TaxTMI 
TaxTMI 
2016 (12) TMI 236
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....d research, manufacturing and marketing capabilities". It produces active pharmaceutical ingredients (APIs) and finished dosage forms (FDFs), including formulations, and sells them around the world. While the assessee has a strong presence in the less regulated markets like India, China, Latin American and CIS countries, Far East Asia, Africa and Middle Eastern countries, the assessee is increasingly focussing on well regulated markets like USA, Canada, Europe and Australia. It is in this context perhaps that the assessee had entered into distribution channel arrangements with certain entities which is well entrenched in these markets and are in a position to market the products of the assessee. In certain cases, one more entity, which assists is developing the products for the related market, is also roped in. The way this business model works is that the profits are worked out by reducing, from sale realization from the end customer, cost of products sold and the marketing costs, and the profits so worked out are shared, in an agreed ratio, between the parties to this arrangement. As for the cost of goods sold, it is an agreed amount between the parties, and in that sense, rather....
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....ed above, but the sharing of distribution channel profit was to be done as follows- Northstar 50%, Activas 25% and the assessee 25%. [6] On these facts, the Transfer Pricing Officer was of the view that the assessee and its distribution partners (namely Northstar and Activas in this year) were associated enterprises under section 92A(2)(i). The legal provision relied upon provides that "For the purposes of sub-section (1), two enterprises shall be deemed to be associated enterprises if, at any time during the previous year..........(i) the goods or articles manufactured or processed by one enterprise, are sold to the other enterprise or to persons specified by the other enterprise, and the prices and other conditions relating thereto are influenced by such other enterprise". The Transfer Pricing Officer relied upon the findings of the Settlement Commission, vide order dated 28.3.2012, for the assessment year 2006-07 to 2010-11. This order takes note of the statement of Shri Krishnan, CFO of the assessee company, to the effect that selling prices are determined exclusively by the distribution channel partners and the assessee has no control or influence over the matter. It is also ....
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.... 2.2.4.5 The next objection raised by the learned A.R. is that clause (i) of the sub-section (2) of Section 92A is not satisfied by the Applicant and hence it cannot be deemed to be an "associate enterprise" of the Distribution Partner (DP). In support of this contention the Applicant has raised two objections. According to the learned A.R. clause (i) specifies that 100% of the goods manufactured or processed by one enterprise are sold to the other enterprise which is not a fact in the Applicant's case and secondly the prices and other conditions relating thereto are influenced by such other enterprise. He stated that, in the Applicant's case, the prices and other conditions are not influenced by the DPs. 2.2.4.6 (a) We are unable to agree with the learned A.R. on this ground also. His argument is that, while percentages are mentioned in other clauses, it is not specified as to which percentage of the goods or articles manufactured or processed by one enterprise are required to be sold to the other enterprise for the applicability of the clause. He also stated that the use of the article "the" in the provision also indicates that the entire or 100% of the goods manufactu....
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....ely receives for the products supplied by it to the DPs (subsequently sold to the end customers) consists of two components. The first component constitutes the cost of manufacturing such products and the second component is the 50% share of profit computed after deducting the marketing cost from the selling price to the ultimate customer. Though the Applicant contended that the selling price is determined jointly by itself and the respective DPs, this contention is not borne out by the facts. We find that the final price (at which the goods are sold to the end customers) is exclusively decided by the DPs. As has been argued before us, it is possible that this price may be influenced by market forces. However, the fact remains that the ultimate determination of the price is done by the DPs. In other words, market forces may influence the judgement of the DPs but do not determine the final selling price as such determination remains the exclusive prerogative of the DPs. Thus, in effect, the amount which the Applicant ultimately gets by way of 50% share of the profits is also determined by the DPs. The share of profits + cost of manufacturing/marketing - both constitute the selling p....
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....shall meet and attempt in good faith to resolve any disputed matters". 2.2.4.10 As we have stated earlier, though such selling prices may be relatable to prevailing market forces, this does not neutralize the control of the DPs as the decision to finalise the sale price to the end customers remains with the DPs. The final selling price so determined is merely communicated to the Applicant. In fact, the Applicant has admitted that it has no mechanism for verifying if the final selling price has been fixed correctly or not and it accepts the selling price fixed by the DPs in good faith. 2.2.4.11 We also find that the DPs also influence "and other conditions relating thereto" as contemplated in clause (i) of Section 92A(2). Such control is exercised by the DPs for the entire value chain of the products concerned. The DPs have influence in deciding which products are to be developed, the production plan and the manufacturing process. They also have the sole discretion to reject the products supplied to them. The agreements with the DPs contain provisions for having joint committees for taking certain decisions relating to production and other activities. 2.2.4.12 In view of the a....
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....similar agreements with one of the DPs of the Applicant. [7] It is on the basis of the aforesaid reasoning of the Settlement Commission that the Transfer Pricing treated Northstar and Actavis as associated enterprises of the assessee. The TPO, inter alia, observed that "There is no need to give a separate finding on the objections raised (which included objections against Northstar and Activas being treated as AEs) since they have been adjudicated by a higher forum" and that "since the facts have not undergone any change for this year, it is desirable to stick to the same stand...". When assessee raised the objection before the Dispute Resolution Panel, against the Assessing Officer proposing to make ALP adjustments by treating Northstar and Activas as AEs of the assessee, the DRP also confirmed the stand of the TPO by simply brushing aside all these submissions and rather mechanically giving a one sentence decision to the effect that "In view of the justification given by the TPO and completing the TP adjustment following the decision of Hon'ble Settlement Commission, the objections of the assessee cannot be accepted". The assessee is not satisfied and is in appeal before us. [....
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....ore executive directors or executive members of the governing board of one enterprise, are appointed by the other enterprise; or (f) more than half of the directors or members of the governing board, or one or more of the executive directors or members of the governing board, of each of the two enterprises are appointed by the same person or persons; or (g) the manufacture or processing of goods or articles or business carried out by one enterprise is wholly dependent on the use of know-how, patents, copyrights, trade-marks, licences, franchises or any other business or commercial rights of similar nature, or any data, documentation, drawing or specification relating to any patent, invention, model, design, secret formula or process, of which the other enterprise is the owner or in respect of which the other enterprise has exclusive rights; or (h) ninety per cent or more of the raw materials and consumables required for the manufacture or processing of goods or articles carried out by one enterprise, are supplied by the other enterprise, or by persons specified by the other enterprise, and the prices and other conditions relating to the supply are influenced by such other ....
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....ise, participate, directly or indirectly, in the management or control or capital of the other enterprise and that persons who participate in such management, control or capital of both the enterprises are common. As long as an enterprise participates in any of the three aspects of the other enterprise, i.e. (a) management; (b) capital; or (c) control, these enterprises are required to be treated as associated enterprise, as also is the position when common persons participate in management, control or capital of both the enterprises. However, the expression 'participation in management or capital or control' is not a defined expression. To find the meaning of this expression, one has take recourse to Section 92(2) which gives practical illustrations, which are exhaustive and not simply illustrative- as clarified in the Memorandum explaining the provisions of the Finance Bill 2002 which, while inserting the words "For the purpose of sub section (1) of section 92A" in Section 92A(2), observed that "It is proposed to amend sub-section (2) of the said section to clarify that the mere fact of participation by one enterprise in the management or control or capital of the other enterpris....
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....layed by one of the enterprise in the capital of the other enterprise, whether equity capital or loan capital or even by guaranteeing borrowings by the other enterprise, is so significant that one enterprise has de facto control over the other. The second segment, which consists of clause (e) and clause (f), covers participation in management. Clause (e) refers to the situation in which more than half of the board of directors can be appointed by the other enterprise, and clause (f) enterprise refers to the situation in which more than half of the board of directors of both the enterprise can be appointed by the same person. These two segments thus refer to the participation in the capital and the management. That leaves us with third segment of the basic rule, enshrined in section 92A(1), i.e. "control", and interestingly, this expression 'control' finds way in addition to the control which is inherent in participation in capital and participation in management. Such a control could either be on account of commercial relationships or personal relationships. In our considered view, third segment, which consists of clauses (g) to (l), refers to the situations in which relationship b....
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....ch is a sine qua non for invoking the status of associated enterprises under third limb of test laid down by Section 92A(1). That's clearly a case in which the prescription of Section 92A(2) has gone far beyond the mandate of Section 92A(1). Be that as it may, let us move on to the last segment of situations dealing with participation in control over the other enterprises, i.e. control by way of relationships other than commercial relationships. Clauses (j), (k) ad (l) deal with this segment. Clause (j) refers to the situation in which an enterprise is controlled by an individual and the same person controls, either on his own or along with his relatives, the other enterprise and when relatives of that person control the other enterprise. Essentially, the emphasis is on control of the enterprises, though by way of relationships other than commercial relationships. Clause (k) is a slight variation of clause (j) dealing with a situation in which an enterprise is controlled by an HUF and the other enterprise is controlled by member of such an HUF or relative of its member- jointly or independently. The element of control is fundamental in the situation envisaged by clause (j) as well.....
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....t less than 5% of entire sales, that there is no element of de facto control over the other enterprise so as hold that two enterprises are associated enterprises. 13. We may, at this stage, take note of decision of a coordinate bench of this Tribunal, in the case of Page Industries Limited Vs DCIT [(2016) 159 ITD 680 (Bang)]. That is a case in which the coordinate bench has held that even though the provisions of Section 92A(2)(g) are satisfied in a case, the assessee cannot be treated as an associate enterprise of the non resident company granting it licence to manufacture its products, because the provisions of Section 92A(1) are not satisfied. 14. As evident from the limited narration of facts in the said decision, the assessee-company (i.e. Page Industries Ltd; PIL in short) was "a licensee of the brand- name 'Jockey' for exclusive manufacture and marketing of goods under license agreement" but "the assessee-company owns entire manufacturing facility, capital investment of Rs. 100 crores and 15000 employees" and "there is no participation of JII (i.e. Jockey International Inc., USA) in the capital and management of the assessee-company". On these facts, the coordinate....
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....to a set of enterprises, set out in section 92A(1) are clearly not fulfilled, even if the conditions under one of the clauses of section 92A(2) are fulfilled, such enterprises cannot be treated as associated enterprise under section 92A. To the limited extent of the principle so laid down by the coordinate bench, we are in considered agreement with the views of the coordinate bench, and it is this principle which is relevant for the purposes of our adjudication. It does directly affect the issue in appeal before us inasmuch as we are also dealing with a situation in which admittedly words of section 92A(2)(i) are clearly satisfied on the facts of this case, the scale of commercial relationship is so insignificant vis-à-vis total business operations of the assessee that there is admittedly no participation in control by one of the enterprise over the other enterprise so as to satisfy the mandate of Section 92A(1). 15. While dealing with this, we may also refer to some observations made by Dr Ramon Dwarkasing, an Associate Professor in Transfer Pricing at Maastricht University, the Netherlands, in his book "Associated Enterprises- A Concept Essential for Application of the Ar....
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....t one of the ways in which use of expression 'influence', in concept of associated enterprises under the transfer pricing, can be rationalized is as dominant influence in the nature of de facto control. The definition of 'associated enterprise', as the above academic analysis shows, has two approaches- wider approach and narrow approach. A narrow approach to the concept of associated enterprises takes into account only "de jure" association i.e. though formal participation in the capital or participation in the management. A wider approach to the concept of 'associated enterprises' takes into account not only the de jure relationships but also de facto control, in the absence of participation in capital or participation in management, through other modes of control such as commercial relationships in which one has dominant influence over the other. This wider concept is clearly discernible from the principles underlying approach to the definition of 'associated enterprises' in the tax treaties and has also been adopted by the transfer pricing legislation in India in an unambiguous manner. There is no other justification in the Indian transfer pricing legislation, except the partici....
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.... relating thereto are influenced by such other enterprise" appears in Section 92A(2)(i), this influence has to be something more than influence in the ordinary course of business and in the process of negotiation, because, even in the course of ordinary every business and in the course of day to day negotiation, selling prices as also conditions of sale are invariably, in a way, influenced by the buyer. Therefore, even when a customer offers terms to someone with a 'take it or leave it' message, such an approach, by itself, cannot be termed as 'influence', for our purposes, unless the seller is in such a position and under such an influence that he has to simply accept the dictated terms. Any other view of the matter will result in all the enterprises dealing with each other as every party to a transaction has an influence over the price and conditions relating to the sale, and will lead to a situation in which all the enterprises dealing with each other on negotiated prices will have to be as associated enterprises. That again is a clearly absurd and unintended result, and it is only elementary that law is to be interpreted in such a manner as to make it workable rather than redun....
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....he assessee's exports through the distribution part constitutes less than 5% of its entire exports, and less than 6% of its entire sales, Northstar is certainly not in a position to exercise any dominant influence, over the assessee. The assessee's decision to accept the terms set out by Northstar, even if that be so, may be justified on account of commercial expediencies or warranted by business exigencies or may simply be compulsion of this somewhat unique and complex business model, but it cannot, by any stretch of logic, be on account of dominant influence of Northstar as a customer. It may even be a sound business strategy to accept a rather passive and back seat role, if one can term it that way, in day to day decision making under this business model, but cannot be on account of dominant influence that Northstar exercises on buying of products from the assessee. The influence of Northstar, given the scale of business through Norrthstar as a distribution part, is too modest to make it a dominant influence in the nature of control. In this view of the matter, as also bearing in mind the earlier discussions on the issue, the assessee and Northstar can not be treated as 'associa....