TaxTMI 
TaxTMI 
2015 (1) TMI 699
X X X X Extracts X X X X
X X X X Extracts X X X X
....ls, API & intermediate to support is internal product development. Assessee's facilities also develops APIs for third parties as well. On the whole, the assessee provides contract manufacture, contract research and development to its parent AE at the US. The parent AE in the US is engaged in development, manufacture and sale and distribution of proprietary and off patent generic pharmaceutical products. 3. Though the parent AE and its associates develop manufacture the products in three core areas, i.e. Specialty Products, Nephrology Products and Generic Products, its association with the assessee summarily rallies around contract Research and Development services, contract manufacturing at their facilities and commercial sales. 4. Since there is involvement of international transactions between the AEs the assessee justifies its ALP with its AE by using TNMM method. 5. In so far as R&D activities which included manpower recruitment are concerned, the assessee explained to the revenue authorities with regard to its functions relating to generic pharma products, its selling and marketing functions. Based or this functional analysis, to justify its transactions with AEs, the....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... Operating Profit (OP) 5,44,59,699 OP/TC 17.43 The assessee has used TNMM as Most Appropriate Method to benchmark the transaction, using OP/TC (Operating profit to Operating Cost) as PLI". based on the following comparables Sr. No. Name of Comparable Average PLI Based on Multiple Year Data 1 Choksi Laboratories Ltd 32.45% 2 Vimta Labs Ltd 20.09% 3 Dolphin Medical Services Ltd 10.22% 4 NG Industries Ltd. 20.04% 5 Max Neeman Medical International Ltd.(Seg.) -5.39% 6 Pfizer ltd. (Seg.) 9.57% Mean 14.50 Assessee's PLI 17.43 12. The TPO after considering the comparables, observed, "In response, the assessee submitted that it considered companies engaged in research and testing services and diagnostic and testing services. The reason given by the assessee to broaden the search is that, as adequate companies could not be found whose business was closely comparable to that of the assessee's R&D segment. In this regard, it is to be stated that there are sufficient number of comparable companies are available in the R&D sector, as evidenced by the co....
X X X X Extracts X X X X
X X X X Extracts X X X X
....rt for FY 2008-09). Thus, the services segment is a captive centre for Pfizer group and thus the segment fails 25% related party transactions filter. 13. On the final analysis, the AO lay his basis on the following final comparables "As a result, after considering the objections of the assessee and also examination of additional companies submitted by the assessee, the following are the final comparables that are used for benchmarking the ALP of the transactions entered by it with its AE under the Contract R&D Segment:- Sr. No. Name of Comparable OP/TC (%) FY 2008-09 1 Choksi Laboratories Ltd 23.67 2 TCG Lifesciences Ltd 41.33 3 Vimta Labs Ltd 13.04 4 Alphageo (India) Ltd 20.25 5 Jubilant Chemsys Ltd 27.18 6 GVK Biosciences Pvt. Ltd 16.61 7 Siro Clinpharm Pvt Ltd 25.59 8 Syngene Intl Ltd. 28.87 9 Research Support Intl Pvt Ltd 23.30 10 Aurigene Discovery Technologies Ltd. 16.23 Mean 23.61 Assessee's PLI 17.43 and arrived at the following result "In view of the above discussions, the international transaction....
X X X X Extracts X X X X
X X X X Extracts X X X X
....as the assessee could not submit any details to substantiate that any of such benefit would be/will be passed on to the customers/distributors in USA. It is to be noted that based on the bargaining power of the AEs, the entire location savings cannot be attributed to India. In the instant case, AE requires the assessee with its FDA approved R&D sites along with technical manpower; whereas the assessee requires E for introducing new generic products to be launched in US market in generic drugs. As the association is mutually beneficial, the split of location savings between assessee and its AE are treated as 50%:50% and accordingly, the location savings of Rs. 18,08,68,785/- is divided between the assessee and the AE on a 50 : 50 basis. In light of above, an adjustment of Rs. 9,04,34,392/- is proposed to the arm's length of the price of the international transactions of assessee on account of location savings. 7. Summary The transfer pricing adjustments made in this order are summarized as under: Sr. No. Nature of adjustment Amount (Rs) 1 Location Savings arising in the manufacturing segment 25,19,22,871 2 Adjustment in product development R & ....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... placed reliance on the following decisions "Dolphin Medical Services Ltd is also into the business of clinical trial services which is broadly comparable to the activity of contract research and development services. This is also reflected in the Annual Report of the Dolphin Medical Services Ltd for financial year 2008-09. The relevant extracts of the report are as follows: "...The company was able to achieve this goal and ensured that no loss was incurred on it. In addition to this due to global recession, the outsourcing of clinical trials from USA and Europe has slowed down and the company needs to explore local opportunities also to fulfil the business requirements of the CR0 venture. The huge monthly rentals for this building will also he a burden to the company in case of any potential problem in getting the Clinical Trails/CR() contracts from the west ... " (refer page no 311 of the paper book). The above extracts demonstrate that they are into clinical trials and contract research (CR0) like the assessee. 11. Another company accepted by TPO namely Siro Clinpharm Pvt. Ltd. is also engaged in Clinical Research & Development Services apart from other service....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... Cost A 31,25,25,091 31,25,25,091 Arm's Length Operating Profit Margin B 23.98% 22.30% Arm's Length Operating Profit C=A*B 7,49,43,517 6,96,80,594 Arm's Length Operating Income D=A+C 38,74,68,608 38,22,05,685 Value of International Transaction E 36,69,84,790 36,69,84,790 Difference between Arm's length price of operating income and value of international transaction F=D-E 2,04,83,818 1,52,20,895 5% of value of international transaction 1,83,49,240 1,83,49,240 Transfer Pricing Adjustment 2,04,83,818 NIL 21. In the above analysis, what is seen and to be decided is whether to include the results of M/s Dolphin Medical Services Ltd. or not. From the final analysis, except for M/s Dolphin, all other comparables as taken by the TPO are accepted by the assessee. 22. As per the submissions of the AR and DR, we find that the reasoning given by TPO to exclude Dolphin was primarily on an argument that functioning of Dolphin Medical Services Ltd. is different. How it is different, the revenue authorities did not make elaborate analysis. On the other....
X X X X Extracts X X X X
X X X X Extracts X X X X
....consulting. These functions are, by and large, similar to the assessee's activities. Therefore, this company on merits also is includable in the set of companies". In the case of ACIT v Schafhorst Marketing Co. Ltd. 13 taxman.com 104 (Mum-Trib), in para 14 of the order, it has been held, "TNMM is more broad based and the variation in the type of services, as in this case can be absorbed in this method". In the case of Tecnimont ICB P Ltd. v ACIT vs ACIT 24 taxman.com 28( Mum-Trib) in para 10, it has been observed, "The assessee had submitted that while it was engaged in mainly execution of engineering services through specilised software, ICBC was engaged in mainly execution of electrical and instrumentation projects, including onsite erection and allied activities which were labour intensive, but the transactional net margin method is more tolerant to differences in functions. It cannot be open to him to contend that there are slight differences at functional level and, for that reason alone, comparables should be rejected". The AR also placed reliance on the decision of William Hare India P Ltd. vs ACIT (ITA 2071/Mds/2012), and submitted that the deision was more o....
X X X X Extracts X X X X
X X X X Extracts X X X X
....Contention of TPO/DRP 17. Hon'ble DRP held that the Assessee has made the claim for risk adjustment in a routine manner and no facts or other material has been brought on record to specify such risk adjustment computation. Accordingly, placing reliance on following rulings, DRP denied to grant risk adjustment (Page 7 of DRP Order): The primary contention of revenue was computation not provided. Wills Processing Services vs. DCIT(2013) Marubem India (P) Ltd vs. DCIT Interra Information Technologies India Pvt. Ltd. vs. DCIT (2013) General Atlantic Pvt. Ltd. vs. ACIT (2013) vii. Argument of the Assessee before Hon'ble Income Tax Appellate Tribunal Risk Adjustment should be allowed 17. In case Dolphin Medical Services Ltd is added to the comparables set then the Assessee's margin falls within +/- 5% range. Therefore in such case risk adjustment would become academic. However, assessee's argument for risk adjustment are as follows: 19. Before Your Honor's the Assessee would like to submit that risk adjustment should be allowed for following reasons: 19.1 Assessee vide submission dated 17/09/2013 has filed detailed working of risk adjustm....
X X X X Extracts X X X X
X X X X Extracts X X X X
....hich undertakes little more risk) and risk free government bond (which undertakes risks) should be allowed. The AR further submitted that even if minimum risk adjustment at rate of 1% is allowed, even then the assessee shall fall within the tolerance range of +/-5% as per second proviso to section 92C(2) of the Act. 28. Even when we consider the risk adjustment, the assessee's case would fall within the tolerance range and therefore, no TP adjustment would be called for. 29. Adjustment of location saving on contract manufacturing of Rs. 25,19,22,871/- and contract R & D of Rs. 9,04,34,392/-. 30. The assessee is engaged in providing contract manufacturing and contract research & development services to its AE(s). In consideration of the said services, the AE(s) compensate the assessee on a total operating cost plus arm's-length mark-up basis. In the Transfer Pricing Study Report prepared by the assessee, search was performed to identify comparable companies engaged in providing simi lar Pharmaceutical contract manufacturing and contract research and development services in India. 31. During the course of proceeding before the DRP, TPO/DRP accepted the TNMM method and....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... position taken by India tax administration in UN TP Manual Chapter 10. 37. Further, TPO held that the assessee did not prove with proper documentary evidence that Watson's competitors in USA having manufacture base in India, so that all the competitors are in sync, and thus made the basis to reduce the prices due to cost savings arising in India 38. In order to allocate location savings, TPO relied upon a research article on the website of Frost and Sul l ivan, written by Aiswariya Chidambaram in respect of Contract Manufacturing segment and an article "Clinical Trial Magnifier Vol. 1:6 June 2008" in respect of Contract R&D segment. 39. Based on these articles TPO concluded that, in case of Contract Manufacturing, cost in India is around 40% of cost in USA (excluding raw material cost) and in case of Contract R&D, the cost of R&D in India (excluding raw material cost) is around 50% of cost in USA. 40. TPO thus computed location savings and apportioned the same on basis of 50:50 ratio between the assessee and its AE. He therefore, suggested an adjustment of Rs. 25,19,22,871/-. 41. Aggrieved by this adjustment/addition, the assessee approached the DRP. 42. Befo....
X X X X Extracts X X X X
X X X X Extracts X X X X
....ning power in hands of the AE. Besides this, there are numerous third party contract manufacturing and R&D service providers in India, which could provide bargaining power to the AE. 47. In any case, as per OECD Guidelines, location savings is not an intangible asset, till such time, where specific advantages are capable of being owned or controlled by an individual enterprise. 48. Profit Split method would be applicable mainly in international transaction involving transfer of unique intangibles, or where international transactions are so interrelated that they cannot be evaluated separately. In the instant case, location specific advantages cannot be called as intangible asset. Thus, the TPO's approach of following India chapter in UN TP Maunal (which is the opinion of tax administration and not the view of Indian Government) which advocates use of profit split method for allocation of location savings is not correct. 49. The assessee also argued that once it is remunerated at an arm's length price by taking regular comparables under this jurisdiction then no location saving is to be attributed. This argument of the assessee was rejected by the DRP stating that i....
X X X X Extracts X X X X
X X X X Extracts X X X X
....ons of section 92C(3) have been fulfilled as the information asked by TPO was not produced by the assessee. That the assessee failed to show that there was no location savings by not producing details of cost of production of the products manufactured by assessee, before and after the transfer of manufacturing site to India. That the AE's Annual Report clearly refers to relocation of manufacturing facility. 53. The DRP, therefore, sustained the additions made by the AO/TPO. 54. Against this order of DRP, the assessee, now is in appeal before the ITAT. 55. Before us the AR reiterated the submissions made before the revenue authorities and submitted that adjustment on account of location savings is not at all warranted, as location saving arises in not perfectly competitive market. In the case of the assessee there is no economic rationale for location savings adjustment as Watson US faces stiff competition in the US market which is evident from the Annual Report of Watson Pharmaceutical Inc. (Page 10 & 32 of Form 10K and DRP Form 35A Page 41 to 43). The relevant extract of Form 10K of Watson Pharmaceutical Inc. is as follows: "We actively compete in the generic pharm....
X X X X Extracts X X X X
X X X X Extracts X X X X
....gly, the level of market share, revenue and gross profit attributable to a particular generic product normally is related to the number of competitors in that product's market and the timing of that product's regulatory approval and launch. Consequently, we must continue to develop and introduce new products in a timely and cost-effective manner to maintain our revenues and gross margins. Additionally, as new competitors enter the market, this may increase pricing pressure on certain products, which would result in lower gross margins. This is particularly true in the case of certain Asian and other overseas competitors, who may be able to produce products at costs lower than the costs of domestic manufacturers. If we experience substantial competition from Asian or other overseas competitors with lower production costs, our profit margins will suffer". (page 32 of Form 10K) Many of the Watson's peer group companies in North America have themselves outsourced manufacturing and/or research facilities in India or China. This is evident from the Form 10K of peer group companies i.e. Mylan Inc. and Teva Pharmaceutical Industries Ltd. 56. According to the AR, neither Watso....
X X X X Extracts X X X X
X X X X Extracts X X X X
....no such analysis or estimates or forecasts or budgets are prepared by the assessee for its business, non furnishing of such non existent records cannot lead to a conclusion that the assessee has not furnished the information and documents prescribed under r. 10(D(1)(f). The maintenance of these records is procedural and non maintenance of the same is not such that it would affect the determination of ALP.....". The Special Bench in this case noted that the relevant provisions have used the words "if any", which means that non submission of records cannot form the basis of making adjustments in the ALP on bald assertions. In such a case, we are of the opinion that one of the reasons for making ALP adjustment is without any basis. 60. We find that the comparables selected by the assessee to determine arm's length price of transaction relating to contract manufacturing and contract research and development are local Indian comparables operating in similar economic circumstances as the assessee. This according to us are in line with the decision of coordinate bench of the ITAT, Delhi, in the case of GAP International Sourcing (India) Pvt. Ltd. (supra), wherein the Tribunal held,....
X X X X Extracts X X X X
X X X X Extracts X X X X
....078) 2 Contract R&D segment Clinical Trial Magnifier Vol. 1:6 Jun 2008 (source: www.clinicaltrial magnifier.com 64. At the outset, the above reliance could not be treated as acceptable, because, these were web articles and not accepted by any forum. In any case, if at all, this aspect has to be considered, then it has to be considered in the context of the AE and not the assessee, because the tested party is the assessee and the international transaction entered into by the assessee has to be tested by comparing the same wi th uncontrol led, unrelated comparable transaction, as held in the case of Syscom Corporation Ltd. vs ACIT, reported in 35 taxmann.com 600 (Mumbai - Trib). 65. The tested party is the assessee and the international transaction entered into by the assessee has to be tested by comparing the same with uncontrolled, unrelated comparable transaction only and not in the context of AE. The issue of comparability analysis, was dealt with by the coordinate Bench of the Mumbai ITAT, in the case of Lloyds TSB Global Services (P) Ltd., reported in 33 taxmann.com 259, wherein the ratio laid down was, "For carrying out comparability analysis, it is....
X X X X Extracts X X X X
X X X X Extracts X X X X
....round raised by the assessee. The same is dismissed". 67. Thus, once the TNMM method is accepted as method of considering assessee as a tested party then any benefit/advantage accruing to AE is irrelevant if the PLI is within the range of comparables. 68. The facts in the decision relied upon by the TPO, are completely different as compared to assessee's case as these case laws were related to the fiscal years (1970's and 1980's) in which economic scenario was completely different but in so far as present scenario is concerned, primitive. Further in above mentioned case, taxpayers were not operating in perfectly competitive market unlike in the case of the Assessee. Summary bringing out difference in facts is provided below: 69. We also take into consideration the reliance placed on UN TP Manual by the TPO, about which we are convinced was incorrect reliance, because UN Manual, is basically view of Indian tax administration and is not binding on Appellate authorities, the relevant extract of which is given below: "consensus has been sought as far as possible, it was considered most in accord with a practical manual to include some elements where consensus could....
X X X X Extracts X X X X
X X X X Extracts X X X X
....TPO has to take care that the method has to be prescribed by the Board, which can do so through relevant Rules. Even relevant Rules do not talk about the method adopted by the revenue authorities. This, in unison with the decision of the coordinate Bench on incorrect method of computation, we are of the view that the TPO/AO and DRP erred in making the adjustment on account of location savings. 75. We, therefore, set aside the order of the DRP and direct the AO to delete the addition. 76. Ground no. 6 pertain to directing the revenue authorities to make adjustments, taking into account the safe harbor range of +/- 5%. Since the safe harbor range has been allowed by the legislature itself, the revenue authorities are bound to follow the same. 77. Since we have set aside the order of the DRP, we, direct the AO to consider the safe harbor zone and compute the income accordingly. 78. Ground no. 6, is therefore, treated as allowed. 79. Grounds no. 4 & 5 pertain to disallowing interest income of Rs. 2,10,65,566/- for the purposes of computing deduction u/s 10B. 80. The AO found that the assessee had taken into consideration the income generated as interest and sale of sc....
X X X X Extracts X X X X
X X X X Extracts X X X X
....business of the undertaking. It is interesting to note that similar provisions are not there while dealing with computation of income under Section 80HHC. On the contrary there is specific provisions like Section 80HHB which expressly excludes this type of incomes. Therefore, in view of the aforesaid provisions, it is clear that, what is exempted is not merely the profits and gains from the export of articles hut also the income from the business of the undertaking. 8. In the instant case, the assessee is a 100% EOU, which has exported software and earned the income. A portion of that income is included in EEFC account. Yet another portion of the amount is invested within the country by way of fixed deposits, another portion of the amount is invested by way of loan to the sister concern which is deriving interest or the consideration received from sale of the import entitlement, which is permissible in law. Now the question is whether the interest received and the consideration received by sale of import entitlement is to be construed as income of the business of the undertaking. There is a direct nexus between this income and the income of the business of the undertaking. Thoug....
X X X X Extracts X X X X
X X X X Extracts X X X X
....of Black & Veatch Consultancy (I) Limited [334 ITR 72]. (ii) Whether on the facts and circumstances of the case and in law, the Hon'ble DRP erred in directing the AO to allow deduction u/s 10B of the Act in respect of its Goa unit without setting off unabsorbed depreciation of another eligible unit situated in Ambernath without taking cognizance of CBDT Circular F no. 279/Misc/M-116/2012-IT dtd. 16.07.2013 2. The appellant prays that the order of the DRP on the above grounds be set aside and that of the AO be restored. 3. The appellant craves leave to amend or alter any grounds or add a new ground which may be necessary". 92. Both the grounds are connected, we, therefore, take up the two grounds. 93. At the time of hearing, the AR submitted that the issue, as raised by the department is covered by the decision of Hon'ble Bombay High court in the case of CIT vs Black & Veatch Consulting Pvt Ltd. reported in 348 ITR 72 (Bom), wherein it has been held, "... deduction under s. 10A, has to be given effect to at the stage of computing the profits and gains of business. This is anterior to the application of the provisions of s. 72 which deals with the carry forward a....
X X X X Extracts X X X X
X X X X Extracts X X X X
....SS USS USSM USS M USSM USSM USSAN USSM USSM NAmmarica US 48.099 367.554 30.000 7.500 22.500 17,012 4,233 12,759 4.210 538 7.931 ° 00 NAmanita Caraca 3.995 45,673 30.000 7.500 22.500 1.370 244 1,002 341 $2 640 0 0.0 LAmerica Argentina 977 15,762 30.000 7,500 22.300 473 118 355 117 18 220 59 18.5 LAmerica 966 8,119 30,000 7,500 22.500 244 61 133 55 9 113 30 16.5 L America Maxico 380 10.369 30.000 7.500 22.500 311 76 223 77 12 145 38 16.5 LAmerica Chile 218 2,565 20,000 7,500 22,500 107 27 20 26 4 50 19 16.5 LAmerica Pen 176 2.218 30.000 7.500 22.500 67 17 50 16 2 31 S 16,5 LAmerica Colombia 150 2.411 $0,000 7.500 22.500 102 26 77 25 4 43 12 16.5 Europe Carmany 5,825 77.756 30,500 7.500 22,500 2,303 563 1,750 577 87 1,005 ° 0.0 Europa France 4,504 56,053 ....
X X X X Extracts X X X X
X X X X Extracts X X X X
....st Europa Remania 522 4,498 30,000 7,500 22,500 135 34 101 37 $ 65 17 16.5 East Euros Slovakia 444 2.731 30.000 7.500 22.500 112 25 8+ 28 + 52 14 16.5 East Europe Bulgaris 855 2.678 30.000 2,500 22,500 30 20 60 20 37 10 16.5 Fast Europe East Europa Turkey 252 4,771 30,000 7.500 22.500 143 今ら 107 35 67 18 18.5 Lithuania 137 2.896 300,000 7,500 22.500 117 29 29 4 54 14 16.5 East Europa Estonia 168 3.387 30.000 7,500 22,500 100 25 75 25 4 47 12 165 East Europe Latvia 152 1.265 80,000 7.500 22.500 23 S 13 5 15.5 East Europe Croatia 127 1.454 30,000 2,500 22.500 44 11 33 IT 2 20 5 14.5 Mid East 626 6,929 30.000 2,500 22.500 208 52 156 51 O 397 20 16.5 Africa S. Africa 369 14.228 30,000 Ash 2,016 36,295 30,000 7.500 22.500 22.500 7,500 427 107 320 105 16 ....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... low cost should have been manufacturer (Fiscal Year 1986-92) produced by competition within the market; moreover Compaq Asia had market power resulting from its ability to meet the product quality and flexibility requirements of its customer. Thus relevant market was US and Court accepted CUP paid by Compaq to unrelated subcontractors (Page 10/11 of the TPO Order) The contract manufacturer was the only manufacturer in Asian Market that could meet the quality standards and provide the product flexibility that its foreign AE needed. Thus it had unique market advantage. Under this scenario location saving was retained with contract manufacturer. Whereas the assessee functions in perfectly competitive market. Thus there is no question of retaining any benefit arising on account of location saving (refer page 10 of the TPO Order). Further there was no separate adjustment on account of location saving since the Court has accepted margin of comparables computed using CUP method. Similarly in our case as well, m....