TMI Blog2014 (5) TMI 882X X X X Extracts X X X X X X X X Extracts X X X X ..... d keeping in view the explanation which was based on the relevant facts and figures - the CIT(A) was fully justified in holding that the profits of the assessee company from its eligible business for the years could not be regarded as more than the ordinary profits which are expected to rise in such eligible business so as to attract the provisions of section 80IA(10) of the Act - the AO was not justified in invoking the provisions of section 80IA(10) of the Act to restrict the deduction claimed by the assessee u/s 10B of the Act – Decided against Revenue. Transfer pricing adjustment – Held that:- Following ITO v. Zydus Altana Healthcare (P.) Ltd. [2010 (4) TMI 883 - ITAT MUMBAI] - it was an organization which was mainly doing the clinical research activity - when the TPO was adopting it as a basis for comparing the assessee's transaction then as per Rule 10B (1)(a)(ii), she was required to adjust in regard to differences . As per sub-clause (iii) of clause (c) of Rule 108, when cost method is adopted, the normal gross profit is required to be adjusted to take into account the functional and other differences, if any, between the international transaction and the comparable unco ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e to the extent of Rs. 135,25,31,353/-. On such examination, he found that the deduction u/s 10B of the Act was claimed by the assessee in respect of its export sales entirely made to M/s Atlanta Pharma AG, Germany in respect of two items with code names KSM -6 and KSM -14. In this regard, he required the assessee to furnish, inter alia, the copies of joint venture agreement, supply agreement and license and distribution agreement for his verification. On analyzing the said agreement, he found that as per the supply agreement, the assessee was to exclusively sale the intermediates to APAG, Germany. He also analysed the manufacturing process involved in the production of the said intermediates with their chemical equations. He also recorded the statements of Dr. Vivek B. Khare and Mr. Prashant Chitnis, Production Managers of the assessee company where they stated that the value addition in each stage of the manufacturing process of KSN-6 was 15%. It was also revealed that the technical know-how required for the manufacture of intermediates was obtained by the assessee company from APAG, Germany and although there was no technology transfer per se for the said intermediates, the asse ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ar i.e. A.Y. 2002-03. He noted that the assessee in this connection could not provide any basis for determination of such higher profits nor it could substantiate the stand that the profits so earned in A.Y. 2004-05 was an ordinary profit. He noted that as per the relevant terms of the supply agreement, the basis of calculation of profit should have been based on the lowest supply price of KSM- 6 and KSM-10 charged by third party suppliers to APAG, Germany and this mechanism of determination of profits was required to be documented by the assessee. The assessee, however, could not produce any such documentation maintained by it. The assessee also could not produce the cost audit report in order to enable the A.O. to ascertain the value addition. According to the A.O., the element of technical know-how and patent was also not taken into account by the assessee company in the calculation of profits which ought to have been done for determination of true and reasonable profits. He held that the real intention of the assessee thus was to maximize the profits to claim higher deduction u/s 10B of the Act and the provisions of section 80 IA(10) r.w.s. 10B of the Act were clearly attracted ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... fferent course for making addition on this issue. He held that the higher ratio of 318.51% between the turnover and cost of production of A.Y. 2005-06 than that of A.Y. 2002-03 was as a result of less cost of sales shown by the assessee and this difference amounting to Rs. 73,55,61,604/- was treated by him as unexplained expenditure adding the same to the total income of the assessee u/s 69-C of the Act. 7. The disallowance made by the A.O. u/s 10B r.w.s. 80IB(10) of the Act was challenged by the assessee in the appeals filed before the ld. CIT(A). Before the ld. CIT(A), it was pointed out on behalf of the assessee that the entire basis of working made by the A.O. to draw an adverse inference against the assessee on this issue was grossly erroneous and the conclusion arrived at by him on the basis of such erroneous working to restrict the claim of the assessee for deduction u/s 10B of the Act was totally unjustified. It was submitted that there were several factual errors and discrepancies in the assessments completed by the A.O. In this regard, the following submissions were made on behalf of the assessee before the ld. CIT(A) to point out that there was a patent mistake in the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f respective quantities of production of the two concerned intermediates viz. KSM-14 and KSM-6 and applying the appropriate rate of cost of raw materials per Kg. for each of the intermediate separately. The correct computation in this regard also stands duly reflected in the revised and corrected chart prepared by the appellant and enclosed hereto as Annexure-I above. (iv) Moreover, while adopting the rate of the respective raw-materials utilized in the production of the two intermediates KSM-14 and KSM-6, the learned A. O. ought to have adopted the average rate per Kg. on the basis of the Accounts duly certified under Schedule- VI of the Companies Act and forming part of the Final Accounts as duly available on record with the learned A. 0. himself Considering the cumulative impact of the aforesaid four aspects, the average expected per Kg. cost of raw materials on the basis as worked out by the learned A.O. should correctly work out to Rs.1,42 7.37 as against Rs.2960.30 per Kg. as computed in the assessment order. Moreover, considering the correct rate of Rs. 1,427.37 as referred to above and applying it to the correct quantity of production (and not sales), the expected am ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... -6 and KSM-14, the production of which was to be exclusively supplied by the appellant to Altana Pharma AG, Germany. To support his conclusion that the appellant has not included such cost attributable to value addition, royalties and other charges, the learned A. 0. has as discussed in para 38 of his order relied upon the chart reproduced by him on page 31 of the assessment order. As pointed out hereinbefore, the very basis of discrepancy as sought to be highlighted by the learned A.O. in the expected amount of cost of raw materials and actual cost of raw materials as reflected in the P L A/c. does not survive and hence the allegation by the learned A.O. on this count holds no ground whatsoever." 9. It was also brought to the notice of the ld. CIT(A) by the assessee that while making allegation of excess and unreasonable profits shown by the assessee in the years under consideration as compared to the initial year i.e. A.Y. 2002-03, the percentage of profits was taken by the A.O. as the ratio of turnover to the cost of production. It was contented that the said ratio did not represent the profitability of the eligible business of the assessee company and such weird basis ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ,022,497) - 1.48% (59,879,198) - 4.89% Total Other Expenses 47,135,329 18,.51% 45,923,681 3.94% 86,555,783 5.14% 12,510,173 1.02% Net Profit before tax 134,847,172 52.96% 901,658,156 77.41% 1,352,745,389 80.25% 1,035,524,264 84.54% 10. It was also brought to the notice of the ld. CIT(A) by the assessee that A.Y. 2002-03 was its first year of production comprising of only seven months of working wherein the capacity utilization was only 38.62% whereas A.Y. 2004-05 was comprising of twelve months of manufacturing activity wherein capacity utilization was 96.51%. In this regard, a comparative chart was prepared and furnished by the assessee to show that there was higher capacity utilization, higher average sales realisation and lower cost of raw material consumption in A.Y. 2004-05 as compared to A.Y. 2002-03. the working so furnished by the assessee before the ld. CIT(A) was as under: COMPARISION OF CERTAIN PARAMETERS OF A.Y. 2002-03 WITH A.Y. 2004-05 PARTICULARS A.Y. 2002-03 A.Y. 2004-05 ACTUAL WORK ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lant is also justified in pointing out that in the chart reproduced on page 31 of the assessment order, the Assessing Officer should have worked out the expected amount of cost of raw material with reference to the production of intermediates, as against the basis of sales adopted by him. My attention was drawn by the appellant's representative to Annexure-I (annexed to this order hereinafter) forming part of the statement of facts and grounds of appeal wherein the revised corrected chart for the purpose has been duly worked out by the appellant. (iii) I also find force in the appellant's contention that as pointed out in the above referred chart at Annexure-I, the expected amount of cost of raw materials ought to have been worked out on the basis of respective quantity of production of the two intermediates KSM-14 and KSM-6 and applying the appropriate rate of cost of raw material per Kg. for each of intermediates separately. I find that the Assessing Officer has computed the cost of raw material on the basis of the total quantity of the sales of the two intermediates together which is not the correct method of computation. (iv) The appellant is also justified in poi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... (Amount) % of sales Sales 25.46 168.56 Total Direct Cost 7.26 28.53% 24.63 14.61% Gross Profit (G.P) 18.20 71.47% 143.93 85.39%. Reasons for above increase in G.P. rate as given by the appellant are : (a) Cost of one of the major raw material called Maltol has gone down from Rs.824 per unit in A.Y.2002-03 to Rs.488 per unit in A.Y.2004-05 which means 40% savings on this account. (b) On account of increased capacity utilization from first year i.e. A.Y.2002-03 to the current year i.e. A.Y.2004-05 further savings in cost of production have been achieved. Yet another reason is increased economy in production process enabling them to re-use the spent solvents in A.Y.2004-05 which was not possible in the first year of production i.e. A.Y.2002-03. (c) Yet another reason is that on account of increase in production, further economies in other manufacturing expenses like Power fuel, Repairs in Plant and Machinery etc. have been achieved as per chart (reproduced on pages 5 to 7 of this order) have been achieved. (d) It is obvious that ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t of higher realization against the Euro. As pointed out by the appellant in its submissions, as also verifiable from the sale invoices of both KSM14 and KSM-6 for the Assessment Years 2002-03 to 2004-05 (produced for verification before me by the appellant), the appellant is correct in contending that the sale price had remained the same for all the three years under consideration. Thus the allegation of the Assessing Officer on page 25 of the assessment order that the appellant had calculated different profit margins in contravention with the Articles as contained in the Joint Venture Agreement does not stand justified. When the sale price was constant, but the appellant fetched higher rupee realization on account of the strengthening of the Euro, it was bound to earn higher profits. Moreover, as explained by the appellant, the cost per unit of production had also decreased in A.Y. 2004-05 on account of cheaper availability of raw material, rupee appreciation against dollar, better production and also effective solvent recovery. The average manufacturing cost of production had also decreased on account of greater stabilization of manufacturing process and economy of scale as expl ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... oyalty and/or technical know-how fee has been paid through illegal channels without recording the same in the books of accounts which is the main conclusion drawn by the A.O. regarding alleged abnormal value addition to the finished product. (xiv) So far as the provisions of section 80-IA(10) and 10B(7) are concerned, the application of the same is warranted only in a case when the profits are more than the ordinary profits. The A.O. has taken the profits of A.Y.2002-03 to be the ordinary profits and compared the same with the current year's profits. However, in doing so, he committed arithmetical mistakes and hence, arrived at wrong conclusions. Had he not committed arithmetical mistakes and not used wrong figures, he would have seen that the figures of P L account match with the analysis and there would be no such vast discrepancy as described in the table on page-3 1 of the assessment order. (xv) Yet another observation of the A.O. in the assessment order is regarding supply agreement and basis for export pricing with Byke Gulden group. Article 5.1.2 of the supply agreement as well as Article 21.2 (c) JV agreement stipulates that the initial supply price applicable ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... close connection and the course of business between them was found by the A.O. to be so arranged that the business transactions between them produced to the assessee more than the ordinary profits which was expected to arise in such eligible business. He contended that the A.O. accordingly proceeded to compute the profits and gain of such eligible business for the purpose of allowing deduction u/s 10B of the Act by taking the amount of profits as might be reasonably deemed to have been derived there from. He submitted that it was found by the A.O. in this context that the profit of Rs. 135.27 crores was shown to have been earned by the assessee in A.Y. 2004-05 from the export turnover of Rs. 165.58 crores which was certainly more than the ordinary profits. He invited our attention to the working given by the A.O. in the assessment order for A.Y. 2004-05 to point out that the ratio between the turnover of the assessee and cost of production was substantially higher at 498% in A.Y. 2004-05 as against 211% shown by the assessee company itself in the first year i.e. A.Y. 2002-03. He contended that the A.O. therefore adopted the profit of the assessee company for A.Y. 2002-03 as normal ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ) of the Act and to disallow the claim of the assessee for deduction u/s 10B of the Act to the extent of such extra ordinary profits. He submitted that there were, however, several factual mistakes and errors committed by the A.O. in the working made in this regard. He invited our attention to such working given in the assessment order for A.Y. 2004-05 and also to the relevant portion of the ld. CIT(A)'s order wherein the factual mistakes and errors committed by the A.O. in the said working were pointed out and discussed. He submitted that such errors were not only committed by the A.O. in the working of cost of raw material but the same were there even in the comparative working of profitability made by the A.O. to allege that the profits as shown by the assessee in A.Y. 2004-05 was 498% as against 211% shown in A.Y. 2002-03. He contended that the said percentage was worked out by the A.O. by taking the ratio between the turnover of the assessee company and cost of production which by no means can be regarded as profitability ratio. He contended that even the cost of production was worked out by the A.O. by taking the figures of office and administrative expenses, depreciation etc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... before the A.O. for his verification during the course of assessment proceedings for A.Y. 2005-06. He invited our attention to the copies of such reports placed before us and submitted that there was no adverse comments made in the said report by the auditors and it was duly certified therein that cost account records were properly kept by the assessee so as to give a true and fair view of cost of production and margin of product. 15. We have considered the rival submissions and also perused the relevant material available on record. In the returns of income filed for all the three years under consideration, deduction u/s 10B of the Act was claimed by the assessee in respect of the profits derived from the eligible export business, the turnover of which was entirely made by the assessee company to APAG, Germany, one of the joint venture partners in the assessee company. There is no dispute that the assessee is entitled to deduction u/s 10B of the Act in respect of the profits of the said eligible business. The claim of the assessee for deduction u/s 10B of the Act however was restricted by the A.O. for all the three years under consideration by invoking the provisions of section ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... dition at each stage of production. He also referred to the relevant terms and conditions of the supply agreement between the assessee company and APAG, Germany to ascertain the mechanism of determination of profits provided therein. He also noted that the components of technical know-how and patent capacity utilization were not taken into account by the assessee while computing its profits eligible for deduction u/s 10B of the Act. He also discussed the manufacturing process involved in the business of the assessee along with the chemical equations. He also made an attempt to work out the cost of raw material required for the production of 1 Kg. of final product of the assessee company and tried to show on the basis of such computation that the cost of raw material debited by the assessee company in the profit and loss account was substantially low to increase deliberately the profits of all the three years under consideration in order to claim higher deduction u/s 10B of the Act. He also obtained a report from National Pharmaceutical Pricing Authority, Department of Chemicals Petrochemicals, Govt. Of India based on the cost audit report of the assessee company for the calendar y ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ost of production 129007220 124923253 122517171 229643123 242070851 223111868 50% 52% 55% 8 Cost of sales/Net Profit ratio 255371697 285808416 357861210 249234143 120524525 1187466572 1710606599 1284758407 211.80% 415.47% 478% 515.48% 18. A perusal of the above working made by the A.O. clearly shows that the year-wise percentage worked out by him was the ratio between total turnover and cost of sales. The said ratio, however, was wrongly treated by the A.O. as the ratio between the costs of sales/net profit ignoring completely that the figure of net profit was not at all taken into account in working out the said ratio. Moreover, the entire cost of sales was taken into consideration by the A.O. for making the comparative analysis including the office administrative expenses, selling ex ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 5 5.58% 54,653,573 4.46% Depreciation Others 7,769,028 3.05% 14,654,105 1.26% 16,357,554 0.97% 17,735,798 1.45% Misc. Expenses W/O 389,404 0.15% 389.404 0.03% 1,168,211 0.07% - 0.00% Other Income (757,133) -0.30% (22,624,630) -1.94% (25,022,497) - 1.48% (59,879,198) - 4.89% Total Other Expenses 47,135,329 18,.51% 45,923,681 3.94% 86,555,783 5.14% 12,510,173 1.02% Net Profit before tax 134,847,172 52.96% 901,658,156 77.41% 1,352,745,389 80.25% 1,035,524,264 84.54% The above working furnished by the assessee shows that the gross profit for A.Y. 2003-04, 2004-05 and 2005-06 was increased only by 9.87%, 13.92% and 14.09% in assessment years 2003-04, 2004-05 and 2005-06 as compared to gross profit rate of assessment year 2002-03. On the other hand, the working made by the A.O. on the basis of the same financial data shown the ratio of 415%, 478% and 515% for assessment years ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d explanation which was based on the relevant facts and figures, we are of the view that the ld. CIT(A) was fully justified in holding that the profits of the assessee company from its eligible business for the years under consideration could not be regarded as more than the ordinary profits which are expected to rise in such eligible business so as to attract the provisions of section 80IA(10) of the Act. In our opinion, the A.O., therefore, was not justified in invoking the provisions of section 80IA(10) of the Act to restrict the deduction claimed by the assessee u/s 10B of the Act and the ld. CIT(A) is fully justified in deleting the addition made by the A.O. by restricting the claim of the assessee for deduction u/s 10B of the Act in all the three years under consideration. 21. It is also pertinent to note that APAG, Germany was a joint venture partner in the assessee company having 50% share only and it is difficult to comprehend as to how and why it will enter into any sort of arrangement to allow the assessee company to make more than ordinary profits at its own cost knowing fully well that the benefit of such arrangement as a result of any excess profit could be shared b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ition made by the A.O. by restricting the claim of the assessee for deduction u/s 10B of the Act invoking the provisions of section 80IA(10)/69-C of the Act in all the years under consideration and dismiss ground No. 3 of the Revenue's appeal for A.Y. 2003-04, and ground No. 1 of the Revenue's appeals for assessment years 2004-05 and 2005-06. 24. The next issue which is raised in ground No. 2 of Revenue's appeal for A.Y. 2004-05 and 2005-06 relates to the additions of Rs. 34,15,631/- and Rs. 14,18,133-/- made by the A.O. on account of T.P. adjustment which have been deleted by the ld. CIT(A). 25. During the years under consideration i.e. assessment years 2004-05 and 2005-06, the assessee company had received remuneration for rendering clinical trial services to APAG, Germany, one of its joint venture partners. A reference, therefore, was made by the A.O. to the TPO for determining the arm's length price of these international transactions of the assessee company with its Associated Enterprise. In this regard, the TPO followed his own order for A.Y. 2002-03 and identified one company as comparable which had shown the profit margin of 21.14% as against 5% shown by the assessee. H ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e comparable uncontrolled transactions. Therefore, 17.14% mark up in the case of SIRO Clinpharm (P.) Ltd was required to be adjusted before it could be made applicable for determining the arm's length price in regard to international transaction entered into by the assessee. 10. Lt. D.R. referred to the details of expenses incurred by the assessee which were reimbursed by the associated concern to the assessee contained at pages 152 and 153 of PB and pointed out that the assessee had incurred such expenses which were directly relatable to the research activity. We find the laboratory charges paid are Rs. 11,875/- but the payments to hospital. for initiating study is Rs,7,54,05Of-. This clearly shows that mainly the assessee has made the payment not for laboratory test but mainly to hospitals that carried out the clinical test on the patients. The assessee's infrastructure was only in the form of furniture, vehicle, office equipments and computers, which were used for general administration and it was not sufficient for carrying out the whole research activity. Therefore, the assessee was solely dependent on the data provided by the doctors in various hospitals. The main func ..... X X X X Extracts X X X X X X X X Extracts X X X X
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