2018 (4) TMI 2014 - AT - Income Tax

TP Adjustment - comparable selection - CIT(A) rejecting Venus Diagnostics Ltd. and Syngene International Limited as comparables HELD THAT - Venus Diagnostics Ltd. is operating as diagnostic centre and not engaged in provision of research services therefore we concur with the finding given by the ld. CIT(A) that the said company cannot be considered as comparable. Nothing contrary was brought to our notice by the ld. DR against the finding of the ld. CIT(A) that the company is operating as diagnostic centre and not engaged in provision of research services for which the same cannot be considered as comparable. We therefore do not find any infirmity in the order of the ld. CIT(A) on this issue. Since Syngene International Limited has two sets of income i.e. income from contract research fees and sale of compounds and since segmental details are not available therefore in absence of any contrary material brought to our notice we do not find any infirmity in the order of the ld. CIT(A). Accordingly the same is upheld and the grounds raised by the Revenue are dismissed.

Summary

1. ISSUES PRESENTED and CONSIDERED

(i) Whether Venus Diagnostics Ltd. can be considered a comparable company for benchmarking the arm's length price (ALP) of the assessee's international transactions involving agricultural R&D services.

(ii) Whether Syngene International Ltd. is a suitable comparable for determining ALP in the context of contract research services provided by the assessee.

(iii) Whether the Transfer Pricing Officer (TPO) erred in treating the agricultural R&D function of the assessee as a separate business operation distinct from its main cultivation activities.

(iv) Whether the research unit of Pioneer Overseas Corporation (POC) India constitutes a Permanent Establishment (PE) under the Indo-US Double Tax Avoidance Agreement (DTAA), and if so, whether the fees for R&D services should be taxed.

(v) Whether the TPO and Commissioner of Income Tax (Appeals) [CIT(A)] erred in selection and application of comparables, including the use of single-year data instead of multiple-year data, and failure to account for risk and functional differences.

(vi) Whether the proviso to section 92C(2) allowing a +/- 5% variance from ALP was appropriately applied.

(vii) Whether penalty proceedings under section 271(1)(c) were correctly initiated.

2. ISSUE-WISE DETAILED ANALYSIS

Issue (i) and (ii): Comparability of Venus Diagnostics Ltd. and Syngene International Ltd.

Legal Framework and Precedents: The determination of arm's length price under the Transfer Pricing provisions requires selection of comparable companies performing similar functions, bearing similar risks, and employing similar assets, consistent with Rule 10B of the Income Tax Rules and judicial precedents. The Tribunal's prior decision in M/s Evonik Degussa India Pvt. Ltd. was considered relevant for comparability analysis.

Court's Interpretation and Reasoning: The CIT(A) rejected Venus Diagnostics Ltd. as a comparable on the ground that it operates primarily as a diagnostic centre and does not provide research services akin to the assessee's agricultural R&D activities. The Tribunal concurred, noting that the Revenue's reliance on the Evonik Degussa decision was misplaced, as the CIT(A) did not base the rejection on that precedent but on the functional dissimilarity evident from the company's annual report.

Regarding Syngene International Ltd., the CIT(A) rejected it as comparable due to its engagement in contract research services in synthetic chemistry and molecular biology, which differ materially from the assessee's agricultural research. The Mumbai 'K' Bench's decision in Evonik Degussa was cited, highlighting the lack of segmental data to isolate contract research income and the functional differences between Syngene and the assessee. The Tribunal upheld this view, emphasizing the absence of contrary evidence from the Revenue.

Key Evidence and Findings: Annual reports and segmental information of Venus Diagnostics and Syngene International Ltd. were examined. Both companies' core activities diverged from the assessee's agricultural R&D function.

Application of Law to Facts: The principle of functional comparability was applied strictly, leading to the exclusion of these companies from the comparable set.

Treatment of Competing Arguments: The Revenue's contention to include these companies based on the Evonik Degussa precedent was dismissed as unfounded and not supported by facts.

Conclusions: Venus Diagnostics Ltd. and Syngene International Ltd. are not appropriate comparables for benchmarking the assessee's international transactions.

Issue (iii): Treatment of Agricultural R&D as a Separate Business Activity

Legal Framework and Precedents: Transfer Pricing regulations require that each international transaction be benchmarked considering its nature and functional profile. The OECD Transfer Pricing Guidelines and Indian Transfer Pricing Rules provide that integrated functions may be treated collectively unless a distinct profit centre is identifiable.

Court's Interpretation and Reasoning: The assessee argued that agricultural R&D is vertically integrated with its main seed cultivation business and not a separate profit centre or service provider. The TPO, however, treated the R&D activity as a separate contract research service and benchmarked it independently.

Key Evidence and Findings: The assessee's submissions and documentation indicated that R&D activities are for internal use, with costs reimbursed on a cost-to-cost basis, and that research data is pooled globally within the group.

Application of Law to Facts: The Tribunal noted that the TPO's approach of benchmarking R&D separately was not accepted by the CIT(A) in part, but the issue was not explicitly upheld or reversed by the Tribunal in this order. The assessee's argument that R&D is an integral part of cultivation activities was acknowledged but not fully adjudicated due to lack of pressing arguments in cross-objection.

Treatment of Competing Arguments: The assessee's contention of vertical integration was contrasted with the TPO's functional segmentation approach.

Conclusions: The issue remains contested, but the Tribunal did not grant relief to the assessee on this ground due to absence of arguments at the final hearing.

Issue (iv): Permanent Establishment and Taxation of R&D Fees under Indo-US DTAA

Legal Framework and Precedents: Article 5(3)(e) of the Indo-US DTAA excludes certain preparatory or auxiliary activities from constituting a PE. Article 7(3) exempts certain fees from taxation if they pertain to services that are preparatory or auxiliary.

Court's Interpretation and Reasoning: The assessee contended that the Indian research unit is not a PE of POC USA under Article 5(3)(e), and that the fees for R&D services are exempt under Article 7(3). The Tribunal observed that these grounds were raised in the cross-objection but were not argued before it. Therefore, these contentions were not entertained and dismissed as not pressed.

Key Evidence and Findings: No substantive evidence or argument was presented at the hearing to support these claims.

Application of Law to Facts: The Tribunal applied the principle that unargued grounds are deemed abandoned.

Treatment of Competing Arguments: The Revenue did not counter these grounds in the absence of arguments from the assessee.

Conclusions: These grounds were dismissed due to non-prosecution.

Issue (v): Selection and Application of Comparables, Use of Single-Year Data, and Adjustments

Legal Framework and Precedents: Rule 10B of the Income Tax Rules mandates selection of comparables based on functional analysis, and allows use of multiple-year data for benchmarking. Adjustments for risk and working capital differences are recognized principles in transfer pricing analysis.

Court's Interpretation and Reasoning: The assessee challenged the TPO's selection of comparables, arguing that they did not perform similar functions or bear similar risks, and that multiple-year data should be used rather than a single financial year. The CIT(A) considered these objections partially, rejecting some comparables but upholding others like TCG Lifesciences Ltd. The Tribunal noted that the assessee did not press these grounds in the cross-objection and accordingly dismissed them.

Key Evidence and Findings: The TPO's comparable set included various contract R&D companies with an average profit margin of 34.61%. The assessee's own margin was significantly higher at 86.67%, indicating an upward adjustment was warranted.

Application of Law to Facts: The Tribunal applied the arm's length principle and accepted the TPO's benchmarking after exclusion of inappropriate comparables.

Treatment of Competing Arguments: The assessee's arguments on functional dissimilarity, risk adjustment, and data period were not pursued at the hearing and thus not considered.

Conclusions: The selection of comparables and use of single-year data by the TPO, as modified by the CIT(A), were upheld.

Issue (vi): Application of +/- 5% Variance under Section 92C(2)

Legal Framework and Precedents: The proviso to section 92C(2) of the Income Tax Act permits a variance of up to 5% from the arm's length price without adjustment.

Court's Interpretation and Reasoning: The TPO observed that the variance between the assessee's margin and the ALP was approximately 34.6%, exceeding the 5% threshold, necessitating an upward adjustment. The CIT(A) and Tribunal concurred with this approach.

Key Evidence and Findings: The cost incurred in research was Rs. 75,668,000, while the ALP computed was Rs. 101,856,694, resulting in a difference of Rs. 26,188,694.

Application of Law to Facts: The statutory threshold was correctly applied to determine the necessity of adjustment.

Treatment of Competing Arguments: The assessee's plea for application of the 5% variance was not pressed.

Conclusions: The upward adjustment exceeding the 5% variance was validly imposed.

Issue (vii): Penalty Proceedings under Section 271(1)(c)

Legal Framework and Precedents: Section 271(1)(c) penalizes concealment of income or furnishing inaccurate particulars.

Court's Interpretation and Reasoning: The assessee raised this ground in the cross-objection but did not argue it. Consequently, the Tribunal dismissed the ground as not pressed.

Key Evidence and Findings: No arguments or evidence were presented on penalty.

Application of Law to Facts: The Tribunal adhered to the principle of non-entertainment of unargued grounds.

Treatment of Competing Arguments: None.

Conclusions: Penalty ground dismissed due to non-prosecution.

3. SIGNIFICANT HOLDINGS

"So far as Venus Diagnostics Ltd. is concerned, we find the ld. CIT(A) while considering the same as not comparable has held that the said company is operating as diagnostic centre which is evident from the annual report of the company. Since it is not engaged in the provision of research services, he held that the same cannot be considered as comparable."

"Insofar as Syngene International Ltd., this company is again 99% subsidiary of Biocon Ltd. and is engaged as a custom research service provider in the drug development process from discovery to supply of development compounds. From annual report, it is seen that the company has two sets of income - one from contract research fees and sale of compounds. However, in the absence of segmental information regarding contract research and manufacturing activities, it is difficult to analyse its main revenue and profit margin from the contract research work. Even otherwise also, apparently it is seen that its functional profile is different with that of the assessee company."

"Proviso to Sec.92C(2) permits a maximum variance of 5% from the arm's length price. In this case the variance being 34.6% exceeds 5% threshold. The Arm's Length Price in respect of the international transaction of performing contract research services to the head office is, therefore, determined at Rs.101,856,694/-."

Core principles established include strict adherence to functional comparability in selecting comparables for transfer pricing, the necessity of applying statutory variance limits under section 92C(2), and the principle that unargued grounds are deemed abandoned.

Final determinations:

• Venus Diagnostics Ltd. and Syngene International Ltd. are not comparable companies for benchmarking.
• The TPO's upward adjustment to the ALP for agricultural R&D reimbursement was justified and upheld.
• The assessee's cross-objections were dismissed for non-prosecution.
• The penalty proceedings issue was not entertained due to lack of argument.