TaxTMI 
TaxTMI 
2021 (10) TMI 908
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....(`Ld. AO') /Additional Commissioner of Income-tax, Transfer Pricing - 2(2) (Ld. TPO) in making an adjustment of Rs. 21,69,17,701 on allocation of alleged location savings with respect to provision of facilitation and co-ordination services provided by the Appellant to the Associated Enterprises (`AE') for performing clinical trials in India. 2. On the facts and in the circumstances of the case and in law, the Ld. AO /TPO erred in treating the alleged location savings to the Appellant as an international transaction as per Section 92B of the Act. 3. Without prejudice to Ground No. 2, the Ld. AO /TPO erred in not following any of the method prescribed by the Act under Section 92C(1). 4. On the facts and in the circumstances of the case and in law, the Ld. AO /TPO and the Hon'ble DRP erred in presuming that location savings advantage accrues to the Appellant. In doing so Ld. AO /TPO: a) disregarded the fact that the clinical trials are undertaken in India as per the instructions of the Sponsor and in line with the Indian regulatory requirement; b) disregarded the fact that, the Appellant as well as the AEs operated in a perfectl....
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.... f) attributing location savings in the ratio of 50:5o between the Appellant and the AEs by disregarding their functional and risk profiles." 3. In the TP order for the current year i.e. AY 2013-14, relying on the TP order for AY 2011-12, the TPO alleged that conducting the clinical trial in India by the AEs through the assessee resulted in location savings for the AEs since the regulatory and compliance cost as well as investigatory costs were significantly lower in India as compared to developed countries where AEs were located. Resultantly, the cost savings that accrue to the AE ought to be shared with the assessee in India. 4. To make the adjustment, the TPO relied upon a random non-contemporaneous article titled 'Clinical Trial Magnifier Vol. 1:6 Jun 2008' published on the website www.clinicaltrialmagnifier.com and computed location savings amounting to Rs. 29,11,647 per clinical trial. The TPO then multiplied the said alleged savings per clinical trial by the total number of clinical trials undertaken in India i.e. 149. Accordingly, the TPO arrived at a total cost savings of Rs. 43,38,35,403 (Rs. 29,11,647*149). The said purported savings were split in the ratio....
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.... the sole purpose of avoidance of tax and treaty shopping. To deal with such transactions between related parties the transfer pricing provisions has been introduced in the statute and are applied for determination of ALP. Therefore the location savings and advantages are very much relevant in the cross border transaction but for limited purpose of carrying out exercise of examination and investigation of the transaction and not as a basis for determining the ALP and consequently adjustment. We find that the Mumbai Bench of the Tribunal in the case of Watson Pharma (P.) Ltd. (supra) has dealt with this aspect and held that when the local comparables are available then instead of going to the location saving as a basis of adjustment, the TNMM shall be preferred. Similar view was taken by the Tribunal in the case of Syngenta India Ltd. (supra) in paras 17 to 20 as under: '17. We have heard the rival submissions and perused the relevant finding given in the impugned orders qua the issue of Transfer Pricing adjustment on account of locational savings. The TPO noted that, one unit of the assessee is captive manufacturer which is producing agro chemicals for sale to the worl....
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....p that relocates some of its activities to a place where costs (such as labour costs, real estate costs, etc.) are lower than in the location where the activities were initially performed, account being taken of the possible costs involved in the relocation (such as termination costs for the existing operation, possibly higher infrastructure costs in the new location, possibly higher transportation costs if the new operation is more distant from the market, training costs of local employees, etc.). Where a business strategy aimed at deriving location savings is put forward as a business reason for restructuring, the discussion at paragraphs 1.59- 1.63 is relevant; 9.149 Where significant location savings are derived further to a business restructuring, the question arises of whether and if so how the location savings should he shared among the parties. The response should obviously depend on what independent patties would have agreed in similar circumstances. The conditions that would be agreed between independent parties would normally depend on the functions, assets and risks of each party and on their respective bargaining powers; 9.150 Take the example of an e....
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....es a fee to its independent clients based on a fixed hourly rate that compares with the hourly rate charged by competitors for similar services in the same market. Suppose that the wages for qualified engineers in Country X are high. The enterprise subsequently opens a subsidiary in Country Y where it hires equally qualified engineers for substantially lower wages, and sub-contracts a large part of its engineering work to its subsidiary in Country Y, thus deriving significant location savings for the group formed by the enterprise and its subsidiary. Clients continue to deal directly with the enterprise in Country X and are not necessarily aware of the sub-contracting arrangement. For some period of time, the well known enterprise in Country X can continue to charge its services at the original hourly rate despite the significantly reduced engineer costs. After a certain period of time, however, it is forced due to competitive pressures to decrease its hourly rate and pass on part of the location savings to its clients. In this case also, the question arises of which party/ies within the MNE group should be attributed the location savings at arm's length: the subsidiary in Coun....
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....commend that, while determining how the locational savings are to be shared between two or more Associated Enterprises then at the threshold it is necessary to consider, firstly, whether location savings exists; secondly, the amount of any net location savings; thirdly, the extent to which locational savings are either retained by a Member or Members of the MNE Group or are passed on to independent customers or suppliers; and lastly, where locational savings are not fully passed on to independent customers or suppliers, the manner in which independent enterprises operating under the similar circumstances would allocate any retained net location savings. Guidelines further states that, suitable comparability adjustment is to be made to account for location savings advantage giving rise to location savings, when function analysis shows that location savings are not passed on to customers or suppliers and there is no local market comparables then, adjustment can be made based on analysis of all the relevant facts and circumstances including functions performed, risk assumed and assets used of the relevant associated enterprises. However, before that, if reliable local market comparabl....
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....ed, out any comparability analysis with an uncontrolled transaction to show that such a factor materially affects the price/profit margin of the transaction. Such a comparability analysis with the uncontrolled transaction is sine quanon for the determination of Arm's Length Price by choosing any of the prescribed method. If such an exercise has not been carried out, then such kind of TP adjustment should not be permitted to be made. If the revenue's case is that, though not canvassed before us, such an adjustment is being made under Rule 10B(3) to eliminate the material effect of a difference between the transactions which is being compared, then the onus is heavily, upon the revenue to bring on record that, due to location savings, the comparability with the local comparables has failed to yield the Arm's Length results. The TPO has made the adjustment by comparing the cost per employee globally with cost of per employee in India. The method by which TPO has made the adjustment lacks merits because comparison of the employees of the AE working in the economic conditions at the location of the AE are completely different and cannot be benchmark factor at the outset. Her....
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.... AO before reference, etc. (as discussed by us in foregoing paragraphs) are not being dealt upon and as they have become pure academic in view our finding given above.' 9. Having concurred with the view of the earlier decisions of this Tribunal, we find that the orders of the TPO and DRP are not sustainable as suffer from serious defect of considering the location saving as basis of adjustment. Further we find that the computation of the location saving by the TPO is purely based on some articles and not on the basis of actual cost in the US in comparison to India. Therefore the price/cost as computed by the TPO is not based on actual data but on presumption of accepting the article on the subject as the comparable cost. Since the functional comparability of the companies selected by the assessee has not been examined by the TPO as well as no steps were taken to find out the other comparables of the assessee for determination of ALP therefore, the issue of determination of ALP and consequential adjustment, if any, is required to be examined and adjudication afresh at the level of TPO/A.O. Needless to say that the assessee is receiving its price in foreign currency ther....
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....covery of expenses' and that too without any mark up. The TPO issued a show cause notice dated 16.09.2016 and the figure of 15.27% was arrived at on the basis of the assessee's own admission of its profit percentage being at 15.27 10. The TPO after examining all the submissions made by the taxpayer was of the view that the assessee's arguments are bereft of logic and proper evidences to back its claim. He observed that the whole Clinical trial hinges on the commitment and knowledge level of these investigators concerned. Without the right set of Investigators, no Clinical trial would achieve its objectives. Clinical trial is a very risky endeavor as it involves experimentation of unknown chemicals on the human body. Hence the investigator administering the clinical trial become the most important person in safeguarding the patient. Hence the Investigator needs to possess certain skill set, should have immense patience (as Clinical trials last for years together) and complete focus and dedication on the job. Any slip from his side will not only affect the life and limb of the patient but will harm the reputation of Parexel India and the Group as a whole. Hence, the selection ....
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....e 'recovery of expenses' of the Investigators fees to be at Cost plus markup of 15.27% as follows:- Issue ALP as determined by taxpayer ALP as per TPO Recovery of expenses 35,71,10,928 41,16,141,766 13. The DRP concurred with the findings of the TPO. Against this, the assessee is in appeal before us. 14. In this case, the contention of the AR is that the assessee entered into agreement with Parexel International GmbH, Germany, under which assessee merely acted as Coordinator and facilitator with no risk in rendering such services and the entire risk relating to such activity is borne by Parexel International GmbH, Germany group and third party investigator and this is cost to cost reimbursement by Parexel GmbH Germany and there is no question of any mark up towards ALP as done by the TPO. 15. Further in terms of clause 4.3 of the addendum to the agreement with AEs, pass through cost is defined as expenses which are ultimately payable by the Sponsor on a cost-to-cost basis as follows:- "4.3. Pass through cost, for the purposes of section 4.1.2 and section 4.2, shall mean costs including but not limited to investigators fee, drug charges, l....
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....payments received by the assessee are purely reimbursements for the expenses incurred on behalf of a third party and therefore, are a passthrough cost for the Group. Profit margin can be determined only vis-à-vis the value-added activities undertaken: 18. In order to appreciate the above proposition, it was submitted it will be very important to first understand the general clinical trial process, explained herein below: * A clinical trial is required for testing the efficacy and safety of a pharmaceutical product developed by a pharmaceutical company. * The pharmaceutical company ('Sponsor'), who intends to undertake the clinical trial, enters into a clinical trial agreement with the Parexel Group (AEs) or a similar vendor. * A clinical trial typically entails undertaking the following phases/ steps: − Preparation of study protocol: A 'study protocol' is a document which defines the medical issues sought to be examined and the statistical tests that are to be conducted; the processes and parameters which are to be considered for conducting the clinical trial. - Pre-clinical trials: Pre-Clinical trials are tes....
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....udy. The Appellant prepares the feasibility study based on certain factors for India related trials. - Appointment of investigators Parexel Group provides investigation brochure and Protocol and the Appellant selects Investigators based on set parameters. - Obtaining Regulatory approvals for undertaking clinical trials Parexel Group obtains FDA and other regulatory body approvals outside India The Appellant obtains regulatory approval within India as the per requirement of Indian Regulations Site visit in India and data collection The Appellant does site visit of the investigation sites in India only to collect the data and information Filing for Drug Approval Sponsor performs this function Post market surveillance Parexel Group performs this function 20. The ld. AR submitted It is very clear from the above table that he entire risk of conducting the clinical trial and its success/ failure lies with the Sponsor/ AEs and the assessee is insulated, in the sense that, irrespective of the success / failure of the trial, the assessee will be remunerated at a cost plus 15% mark-up. It will be necessary to appreciate that a clinical trial activity is a com....
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.... other hand, all trial Investigators should possess appropriate qualifications, training and experience and should have access to such investigational and treatment facilities as are relevant to the proposed trial protocol as per Drugs and Cosmetics (IInd Amendment) Rules, 2005 - Schedule Y: Requirements And Guidelines For Permission to Import And / Or Manufacture Of New Drugs For Sale Or To Undertake Clinical Trials. Risks undertaken by Parexel India and the Investigator 27. It was submitted it is also pertinent to note that these Investigators actually perform the clinical trial and assume the risk of the trial being conducted as per set protocols. It is the Investigator who is responsible for trial-related decisions. In fact, Schedule Y of the Drugs and Cosmetics (IInd Amendment) Rules, 2005 which is the key document that governs clinical research in India, provides that the "Investigator shall be responsible" for the conduct of the entire clinical trial activity. The relevant extract of the >aid rule is reproduced below: "The Investigator(s) shall be responsible for the conduct of the trial according In the protocol .and the GCP Guidelines and also for compliance....
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....ols on the Investigator. Rather, a negligible amount insurance expenses incurred by the assessee during the current year of Rs. 23,611. (for the year ended 31 March 2013(Pg.13 of the PB) indicates it does not carry any substantial risk. 32. In view of the above, the assessee submitted that it neither undertakes any functions nor assets nor any risks vis-à-vis the provision of clinical trial activity. It merely coordinates and facilitates the provision of clinical trial services to the Sponsors. Therefore, the profit margin of the services rendered by Parexel India should be determined taking into consideration only the cost incurred by the assessee for value added functions i.e., its own internal costs. Doing otherwise would result into a fallacy where the Appellant is being expected to earn a mark-up on costs incurred on behalf of third parties. 33. It was further submitted that it is an accepted principle that service providers need not apply a mark-up on pass through expenses which are recharged to third parties. This principle is fully supported by the Transfer Pricing Guidelines for Multinational Enterprises and Tax Administration (OECD Guidelines) which provide t....
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.... is reproduced below:- " It is, thus, clear that the assessee has not assumed any risk on account 61 non-payment by its customers or associated enterprises. As per ITS 2009 Transfer Pricing Guidelines accepted by the OECD, when an AEs is acting only as an agent or intermediary in the provision of service, it is important in applying the cost plus method that the return or mark-up is appropriate for the performance of an agency function rather than for the performance of the services themselves, and, in such a case, it may be not appropriate to determine ALP as a mark-up on the cost of services but rather on the cost of agency function itself, or alternatively, depending on the type of comparable data being used, the mark-up on the cost of services should be lower than that would be appropriate for the performance of the services themselves. In these type of cases, it will be appropriate to pass on the cost of rendering advertising space, to the credit recipient without a mark-up and to apply a mark-up only to the costs incurred by the intermediary in performing its agency function. In the light of ITS 2009 Transfer Pricing Guidelines, it would be clear that a mark-up is to....
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....TP)A No. loo6/Mum/2016) the Mumbai Tribunal has held that if the recovery of expenses did not involve any element of profit or mark-up in the hands of the AE, the mark-up on the recovery by the Assessee was not warranted. The relevant portion of the order is reproduced below:- "13.3 All this material clearly brings out a pertinent feature tint in the entire transaction involving payment of expenditure by the assessee, its recovery from the associated enterprises which-in turn recovers it from the end clients there is no involvement of any profit-element in the hands of the associated enterprises. Therefore. it would be wrong on the part of the income tax authorities to take a position and infer notionally about recovery of mark-up or profit element in the hands of assessee. 38. The jurisdictional Tribunal in Tesco Hindustan Service Centre Pvt Ltd vs. DCIT (IT(TP)A No.1317/Bang/2010) has held that when a taxpayer acts solely as an agent for a group company it would be not be appropriate to charge mark-up on the cost of services acquired from an arms' length party. The relevant portion of the order is reproduced below:- "35. We have considered the rival submi....
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.... all of its costs that are incurred to find and appoint investigators and also to perform other coordination and facilitation activities. All of such value-added costs (salary costs etc.) form a pint of its "Operating costs" in terms of the agreement entered into by the assessee with its AEs as under:- "4.1. In consideration of PICRPL's performance of Services under this Agreement, PIC agrees to pay PICRPL, on a monthly basis, an amount comprising of ..... 4.2. Operating Expenses, for the purposes of section 4.1.1, shall mean and refer to the operating cost of PICRPL in respect of PICRPL's activities of coordination and facilitation of clinical trials, including, but not limited to personnel costs, general and administration expenses, depreciation and amortization based on the financial statements of PICRPL. For avoidance of doubt, Operating Expenses shall not include any financing costs, extraordinary expenses, prior period cost, capital expenses and pass through cost." 41. Therefore, the allegation of the TPO that the assessee has not charged mark-up on such costs is completely baseless. 42. The TPO at para no. 7.6.2 has concluded that the....
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....is concerned, qua the provision of services stated in the agreement i.e., coordination and facilitation services, it was submitted that clearly the assessee does not act as an agent for the AE. But, qua the appointment of Investigators and incurring related costs, the assessee has entered into such agreement "on behalf of the Sponsor" and is not responsible for their performance. 47. In view of the above discussions it was prayed that the transfer pricing adjustments on account of Location Savings amounting to Rs. 21,69,17,701 and Imputation of mark-up on pass through costs amounting to Rs. 5.45,30,838 be deleted. It is further the humble prayer that in case it is held that the investigator fees and other incidental costs are to be considered as a part of the operating expenses and operating revenue for benchmarking the transaction relating to provision of coordination and facilitation services (pursuant to set-aside as per the earlier years orders), there ought not to be a separate adjustment by way of imputation of markup on investigator and incidental costs as the same would result into double adjustment. A direction in this regard was also prayed for. 48. On the other han....
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....such written communication shall be considered as an addendum to this Agreement. Any taxes leviable in India on the above fee shall be borne by PIC. Further, PIC may withhold taxes to the extent it is required to do so as applicable in its jurisdiction. 4.4 PIC shall pay the remuneration on the basis of the invoices duly issued by PISPL within 10 (ten) days after the end of each month. PISPL shall maintain true and accurate books of accounts and records reflecting the services and cost incurred in connection therewith. PIC may from time to time request for the detailed break up cost incurred and PISPL agrees to provide details as and when requested for." 50. We have considered the rival submissions. In this case, the assessee coordinated between the individual investigator and Paraxel International GmbH Germany. The contention of the assessee is that assessee has not undertaken any risk and all risk was taken over by Paraxel International GmbH Germany and relied on the Addendum dated 19.9.2007. However, the fact is that the assessee acted as coordinator and facilitator in selecting the investigator so as to conduct clinical trial. Selection of the investigator demonstra....
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....ot limited to investigators fee, drug charges, laboratory fees, legal & professional charges, translation cost, related travel & conveyance expenses, and any other expenses incurred by the PICRPL which are ultimately payable by the Sponsor on a cost to cost basis to PIC or any other contracting affiliate. The Parties agree that PICRPL will not load any margin on the recharge of such pass through cost. PICRPL shall maintain complete, accurate and up-to date accounting records relating to such 'Pass through Costs' which can be produced to PIC. 4.4. These terms are based on the parties determination of an amount equal to Arm's Length compensation that are adequate to compensate for the functions performed, assets employed and risks assumed by PICRPL and will be determined by PIC and PICRPL in accordance with arm's length standards. Any changes to the fees shall be communicated between the parties in writing and such written communication shall be considered as addendum to this agreement. Any taxes leviable in India on the above fees shall be borne by PIC. Further, PIC may withhold taxes to the extent required to do so as applicable in its jurisdiction. ....
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....titled to receive any consideration for facilitating investigations. Further, it is to be noted that in the earlier years, investigator payments were reimbursed to the assessee with a mark-up. However, for the assessment year under consideration, it was treated as pass through cost under the head 'recovery of expenses' and there was no mark-up paid to the assessee. The assessee failed to explain why in this assessment year there was no mark-up on the investigator payments. The assessee only relied on the Addendum filed by the assessee, wherein it was mentioned that it was only pass through costs. As discussed earlier, this Addendum is only a make believe story and the AO has right to go beyond this document to find out the real intention of the parties. We observe that the real intention to this Addendum is different from what it appears ex facie. Hence, we have to proceed on the basis of the professed intention and the AO is justified in finding out the real intention of the parties by ignoring the apparent and the conceded intention was to evade the tax liability. The lower authorities merely removed the facade to expose the real intention of the parties cleverly cloaked and disc....