TaxTMI 
TaxTMI 
2018 (4) TMI 688
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...., whereas these expenditures are not part of any transactions involving third parties. 4. The CIT(A) erred in making the deletions without appreciating the observations made by the TPO that the impugned expenditures are not recovered from the AE by way of sales price of finished products, charged to the AE. 5. The CIT(A) erred in mis-interpreting the action of TPO in determining of ALP w.r.t. international transactions at NIL as against the observation of TPO in the order, that it resulted in suppression of profit. 6. The CIT(A) ought to have appreciated that the facts in all the relied upon cases and the assessee's case are distinguishable and distinct in so far as determination of ALP of the license fees and management fee by the TPO is on account of non-recovery of amounts by way of sales price and not due to reasons given in the cited cases. 7. The CIT(A) was not correct in deleting the adjustment made without appreciating the fact that even otherwise, these expenses would have been disallowed u/s. 37(1) of the Income tax Act, as the conditions of said section 37(1) of the Income tax Act wer....
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.... 37(1) of the Income tax Act were not met. 9. For these and such other grounds that may be urged at the time of hearing, it is humbly prayed that the order of the CIT(A) be reversed and that of the Assessing Officer be restored. 10. The appellate craves leave to add, to alter, to amend or delete any of the grounds that may be urged at the time of hearing of the appeal. IT(TP)A No.1039/Bang/2015 : 04. Ground nos.1, 2, 8 and 9 are general in nature. Ground nos.3, 4, 5 & 6 deal with the issue of licence fee and management fees. Brief facts relevant to decide the present appeal are as follows. The assessee is a company incorporated in India and is engaged in manufacture of pharmaceutical formulations for Adcock Ingram Health Care (Pty)Ltd, South Africa (AIHPL) and providing outsourced formulation manufacturing services to domestic pharmaceutical companies. The assessee was established as a joint venture company on 05.02.2007 between Medreich SA (Indian company) and AIHPL (AE) for the purposes mentioned in the joint venture agreement with shareholding of 50.1% and 49.9% of Medreich and AIHPL respectively. 05. The assessee company (re....
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....es 3,335,798 3,335,798 Depreciation 19,170,374 19,170,374 Fringe Benefit Tax 235,493 235,493 Non-operating expenses 38,587,137 38,587,137 Total operating cost 488,966,290 83,950,298 2,813,821 38,822,630 614,553,039 On the basis of the above, it was submitted by the assessee that operating profit / operating cost at the entity level was 25.49% as against the non-AE it was 5.26 %. Thus it was submitted that the international transactions at the entity level for the 'Manufacture and export of drug formulations', was as under : International Transactions Received Paid 1. Sales of Manufactured Products 603003808 2. Licence Fee 16100000 3. Service Fee 3320309 4. Purchase of Raw Material 15760215 5. Purchase of Fixed assets &nbs....
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....osed to be applied to determine as 'nil' the ALP of the license fee paid by the Company. 1.6 Payment of management fee is at arm's length: - Arm's length price of the transaction should not be considered as 'nil' since as per the Act, the ALP is required to be determined in light of the any of the five prescribed methods (as then existing) in the manner prescribed in Rule 10B. Your goodself has not mentioned as to which method is proposed to be applied to determine as 'nil' the ALP of the license fee paid by the Company. - There is commercial need for the payment of the management fee since the payments directly benefit the Company by enabling it to carry out its business operations more efficiently. - Your approach of enquiring on commercial expediency of the impugned payment is incorrect in law. - In the pharmaceutical industry it is common to procure the services for which the management fee payout is made. 1.7 Transactions relating to license fee and management fee are closely linked to the principal transaction of manufacture and export of drug_ formulations. In this regard, your goodself should note that the license fee and ma....
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....pact on the taxable profits would be nil." Payment of license fee by the Company meets market conditions 2.14 Your goodself has mentioned that the license fee payment does not meet the market conditions since the scope of procurement of an alternative cost effective know-how is restricted which could be available to the assessee. Your goodself has also mentioned that even if it is a situation that no alternative know-how is available, the conditions cannot be prohibitory in nature. 2.15 The Company submits that the above Contentions are incorrect. We request you to note that the license fee paid by the Company is determined as a percentage of the Net Sales Price as defined in the agreement (and thus, variable) and is not a fixed lump sum. Such an approach for determining license fee payments is typically adopted in independent market conditions. This would have been the scenario even where the know-how had been obtained by the Company from an alternative source (subject to such alternative source being available for the nature of products that are manufactured by the Company). 2.16 It is also submitted that had an alternative know-how source been available from a compar....
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....tion with AIHPL comprises of two key elements: (a) obtaining and using knowhow and technology required to manufacture the drug formulations; and (b) awareness of the dynamics of the South African pharma market, the South African pharma regulatory environment and liaisoning with AIHPL, its customer, for production scheduling, budgeting, delivery and timely collection of dues from AIHPL. 4.4 The Company pays a license fee to its AIHPL for a non-exclusive use of the know-how required to manufacture the products requisitioned by AIHPL. The license fee is paid at the rate of 8% of the Net Sales Price (as defined in the inter-company agreement). It can be seen that the royalty is computed having regard to the sale price that relates to the principal transaction relating to manufacture and export of drug formulations to AIHPL. It can also be seen that the royalty is paid to a common source, that is, AIHPL. 4.5 The Company pays management fees to MSPL to liaise with AIHPL and keeping the Company informed of developments within the South African pharma industry. The management fee payable is determined at 3% of the net sales. It can be seen that the remuneration is computed having reg....
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.... which are higher than the margins of the comparable companies identified by the Appellant at 9.05%. The comparable companies identified by the Appellant have not been challenged by the TPO and the transaction of export of pharmaceutical products has been found to be at arm's length." 16. In view of the above discussion, I hold that the License fee and management fee paid are closely interlinked to the appellant's activity of manufacture and export of drug formulations to the AE. The same being closely linked to the export activity, the impugned transactions cannot be considered as separate class of transactions for the purpose of transfer pricing analysis. As such, the ground no.2 raised by the Appellant is allowed. Similarly, having regard to the above discussion which covers the ground Nos.4.1,4.2,5.1 and5.2,the said grounds are also allowed. Thereafter the appeals of the assessee were allowed by the CIT (A). Feeling aggrieved by the order passed by the CIT (A), the Revenue is in appeal before us on the grounds mentioned herein above. 12. The Ld. DR pointed out that in the show-cause notice (page 5), the TPO has mentioned giving the show-cause notice to the assessee, as....
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.... 364 - Pune ITAT 2. Cummins India Ltd. v. Addl. CIT[2015] 53 taxmann.com 53 -Pune ITAT 3. Toyota Kirloskar Motor (P.) Ltd. v. Asstt. CIT [TS-217-ITAT-2014-Bang] 4. SC Enviro Agro India Ltd. v. Dy. CIT[2013] 34 taxmann.com 127 - Mumbai ITAT 5. CIT v. EKL Appliances Ltd.[2012] 20 taxmann.com 509 - Delhi High Court 6. Safran Aerospace India (P.) Ltd. v. Dy. CIT [IT Appeal No. 1261 (Bang.) of 2010] 7. Hive Communication (P.) Ltd. v. CIT[2011] 12 taxmann.com 287 - Delhi High Court 8. CIT v. EKL Appliances (20 taxmann.com 509)- Delhi High Court 9. Siemens VDO Automotive Ltd. v. Dy. CIT [IT Appeal No. 923 (Bang.) of 2012] 10. Luwa India Pvt. Ltd. v. ACIT (568/Bang/2012) - Bangalore ITAT 16. We have heard the rival contentions, perused the records as also the case laws cited by both the parties. From a reading of the effective grounds raised by the Revenue, it is clear that the finding of fact recorded by the CIT (A) in paras 15 and 16 (reproduced above) have not been refuted by the Revenue by way of challenging that the management fees and licence fees ....
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....ering into such transactions likely to affect the price or cost charged etc. A reading of Rule 10C reassures and affirms that the general principle of plurality is not abandoned or discarded. And coordinate bench decision in the matter of Gulbrandsen Chemicals (P.) Ltd. v. Deputy Commissioner of Income-tax* [2017] 79 taxmann.com 105 (Ahmedabad - Trib.) had held as under 8 ...........................................We find that, in the case of Knorr-Bremse India (P.) Ltd. v. Asstt. CIT [2016] 380 ITR 307/236 Taxman 318/[2015] 63 taxmann.com 186 (Punj. & Har.), Hon'ble Punjab & Haryana High Court has observed that "The doubt, if any, in this regard is set at rest by rule 10A(d), which provides that for the purpose of rule 10A and rules 10 B to 10E, 'transaction' includes a number of closely related transactions" and that "Thus, the closely linked transactions can, in a given situation, be components of single composite transaction". Their Lordships have then added that "The assessee would, however, have to prove that although each sale and each provision of service is priced separately, they were all provided under one composite agreement which constitutes one inter....
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....nd 10B of the Rules, a number of transactions can be aggregated and construed as a single 'transaction' for the purposes of determining the ALP, provided of course that such transactions are 'closely linked'. Ostensibly the rationale of aggregating 'closely linked' transactions to facilitate determination of ALP envisaged a situation where it would be inappropriate to analyse the transactions individually. The proposition that a number of individual transactions can be aggregated and construed as a composite transaction in order to compute ALP also finds an echo in the OECD guidelines under Chapter III wherein the following extract is relevant:- "Ideally, in order to arrive at the most precise approximation of arm's length conditions, the arm's length principle should be applied on a transaction-bytransaction basis. However, there are often situations where separate transactions are so closely linked or continuous that they cannot be evaluated adequately on a separate basis. Examples may include 1. Some long term contracts for the supply of commodities or services; 2. Rights to use intangible property; and 3. Pricing a range of closely linked prod....
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....e' indicates that the most appropriate method will have to be selected after a meticulous appraisal of the facts and circumstances of the international transaction. Further, the selection of the most appropriate method shall be for each particular international transaction. The term 'transaction' itself is defined in rule 10A(d) to include a number of closely linked transactions. Therefore, though the reference is to apply the most appropriate method to each particular transaction, keeping in view, the definition of the term 'transaction', the most appropriate method may be chosen for a group of closely linked transactions Two or more transactions can be said to be linked when these transactions emanate from a common source being an order or a contract or an agreement or an arrangement and the nature, characteristics and terms of these transactions are substantially flowing from the said common source. For example, a master purchase order is issued stating the various terms and conditions and subsequently individuals orders are released for specific quantities. The various purchase transactions are closely linked transactions. 13.8 It may be noted that in ord....
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....ent. Therefore, the benefit test was a necessary part of determining the arm's length price of any intra group services; The 'benefit' needed to be identified from the taxpayer's viewpoint, which could be potential, reasonable, foreseeable, may not be quantifiable in money alone, and may be strategic, but could not be incidental. The benefit also could not have qualifications such as "substantial", "direct" and "tangible" because these qualifications were not given in section 92(2) of the Act. There are several non-monetary terms other than profitability, like usefulness, enhancement in value, sustainability and enhancement of business interest, which were required to be seen while judging the benefit test. Like in the present case , the licence is required for long term manufacturing of drugs and formulation within know how of the AE further the assessee is Joint venture company therefore TPO cannot lose sight of various benefit which may flow to Indian partner in the absence of provision for making the payment for the use of license In the case in hand TPO has concluded that no licence fee should have been charged by AIHPL as all the manufactured drugs formulations are exporte....
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....oreover it is difficult to comprehend the manufacturing of drugs in India without there being any operation in licence to manufacture the drugs from the statutory authorities and for that to have the access on the formulation which is the technical knowledge and domain of AE. The prices charged by the assessee and the amount of licence fees paid to AE cannot be examined on stand-alone basis, because it will have effect of determination the net prizes received by the assessee. Further the charges paid by the assessee ( JV) to AE for acquiring the technical know-how and is a valuable assets. In the present case, TPO has not brought on record any comparable uncontrolled party( JV or otherwise ) which is manufacturing the drugs with the same prices or less prices as that of the assessee without separately charging the license fee, therefore the approach of the Transfer Pricing Officer to compute NIL charges for the license fee cannot be uphold as transfer prices adjustment can be made in accordance with the one of the method provided under the rules framed under the income tax act. In view thereof, we find no merit in the analysis carried out by the TPO by benchmarking the licence fee.....
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....es as alleged there was no evidence of rendering the services for the Management . In our view taxpayer could only be asked to maintain and produce the evidence of receipt of service which a businessman keeps and maintains regarding services received from a third party. The burden of maintenance of documents/ evidences could not be higher on the taxpayer merely due to the reason that it was receiving services from its AEs further TPO has not held that the similar kind of services was already available with the taxpayer with any concrete evidence. In the absence of any instances of services provided by the AE and from the fact that services availed by the taxpayer from the third parties were similar in nature, the TPO's viewpoint on duplication test was not acceptable. In all. We find that in a materially identical situation in the case of Merck Ltd. v. Dy. CIT [2016] 69 taxmann.com 45 (Mum.), a coordinate bench, has observed, inter alia, as follows: '9. We find that there is a clear contradiction in the findings of the authorities below. On one hand, the stand of the authorities below is that no services are rendered, and, on the other hand, there are categorical findings th....
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....irrelevant as to whether the assessee benefits from it or not; the real question which is to be determined in such cases is whether the price of this service is what an independent enterprise would have paid for the same. In case TPO can demonstrate that the consideration for similar services, under the CUP method, is NIL, he can very well do so. That's not, however, his case. He only states that these services are not worth the amount paid by the assessee. Such band statements and sweeping generalizations cannot help the case of the revenue authorities. The assessee has benchmarked the transaction on TNMM basis, and unless the revenue authorities can demonstrate that some other method of ascertaining the arm's length price on the facts of this case will be more appropriate a method of ascertaining the arm's length price, the TNMM cannot be discarded. Dealing with almost a similar situation, as we are in seisin of, a coordinate bench of this Tribunal, in the case of AWB India (P.) Ltd. v. Dy. CIT [2015] 152 ITD 770, has observed as follows: "11. In ground nos. 5 to 9, which we will take up together, the assessee has raised the following grievances: 5. That, on the....
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....e value under CUP method will be best indicator of the value of these services. It was in this background that the TPO made certain adverse inferences against the assessee. The TPO was of the view that while the assessee has made a payment of Rs. 20,35,907 towards financial management and reporting services, "but the services rendered are negligible compared to the cost incurred". The TPO was also of the view that "a minor clarification or seeking of certain guidance on verify basic issue does not call for a payment of Rs. 20 lakhs. Therefore, the ALP of these services was taken as 'NIL'. He further noted that while the assessee has made a payment of Rs. 1,23,476 towards human resources services, the assessee has "not furnished any specific input on training and development of human resources and it is also noticed that these services are of routine nature and duplicate at best". Accordingly, the TPO also treated ALP of these services as 'NIL'. As regards the payment of Rs. 96,355 towards 'legal services', the TPO did take note of the services that the assessee was entitled to under these arrangements but as there is no evidence of any services having been a....
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....allowance of any expenditure on the ground that it was not necessary or prudent for the assessee to have incurred the same". 16. The very foundation of the action of the TPO is thus devoid of legally sustainable merits. There is no dispute that the impugned payments are made under an arrangement with the AE to provide certain services. It is not even the TPO's case that the payments for these services were not made for specific services under the contract but he is of the view that either the services were useless or there was no evidence of actual services having been rendered. As for the services being useless, as we have noted above, it is a call taken by the assessee whether the services are commercially expedient or not and all that the TPO can see is at what price similar services, whatever be the worth of such services, are actually rendered in the uncontrolled conditions. 17. As for the evidence for each of the service stated in the agreement, it is not even necessary that each of the service, which is specifically stated in the agreement, is rendered in every financial period. The actual use of services depends on whether or not use of such services was warranted....
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....hort reason alone. In our considered view, the facts of the case before us are materially similar inasmuch as the services are indeed rendered by the AE, as evident from the documentary evidences on record and yet its arm's length value is held to be NIL only because, according to the authorities below, these services were worthless, these services were not required by the assessee, the assessee could have performed these services on its own and the services were not rendered by the group entity. The TPO has rejected the determination of arm's length price on the basis of TNMM, at entity level, but then he has not adopted any other permissible method for determination of arm's length price. Such a course of action, as noted above, is not permissible in law. Just because these services are worthless in the eyes of the revenue authorities, the arm's length price of these services cannot be held to be NIL. Similarly, the findings that no services were rendered and that the assessee could have performed these services on its own are contradictory. If no services were rendered, which services the authorities below hold that the assessee could have performed on its own. E....
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....ecord , that the authority of the TPO is to conduct a transfer pricing analysis to determine the ALP and not to determine whether there is a service or not from which the assessee benefits. That aspect of the exercise is left to the AO. This distinction was made clear by the ITAT in Dresser-Rand India Pvt. Ltd. v. Additional Commissioner of Income Tax, 2012 (13) ITR (Trib) 422: "When evaluating the arm's length price of a service, it is wholly irrelevant as to whether the assessee benefits from it or not; the real question which is to be determined is whether the price of this service is what an independent enterprise would have paid for the same. Similarly, whether the AE gave the same services to the assessee in the preceding years without any consideration or not is also irrelevant. The AE may have given the same service on gratuitous basis in the earlier period, but that does not mean that arm's length price of these services is 'nil'. Thus, it becomes important to clarify the extent of the TPO's authority in this case, which is to determining the ALP for international transactions referred to him or her by the AO, rather than determining whether such ....