/s 10B as per sub section (vii) of the section 10B of the Act. The provisions of section 80IA(10) of the Act bein....
X X X X Extracts X X X X
X X X X Extracts X X X X
....n the mechanism of determination of profits provided therein. He also noted that the components of technical know-how and patent capacity utilization were not taken into account by the assessee while computing its profits eligible for deduction u/s 10B of the Act. He also discussed the manufacturing process involved in the business of the assessee along with the chemical equations. He also made an attempt to work out the cost of raw material required for the production of 1 Kg. of final product of the assessee company and tried to show on the basis of such computation that the cost of raw material debited by the assessee company in the profit and loss account was substantially low to increase deliberately the profits of all the three years under consideration in order to claim higher deduction u/s 10B of the Act. He also obtained a report from National Pharmaceutical Pricing Authority, Department of Chemicals &Petrochemicals, Govt. Of India based on the cost audit report of the assessee company for the calendar years 2004, 2005 and 2006. 17. Although the assessee made elaborate submissions before the ld. CIT(A) to meet all the objections raised by the A.O. and also pointed out the....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... 50% 52% 55% 8 Cost of sales/Net Profit ratio 255371697 285808416 357861210 249234143 120524525 1187466572 1710606599 1284758407 211.80% 415.47% 478% 515.48% 18. A perusal of the above working made by the A.O. clearly shows that the year-wise percentage worked out by him was the ratio between total turnover and cost of sales. The said ratio, however, was wrongly treated by the A.O. as the ratio between the costs of sales/net profit ignoring completely that the figure of net profit was not at all taken into account in working out the said ratio. Moreover, the entire cost of sales was taken into consideration by the A.O. for making the comparative analysis including the office administrative expenses, selling expenses and depreciation which were not of variable nature. The ratio worked out by the A.O. thus was not a proper profit level indicator and the comparison made by....
X X X X Extracts X X X X
X X X X Extracts X X X X
....1,035,524,264 84.54% The above working furnished by the assessee shows that the gross profit for A.Y. 2003-04, 2004-05 and 2005-06 was increased only by 9.87%, 13.92% and 14.09% in assessment years 2003-04, 2004-05 and 2005-06 as compared to gross profit rate of assessment year 2002-03. On the other hand, the working made by the A.O. on the basis of the same financial data shown the ratio of 415%, 478% and 515% for assessment years 2003-04, 2004-05 and 2005-06 as compared to 212% for A.Y. 2002-03 which clearly shows that the working made by the A.O. did not give correct picture of comparative profitability and gave a misleading picture on the basis of which a wrong conclusion was drawn by the A.O. As already noted, the assessment year 2002-03 was the first year of operations of the assessee's eligible business and capacity utilization during the said year comprising of seven months of business operation was quite low at 38.62%. During the subsequent years i.e. assessment years 2003-04, 2004-05 and 2005-06 which are under consideration, the capacity utilization increased substantially which resulted in decrease in manufacturing expenses in proportion to the corresponding sales giv....
X X X X Extracts X X X X
X X X X Extracts X X X X
....ears under consideration. 21. It is also pertinent to note that APAG, Germany was a joint venture partner in the assessee company having 50% share only and it is difficult to comprehend as to how and why it will enter into any sort of arrangement to allow the assessee company to make more than ordinary profits at its own cost knowing fully well that the benefit of such arrangement as a result of any excess profit could be shared by it only to the extent of 50% with the balance 50% going to the other joint venture party. In the case of Digital Equipment India Ltd. v. Dy. CIT [2006] 103 TTJ 329 (Bang) cited on behalf of the assessee before the ld. CIT(A), a similar issue was involved wherein the deduction claimed by the joint venture company was restricted by the Revenue Authorities by invoking the provisions of section 80I(9) which are analogues to the provisions of section 80IA(10) of the Act and the addition made on this issue was deleted by the Tribunal holding that the Digital Group Worldwide, the overseas joint venture partner will not pay any undue sum to the joint venture which it could not recoup entirely to the exclusion of others. It was also held that mere substantial pr....
X X X X Extracts X X X X
X X X X Extracts X X X X
....ces to APAG, Germany, one of its joint venture partners. A reference, therefore, was made by the A.O. to the TPO for determining the arm's length price of these international transactions of the assessee company with its Associated Enterprise. In this regard, the TPO followed his own order for A.Y. 2002-03 and identified one company as comparable which had shown the profit margin of 21.14% as against 5% shown by the assessee. He accordingly proposed the TP adjustment of Rs. 34,16,631/- in respect of the transactions of the assessee company with its Associated Enterprise for providing clinical trial services and accordingly addition of Rs. 34,16,631/- was made by the A.O. to the total income of the assessee on account of TP adjustment for A.Y. 2004-05. On similar basis, addition of Rs. 14,88,133/- was made by the A.O. to the total income of the assessee on account of TP adjustment in respect of similar international transaction with its Associated enterprise in A.Y. 2005-06. On appeal, the ld. CIT(A) deleted the additions made by the A.O./TPO on account of TP adjustment for both the years i.e. assessment years 2004-05 & 2005-06 by following his own order in assessee's own case for A....
X X X X Extracts X X X X
X X X X Extracts X X X X
....assessee has made the payment not for laboratory test but mainly to hospitals that carried out the clinical test on the patients. The assessee's infrastructure was only in the form of furniture, vehicle, office equipments and computers, which were used for general administration and it was not sufficient for carrying out the whole research activity. Therefore, the assessee was solely dependent on the data provided by the doctors in various hospitals. The main function of the assessee was to collate the data and transmit the same to Byk Gulden for which it was suitably reimbursed by Byk by mark up of 5% over the cost. The assessee's functions were more like coordinator/facilitator rather than performing the function itself. Further, the assessee's submission that its profits were exempt u/s 10B carries lot of substance because the assessee was, in no way, benefited by charging 5% mark up as against 17.14% fixed by TPO because, in any view of the matter, the profits were exempt. The assessee has also pointed out that the profits by the AEs have been subjected to tax in the respective overseas jurisdiction and, therefore, there is no necessity for the assessee to transfer the profits ....