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TMI Blog2015 (1) TMI 699X X X X Extracts X X X X X X X X Extracts X X X X ..... product development. Assessee's facilities also develops APIs for third parties as well. On the whole, the assessee provides contract manufacture, contract research and development to its parent AE at the US. The parent AE in the US is engaged in development, manufacture and sale and distribution of proprietary and off patent generic pharmaceutical products. 3. Though the parent AE and its 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 we ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... used TNMM as Most Appropriate Method to benchmark the transaction, using OP/TC (Operating profit to Operating Cost) as PLI". based on the following comparables 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 regard, it is to be stated that there are sufficient number of comparable companies are available in the R&D sector, as evidenced by the comparables considered by the TPO. Secondly, even under TNMM, the primary emphasis is on to search for comparables, as close as possible to the functions ca ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... inal 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 2 TCG Lifesciences Ltd 41.33 3 Vimta Labs Ltd 13.04 4 Alphageo (India) Ltd 20.25 5 Jubilant Chemsys Ltd 27.18 6 GVK Biosciences Pvt. Ltd 16.61 7 Siro Clinpharm Pvt Ltd 25.59 8 Syngene Intl Ltd. 28.87 9 Research Support Intl Pvt Ltd 23.30 10 Aurigene Discovery Technologies Ltd. 16.23 Mean 23.61 Assessee's PLI 17.43 and arrived at the following result "In view of the above discussions, the international transactions on account of Contract R&D services provided by the assessee to its AE are proposed to be benchmarked to determine the ALP, by applying the mean margin of 23.61% of the nine comparables finally selected and retained from the list of the nine comparables finally selected and retained from the list of comparables suggested by ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... cts to be launched in US market in generic drugs. As the association is mutually beneficial, the split of location savings between assessee and its AE are treated as 50%:50% and accordingly, the location savings of Rs. 18,08,68,785/- is divided between the assessee and the AE on a 50 : 50 basis. In light of above, an adjustment of Rs. 9,04,34,392/- is proposed to the arm's length of the price of the international transactions of assessee on account of location savings. 7. Summary The transfer pricing adjustments made in this order are summarized as under: Sr. No. Nature of adjustment Amount (Rs) 1 Location Savings arising in the manufacturing segment 25,19,22,871 2 Adjustment in product development R & D segment under TNMM 1,93,27,475 3 Location Savings arising in the product development R&D segment 9,04,34,392 TOTAL 36,16,84,738 16. The TPO, therefore, suggested the TP adjustment at Rs. 36,16,84,738/-. The adjustment so made has been sustained 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 de ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ecession, the outsourcing of clinical trials from USA and Europe has slowed down and the company needs to explore local opportunities also to fulfil the business requirements of the CR0 venture. The huge monthly rentals for this building will also he a burden to the company in case of any potential problem in getting the Clinical Trails/CR() contracts from the west ... " (refer page no 311 of the paper book). The above extracts demonstrate that they are into clinical trials and contract research (CR0) like the assessee. 11. Another company accepted by TPO namely Siro Clinpharm Pvt. Ltd. is also engaged in Clinical Research & Development Services apart from other services. Thus, the TPO has also considered broadly comparable companies. The relevant extract of Annual Report of Siro Clinpharm Pvt. Ltd. is as follows: "Revenue from clinical trial research activities is accounted for as and when the services are rendered as per the terms and conditions 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ervices 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 assessee had included the results of Dolphin. 23. The AR submitted that functional profile of Dolphin was broadly similar to that of the assessee. The AR submitted that besides the OECD Guidelines issued in July 2010 in para 2.62, and the relevant Income Tax Rules 1962 i.e. Rule 10b(2) also emphasize that functionally similar companies can be treated as comparables. The AR submitted that Dolphin is into the business of clinical trial services, which is broadly similar to the function of the assessee. This fact, it is noted is not countered by the DR, who submitted that when TPO and DRP have excluded the results of Dolphin, then it is necessary that the r ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s 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 the light of the above, we are of the considered opinion that results of Dolphin should not be excluded, as Dolphin is functionally acceptable comparable, whereby, the resultant PLI shall fall within safe harbor of +/-5 and no adjustment shall be required. 25. We therefore, direct the revenue authorities to delete the addition made on contract research and development segment, made at Rs. 2,04,84,562/-. 26. Another aspect intrinsically attached to the above ground is the risk adjustment, not taken into consideration by the TPO/DRP. It had been contended "Before Hon'ble DRP, Assessee contended that economic adjustment for difference in risk profile of Assessee vis-&agra ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 book for submission of Risk Adjustment made to Hon'ble DRP) 19.2 Research and development activities pertaining to pharmaceutical industry (clinical trial, chemical research, formulation development etc) can be broadly classified under two models (a) where risks are borne by service provider and (b) where risks are not borne by service provider 19.3 By and large all Indian research and development service providers would fall under category (a) whereas research and development service providers set by multinational units would fall under category (b) 19.4 Contract Research and development service providers set by multinational companies operate on shared service concept basis. Revenue models are ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... -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 assessee to its AEs. 32. However, the TPO/DRP contended that the assessee ought to have received extra compensation on account of location savings over and above the margins earned by the comparables. The TPO/DRP then proceeded with the computation of location savings by use of articles appearing in journals and websites. 33. The TPO/DRP, allocated the location savings on ad-hoc basis by dividing the savings equally between Assessee and its AE. Based on this approach TPO/DRP made an adjustment of Rs. 34,23,57,263/- on account of location savings in respect to the contract manufacturing segment and contract research and development segment. The break-up of the adjustment is as follows: Sr. No. Particulars Amount 1 Locatio ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 Rs. 25,19,22,871/-. 41. Aggrieved by this adjustment/addition, the assessee approached the DRP. 42. Before DRP, the assessee contented that adjustment in respect of location savings is not warranted because, the assessee had complied with the provisions of Section 92C(1) and 92C(2) of the Act for determining arm's length price of international transactions with AE. That the TPO erred in disregarding the transfer pricing analysis carried out by the assessee and has failed to appreciate that in the case of the assessee none of the conditions set out in Section 92C(3) of the Act get satisfied. 43. It was argued that the assessee does not have exclusive access to the factors that may result in the location specific advantages. As a result, there is no super profit that arises in the entire supply chain. 44. It was further pointed out that the comparables selected by the assessee are local Indian comparables, operating in similar economic circumstances as the assessee, and accordingly, if at all, t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ngs 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 saving is to be attributed. This argument of the assessee was rejected by the DRP stating that it cannot be said that the assessee has been remunerated at the arm's length price. In support of its contention assessee has submitted that as its margins are better than full fledged manufacturers of pharma in India or research and development service providers, the price realized by it from its AE is at arm's length. However in this regard comparing profits is not reliable. As stated by the assessee, it is selling generic pharma products to its AE for which there are number of competitors in the market. So, the more reliable measure of the arm's length price will be sale price of other manufacturers in USA. 50. DRP further asked assessee to provide information relating to sale price prevailing in the US market in respect of the goods exported by the assessee to its AE. Assessee furnished a reply dated December 17, 2013 wherein details of only 19 stock keeping units (SKUs) (out of 79 SKUs) was avail ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 10K of Watson Pharmaceutical Inc. is as follows: "We actively compete in the generic pharmaceutical industry. Revenues and gross profit derived from the sales of generic pharmaceutical products tend to follow a pattern based on certain regulatory and competitive factors. As patents and regulatory exclusivi ty for brand name products expire or are successful ly challenged, the first off-patent manufacturer to receive regulatory approval for generic equivalents of such products is generally able to achieve significant market penetration. As competing offpatent manufacturers receive regulatory approvals on similar products, market share, revenues and gross profit typically declines, in some cases dramatically. Accordingly, the level of market share, revenues 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, in relat ion to compet ing approvals and launches. Cons ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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. Mylan Inc. and Teva Pharmaceutical Industries Ltd. 56. According to the AR, neither Watson US (i.e. AE) nor the assessee have any monopoly in the market in which they operate and neither the assessee has general access to all the location specific advantages. Accordingly, if there exists any location savings because of market forces, they would be passed on to the ultimate customers of Watson US (i.e. AE). On this point the AR relied on the decision of Hon'ble Delhi Income Tax Appellate Tribunal in the case of GAP International Sourcing (India) Pvt. Ltd vs. ACIT (2012) 149 TTJ 437 (Del ITAT) at Para 9.2 (vii) Page 43 held, "... the intent of sourcing from low cost countries for a manufacturer/retailer is to survive in stiff competition by providing a lower cost to its end-customers. Generally, the advantage of location savings is passed onto the end-customer via a competitive sales strategy....". The AR to clarify that no additional evidence had been submitted, submitted that the 10K document, as referred to in the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... perating 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 the case of GAP International Sourcing (India) Pvt. Ltd. (supra), wherein the Tribunal held, "The arm's length principle requires benchmarking to be done with comparables in the jurisdiction of tested party and the location savings, if any, would be reflected in the profitability earned by comparables which are used for benchmarking the international transactions. Thus in our view, no separate/ additional allocation is called for on account of location savings". 61. Further, OECD and G20 in Action 8: Guidance on Transfer Pricing Aspects of Intangibles which is part of Base Erosion and Profit Shifting Project, has provided guidance on issue of location savings and concluded that where local market comparables are available specific adjustment for location saving is not required. All the G20 countries have give their concurrence to this position and India is part of G20 countries. Relevant extracts of Action 8 are as follows: "1.83 Where the functional analysis shows that location savings exist that are not passed on to custo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... inate Bench of the Mumbai ITAT, in the case of Lloyds TSB Global Services (P) Ltd., reported in 33 taxmann.com 259, wherein the ratio laid down was, "For carrying out comparability analysis, it is to be seen as to whether comparable company is comparable having regard to characteristic of property and services, functions performed, assets used and risk assumed". 66. The concept of Transfer Pricing is based on the principle that instead of entering into a transaction with related party, if the assessee had entered into a similar transaction with unrelated party, what would have been the prices of said transaction between the assessee and unrelated party. The comparison is always in the context of the effect of the related party transaction and unrelated party transaction in the hands of the assessee. Therefore, the financial 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. This ratio laid down by the Co-ordinate Bench at t Mumbai in the case of Syscom Corporation Ltd. vs. ACIT, reported in 35 taxmann.com 600 (Mumbai - Trib.). Relevant extract of the Syscom ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nt extract of which is given below: "consensus has been sought as far as possible, it was considered most in accord with a practical manual to include some elements where consensus could not he reached, and it follows that specific views expressed in this Manual should not he ascribed to any particular persons involved in its drafting. Chapter 10 is different from other chapters in its conception, however. It represents an outline of particular country administrative practices as described in some detail by representatives from those countries, and it was not considered feasible or appropriate to seek a consensus on how such country practices were described. Chapter 10 should be read wit/i that difference in mind". 70. In fact in Action 8: Guidance on Transfer Pricing Aspects of Intangibles issued by OECD and G20 states that where local market comparables are available specific adjustment for location saving is not required. G20 countries have also give their concurrence to this position and India is part of G20 countries. 71. This, in any case is inconsistent with TPO's own approach for assessment year 2008-09. 72. In assessment year no adjustment has been made by the TPO o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... for the purposes of computing deduction u/s 10B. 80. The AO found that the assessee had taken into consideration the income generated as interest and sale of scrap, for the purposes of computation of deduction u/s 10B. He treated the same as income from other sources, being not derived from the operations of business. He relied on various decisions, which were countered by the assessee, but the AO excluded the income from interest and sale of scrap from the computation. 81. Against this, the assessee along with TP issues approached the DRP, who sustained the disallowance made by the AO. 82. Against these disallowances, the assessee is now before the ITAT. 83. Before us, the AR submitted that the instant issue is covered by the decision in the case of Maral Overseas Ltd. vs Add. CIT, reported in 16 ITR 565 (Trib-Indore) and also by the Bangalore Bench of the ITAT in the case of GE India Technology Center (P) Ltd. vs DDIT, reported in 30 taxmann.com 249 (Bang) and is now covered by the Hon'ble Karnataka High court in the case of CIT vs Motororala India Electronics (P) Ltd. reported in 265 CTR 94, wherein it has been observed, "For the purposes of sub-section (1), the profits de ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ued as income of the business of the undertaking. There is a direct nexus between this income and the income of the business of the undertaking. Though it does not par take the character of a profit and gains from the sale of an article, it is the income which is derived from the consideration realized by export of articles. In view of the definition of 'Income from Profits and Gains' incorporated in Subsection (4), the assessee is entitled to the benefit of exemption of the said amount as contemplated under Section 10B of the Act. Therefore, the Tribunal was justified in extending le benefit to the aforesaid amounts also. We do not find any merit in these appeals". 84. Similar view was taken in the decision rendered earlier by Hon'ble Bombay High Court in the case of CIT vs Lok Holdings, reported in 308 ITR 356 (Bom), wherein it was held, "interest earned by the assessee, a property developers, by making temporary deposits of surplus money out of advances received by it from intending purchaser is business income and cannot be assessed as "income from other sources". 85. In such a situation where the incomes sought to be taxed are intrinsically connected to the business ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s of business. This is anterior to the application of the provisions of s. 72 which deals with the carry forward and set off of business losses. A distinction has been made by the Legislature while incorporating the provisions of Chapter VI-A. Section 80A(1) stipulates that in computing the total income of an assessee, there shall be allowed from his gross total income, in accordance with and subject to the provisions of the Chapter, the deductions specified in ss. 80C to 80U. S. 80B(5) defines for the purposes of Chapter VI-A 'gross total income" to mean the total income computed in accordance with the provisions of the Act, before making any deduction under the Chapter. What the Revenue in essence seeks to attain is to telescope the provisions of Chapter VI-A in the context of the deduction which is allowable under s. 10A, which would not be permissible unless a specific statutory provision to that effect were to be made. In the absence thereof, such an approach cannot be accepted. Thus ITAT was correct in holding that the brought forward unabsorbed depreciation and losses of the unit the Income which is not eligible for deduction under s. 10A of the Act cannot be set off aga ..... X X X X Extracts X X X X X X X X Extracts X X X X
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