TMI Blog2019 (5) TMI 1543X X X X Extracts X X X X X X X X Extracts X X X X ..... eld by the Tribunal that the assessee was entitled for relief on this issue even on the basis of non-discrimination clause contained in Article 24(4) of the Indo-Netherland DTAA. We, therefore, respectfully follow the decision of the Tribunal rendered in assessee s own case and delete the disallowance made by the AO u/s 40(a)(i) and confirmed by the ld. CIT(Appeals) - Decided in favour of assessee Disallowance of conversion charges on account of prior period expenses - HELD THAT:- The amount in question payable by the assessee on account of difference between the actual conversion charges and minimum conversion charges for the year under consideration representing contractual liability was in dispute and the same was settled and crystallized only in the F.Y. 2006-07 relevant to A.Y. 2007-08. As rightly contended by the ld. D.R., the assessee, therefore, was not entitled for deduction on account of this contractual liability pertaining to the year under consideration as the same represented disputed liability and since this dispute was settled and the liability was crystallized only in the F.Y. 2006-07, the assessee was entitled for the deduction of the same only in A.Y. 2007- ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e Tax (Appeals)-12, Kolkata dated 29.03.2010. 2. Grounds No. 1 to 5 of this appeal involve a common issue relating to disallowance of ₹ 41,20,200/- made by the Assessing Officer under section 40(a)(i) of the Act and confirmed by the ld. CIT(Appeals) for the alleged non-deduction of tax at source from the payment made for Microsoft licence fees. 3. The assessee in the present case is a Company, which is engaged in the business of manufacturing, trading and sale of pharmaceutical products as well as manufacturing of ready-to-eat foods products on contract basis for Government. The return of income for the year under consideration was filed by it on 31.10.2005 declaring total income of ₹ 24,50,77,530/-. As noted by the Assessing Officer during the course of assessment proceedings, the assessee had paid an amount of ₹ 41,20,200/- to its Associated Enterprise at Netherland namely M/s. Organon NV and the same was claimed to be towards reimbursement of expenses. It was claimed on behalf of the assessee-company in this regard that its Netherlands based Associated Enterprise had purchased Software on licence from Microsoft for use by all its ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... see to deduct tax at source from the said amount attracted the provisions of section 40(a)(i) and the disallowance made by the Assessing Officer by invoking the said provision was confirmed by the ld. CIT(Appeals). He also took note of the fact that a similar issue was involved in assessee s own case for A.Ys. 2003-04 and 2004-05 and the same was decided by the first appellate authority. 5. The ld. Counsel for the assessee submitted that a similar issue was involved in assessee s own case for earlier years i.e. A.Ys. 2003-04 and 2004-05 and the same has already been decided by the Tribunal in favour of the assesese vide its common order dated September 20, 2017 passed in ITA Nos. 863/KOL/2008 and 978/KOL/2009. He also invited our attention to the relevant portion of the order of the Tribunal as contained in paragraph no. 14 to 18 and submitted that a similar amount paid by the assessee-company to its Netherlands based Associated Enterprise for its share of the expenditure incurred on purchase of Software on licence from Microsoft USA was held to be not liable for deduction of tax at source by the Tribunal and the disallowance made under section 40(a)(i) was deleted. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ct tax at source from the said payment under section 195. It was further held by the Tribunal that the assessee was entitled for relief on this issue even on the basis of non-discrimination clause contained in Article 24(4) of the Indo-Netherland DTAA. The Tribunal accordingly deleted the disallowance made by the Assessing Officer under section 40(a)(i) of the Act and confirmed by the ld. CIT(Appeals) in both the years i.e. A.Ys. 2003-04 and 2004-05. 9. At the time of hearing before us, the ld. D.R. has not disputed the fact that this issue stands squarely covered in favour of the assessee by the decision of the Tribunal rendered in assessee s own case for A.Ys. 2003-04 and 2004-05. He, however, has relied on the decision of the Hon ble Calcutta High Court in the case of CIT vs.- Andaman Sea Food Pvt. Limited (ITAT No. 19 of 2013 dated 23.07.2014) which, according to him, supports the revenue s stand on this issue. However, as rightly contended by the ld. Counsel for the assessee, the said case decided by the Hon ble Calcutta High Court is distinguishable on facts, inasmuch as, the transactions under consideration in the said case were not covered by the relevant D ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f income for F.Y. 2006-07 relevant to A.Y. 2007-08 being the expenditure of prior period. During the course of assessment proceedings for the year under consideration, i.e. A.Y. 2005-06, the assessee claimed a deduction of ₹ 35,87,454/- being the expenditure incurred on conversion charges pertaining to A.Y. 2005-06. Since the said deduction was not claimed by the assessee either in the original return or even in the form of revised return, the Assessing Officer did not entertain the claim of the assessee for the said deduction by relying on the decision of the Hon ble Supreme Court in the case of Goetze India Limited [284 ITR 323]. On appeal, the ld. CIT(Appeals) upheld the action of the Assessing Officer on this issue by observing that the assessee was not entitled to make any fresh claim, which was not made either in the return of income originally filed or by way of filing a revised return. 12. The ld. Counsel for the assessee submitted that the assessee was liable to make good any short-fall in the minimum conversion charges payable as per the agreement entered into with a contract manufacturer. He submitted that such short-fall pertaining to the year unde ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... and crystallized. 14. We have considered the rival submissions and also perused the relevant material available on record including the Audit Note on the issue under consideration as given at page no. 380 of the paper book. It is observed that there was a difference between the actual conversion charges and minimum conversion charges for the year under consideration as payable by the assessee to M/s. ASG Bio Chem Limited in terms of the Loan Licensing Agreement dated 1st January, 2005. It is also observed that Debit Notes for such difference were raised by M/s. ASG Bio Chem Limited during the year under consideration on 15.02.2005 and 15.03.2005. However, the amount raised in the said Debit Notes was not accepted by the assessee and the same was in dispute. The said dispute was finally settled in the financial year 2006-07 relevant to assessment year 2007-08 and accordingly the amount of difference payable by the assessee to M/s. ASG Bio Chem Limited was debited to the Profit Loss Account for the F.Y. 2006-07. It is thus clear that the amount in question payable by the assessee on account of difference between the actual conversion charges and minimum conversion c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Sales/Commissioner income 7,50,96,654 5331094 Material consumed 51401792 1425626 Adjustment for difference -18275397 -200396 Material consumed 33126395 1225230 Purchase for trading NIL NIL Excise duty NIL NIL Adjustment for difference NIL NIL Purchases for trading NIL NIL Gross Margin 23694862 3905468 Value Adding expenses(VAE) ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... fficer found that administrative and other allocable expenses had not been allocated by the assessee to the segment, wherein sales were made to the Associated Enterprises and the same were entirely allocated to the segments where sales were made to the unrelated parties. He also found that operating margin to sales in case of sale made to unrelated parties was 31.51% as compared to 11.36% in case of sales made to Associated Enterprises. As noted by the Transfer Pricing Officer, if the administrative and other expenses had been allocated to the segment involving sales made to the Associated Enterprise, profit of the said segment would have further gone down. He accordingly required the assessee to explain as to why the transactions of the segment involving sales made to Associated Enterprise should not be considered as not being entered into at Arm s Length since both the purchases and sales were controlled transactions entered into with the related parties. In reply, the following explanation was offered by the assessee:- On and from Financial Year 2003-04, Organon India Limited (OIL), apart from having its own manufacturing facilities, also started sub-contractin ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ed by OIL with respect to the above mentioned international transactions has been summarised as under:- OIL imports raw materials from group companies as well as non group companies, which are used in the manufacturing of the final products, the nature of the pharmaceutical industry is such that the quality of inputs (specially the active ingredients) is of paramount importance in determining the quality of the end product. Before a raw material can be used in the production process, the quality parameters need to be set. Once the raw materials pass the quality control procedure, they can be used for the production process. In the case of OIL, such quality testing is generally done by the associate enterprise from whom the raw materials are purchased. In the case of imports from non group entities (i.e. third parties) quality testing is done by OIL. The other general functions performed in the course of purchase of raw materials are receiving an indent, obtaining quotations, placing of purchase orders, making timely shipments and payment to the suppliers. In relation to segment 2, OIL does not perform any quality control functio ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the assessee s contention that two segments could not be functionally compared and applying the operating profit margin to sales of 31.51% of the segment involving export of goods to unrelated parties after allowing the adjustment of 1.51% on account of commission/charges paid to the loan manufacturer in lieu of the services, he determined the arm s length operating margin of the assessee-company of the segment involving export to Associated Enterprise at ₹ 2,25,38,783/- as against the operating margin of ₹ 85,34,686/- shown by the assessee. Accordingly Transfer Pricing Adjustment of ₹ 1,40,04,097/- (₹ 2,25,38,783/- minus 85,34,686/-), was worked out by the Transfer Pricing Officer in respect of these international transactions of the assessee-company with its Associated Enterprise and in the assessment completed under section 143(3) vide an order dated 22.12.2008, an addition to that extent was made by the Assessing Officer to the total income of the assessee on account of transfer pricing adjustment. 19. The addition of ₹ 1,40,04,097/- made by the Assessing Officer on account of transfer pricing adjustment was challenged by the assess ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ple that there was no apparent purpose or utility of such audit to the assessee. Therefore, I find no merit in the decisions of the TPO in this respect and hence, the AO. is directed to allow the claim .... Based on the judgment of the CIT (Appeals), the appellant humbly submits before your goodself, that, the adjustment of ₹ 1,400,719 made by the TPO and as accepted by AO is erroneous and bad in law since the same is in contradiction of the provisions of the Act and against the decision of various Tribunal. D. Variance of 5% from the arithmetical mean as provided under the Act has not been allowed by the TPO and the Assessing Officer. Further, the Ld. A.R. made submissions vide his letter dt. 2409-2009 as under: Adhoc allowance by the Transfer Pricing Officer ( TPO ) and the Assessing Officer ( AO ) of 1.51 % as commission charges payable to the loan manufacturer 1.0 The appellant would like to reiterate from the submission dated 5th June dated 2009 (Copy of the same is attached as Appendix 1) that the TPO has wrongly compared 'segment 2' with 'segment 3' (where purc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... (d) conditions prevailing in the markets in which the respective parties o the transactions operate, including the geographical location and size of the markets, the laws and Government orders in force, costs of labour and capital in the markets, overall economic development and level of competition and whether the markets are wholesale or retail. The TPO' and accordingly the AO while comparing the two segments and also computing the adjustment did not take cognizance to the parameters laid down in Rule 10B of the Rules. 2.1 Further, the Rules also provides that an uncontrolled transaction would be comparable to an international transaction if 1. None of the differences between the transactions being compared or between the enterprises entering into such transactions materially affect the price of the international transaction, or 2. A. reasonable adjustment could be made to eliminate the effects of such differences. In this regard, reference, can be drawn from Rules 10B (3) of the Rules, 10B (3) An uncontrolled transaction shall be comparable to an international transaction if - i) ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... action is on the ground that the TPO/AO failed to communicate to the appellant the relevant clause u/s 92C(3) of the Act which triggered the application of provisions of the transfer pricing. But this objection of the appellant has no substance at all as the reference to TPO was made by A.O u/s 92CA(1) and not u/s 92C(3). Hence appellant's objection raised vide ground no. 5 is rejected. 5.3.2. The appellant's other objections to adjustment are on the ground of non-comparability of both segments on account of FAR differences, involvement of related party transactions in both segments etc. In this connection my observations are as under: (i) The appellant has imported raw materials from its AE and in turn exported goods after manufacturing to its AE's and non AE's both. The goods exported to AE's have been manufactured by- the appellant through the loan licensee (contract manufacturer) and this segment is hereinafter called 'segment 2' and the goods exported to non AE's have been manufactured by the appellant itself and this segment is hereinafter called 'segment 3'. The A/O has compared these two segments an ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... implies that after making such adjustments 'segment 3' had become comparable to 'segment 2'. (iv) Moreover, the manufacturing cost in case of 'segment 2' represents cost of job charges paid to loan licensee. It is observed that the ratios of manufacturing costs to raw materials consumed are 42.86% in case of segment 2 being contract manufacturing and 45.98% in case of segment 3 being own manufacturing, It means the outsourcing of manufacturing facility is beneficial in the case of the appellant also. But the ratios of gross margin to sales are 31.55% in case of 'segment 2' and 73.26% in case of 'segment 3' which shows that in spite of the fact that the contract manufacturing is beneficial the gross margin to sales in case of 'segment 2' is very low as compared to 'segment 3'. This proves that the appellant sell goods to its AE's at prices lower than the market price, so that on resale most of the profits would be reported in AE's jurisdiction. (v) Reliance is placed on Ranbaxy Laboratories Ltd. Vs. ACIT (2008) 110 ITD 428 (Delhi) wherein the Hon'ble Tribunal has dismissed the ass ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sfer Pricing Officer were functionally different. He submitted that even though the raw material consumed in both these segments was purchased by the assessee-company from the related parties, the products manufactured from one segment and sold by the assessee to Associated Enterprises was classified as active pharmaceutical ingredients or bulk drugs while the products of the other segment manufactured and sold to unrelated parties were formulations. He also invited our attention to the list of such products manufactured in both the segments and submitted that the active pharmaceutical ingredients/bulk drugs produced by the assessee in one segment were in the nature of intermediates which were required to be further processed by the Associated Enterprises to produce the final products for sale to their customers. He submitted that the formulations produced in the other segment by the assessee-company and supplied to the unrelated parties, on the other hand, were final products. By relying on the decision of Ahmedabad Bench of ITAT in the case of Inducother (India) Pvt. Limited vs.- DCIT, he contended that these two segments, therefore, were not comparable and the Transfer Pricing ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... contended that there was thus no functional difference in these two segments and even if there was some difference in the nature of products manufactured as pointed out by the ld. Counsel for the assessee, the same is not relevant when the method adopted is TNMM. As regards the difference in risk undertaken in two segments as pointed out by the ld. Counsel for the assessee, he contended that such difference is only marginal and not substantial. He contended that when these two segments are found to be the functionally comparable, some adjustments can be made for the marginal difference in risk undertaken while determining the transfer pricing adjustment. 23. We have considered the rival submissions and also perused the relevant material available on record. It is observed that the segment in which sales were made by the assessee to its Associated Enterprises, the products were in the nature of active pharmaceutical ingredients/bulk drugs, which were intermediates and the said intermediates were required to be further processed by the Associated Enterprises for producing the final products for sale of its customers. In the other segment where sales made by the assess ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y risk involved in the relevant transactions. 25. It is pertinent to note here that the two segments compared in the process of transfer pricing analysis done in the year under consideration were also sought to be taken as comparables by the Transfer Pricing Officer in A.Y. 2007-08 and when specific query was raised by him, the difference in business profile of both these segments was explained by the assessee by pointing out that the final products exported to Associated Enterprises were active pharmaceutical ingredients, which were active chemicals with medicinal properties used in the further manufacturing of drugs (formulations), whereas the goods exported to unrelated parties were formulations being the finished products (Drugs). It was also pointed out by the assessee that the nature of risk borne by the assessee in these two segments was different, inasmuch as, the risk undertaken in the manufacturing and export of goods to Associated Enterprises was low while the risk undertaken in manufacturing and export of final products to unrelated parties was high. As pointed out by the ld. Counsel for the assessee from the Transfer Pricing Officer s order dated 28.10. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tment of ₹ 14,00,719/-. When the addition was made by the Assessing Officer on account of this transfer pricing adjustment, the assessee challenged the same in the appeal filed before the ld. CIT(Appeals). During the course of appellate proceedings before the ld. CIT(Appeals), it was submitted on behalf of the assessee-company that it did not have any internal audit department in its organisation and hence internal audit services were availed from external agencies in order to have an internal audit system commensurate with its size and nature of business. The benefits received from such internal audit services were also explained by the assessee before the ld. CIT(Appeals). The ld. CIT(Appeals), however, did not find merit in the case of the assessee on this issue and confirmed the addition made by the Assessing Officer on account of transfer pricing adjustment for the same reasons as given by the Assessing Officer. 29. We have heard the arguments of both the sides on this issue and also perused the relevant material available on record. Although the ld. D.R. has strongly relied on the orders of the authorities below in support of the revenue s case on this i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... (Appeals) while deciding this issue vide his impugned order passed for the year under consideration. As found by the ld. CIT(Appeals) in A.Y. 2004-05, the assessee-company was benefited by the internal audit by way of better control, better administration and better functioning and keeping in view the same, the Transfer Pricing Officer s conclusions that no tangible benefit had accrued to the assessee-company directly or indirectly by such internal audit was held to be incorrect by the ld. CIT(Appeals) in A.Y. 2004-05. Even in his impugned order passed for the year under consideration, the ld. CIT(Appeals) accepted the fact that the internal audit conducted by the parent company was to ensure that the affairs of the assessee company are carried out as per the global practices of the group. He, however, held that the parent company was not willingly appointed by the assesese-company to conduct the audit and, therefore, there was no additional benefit that had accrued to the assessee directly or indirectly from such audit. Keeping in view all the facts of the case as well as the decision of the ld. CIT(Appeals) in assessee s own case for the immediately preceding year i.e. A.Y. 2004- ..... X X X X Extracts X X X X X X X X Extracts X X X X
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