TMI Blog2010 (12) TMI 60X X X X Extracts X X X X X X X X Extracts X X X X ..... ,856 Trimetazidine 2003-04 2,74,85,204 Indapamide 2003-04 47,06,566 Glicazide 2003-04 1,55,31,833 Trimetazidine 2004-05 3,60,21,884 Indapamide 2004-05 53,25,367 Glicazide 2004-05 2,12,49,394 Aggregate of impugned ALP adjustments 12,98,53,656 2. The taxpayer, i.e. Serdia Pharmaceuticals India Private Limited (Serdia, in short), is a company incorporated in India and 74% of its share capital is held by Servier International BV (Servier BV, in short), a company incorporated in the Netherlands, and the remaining 26% of its share capital is held by a Mauritius based company by the name of Serdia (Mauritius) Limited. Servier BV, in turn, is a subsidiary of Les Laboratoires Servier France (Servier France, in short), a well-known pharmaceutical company which is said to have its presence in more than 140 countries worldwide, including in Egypt by way of a subsidiary in the name of Servier Egypt Industries Ltd Egypt (Servier Egypt, in short). 3. Serdia is enagegd in the business of producing drugs mainly in the field of anti-hypertension and m ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... with excipients, and thus produce the FDF, i.e. finished dosage form, for consumption by the end user. The FDF is produced and marketed by Serdia, while the API is imported from its AEs. So far as the dispute in the first year, i.e. assessment year 2002-03, is concerned, the FDFs produced by Serdia are Flavedon 20, Flavedon MR (in which Trimetazidine is used as API) and Natrilix and Natrilix SR (in which Indapamide is used as API). In the next two years, i.e. assessment years 2003-04 and 2004-05, the dispute extends to FDF Diamicron and Diamacron MR, which has Gliclazide as API. 7. The issue in dispute is the arm's length price of the above three APIs, i.e. Trimetazidine, Indapamide and Gliclazide, that Serdia is importing from its AEs - namely Servier France and Servier Egypt. 8. During the course of related assessment proceedings, the Assessing Officer made references to the Transfer Pricing Officer (TPO, in short) under section 92CA(2) for determination of arm's- length price for the transactions that Serdia entered into with its AEs. As far as assessment year 2002-03 is concerned, the TPO received the reference on 20th January 2004. The TPO noted that the Serdia has determi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y the same, from its AE, at the price of Rs 1,89,456 per kg. The TPO further noted that while the assessee had imported Trimetazidine from its Servier Egypt at the price of Rs 52,546 per kg, the same drug was sold by other vendors at much lower rates of Rs 8,150 per kg (Nivedita Chemicals Pvt Ltd), Rs 8,625 per kg (Sharon Pharmachem Limited), Rs 10,558 per kg (Orion) and Rs 11,000 per kg (Trichem). 10. As for the comparability of these prices of the API, while the assessee did not seem to have much to say so far as Indapamide is concerned, beyond pointing out that the assessee is market leader, with 68.9% market share, in respect of the FDF made of Indapamide, the assessee did seriously challenge the quality of Trimetazidine. The assessee also contended that both the products of the assessee are patented in Europe and USA, that these products are market leaders even as the products are sold at higher prices and that all these factors put together show that the APIs used by the assessee are better than that used by its competitors. The assessee made elaborate submissions to demonstrate that the quality of Trimetazidine manufactured in India, is not at all comparable with the quali ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he Indapamide. 13. As regards CUP of Trimetazidine, the TPO noted that the highest CUP, as per information gathered by the assessee - which was duly confronted to the assessee, was Rs 11,000 i.e. of Trimetazidine supplied by Nivedita Chemicals Pvt Ltd. Since the assessee had challenged the purity standards of the Trimetazidine manufactured by Nivedita, the TPO made two adjustments - Rs 4,850 per kg for differences in quality norms, based on the differences in prices in British Pharmacopoeia quality standards vis- -vis Japanese Pharmacopoeia quality standards, and a further Rs 5,000 per kg for any variations in purity standards. The adjusted CUP was thus computed at Rs 20,850 (i.e. Rs 11,000 + Rs 4,850 + Rs 5,000), as against price of Rs 52,546 per kg paid by the assessee to its AE for imports of Trimetazidine. The price paid to the AE was thus more than 2.5 times the ALP, even after making all these adjustments, of the Indapamide. 14. The adjustments in respect of the above two APIs, i.e. Trimetazidine and Indapamide, were also made in the subsequent two years as well. There are variations in the figures but in principle, as learned representatives agree, the adjustments were o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... anges to the price list applicable for India". These statements, according to the Assessing Officer, clearly establish that the prices at which the transactions have taken place with the AEs are actually governed by the selling prices of the FDFs and not the market forces regarding the API itself. The remand report thus reinforced the stand taken at the assessment stage. The elaborate submissions made by the assessee, against the stand taken by the TPO at the assessment and the remand stage, did not impress the Assessing Officer. While rejecting the submissions made by the assessee for the assessment year 2002-03, which has been followed in the subsequent years as well, learned CIT(A) has, inter alia, observed as follows:- The appellant has not given any cogent reasons as to why the TNM method is applicable to its case. In fact on page 16 of the E and Y report on Transfer Pricing, it has been stated that the TNM approach has been followed, based on the hypothesis that the since operating margins earned from the appellant's manufacturing and marketing are on an arm's length basis, then it must be assumed that the underlying payments to the AEs for imports of APIs too are on an arm ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... in other companies are found to be comparable, for the following reasons:- a. Except for some internal studies, which are not of any independent or statutory authority, the appellant has not given any authoritative and unchallengeable data or document, to establish the superiority or purity better quality of the APIs imported by it, as compared to the instances cited by the ACIT-TP. b. The differences in efficacy of the appellant's FDFs are compared with others too are not established by an independent and authoritative data. c. The appellant has been unable to give contractual data in respect of the said APIs supplied by its AEs to third parties on comparable terms and circumstances, so as to establish that its own international transactions with its AEs in this regard were on an arm's length basis. d. The appellant's additional advantages, derived from its AEs in terms of manufacturing and marketing assistance by importing the products are not related to product imports in ordinary circumstances, but are actually technical and managerial services received for which normally royalty and fees is paid by a party. Perhaps the cost of such services which should have been added ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sessee has raised several grounds of appeal which are no more than arguments in support of its short main grievance that on the facts and in the circumstances of the case, the CIT(A) erred in upholding the arm's length price adjustments made in the price of APIs purchased by the assessee from its associated enterprises. For ready reference, however, related grounds of appeal for the assessment year 2002-03 are reproduced below:- 1. The learned CIT(A) has erred in upholding the addition of Rs.19,533,408 made by the ACIT pursuant to the order of the learned ACIT (Transfer pricing) to the total income of the appellant on account of computing the arm's length price relating to the international transaction pertaining to import of active pharmaceutical ingredients (ATP) namely, Trimetazidine and Indapamide, from associated enterprises. 2. The learned CIT(A) has erred in upholding the non-acceptance of Transactional Net Margin Method (TNMM) adopted by the appellant for determination of its arm's length price in connection with its international transaction relating to import of raw materials (Trimetazidine and Indpamide) from its associated enterprises. Your appellant submits that TN ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... prays that the addition be deleted. 9. The learned CIT(A) has erred in disregarding prices at which he appellant's associated enterprise has sold the two APIs, viz, Trimetazidine and Indapamide to unrelated parties, which are identical to the two APIs sold by the appellant's associated enterprise to the appellant. Your appellant submits that even if the CUP method is to be applied, the above data shows that no addition is required in your appellant's case and prays that the addition be deleted. 10. The learned CIT (A) has erred in not considering the order passed by Dy. Commissioner of Custom, GAT valuation cell, Mumbai accepting the import prices of the APIs imported by Serdia from its associated enterprises, including, inter alia, Trimetazidine and Indapamide, to be at arm's length. Your appellant submits that the above further proves that the transaction undertaken by the appellant with its associated enterprises is at arm's length and hence prays that the addition be deleted. 11. The learned CIT (A) has erred in not considering the results of the tests conducted by independent third parties on the quality of the APIs imported by the appellant and the APIs available in th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nd, out of 5 compounds which are tested on humans, only 1 drug is approved. As against theses patented drugs, a generic drug is produced and distributed without any patent protection. Even a generic drug may have a patent on the formulation in the sense that a general drug manufacturer can duplicate the active pharmaceutical ingredient but not the colours, favours and other inactive ingredients. Learned counsel goes on to give example of a generic drug by the name of 'fluoxtine' launched by Dr. Reddy's Laboratories which is generic version of Eli Lilly's Prozac, with norfluoxteine as the common API. Learned counsel submits that principal reason of lower price of generic drugs is that there is more competition as there is a larger number of producers of the same drug, that generic drug manufacturers donot incur the cost of drug discovery , that generic drug manufacturers donot bear the burden of proving the safety and efficacy of drugs through clinical trials, and that generic drug manufacturers may also enjoy the benefits of previous marketing efforts of the brand name. Learned counsel then takes us through details of various stages of drug discovery, product development, pre clini ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... od of ascertaining the ALP should have priority over other methods. It is submitted that the right to choose the most appropriate method, for determining the arm's length price, rests with the taxpayer, and unless the Assessing Officer can demonstrate that arm's length price so computed is not computed in the manner as prescribed in the regulations, he cannot reject the method chosen by the taxpayer. Learned counsel then refers to the CBDT circular no. 14 of 2001 which, inter alia, states that where the taxpayer has discharged the primary onus of determining the ALP as per the rules and substantiating the same with prescribed documentation, there can be no intervention in the ALP by the Assessing Officer. A reference is then also made to a coordinate bench's decision in the case Development Consultants Pvt Ltd vs DCIT (115 TTJ 577) and Philips Software Centre Ltd vs ACIT (26 SOT 226) in support of the proposition that taxpayer's documentation should be accepted, unless the Assessing Officer is able to controvert the same. Learned counsel then points out that the Assessing Officer did not have good and legally sustainable reasons to reject the transactional net margin method as adop ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ted to an observation made by Special Bench decision in the case of Aztec Software (supra) to the effect that "even minor differences in contractual terms or economic conditions, geographical areas, risks assumed, functions performed etc could materially affect the amount charged in an uncontrolled transaction" and that "comparability under this method (i.e. CUP) depends on close similarities with respect to various factors". Learned counsel then invites our attention to Hon'ble Supreme Court's judgment in the case of CCE vs Universal Glass Limited (182 ELT 3) wherein it is observed that simply because two goods are known by the same known or the same group, it does not mean that they are comparable goods and that even if they are assumed to be comparable, the relevant differences, all relevant differences, as far as possible, should be recognized. According to the learned counsel, these observations show that comparables proposed by the TPO cannot be considered to be comparable only because they are known by the same name. 23. Learned counsel then submits that, as observed by a co ordinate bench of this Tribunal in the case of Sony India Pvt. Ltd. vs DCIT (118 TTJ 685) sales of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nce the prices at which Trimetazidine and Indapamide are supplied by Servier to the assessee at prices lower than these prices, the prices at which assessee has bought these APIs should be treated as ALPs. Elaborate submissions are also made on as to why these inputs about internal CUPs should be accepted, and as to why these inputs should not be treated as additional evidences. 26. It is then submitted that there is no contradiction in the stand of the assessee before the custom authorities vis- -vis stand before the transfer pricing authorities. It was submitted that the assessee's stand before the custom authorities to the effect that the price of API has been renegotiated with the AEs, due to fall in the selling prices of the FDFs, only demonstrates that the AEs are unrelated parties and the appellant negotiated and brought about the reduction in prices. It is submitted that even if it is assumed that FDFs manufactured by the assessee and those manufactured with locally produced APIs constitute the same market, there is a wide gap between the quality and characteristics of the same product. It is also submitted that since custom department has accepted the said valuation for ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ern the case before us. The hearing was adjourned by a day to enable the parties to peruse these decisions and address us on the same. 30. Learned counsel's preliminary objection is that these judicial precedents have no binding force of law in India and we need not be influenced by the same. He points out that the decisions from foreign courts, no matter whatever be the degree of respect that these decisions are extended by the judicial forums in other countries, have no binding precedent value. He also points out that the transfer pricing legislation in India is not in pari materia , including on the core question of hierarchy of methods of determining arm's length price. It is submitted that, as evident from paragraph 34 of the Federal Court decision, there is a hierarchy of methods implicit in Canadian transfer pricing legislation. The relevant observation in paragraph 34 of the said decision is that "(t)here was no dispute between the parties that the Cost-Plus and Resale Price methods were secondary methods to be used when the CUP method was not appropriate and that the Transactional Net Margin method was another alternative to be used when the Cost-Plus and Resale Price me ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s to improve upon their case. It is once again reiterated that the assesse had applied the TNMM for ascertaining ALP, given full documentation in support of the same, and the Transfer Pricing Officer has rejected, without placing on record any cogent reasons, the ALP determination method adopted by the assessee. On these facts, according to the learned counsel, we must vacate the adjustments made by the Transfer Pricing Officer and uphold the grievance of the assessee. 33. In response to bench's query whether the assessee is in a position to give any further inputs on application of the CUP method for determining the ALP, beyond what has been filed at the assessment and appellate stage, or whether the assessee considers any of the same API being sold in India a comparable, learned counsel expressed regret for not being able to do so. 34. On the strength of all these arguments, as also on several other arguments on peripheral procedural issues and written submissions filed before us, learned counsel urged us to delete the impugned ALP adjustments. 35. Learned Departmental Representative submits that it is an undisputed position that the APIs in question are no longer patented ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tors cannot be preferred over a direct method like CUP method. We are taken through the orders of the authorities below to show as to why, on the facts of this case, CUP method is a more appropriate method. Learned Departmental Representative vehemently relies upon the orders of the authorities in this regard. 39. It is submitted that the related APIs are products which are sold in the market, and, therefore comparable uncontrolled prices are easily available. As for the variations in quality, every producer makes a claim that his product is better than other similar products and that is more of a marketing gimmick than real differentiation. On the facts of this case, and particularly as API is a standard product for which transaction prices between unrelated parties are available and as it is a direct method with minimum distortions by irrelevant factors, it is a fit case for use of CUP method for determining the ALP. According to the learned Departmental Representative, the Transfer Pricing Officer has given liberal adjustments in respect of the quality differences claimed by the assessee. It is submitted that the Transfer Pricing Officer has given cogent, though perhaps brief, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 2. Learned Departmental Representative then takes us through the decisions of Tax Court of Canada and Federal Court of Appeals in Canada, in the case of Glaxo SmithKline Inc. (supra). While he does not dispute that these decisions have any binding precedence value in India, he submits that the logic and rationale of these decisions bind every reasonable persons. He points out that the hearing of Canadian Tax Court was spread over forty days and in coming to their conclusions, the judges was not only guided by illuminating legal arguments by tax experts but also by industry insight provided by several expert witnesses. It is more like a research paper, according to the learned Departmental Representative, which deserves utmost respect and which succinctly explains the functioning of the pharmaceutical industry and demystifies their working. It is pointed out that, as rightly held by the Canadian Tax Court, to ascertain arm's length price of APIs manufactured even by the original patent holder, prices of the same API produced by a generic drug producer must be taken into account. We are urged to follow the same approach. As regards Federal Court of Appeal decision, it is pointed out ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... g the ALP, the choice of method rests only with the assessee and unless ALP computed on that basis is found to be contrary to the provisions of transfer pricing regulations, the Transfer Pricing Officer cannot reject the same. We are once again urged to set aside the orders of the authorities below and hold that the impugned ALP adjustments are indeed unsustainable in law. 47. We have duly considered the rival submissions, perused the material on record and duly considered the rival submissions as also the applicable legal position. 48. The first issue that we need to adjudicate on is whether, in the absence of a hierarchy of methods of determining the arm's length price, it is permissible for the Transfer Pricing Officer to reject the transactional net margin method to determine the arm's length price of the transactions with AEs, on the ground that the comparable uncontrolled price method to determine the ALP will be more appropriate and even as the Transfer Pricing Officer has not pointed out any defects in the method adopted by the assessee. 49. Let us deal with some fundamentals first. Section 92C of the Act, which deals with determination of arm's length price in relati ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ub-sections (1) and (2), on the basis of such material or information or document available with him:- Provided that an opportunity shall be given by the Assessing Officer by serving a notice calling upon the assessee to show cause, on a date and time to be specified in the notice, why the arm's length price should not be so determined on the basis of material or information or document in the possession of the Assessing Officer. (4) Where an arm's length price is determined by the Assessing Officer under sub-section (3), the Assessing Officer may compute the total income of the assessee having regard to the arm's length price so determined:- Provided that no deduction under section 10A 27 [or section 10AA] or section 10B or under Chapter VI-A shall be allowed in respect of the amount of income by which the total income of the assessee is enhanced after computation of income under this sub-section:- Provided further that where the total income of an associated enterprise is computed under this sub-section on determination of the arm's length price paid to another associated enterprise from which tax has been deducted or was deductible under the provisions of Chapter XVIIB, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ethod of computing the arm's length, in terms of the provisions of Section 92C (2), as also when the method of selecting most appropriate method of computing the arm's length price is not determined in accordance with the scheme of things envisaged under section 92 C(1). This provision is, however, subject to the condition that the Assessing Officer has to give an opportunity of hearing to the taxpayer, on as to why he should not do so, by serving a show cause notice. The twin conditions of compliance with the provisions under section 92C (1) and 92C (2) have to be fully complied with by the taxpayer, and it is only when this onus is properly discharged by the taxpayer that the Assessing Officer is restrained from resorting to determination of arm's length price by him in terms of Section 92 C (3)(a). of course, there are other situations, as se out in clauses (b), (c) and (d) of Section 92 C (3), in which the Assessing Officer can proceed to determine the arm's length price under section 92 C(1) and (2), but, in the context of the situation that we are in seisin of, it is not really necessary to deal with the same. 51. In view of the above discussions, in our considered view, it ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... hough, in relatively more specific terms, Rule 10C(2) lists out the factors to taken into account while selecting the most appropriate method. It is somewhat akin to the best rule method in Section 482-1(C)(1) of US transfer regulations which provides that, "the arm's length result of a controlled transaction must be determined under the method that, under the facts and circumstances, provide the most reliable measure of an arm's length result". 53. In a situation in which the Assessing Officer finds that the selection of most appropriate method is not appropriate to the all the relevant factors, he has the powers, as indeed the corresponding duty, to select the most appropriate method and compute the arm's length price by applying that method. It is not at all necessary, as has been contended by the assessee, that unless the Assessing Officer can demonstrate that arm's length price computed by the assessee is not computed in the manner as prescribed in the regulations, he cannot reject the method chosen by the taxpayer. The selection of most appropriate method of computing the arm's length price is a significant component of the process of determining the arm's length price and ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... but such a specified method must also be most appropriate method of determining the arm's length price 'which is best suited to the facts and circumstances of each particular international transaction, and which provides the most reliable measure of an arm's length price in relation to the international transaction'. The exercise of selecting most appropriate method essentially implies that appropriateness of method is to be ranked in some order, and that one cannot put all the methods, even as all the methods may be appropriate to the facts of a case, at par in this respect. Undoubtedly, the transfer pricing legislation in India does not prescribe a particular order of preference about methods of determining the arm's length price, but the selection of most appropriate method of determining arm's length price, under Section 92 C(1) read with Rule 10 C, essentially requires the methods of determining the arm's length price to be ranked, on a sound and rationale basis, in an order of preference vis- -vis the facts of every case. Compared with a situation in which transfer pricing legislation itself provides for order of preference in selection of method for determining arm's length ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... eparately, as, at present, our concern is only with the broad proposition as to whether the most appropriate method selected by the assessee can be rejected by the Transfer Pricing Officer without recording a finding that the arm's length price computed by the assessee, on the basis of such a method of ascertaining arm's length price, is contrary to the transfer pricing legislation. As far as this aspect of the matter is concerned, in our considered view, the proposition advanced by the assessee has to be rejected by relying upon the observations made by Special Bench in Aztec's case. 57. As far as learned counsel's reliance on decision of the coordinate bench in the case of Philips Software (supra) is concerned, we find that the coordinate bench was in seisin of a situation in which none of the conditions set out in 92 C(3) (a) to (d) were satisfied, and yet the arm's length price as determined by the assessee was rejected. As a matter of fact, the coordinate bench, having taken note of the scope of Section 92 C (3), which have reproduced above, observed that "the above-mentioned section clearly provides that before the arm's length price is determined, the Assessing Officer has ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y way of a speaking order. 58. For the reasons set out above, we are unable to approve learned counsel's plea that, as the results arrived at by determination of arm's length price computed by the assessee were not contrary to the transfer pricing regulations, it was not open to the Transfer Pricing Officer to reject the most appropriate method adopted by the assessee. In our considered view, the Transfer Pricing Officer was well within his powers to go into the question as to whether the method of determining the arm's length price adopted by the assessee was indeed most appropriate method of determining the arm's length price on the facts of assessee's case, and, on being satisfied that it was not the most appropriate method of determining the arm's length price, the Transfer Pricing Officer was also justified in determining the arm's length price on the basis of, what he found to be, the most appropriate method on the facts of the case. 59. That takes us to the question as to whether, on the facts of this case, the CUP method is indeed preferable over the TNM method for determining the arm's length price. 60. The thrust of learned counsel's arguments is that since transfer ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... is quite in line with Indian transfer pricing legislation which requires selection of most appropriate method rather than the method being picked up in the order of priority. To this extent, the approach of OECD and Indian transfer pricing legislation is now quite in harmony with each other. 63. It will, however, be stretching the things too far to suggest that in the 2010 version of OECD Guidelines, all the methods of determining the arm's length price have been placed at par with each other. The change in the OECD Guidelines, as we see it, is in respect of the order in which suitability of the methods is to be considered and in recognition of the fact that there can be situations in which transactional profit methods can have an edge over traditional transactional methods. However, wherever transactional profit methods as also traditional transactional methods can be applied in equally reliable manner, the OECD Guidelines still consider the traditional transactional methods to be preferable, as is evident from following observations in paragraph 2.3 of the OECD Guidelines 2010:- 2.3 Traditional transaction methods are regarded as the most direct means of establishing whether ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... relationship between the associated enterprises that is sought to be neutralized by the transfer pricing regulations. As long as CUP method can be reliably applied on the facts of a case, it does offer most direct method of neutralizing the impact of interrelationship between AEs on the price at which the transactions have been entered into by such AEs. 65. While traditional methods seek to compute the prices at which international transactions would normally be entered into by the associated enterprise, but for their interdependence and relationship, transactional profit methods seek to compute the profits that the tested party would normally earn on such transactions with unrelated parties. It is only axiomatic that the profits earned by an enterprise is dependent on several factors, and not only on the prices at which transactions have been entered into with the associated enterprises. The profit based results thus admit possibility of vitiation of results by a number of factors which are not relevant to the determination of prices at which international transactions are entered into by the associated enterprises. These methods, which are a step removed from the methods of com ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s could be found. This decision notes the agreed position as follows:- [64] Both parties called an expert witness to explain transfer pricing and to testify as to the appropriate method of establishing the transfer price between the appellant and Adechsa (i.e. vendor of the generic drug manufactured by the original patent holder). Dr. J. Gregory Ballentine testified for the appellant. Dr. Jack Mintz testified for the respondent. Both experts agreed that the CUP method is the preferred method for determining transfer prices. [65] Only in the absence of useful evidence of an uncontrolled transaction will it be necessary to use another method. For example, because no comparable transaction exists or because there are differences in the transactions that cannot be taken into account. The other methods are also useful in that they can be used as a check on each other. (Emphasis by underlining supplied by us) 70. Closer home, in the second case, the same question fell for consideration before a coordinate bench of this Tribunal, in the case of UCB India Pvt Ltd vs ACIT (supra). This was a case in which comparables cited by the Transfer Pricing Officer were inferred to have been pro ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t on observations on factual matters. As to how should we construe the observations, we find guidance from the oft quoted observations made by Hon'ble Supreme Court, in the case of CIT vs Sun Engineering Pvt Ltd (198 ITR 297), to the effect that "it is neither desirable nor permissible to pick out a word or a sentence from the judgment of this Court, divorced from the context of the question under consideration and treat it to be the complete 'law' declared by this Court". We must not, therefore, proceed on the basis that since CUP method was rejected in the case of a generic drug being manufactured by innovator of that generic drug, the CUP method must also be rejected in all cases where generic drugs are manufactured by the innovators of that generic drug; essentially, a lot depends on the quality of CUP inputs as well. 72. While dealing with UCB's case, we may also add that it was a case in which the Tribunal did not give any finding about as to which method of determining the arm's length price was the most appropriate method, having regards to the facts of that case, and the matter was remitted to the file of the Assessing Officer for fresh adjudication on that question. UCB ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... decision cannot, therefore, be an authority for the proposition that in the cases of generic drugs, in which drug is manufactured and sold by is the original patent holder, CUP method cannot be applied at all. 74. We also find that the prices at which the generic drugs are purchased by the assessee from its associated enterprises are admittedly not driven by the market forces but on considerations which have no role to play in a typical arm's length transaction. In the order dated 6th May 2003 passed by the Deputy Commissioner of Customs, following stand of the assessee has been noted:- They (Serdia India) have stated that increased market competition in India has resulted in overall reduction in prices of selling price of their formulations manufactured by them in India. In order to retain their market share in India, their suppliers (Servier Group) have agreed to renegotiate the to sell the bulk drug to them at reduced price by affecting necessary changes to the price list applicable for India. 75. On the one hand, the assessee claims that he is a market leader and his FDFs sell at higher prices because of the premium its API commands, which justifies the higher price pai ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 78. The assessee claims that these are unique items in the sense that APIs manufactured its AEs are better, of proven effectiveness, employing manufacturing process compliant with WHO - GMP (World Health Organization - Good Manufacturing Practices), guaranteed for quality and these AEs also provide product liability cover in respect of FDFs manufactured out of such APIs. 79. The question whether an API can be considered to be unique product on such ground that GMP (Good Manufacturing Practices) and HSE (Health, Safety and Environment) standards were followed in its production process whereas such high standards were not maintained by other generic drug manufacturers, was also one of the issues which came up for adjudication before Tax Court of Canada in the case of Glaxo Smithkline (supra). 80. Briefly stated, the relevant material facts of Glaxo's case were like this. Ranitidine is the active pharmaceutical ingredient ("API"), used in a drug marketed by the assessee in Canada under the brand name Zantac. Ranitidine was discovered by the assessee's parent company in 1976 and was approved for sale in Canada in 1981. Zantac was launched by the taxpayer in 1982. During the peri ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ion to another. The Tax Court also endorsed the OECD's hierarchy of transfer pricing methods. It therefore concluded that the comparable uncontrolled price ("CUP") method is the preferred method and that the purchase price paid by the generic pharmaceutical producers is an appropriate CUP. The Court indicated that the highest price paid by the generic pharmaceutical producers represents a reasonable price that the taxpayer could have paid Adechsa. The judge did allow an additional C $ 25 per kilogram of ranitidine in acknowledgement that the ranitidine purchased from the related party manufacturer in Singapore was granulated. 81. This matter was heard at great length and in fine detail for over forty days, as noted in the order itself, and the Court was not only assisted by illuminating arguments by the learned counsel but also by expert witnesses, in a way, demystifying the pharmaceutical industry and sharing their insights on the manufacturing process of the APIs, as evident from the following observations in the said decision:- [93] A point in dispute is the impact of Glaxo's GMP. The appellant submits that the Glaxo ranitidine and that purchased by generic companies are not ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... The appellant argued that Glaxo's standards differed from those of the generic API manufacturers in that Glaxo World required that its ranitidine be:- (1) manufactured under Glaxo's GMP standards, (2) produced in accordance with HSE, and (3) granulated to Glaxo World standards. The suppliers to the generic companies did not manufacture ranitidine according to Glaxo standards. [98] When Mr. Ment was asked "[t]o what extent can test methods be developed to detect adventitious contamination, cross-contamination or all and any kind of chemical that may be found in a batch?" he replied, "[i]t would be extremely difficult, if not impossible, to do that with a battery of tests that companies typically run for batch release testing. They are not designed to detect and to identify adventitious contamination, except to a very limited extent." [99] A similar sentiment was expressed by Dr. Ian Keith Winterborn, the appellant's science nominee at discovery who also testified at the trial of these appeals. He said "[i]t is impossible to design - well, it is not impossible, but it would be onerous to try to design analytical tests which could detect and quantify any and all potential ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tamination it was not unreasonable for the appellant, for its comfort and that of the Glaxo World, to purchase ranitidine produced under good manufacturing practices for a marginally higher price than one would pay for ranitidine that lacked GMP. [103] The Therapeutic Products Directorate of the Health Products and Food Branch of Health Canada is the Canadian authority that regulates pharmaceuticals and medical devices for human use. The respondent's witness, Mr. Sultan Ghani, became the director of the Bureau of Pharmaceutical Sciences of the TPD in 2002. He was qualified as an expert in good manufacturing practices of the pharmaceutical industry in general, the drug approval process, quality assurance and GMP in the pharmaceutical industry in Canada. [104] Mr. Ghani explained that, during the years in issue and right up to the time of his testimony, Canadian regulations placed the responsibility for the quality of the active pharmaceutical ingredient on the dosage form (or secondary) manufacturer, and that this was where Health Canada considered the responsibility to rest as well. However, this practice will soon change due to international efforts to bring GMP standards to A ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... affect its comparability with the same API manufactured by generic drug companies. 84. It was in this backdrop that the Tax Court of Canada finally concluded as follows:- [161] CUP is the preferred method and the generic companies in Canada are an appropriate comparator using the CUP method. The appellant acquired granulated ranitidine from Adechsa at an amount in excess of the fair market value of ranitidine, and pursuant to subsection 69(2) of the Act the appellant is deemed to acquire it at a reasonable amount. The price that would have been reasonable in the circumstances for Glaxo Canada to pay Adechsa for a kilogram of ranitidine is the highest price the generic companies paid for a kilogram of ranitidine. However, to this amount I would add $25 per kilogram as this was the approximate cost to Singapore for granulation. The ranitidine purchased by the generic companies was not granulated. The GMP performed by a Singapore may have increased the value of its ranitidine but only to the extent that, as stated earlier in these reasons, it gave some degree of comfort to the appellant that the product would probably have less impurities and contaminants than that of its generic ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Agreement need to be considered in determining the arm's length price. As a result, the Court sent the case back to the Tax Court to determine the arm's length price based on the terms of the License Agreement. The Federal Court of Appeals concluded as follows:- [74] ......it is my view that the Judge was bound to consider those circumstances which an arm's length purchaser would necessarily have had to consider. In other words, the test mandated by subsection 69(2) does not operate regardless of the real business world in which the parties to a transaction participate. [75] This is not what the Judge did. Rather, he determined the "fair market value" of ranitidine, which he found to be the price paid by Apotex and Novopharm, and then found that anything paid by the appellant over that amount, save for a $25 per kilo upward adjustment, was in excess of "the reasonable amount". [76] Clearly, in the circumstances of this case, the Judge's approach was mistaken. In a real business world, presumably an arm's length purchaser could always buy ranitidine at market prices from a willing seller. However, the question is whether that arm's length purchaser would be able to sell his r ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ss to the portfolio of other patented and trademarked products to which it had access under the License Agreement. [80] The appellant submits, and I agree entirely with that view, that these circumstances do not arise from the non-arm's length relationship between the appellant and Adechsa or between the appellant and Glaxo Group. To the contrary, these circumstances, and I quote the appellant, "arose from the market power attaching to Glaxo Group's ownership of the intellectual property associated with ranitidine, the Zantac trademark and the other products covered by its License Agreement with Glaxo Canada". As the Administrative Appeals Tribunal of Australia stated in Roche Product Pty Limited and Commissioner of Taxation, [2008] AATA 639 (July 22, 2008) at paragraph 153:- It is the intellectual property which is really the product, not the pill or capsule by which it is dispensed. The intellectual property included patent rights. The intellectual property came from very substantial expenditure on research and development, much of which would have produced no result. The profits from the exploitation of the intellectual property rights was something to which [the parent comp ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... atisfied that the record is sufficient or he may request the parties to adduce additional evidence and submissions as a result of this Court's decision. 88. The grounds on which the Glaxo decisions of the Tax Court of Canada was overturned by the Federal Court of Appeal have nothing to do with claimed superiority of the product, as is the case before us, but on the basis of compulsions of the licence agreement, because of which the assessee was said under an obligation to purchase the API at a higher price. 89. In the case before us, the plea of the assessee is of superiority of APIs manufactured by its associated enterprises that the APIs purchased by the assessee command a higher price, and not that it was on account of the compulsions of license agreement that the assessee had to buy it at a higher price. In any event, the assessee has not even filed copies of any agreements, including the license agreement, before us. As we make these observations, we make it clear our observations should not be construed an expression of opinion on things not before us. That is a plea which will have to be dealt with, on merits, when it is made. That apart, there are many other peripheral ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... prises, it has two implications - first, that domestic tax liability is reduced in respect of income of the enterprises situated in that tax jurisdiction, and - second, a payment for dividend, royalty or other income is made to the foreign AE in the garb of payment for such goods or services. Once it is held that a part of payment made to the foreign AE is wrongly characterized as payment of goods or services, it is only a natural corollary of this finding that the payment so made in excess of arm's length price must have some other character. While a lower deduction, on account of ALP adjustment, neutralizes the erosion of domestic tax base caused by reporting artificially lower profits, a simplictor ALP adjustment does not neutralize the non-taxability, in source country, of the payment of dividend, royalty or other incomes to the foreign AEs, in the garb of payment for goods or services. Many countries, including Canada - by way of Section 247(2) of Canadian Income Tax Act , neutralize this ill effect of a payment in excess of arm's length price by providing for re-characterizing the amount paid in excess of ALP. In India, re characterization provisions in respect of payments ma ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... having regard to legitimate business needs", since, unlike in the case of Section 40A(2) with which this decision dealt, the Income Tax Act provides a specific mechanism for computation arm's length price, and it is only when determination of arm's length price is made in accordance with the scheme of the Act that the onus of the assessee is discharged. Merely because another arm of the Government considers this price at an arm's length price, even though for the purposes of customs duty, the assessee can not be relieved of the burden of establishing that it is an arm's length, for the purposes of transfer pricing requirements, in terms of the provisions of the Income tax Act. 96. In view of the above discussions, and bearing in mind entirety of the case, we are of the considered view that CUP method of determining the arm's length price is most appropriate method for determining arm's length price, on the facts of this case, and the selling price of related APIs in Indian market constitute good comparables for applying the said method. 97. As regards Indapamide, based on the information about competitor drugs submitted by the assessee himself, the Transfer Pricing Officer asc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Chemicals and the same product as per British Pharmocopia standards, as was the product imported by the assessee from its AE, worked out to Rs 4,850. In addition to the CUP of Rs 12,000 per kg, the Transfer Pricing Office allowed Rs 4,850 per kg for higher quality standard as also an additional allowance of Rs 5,000 towards impurities. The assessee has not made out a case for higher adjustments to be allowed in respect of the same, and it is not, therefore, the case that an adjustment for higher quality of product has been declined to the assessee. Even as we confirm the orders of the authorities below on this issue, we make it clear that the assessee is not prevented from making any such claim for adjustments in value, as he may deem appropriate and can justify, in future, and, to this extent, the issue is left open. Subject to these observations, in our considered view and on the given facts, these adjustments reasonably cover the variations in quality of API manufactured by Nivedita Chemicals vis- -vis API manufactured by Servier Egypt which was purchased by the assessee for Rs 52,546 per kg. 103. As regards the internal CUPs furnished by the assessee, we find that these input ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... and that, as held by Bilaspur bench of this Tribunal in the case of Sunita Finlease Limited vs DCIT (118 TTJ 263), when an Assessing Officer carried out a scrutiny assessment beyond the time limit prescribed vide a CBDT instruction, the assessment order so passed was liable to be quashed as it suffered lack of jurisdiction. A reference was then also made to Hon'ble Andhra Pradesh High Court's judgment in the case of CIT vs Nayana P Dedhia (270 ITR 572) which holds that selection of a case for scrutiny assessment in violation of directions of the Central Board of Direct Taxes was legally unsustainable, and the assessment framed on the basis of such assessment was liable to be set aside. On the basis of these arguments, learned counsel submits that the reference made to the TPO was void ab initio as it was made after the time limit stipulated by the CBDT. We are urged to set aside the order passed by the Transfer Pricing Officer for this short reason alone. Learned Commissioner (Departmental Representative), on the other hand, vehemently opposes the submissions made by the learned counsel for the assesse. He submits that the directions contained in the circular dated 20th May 2003, a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t was recommended that "(t)he work relating to selection of cases for scrutiny and reference to TPO on the above basis in respect of pending returns filed for the assessment year 2002-03 should be completed by June 30, 2003". A plain reading of this instruction does not suggest that there was any bar on making of references to the TPO after 30th June 2003 or that all these references will have to be necessarily completed before that date, as, for example was the position, in the context of CBDT instruction dealt by the Bilaspur bench of this Tribunal in the case of Sunita Finlease (supra), and by Hon'ble Andhra Pradesh High Court in the case of Nayana P. Dedhia (supra). In the case of Sunita Finlease (supra), the coordinate bench was dealing with a situation in which the CBDT had specifically directed that "(f)or returns filed during the current financial year 2004- 05, the selection of cases for scrutiny will have to be completed within 3 months of the date of filing of the return" (emphasis supplied by us). Similarly, in the case of Nayana P Dedhia (supra), Their Lordships were dealing with a situation in which there was a specific bar from selecting a case in scrutiny assessment ..... 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