TMI Blog2015 (1) TMI 699X X X X Extracts X X X X X X X X Extracts X X X X ..... vantage to the assessee over competitors. We are basing our opinion on the fact that the revenue authorities were not able to substantiate the adjustments made either from the present day scenario or any authenticated and globally material.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. TPO has based his computation on a method, which is not ascribed by the provisions of the Act. Adjustment on account of location savings - Held that:- No doubt, clause (f) of section 92C(1) says, “such other method as may be prescribed by the Board”. For adoption of this method, the 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. We, therefore, set aside the order of the DRP and direct the AO to delete the addi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 assessee identified 6 comparable companies, that were engaged in similar contract R D activities, computed mean profit margin at 14.50%, against 17.43% declared by the assessee. 6. In respect of contract manufacturing activity, the assessee undertakes trial packs in its R D Laboratory where detailed tests are undertaken and on computation of such tests, the assessee files its results with US FDA. After getting the approval, the asses ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ending with November, 2009. Further, the Services segment is into Clinical Development Operations, which primarily include conducting clinical trials, new product development and undertaking comprehensive data management for new drug development. The segment revenue for the FY 2008-09 is of ₹ 22.09 crores and ₹ 21.95 crores are with related parties (Source: Annual Report 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... USA. Based on this reasonable assumption, with backing of a research article, the location savings are computed as follows: Amount in INR Contract R D Formulation R D Material Cost 2,63,44,433.17 Facility Overheads allocation on batches 36,88,019.18 Allocated R D Overheads 5,24,47,957.71 Total formulation R D Expenses 8,24,80,410.06 API R D Material Cost 5,23,54,759.51 Facility Overheads allocation on E batches 83,32,958.76 Allocated R D Overheads 3,69,48,070.88 Total API R D Expenses 9,76,35,789.15 BEC 7,94,51,778.21 Grand Total (Formulation + API + BEC) ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tained by the DRP, hence, the instant appeal before the ITAT. 17. Before us, the AR submitted, in order to determine arm's length price of international transaction relating to provision of contract research and development services to AE, Assessee considered Transactional Net Margin Method ( TNMM ) as Most Appropriate Method and selected Operating Profit to Total Cost ( OP/TC ) margin as Profit Level Indicator. The assessee selected 6 comparables in its Transfer Pricing Study Report with three years average OP/TC margin of 14.50%. As against this the Assessee earned OP/TC margin of 17.43% during AY 2009-10. However, during Transfer Pricing Assessment, the TPO directed assessee to compute OP/TC margin of comparables using single year data (i.e. data for Financial Year 2008-09). Further, out of 6 comparables selected by the assessee in its Transfer Pricing Study Report, the TPO rejected 4 comparables and added 8 new comparables. Based on this approach TPO computed OP/TC margins of the comparables at 23.61%. The DRP confirmed the approach of TPO/AO, except that the DRP directed TPO/AO to exclude Alphageo Ltd. from the set of comparables. Consequently, it resulted in transfer p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... itions of the respective agreements under the proportionate completion method. Revenue relating to the work accomplished is recognized when no significant uncertainty as to measurability or collectability exist. (refer page II of the annual report of Siro Clinpharm Pvt. Ltd). Hence, Dolphin Medical should also be accepted as a comparable . In number of rulings Hon ble Income Tax Appellate Tribunal has recognized that TNMM requires only broad functional and product/services similarity. These rulings are cited below: o GE India Technology Centre (P.) Ltd. vs. DCIT 30taxman.com249(Bang) o Lloyds TSB Global Services P Ltd v DCIT 33taxman.com259(Mum-Trib) o ACIT v Schafhorst marketing Co Ltd 13taxman.com 104(Mum-Trib) o Tecnimont ICB P Ltd. v ACIT vs ACIT 24taxman.com28(Mum-Trib) o William Hare India P Ltd vs ACIT (ITA 2071/Mds/2012) 20. The AR, therefore submitted that in case results of Dolphin Medical Services Ltd. is included, as included by the assessee before the TPO/DRP, then the margin shall come within the +/-5% range and therefore no adjustment of ₹ 2,04,84,562/- shall be required. To substantiate, the AR gave the following comparison ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 hand, the AR submitted detailed reasoning before the revenue authorities and now before us, as to why the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y 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 on the point of view that in TNMM functional comparability is important then product similarity. 24. In t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ne 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 adjustment using CAPM (Capital Asset Pricing Model) Method before Hon'ble DRP (refer page no. 314 to 316 of the paper bo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rther 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 ₹ 25,19,22,871/- and contract R D of ₹ 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 also the comparables selected by assessee for benchmarking contract manufacturing services provided by the a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r 1976 to 1981) Bausch Lomb vs. Comm (Fiscal Year 1980) 36. TPO also relied on the 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 ₹ 25,19,22,871 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... even third parties. Thus, there are various alternatives available to AE, which confers bargaining 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 sa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of TPO and upheld the adjustment on account of location savings. According to the DRP, Conditions 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... arket share, revenues and gross profit typically decline, in some cases dramatically. Accordingly, 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... essee s case is that it has never prepared the records as laid down by Rule 10D(1)(f). When 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 th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Contract manufacturing segment Indian Generic Pharmaceuticals Market-A Snapshot (Source:- http://www.frost.com/sublib/displaymarketinsight- top.doid=264038078) 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the assessee. Therefore, the f inancial results of the AE are not at all relevant for the purpose of determination of arm's length price in relation to the international transaction entered into by the assessee. Accordingly, we do not find any merit in the ground 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 bas ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... accepted as ALP . 74. Last but not the least, the TPO has based his computation on a method, which is not ascribed by the provisions of the Act. No doubt, clause (f) of section 92C(1) says, such other method as may be prescribed by the Board . For adoption of this method, the 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, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... derived from export of articles is different from the income derived from the profits of the business of the undertaking. The profits of the business of the undertaking includes the profits and gains from export of the articles as well as all other incidental incomes derived from the 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 permissibl ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 relying on the decision of Hon ble Bombay High Court in the case 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 Consul ..... X X X X Extracts X X X X X X X X Extracts X X X X
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