TMI Blog2011 (11) TMI 398X X X X Extracts X X X X X X X X Extracts X X X X ..... at the way Operating Profit has been arrived at in both the cases, it is observed that adjustments made to the operating profit margins of the two comparables would get neutralised and therefore their margins as claimed by the Assessee for arriving at the arithmetic mean of 11.71% after including all comparable companies considered by the TPO and the results of Clingene International Pvt. Ltd. is held to be proper and acceptable. In view of second Proviso to Sec.92C(2), the price at which the international transaction has actually been undertaken shall by the Assessee is held to be at arm's length. The order of the CIT(A) is upheld on this ground - Decided against the Revenue. In view of the above conclusion, the other issues with regard determination of nature of services and non-consideration of other factors laid down in Rule 10B(1)(e)(i) are not being considered. In respect of deletion of dis-allowance of interest paid on working capital loan received from group company (MIL) – assessee have also advanced interest free loan to MIL for placing security deposit by MIL with the lessor in respect of flat taken for accommodation of Business Head – A.O. disallowed deduction of int ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tures in India. 4. MTC entered into a Support Agreement with MHPL dated January 1, 2001. Since the said agreement was valid only for a period of one year, a fresh agreement was executed by the contracting entities (effective from April 1, 2002) ('the Support Agreement'). The Support Agreement envisages provision of following services by MHPL. Contract Research Services: - Provide contract research services in certain specific area (viz. agriculture and agro chemicals) for research projects initiated by MTC; and - Undertake (at the request of MTC) special studies and market research on products launched by MTC, concerning the new need of the Indian market. Corporate Support Services: - Assist MTC in expanding its business presence in India through subsidiaries / JVs; - Update MTC with the changing regulatory scenario, which includes import-export regulations, foreign direct investment policy, commercial issues, etc.; and - Identity appropriate business opportunities and communicate the same to MTC; MHPL provides contract research and support services to MTC from a separate facility set-up in Bangalore known as Monsanto Research Center ('MRC'). The ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Average 3.17% The operative margin of the assessee was worked out at 7.09% of the total cost. According to the Assessee the operative margin was higher than the average OPM of comparable companies i.e. 3.17% and accordingly, having regard to the provisions of Section 92(3), the consideration being received by MHPL for rendering support services to MTC meets with the arm's length principle. The assessee thus claimed that the international transaction with its AE was at Arms Length Price and the same should be accepted as proper. 8. The Transfer Pricing Officer (TPO) however was of the view that the comparable cases which were referred to by the assessee in its Transfer pricing were not comparable for the following reasons: S.No. Name of the company Remarks 1. Amtrac Management Services This company is a share transfer agency. Its total revenues is Rs. 15 lakhs during the P.Y as compared to Rs. 14 lakhs in the preceding year. It appears that the services provided by this company is of routine nature. 2. Dabur Research Foundation This company is engaged in research activity. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nnection with water, food, drug, chemical, petro products, mineral water and contract research (iii) Chokshi Laboratories Ltd.: The company was a commercial testing house engaged in testing of various products and offers services in the field of pollution control. (iv) Syngene International Pvt. Ltd.: This company was formed for providing contract research services to overseas customers in the field of synthetic chemistry and molecular biology. 9. The assessee submitted before the TPO that the comparable cases identified by the TPO are not engaged in similar activities as that of the assessee. It was further submitted that the services provided by the comparable cases identified by the TPO were high end services, whereas the services performed by the assessee were in the nature of low end services. It was also submitted that two of the comparable companies identified by the TPO namely Vimta Labs Ltd. Syngene International Pvt. Ltd. had engaged in transactions with related parties and were, therefore, not comparable. It was further submitted that the assets employed by Vimta Labs Ltd. and Alpha Geo Ltd. were much more than the assets employed by the assessee. It was also p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rables identified by her. Thereafter the TPO worked out the arithmetic mean of the four companies identified by her and also six companies identified by the assessee and arrived at 18.22%. This was later rectified as there were apparent mistakes in such calculation to16.28%. An addition on account of adjustment to ALP was determined by the TPO as follows: Particulars As per revised calculation Revenue from support services including contract research services. 129,750,895 Profit from the above activity 8,594,456 Cost of the above activity 121,156,439 Profit markup on cost 7.09% Arm's Length profit mark up 16.28% Arm's length profit (Rs.) 19,719,483 Arm's Length price (Rs.) 140,875,922 Difference between transaction value and arms length price (adjustment value) 11,125,027 The same was adopted by the AO and a sum of Rs. 1,11,25,027 was added to the total income of the Assessee by the AO in the order of assessment. 11. Aggrieved by the order of the AO, the Assessee filed appeal before the CIT(A). The submissions as were made ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... functions performed by the Assessee in respect of the international transaction, the Assessee gave a description of the nature of functions and risks assumed by the four companies chosen as comparable by the TPO. A comparative analysis of the activities of the said additional companies ( based on information available in the annual accounts and official websites of the companies) vis- -vis the activity of the assessee, was given by the Assessee in the form of the following table: S.No. Name of company Activity of identified company The assessee's activity 1. Alphageo (India) Ltd. - Acquiring and processing seismic data - Provides seismic survey services to oil companies and government, in relation to oil exploration projects. Provision of research support and facilitation services. 2. Choksi Laboratories - Analytical testing of building materials, drugs, food, water, etc. 3. Syngene International Pvt. Ltd. - Research in the field of synthetic chemistry and molecular biology. - Sale of products arising from research activity. 4. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e Limited 2. Panacea Biotec Limited. ('Research and development' segment) 3. I D C (India) Limited 4. CRISIL Limited ('Information segment' pertaining to the company's research activity) 5. ICRA Limited ('Information segment' pertaining to the company's research activity) 13. It was brought to the notice of the learned CIT(A) that the Assessee had submitted before the AO vide letter dated March 24, 2006 requesting the learned AO to include Clingene International Pvt. Ltd. as a comparable (along with other companies considered in the TPO's order) for benchmarking the Assessee's international transaction. It was pointed out that as per the annual report of Clingene International Pvt. Ltd. for FY 2002-03 the said company was engaged in similar activity as Syngene International Pvt. Ltd. one of the companies considered by the learned TPO as comparable. It was highlighted that the operating profit margin of Clingene was (-) 33.97% of its operating cost. Thus, it was prayed that if Syngene is considered as comparable, then even Clingene International Pvt. Ltd. ought to have been included as a comparable in determining the arm's length price. After including Clingene I ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Length Price 13,53,41,290 Difference between the transaction value and Arm's Length Price 55,90,395 95% of Arm's Length Price 12,85,74,225 Since the Transaction value falls within 5% range, the Assessee's price should be accepted as at Arm's Length. 14. Without prejudice to the above contentions and in the alternative the Assessee pointed out that in terms of Rule 10B(1)(e)(i) of the rules, the TNMM can be applied by taking three criteria viz., the net profit margin realised by the enterprise from an international transaction entered into with an associated enterprise can be computed in relation to costs incurred or sales effected or assets employed or to be employed by the enterprise or having regard to any other relevant base. The Assessee point out that if cost to Asset ratio is taken in respect of the companies identified by it and that identified by the TPO, the Assessee's cost to asset ratio is much higher. The following charts were given to demonstrate the above proposition: Chart-1: Ratio of Operating Costs to Assets of the comparable companies identified by the Assessee: Name of the Company Operating c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... TPO did not reject the comparable identified by the Assessee. (c) The CIT(A) also held that Syngene International Pvt. Ltd. And Clingene International Pvt. Ltd. Were both subsidiary companies of Biocon Ltd. Engaged in identical business and the TPO arbitrarily selected Syngene International Pvt. Ltd. As comparable and ignored Clingene International Pvt. Ltd. As comparable. The CIT(A) held that had Clingene International Pvt. Ltd. been considered as comparable then the arithmetic mean would of all comparables selected by the TPO and the Assessee would be only 11.71% and applying the safe harbour rules in terms of Second Proviso below Sec.92C(2) of the Act, the difference in price between the one adopted by the Assessee and the ALP determined by including Clingene International Pvt. Ltd. Would be within + or - 5% range calling for no adjustment to the price adopted by the Assessee in respect of the international transaction. For the above reasons, the CIT(A) deleted the addition made by the AO. 17. Aggrieved by the order of the CIT(A), the Revenue has preferred the present appeal before the Tribunal. We have heard the submissions of the learned D.R. and the learned counsel for ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... esults of Clingene International Pvt. Ltd., for the Financial Year ending 31.3.2005 cannot be taken for comparison for the reason that the said company incurred loss due to the following reasons as stated in the Directors Report: "For the Financial year, the company has incurred a loss of Rs. 5.56 million as against a profit of Rs. 8.4 million in the previous year. This is due to the completion of the diabetes study for Surromed Inc. and the continuation of the self-sponsored diabetic study. This study has enrolled two research partners viz., Strand Genomics and IISC and the progress has generated several potentially high value patents for Clingene International Pvt. Ltd. in the area of new biomarker for Diabetic Nephrology. The company is also in the process of setting up a Human Pharmacology unit to carry out Phast-1 to Phase-3 clinical trial and BAVBE studies. Necessary application for establishment of the same have been filed and the facility is expected to be operational by September, 2003." Based on the above remarks of the directors the learned D.R. submitted that firstly Clingene International Pvt. Ltd. was doing its own research and had suffered loss during the previ ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rescribed by the Board. (2) The most appropriate method referred to in sub-section (1) shall be applied, for determination of arm's length price, in the manner as may be prescribed : Provided that where more than one price is determined by the most appropriate method, the arm's length price shall be taken to be the arithmetical mean of such prices: Provided further that if the variation between the arm's length price so determined and price at which the international transaction has actually been undertaken does not exceed five per cent of the latter, the price at which the international transaction has actually been undertaken shall be deemed to be the arm's length price. 10B. Determination of arm's length price under section 92C. (1) For the purposes of sub-section (2) of section 92C, the arm's length price in relation to an international transaction shall be determined by any of the following methods, being the most appropriate method, in the following manner, namely : ( a ) to ( d ) ** ** ** (e) transactional net margin method, by which, (i) the net profit margin realised by the enterprise from an international transaction ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... g into such transactions are likely to materially affect the price or cost charged or paid in, or the profit arising from, such transactions in the open market; or (ii) reasonably accurate adjustments can be made to eliminate the material effects of such differences. (4) The data to be used in analysing the comparability of an uncontrolled transaction with an international transaction shall be the data relating to the financial year in which the international transaction has been entered into : Provided that data relating to a period not being more than two years prior to such financial year may also be considered if such data reveals facts which could have an influence on the determination of transfer prices in relation to the transactions being compared. 23. A reading of the provisions of Rule 10B(2) of the Rules shows that uncontrolled transaction has to be compared with international transaction having regard to the factors set out therein. In terms of Rule 10B(3) of the Rules an uncontrolled transaction shall be considered as comparable if none of the differences between the controlled and uncontrolled transactions materially affects the price or cost charged or paid ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... g not only contract research but was also doing own research. Operating Profit ('OPM') on total cost considered by the Assessee according to the learned D.R. would not be proper as the operating expenses would be inclusive of own research as well as contract research. 25. To appreciate this contention, we have to have a look at the way Operating Profit has been arrived at both in the case of Clingene International Pvt. Ltd and Syngene International Pvt. Ltd, which are as follows: Clingene International Pvt. Ltd Particulars Amount F.Y.2002-03 Sales/Service Income (as per P L A/c) 1,10,72,704 Total Operating Income 1,10,72,704 Profit Before Tax (as per P L A/c.) (60,52,929) Add: Interest Expenses (as per P L A/c.) 3,55,460 Operating Profits (56,97,469) Operating Costs 1,67,70,173 Operating Profit % on cost -33.97% Syngene International Pvt. Ltd Particulars Amount F.Y.2002-03 Total Income (as per P L A/c) 26,17,97,528 Less: Non operating ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ational Pvt. Ltd would not cease to be a comparable company because of the fact that they were also doing own resource during the financial year ending 31.3.2003. As pointed out above, downward adjustment to the operating profit margin of Synigene International Pvt. Ltd ought to have been given for the activity relating to sale of compounds. An upward adjustment ought to have been made for the expenses relating to own research having been considered while arriving at the operating profit margin. Thus the adjustment to be made to the operating profit margins of the two comparables of Synigene International Pvt. Ltd and Clingene International Pvt. Ltd would get neutralised (without going into actual details of quantification) and therefore their margins as claimed by the Assessee for arriving at the arithmetic mean of 11.71% after including all comparable companies considered by the TPO and the results of Clingene International Pvt. Ltd. is held to be proper and acceptable. In that view of the matter the difference between the profit margin from the Assessee's contract research and support services activity of 7.08% on cost being the transaction value the Assessee's international tra ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ered by it from the Assessee in future in any form. 29. The TPO drew up list of comparable 11 companies, which were the same as was done by the TPO in AY 03-04. The arithmetic mean of these 11 companies is as follows: Sr.No. Name of the Company Profit margin % on cost 1. Amtrac Management Services (-) 9.86% 2. Dabur Research Foundation 0.73% 3. Hinduja Group India Ltd. 5.79% 4. IDC India Limited 11.99% 5. ICI India Research and Technology Services. (-) 0.91% 6. Manu Consultants Ltd. 0.73% 7. Raptakos Brett Tests Laboratories Ltd. 8.54% 8. Alpha Geo Ltd. 47.56% 9. Vimta Laboratories 61.04% 10. Choksi Laboratories Ltd. 33.48% 11. Syngene International Pvt. Ltd. 71.12% Arithmetic Mean of all 11 companies 20.93% MHPL 18.87% 30. The TPO thereafter determined the ALP of the international transaction as follows: "18. From the aforesaid and the certificate provid ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on cost, the CIT(A) held as follows: "7.20. The TPO has also proceeded by applying the margins worked out by him on hypothetical cost base. Actual cost of the appellant was Rs. 11,96,35,967/-. After adding margins of the appellant. of Rs. 2,25,70,303/-, the amount charged to AE worked out to Rs. 14,22,06,270/-. Thus, margins of appellant stood out 18.87%. As per the terms and agreement with AE, the appellant was supposed, to charge cost plus 7%. Such charging was derived on the basis of budgeted cost. Since actual cost incurred by the appellant was less than the budgeted costs for the current year, its margin ultimately worked out to be 18.87%. The appellant also represented before TPO and filed confirmation before AO that excess sum charged is not refundable to its AE. In any event appellant had offered full margin of Rs. 2,25,70,303/- (18.87%) to tax. The TPO disregarded all these and did backward calculation. He began with amount charged by appellant to its AE (i.e. Rs. 14,22,06,270/-). From that he reduced the assumed margin of 7% and considered the resultant figure (Rs. 13,29,03,056/- as hypothetical cost against actual cost (Rs. 11,96,35,967/-). On this hypothetical cost b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s. If 18.87% is the margin on cost then difference between the value of international transaction by applying the arithmetic mean of 20.93% determined by the TPO and the actual value of international transaction by the Assessee with its AE, would be within the range of plus or minus 5% range, calling for no adjustment in view of the second proviso below Sec.92C(2) of the Act. Even on this basis the additional made by the AO was rightly deleted by the CIT(A). Consequently, we find no merit in Gr.No.2 raised by the Revenue in its appeal and the same is dismissed. 33. Gr.No.1 raised by the Revenue reads as follows: "On the facts and in the circumstances of the case and in law, the learned CIT(A) erred in allowing deleting the disallowance of interest of Rs. 15,15,000/- without appreciating the facts of the case." The Assessee had advanced an interest free loan of Rs. 2 crores to Monsanto India Ltd., a group company (MIL), during the previous year 2000-01 i.e. Assessment year 2001-02. The said sum was advanced for placing an interest-free security deposit of Rs. 2 Crores by MIL with the lessor in respect of flat taken in Mumbai on leave and license basis for providing accommodati ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... imited way back in FY 2000-01 was a separate business transaction unlinked to the working capital loan taken by the appellant during the AY under consideration. The assessee also placed reliance on the judicial precedents in the case of S A Builders Ltd. v. CIT [2007] 289 ITR 26/158 Taxman 230 (SC) and CIT v. Sridev Enterprises [1991] 192 ITR 165/59 Taxman 439 (Kar.). 38. The CIT(A) held as follows: "6.5 I have considered the appellant's arguments/submissions as well as AO's findings as discussed in his order. I agree with the appellant's contention that there is no nexus between the advance placed by the appellant and the working capital borrowing obtained by the appellant from Monsanto India Limited since there is a time appellant way back in FY 2000-2001 and the commercial expediency was not disputed by the AOs during the assessment proceedings for the earlier financial years. The appellant's claim that Mr. Shekhar Natrajan was South Asia Business head of Monsanto Group of Companies and hence loan advanced to sister concern for the purpose of his residence was out of appellant's business need has not been disputed by the AOs in earlier years when the loan was given. Further ..... X X X X Extracts X X X X X X X X Extracts X X X X
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