TMI Blog2016 (12) TMI 236X X X X Extracts X X X X X X X X Extracts X X X X ..... orthstar, given the scale of business through Norrthstar as a distribution part, is too modest to make it a dominant influence in the nature of control. In this view of the matter, as also bearing in mind the earlier discussions on the issue, the assessee and Northstar can not be treated as ‘associated enterprises’ under section 92 A. We uphold the plea of the assessee. Once the assessee and Northstar are held to be independent enterprise, outside the scope of Section 92A, the very basis of ALP adjustments ceases to hold good in law. The impugned ALP adjustment of ₹ 2,51,91,556 must stand deleted for this short reason alone - Decided in favour of assessee - I.T.A. No. 771/CHNY/2016 - - - Dated:- 30-11-2016 - Pramod Kumar AM and G Pavan KumarJM For The Appellant : T Banusekar For The Respondent : S Bharat ORDER Per Pramod Kumar AM [1] This appeal, filed by the assessee, calls into question correctness of the order dated 26th February 2016 passed by the Assessing Officer under section 143(3) r.w.s. 144C (13) of the Income Tax Act, 1961, for the assessment year 2011- 12. [2] Ground no. 1 is general in nature and it does not call for any adjud ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of the agreed price which was defined as cost of goods sold in the said, fifty percent of excess of sale price realized by Northstar from end customers of such products plus marketing costs over the agreed price i.e. cost of goods sold as specified in the agreement. The additional payments, over and above the agreed price, was thus worked out as follows: Price at which Northstar sells the products to the end customer a Minus : Marketing expenditure actually incurred by Northstar b Reference Price a-b Minus : Agreed price i.e. cost of goods sold, as specified in the agreement c Excess of sale price realized by Northstar over the cost of goods sold (i.e. agreed price) and marketing exps incurred by Northstar (a-b) c i.e. profit through Distribution channel or, a (b+c) Profit through distribution channel to be shared Equally between the asse ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... develop in future. It is in the background of these observations that the Settlement Commission held that the assessee and the distribution partners, including Northstar, were associated enterprises. Since the Transfer Pricing Officer has simply relied upon the order of the Settlement Commission, and, to that extent, adopted the reasoning taken by the Settlement Commission, we consider it appropriate to reproduce the relevant observations in the said order: Export to Distribution Partners 2.2.4.3 The first objection of the Applicant is that the Department has not been able to establish that the Distribution Partners (DPs) and the Applicant are Associated Enterprises . It has been argued that the sub-section (2) of Section 92A can come into play only if sub-section (1) is satisfied. It is submitted that Section 92A(1) requires direct/indirect participation in the management / control / capital of one enterprise of the other and such participation in management/control/capital should be at the enterprise level and not at the transaction level. It is the case of the Applicant that, in its case, it has not been established that there is any participation at enterprise lev ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... se (g) the word wholly has been mentioned. In clause (h) the phrase 90% or more has been used. Hence, if it had been the intention of the legislature that 100% of the goods or the whole of the goods manufactured or processed by one enterprise were to be sold to the other enterprise, the clause would have specified that situation. In other words, in the Applicant's case, it is sufficient if only a part of the goods manufactured by it are sold to the DPs because, in our opinion, the emphasis in the clause are on the words the prices and other conditions relating thereto are influenced by such other enterprises . The sale of goods or articles is only a condition which should precede the influencing of prices and other conditions. In other words, even if 1/2% of goods or articles manufactured or processed by one enterprise is sold to the other enterprise (as long as they are manufactured or processed by the enterprise concerned) clause (i) would still come into play if the prices and other conditions relating to the sale are influenced by the other enterprise. The quantum of sales (%) has no relevance as long as the other limb of the clause (viz. influence on prices and othe ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... element of responsibility and decision making control with regard to marketing and pricing of the products shall belong solely with Par Pharmaceuticals. There are similar stipulations in the agreement with North Star Healthcare Ltd ... Relevant clauses of those agreements with the Applicant are reproduced as under :- Agreement with NHL Clause 6.1 Prices: NHL shall pay to Orchid for each Product supplied a Price in an amount equal to the Cost of Goods Sold, plus fifty percent (50%) of the difference between the Reference Price less the Cost of Goods Sold. The current Cost of Goods Sold for each Product is set forth on Schedule 2 attached hereto next to such Product. There shall be no increase in the API Conversion Cost nor the Finished Dosage Form Conversion Cost during the initial three (3) year term of this Agreement. Any increases thereafter will be discussed between Orchid and NHL in good faith based on market conditions and such increases will be subject of NHL approval. If, in connection with the half-yearly analysis, it is determined that the Cost of Goods Sold as set forth in Schedule 2 are less than or greater than the actual Cost of Goods Sold, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... refore, would come into play. 2.2.4.13 Here we would like to discuss the argument of the Applicant that, though there are similar agreement of one of the DPs (North Star) with other Indian companies, the Department has not initiated any transfer pricing proceedings in the hands of such Indian companies. It is contended that since the DP concerned (North Star) is sharing profits at 50:50 (i.e. in the same ratio as with the Applicant) with the other Indian companies, the same ratio should be accepted as reasonable in the Applicant's case also. The Department had been directed by us to make enquiries in this respect and report the findings. The Department has made enquiries and reported to us that it is true there are similar agreements of North Star with a few other Indian pharmaceutical companies and such agreements are on the same lines (sharing of profit in addition to recovery of cost, etc.). However the learned CIT-III has also pointed out that, just because no transfer pricing proceedings have been initiated in other cases, it does not mean that the issue cannot be considered in the Applicant's case on merits. We agree with the contentions of the learned CIT-lll ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... egal position that the decisions of the Settlement Commission do not constitute a binding precedent and, therefore, the only way the reliance of the authorities below, on the order of the Settlement Commission, can be rationalized is that these authorities have adopted the same line of reasoning as adopted by the Settlement Commission in their order dated 28th March 2012. It is in these circumstances, and for the limited purpose of deciding correctness of the impugned ALP adjustments, that we deal with the reasoning adopted by the authorities below. As we do so, we may take note of the relevant legal provision, i.e. 92A, as follows: Meaning of associated enterprise. 92A. (1) For the purposes of this section and sections 92, 92B, 92C, 92D, 92E and 92F, associated enterprise , in relation to another enterprise, means an enterprise - (a) which participates, directly or indirectly , or through one or more intermediaries , in the management or control or capital of the other enterprise ; or (b) in respect of which one or more persons who participate, directly or indirectly, or through one or more intermediaries, in its management or contr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ns specified by the other enterprise, and the prices and other conditions relating thereto are influenced by such other enterprise ; or (j) where one enterprise is controlled by an individual, the other enterprise is also controlled by such individual or his relative or jointly by such individual and relative of such individual; or (k) where one enterprise is controlled by a Hindu undivided family, the other enterprise is controlled by a member of such Hindu undivided family or by a relative of a member of such Hindu undivided family or jointly by such member and his relative; or (l) where one enterprise is a firm, association of persons or body of individuals, the other enterprise holds not less than ten per cent interest in such firm, association of persons or body of individuals; or (m) there exists between the two enterprises, any relationship of mutual interest, as may be prescribed. [Emphasis, by underlining, supplied by us] [10] A plain reading of this statutory provision makes the legal position quite clear. The basic rule for treating the enterprises as associated enterprises is set out in Section 92A(1). The illustrations in which basic ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ses shall not make them associated enterprises, unless the criteria specified in sub-section (2) are fulfilled . In this sense, Section 92A(2) governs the operation of Section 92A(1) by controlling the definition of participation in management or capital or control by one of the enterprise in the other enterprise. If a form of participation in management, capital or control is not recognized by Section 92A(2), even if it ends up in de facto or even de jure participation in management, capital or control by one of the enterprise in the other enterprise, it does not result in the related enterprises being treated as associated enterprises . Section 92A(1) and (2), in that sense, are required to be read together, even though Section 92A(2) does provide several deeming fictions which prima facie stretch the basic rule in Section 92A(1) quite considerably on the basis of, what appears to be, manner of participation in control of the other enterprise. [11] As a matter of fact, when we look at all the clauses of Section 92A(2)- barring clause (i) which we shall deal with a little later and clause (m) which is a residuary clause enabling any other test being prescribed by the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... other enterprise, and the control is not on account of participation in capital or management. Clauses (g), (h) and (i) refer to the control by one of the enterprise over the other enterprise on account of commercial relationship. Clause (g) refers to a situation in which manufacture or processing of products of one of the enterprise is wholly dependent on certain types of intellectual properties etc owned by the other enterprise or in respect of which such other enterprise has exclusive rights. Clearly, the role of these valuable inputs is so significant that the enterprise owning or having exclusive rights has de facto control over the other enterprise. Clause (h) refers to the situation in which ninety per cent or more of the raw materials and consumables required for the manufacture or processing of goods or articles carried out by one enterprise, are supplied by the other enterprise, or by persons specified by the other enterprise, and the prices and other conditions relating to the supply are influenced by such other enterprise. Here also the role of the enterprise supplying or controlling the supplies of raw materials and consumables is so significant that it virtually ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... als or association of persons, and the other enterprise holds at least ten percent interest in the same. The threshold limit of ten percent essentially relates to significance of the quantum of holding and the control through the same. The common thread in all the clauses of Section 92A(2), barring section 92A(2)(i) with which we will be dealing separately and section 92A(2)(m) which is a dead letter as on now as nothing has been prescribed thereunder, is that one of the enterprise has participation in capital of the other enterprise (clauses a, b, c and d), participation in management of the other enterprise (e and f) or participation by way some of degree of control over the other enterprise ( g and h due to commercial relationship and j, k and l due to other than commercial relationships between the enterprises). 12. It is in this background that we have to address ourselves to the scope of Section 92A(2)(i) which provides that two enterprises will be deemed to be associated enterprises when the goods or articles manufactured or processed by one enterprise, are sold to the other enterprise or to persons specified by the other enterprise, and the prices and other condit ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... no participation by JII in management or capital of PIL (emphasis supplied by us) . We have our reservation, whatever be it s worth, on the conclusions arrived at in this case but that does not dilute our highest respect for an important principles of law laid down by the coordinate bench. The reasons for this approach are as follows. The expression control appearing in Section 92A(1) is very crucial and the manner in which control is exercised could go well beyond capital and management, but the coordinate bench had no occasion to deal with the control aspect at all. As held in the case of Diageo India Pvt Ltd Vs DCIT [(2011) 47 SOT 252 (Mum)], even when an enterprise exercise control over the other enterprises by way of controlling the supply of raw material or use of trade marks, this also constitutes participation in control leading to the status of associated enterprises under section 92A(1). It appears that this aspect of the matter has not been brought to the notice of, or pleaded before, the bench. While the conclusion arrived at by the bench clearly overlooks the specific mention of the word control in both limbs of the basic rule under section 92A(1) (i) a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lf Legal Publishers, the Netherlands @ page 6], as follows: ..in various countries, the concept of associated enterprises may even cover relationships between independent enterprises, for instance, where a foreign buyer has a strong negotiating power . For example, an Indian software company has a customer in Netherlands which is responsible for more than 90% of turnover of Indian software developer. The Dutch customer is able to dictate the prices to Indian software developer. The Indian software company is, therefore, able to charge a price with 1% margin/mark up, which is very low compared to his Indian counterparts (which apply, for instance, 6% mark up). According to the Indian transfer pricing law, if the gods or articles manufactured or processed by one enterprises, are sold to other enterprise abroad or to person specified by such other enterprise, and the prices and other conditions relating thereto are influenced by such other enterprises, the two enterprises shall be deemed to be associated enterprises [See section 92A(2)(i) of the Indian Income Tax Act, 1961] The Indian tax authorities consider the Indian software developer and its Dutch customer to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... an enterprise, management of an enterprise or control of an enterprise, which can lead to the relationship between enterprise being treated as associated enterprises . What essentially follows is that clause (i) of Section 92A(2) has, at its conceptual foundation, de facto control by one of the enterprise over the other enterprise, on account of commercial relationship of its buying the products, either on his own or through any nominated entities, from such other enterprise and in a situation in which it can influence the prices and other related conditions. The wordings of clause (i), however, do not reflect this position in an unambiguous manner inasmuch as it does not set out a threshold of activity, giving de facto control to the other enterprise engaged in such commercial activity, in percentage terms or otherwise- as is set out in clause (g) and (h) or, for that purpose, in all other operative clauses of Section 92A(2). If the words of this clause are to be interpreted literally, as the authorities below have read, even if there is one isolated transaction with an enterprise in such an enterprise can influence the prices, such an enterprise is to be treated as an assoc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... iple is expressed in the latin maxim ut res magis valeat quam pereat . Explaining this principle, Hon ble Supreme Court has, in the case of CIT Vs Hindustan Bulk Carriers [(2003) 259 ITR 449 (SC)], has observed that A construction which reduces the statute to a futility has to be avoided and that A statute or any enacting provision therein must be so construed as to make it effective and operative on the principle expressed in maxim utres magis valeat quam pereat i.e., a liberal construction should be put upon written instruments, so as to uphold them, if possible, and carry into effect the intention of the parties. [See Broom s Legal Maxims (10th Edition), p. 361, Craies on Statutes (7th Edition) p. 95 and Maxwell on Statutes (11th Edition) p. 221.] It is, therefore, important that the expression influence is given a sensible meaning so as to make the provisions of Section 92A(2)(i) workable rather than adopting a literal meaning which will lead to wholly incongruous results. 17. Viewed in this perspective, we must adopt a sensible meaning of expression influence which advances the scheme of the transfer pricing provisions rather than ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... not be treated as associated enterprises under section 92 A. We uphold the plea of the assessee. 18. Ground no. 2 is thus allowed. 19. In view of the fact that we have already held that the assessee and Northstar can not be treated as associated enterprises, transfer provisions will not come into play on the facts of this case, and, therefore, all other issues raised in the present appeal, which are in respect of the quantification of the arm s length price adjustments with respect to transactions with Northstar, are rendered academic and infructuous. We need not deal with those issues at this stage. Once the assessee and Northstar are held to be independent enterprise, outside the scope of Section 92A, the very basis of ALP adjustments ceases to hold good in law. The impugned ALP adjustment of ₹ 2,51,91,556 must stand deleted for this short reason alone. Ground nos. 3,4 and 5 are thus dismissed as infructuous, but the relief prayer for, in this appeal, is granted. 20. As we part with this matter, we may only add that prima facie there is an inadvertent omission, with respect to threshold for application of Section 92A(2)(i)- whether in terms of a percentage of s ..... X X X X Extracts X X X X X X X X Extracts X X X X
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