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TMI Blog2021 (10) TMI 908X X X X Extracts X X X X X X X X Extracts X X X X ..... nsfer Pricing - 2(2) (Ld. TPO) in making an adjustment of Rs. 21,69,17,701 on allocation of alleged location savings with respect to provision of facilitation and co-ordination services provided by the Appellant to the Associated Enterprises (`AE') for performing clinical trials in India. 2. On the facts and in the circumstances of the case and in law, the Ld. AO /TPO erred in treating the alleged location savings to the Appellant as an international transaction as per Section 92B of the Act. 3. Without prejudice to Ground No. 2, the Ld. AO /TPO erred in not following any of the method prescribed by the Act under Section 92C(1). 4. On the facts and in the circumstances of the case and in law, the Ld. AO /TPO and the Hon'ble DRP erred in presuming that location savings advantage accrues to the Appellant. In doing so Ld. AO /TPO: a) disregarded the fact that the clinical trials are undertaken in India as per the instructions of the Sponsor and in line with the Indian regulatory requirement; b) disregarded the fact that, the Appellant as well as the AEs operated in a perfectly competitive market and the services of the Appellant do not confer any unique competitive a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... current year i.e. AY 2013-14, relying on the TP order for AY 2011-12, the TPO alleged that conducting the clinical trial in India by the AEs through the assessee resulted in location savings for the AEs since the regulatory and compliance cost as well as investigatory costs were significantly lower in India as compared to developed countries where AEs were located. Resultantly, the cost savings that accrue to the AE ought to be shared with the assessee in India. 4. To make the adjustment, the TPO relied upon a random non-contemporaneous article titled 'Clinical Trial Magnifier Vol. 1:6 Jun 2008' published on the website www.clinicaltrialmagnifier.com and computed location savings amounting to Rs. 29,11,647 per clinical trial. The TPO then multiplied the said alleged savings per clinical trial by the total number of clinical trials undertaken in India i.e. 149. Accordingly, the TPO arrived at a total cost savings of Rs. 43,38,35,403 (Rs. 29,11,647*149). The said purported savings were split in the ratio of 50:50 between the AE and the assessee and thereby, TPO proposed an adjustment of Rs. 21,69,17,701 on account of alleged location savings. 5. Aggrieved, the assessee file ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... are applied for determination of ALP. Therefore the location savings and advantages are very much relevant in the cross border transaction but for limited purpose of carrying out exercise of examination and investigation of the transaction and not as a basis for determining the ALP and consequently adjustment. We find that the Mumbai Bench of the Tribunal in the case of Watson Pharma (P.) Ltd. (supra) has dealt with this aspect and held that when the local comparables are available then instead of going to the location saving as a basis of adjustment, the TNMM shall be preferred. Similar view was taken by the Tribunal in the case of Syngenta India Ltd. (supra) in paras 17 to 20 as under: '17. We have heard the rival submissions and perused the relevant finding given in the impugned orders qua the issue of Transfer Pricing adjustment on account of locational savings. The TPO noted that, one unit of the assessee is captive manufacturer which is producing agro chemicals for sale to the world market by a Singapore based entity. Due to unique location of operating in India, the assessee company is able to generate cost savings on one or many of the factors of production for which ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ing taken of the possible costs involved in the relocation (such as termination costs for the existing operation, possibly higher infrastructure costs in the new location, possibly higher transportation costs if the new operation is more distant from the market, training costs of local employees, etc.). Where a business strategy aimed at deriving location savings is put forward as a business reason for restructuring, the discussion at paragraphs 1.59- 1.63 is relevant; 9.149 Where significant location savings are derived further to a business restructuring, the question arises of whether and if so how the location savings should he shared among the parties. The response should obviously depend on what independent patties would have agreed in similar circumstances. The conditions that would be agreed between independent parties would normally depend on the functions, assets and risks of each party and on their respective bargaining powers; 9.150 Take the example of an enterprise that designs, manufactures and sells brand name clothes. Assume that the manufacturing process is basic and .that the brand name is famous and represents a highly valuable intangible. Assume that the ent ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... high. The enterprise subsequently opens a subsidiary in Country Y where it hires equally qualified engineers for substantially lower wages, and sub-contracts a large part of its engineering work to its subsidiary in Country Y, thus deriving significant location savings for the group formed by the enterprise and its subsidiary. Clients continue to deal directly with the enterprise in Country X and are not necessarily aware of the sub-contracting arrangement. For some period of time, the well known enterprise in Country X can continue to charge its services at the original hourly rate despite the significantly reduced engineer costs. After a certain period of time, however, it is forced due to competitive pressures to decrease its hourly rate and pass on part of the location savings to its clients. In this case also, the question arises of which party/ies within the MNE group should be attributed the location savings at arm's length: the subsidiary in Country Y, the enterprise in Country X, or both (and if so in what proportions); and 9.153 In this example, it might be that there is a high demand for the type of engineering services in question and the subsidiary in Country Y ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tion savings; thirdly, the extent to which locational savings are either retained by a Member or Members of the MNE Group or are passed on to independent customers or suppliers; and lastly, where locational savings are not fully passed on to independent customers or suppliers, the manner in which independent enterprises operating under the similar circumstances would allocate any retained net location savings. Guidelines further states that, suitable comparability adjustment is to be made to account for location savings advantage giving rise to location savings, when function analysis shows that location savings are not passed on to customers or suppliers and there is no local market comparables then, adjustment can be made based on analysis of all the relevant facts and circumstances including functions performed, risk assumed and assets used of the relevant associated enterprises. However, before that, if reliable local market comparables are available which can be used to identify Arm's Length Prices, then specific Comparability adjustment or location savings may not be required at all. The guidelines, however, does not prescribe any formula or basis for adjustment. The Indi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ion of Arm's Length Price by choosing any of the prescribed method. If such an exercise has not been carried out, then such kind of TP adjustment should not be permitted to be made. If the revenue's case is that, though not canvassed before us, such an adjustment is being made under Rule 10B(3) to eliminate the material effect of a difference between the transactions which is being compared, then the onus is heavily, upon the revenue to bring on record that, due to location savings, the comparability with the local comparables has failed to yield the Arm's Length results. The TPO has made the adjustment by comparing the cost per employee globally with cost of per employee in India. The method by which TPO has made the adjustment lacks merits because comparison of the employees of the AE working in the economic conditions at the location of the AE are completely different and cannot be benchmark factor at the outset. Here the tested party is SIL, i.e. assessee, which operates in a perfectly competitive market and in such a market; a manufacturer will have to pass on any location specific advantages to the customers to remain competitive. Otherwise it would not be able to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... at the orders of the TPO and DRP are not sustainable as suffer from serious defect of considering the location saving as basis of adjustment. Further we find that the computation of the location saving by the TPO is purely based on some articles and not on the basis of actual cost in the US in comparison to India. Therefore the price/cost as computed by the TPO is not based on actual data but on presumption of accepting the article on the subject as the comparable cost. Since the functional comparability of the companies selected by the assessee has not been examined by the TPO as well as no steps were taken to find out the other comparables of the assessee for determination of ALP therefore, the issue of determination of ALP and consequential adjustment, if any, is required to be examined and adjudication afresh at the level of TPO/A.O. Needless to say that the assessee is receiving its price in foreign currency therefore the comparable uncontrolled price shall also have at least 75% of their revenue in foreign currency otherwise the price received from domestic market may not be acceptable when the assessee is receiving its 100% revenue in foreign exchange. Accordingly, the matte ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f the view that the assessee's arguments are bereft of logic and proper evidences to back its claim. He observed that the whole Clinical trial hinges on the commitment and knowledge level of these investigators concerned. Without the right set of Investigators, no Clinical trial would achieve its objectives. Clinical trial is a very risky endeavor as it involves experimentation of unknown chemicals on the human body. Hence the investigator administering the clinical trial become the most important person in safeguarding the patient. Hence the Investigator needs to possess certain skill set, should have immense patience (as Clinical trials last for years together) and complete focus and dedication on the job. Any slip from his side will not only affect the life and limb of the patient but will harm the reputation of Parexel India and the Group as a whole. Hence, the selection of investigators is very important and this is the job of the Taxpayer. This is a very important job and cannot be done routinely. The taxpayer invests considerable time and resources on this. The same was recognized by the AE. The AE was not only reimbursing the investigator's costs but, considering the in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... us. 14. In this case, the contention of the AR is that the assessee entered into agreement with Parexel International GmbH, Germany, under which assessee merely acted as Coordinator and facilitator with no risk in rendering such services and the entire risk relating to such activity is borne by Parexel International GmbH, Germany group and third party investigator and this is cost to cost reimbursement by Parexel GmbH Germany and there is no question of any mark up towards ALP as done by the TPO. 15. Further in terms of clause 4.3 of the addendum to the agreement with AEs, pass through cost is defined as expenses which are ultimately payable by the Sponsor on a cost-to-cost basis as follows:- "4.3. Pass through cost, for the purposes of section 4.1.2 and section 4.2, shall mean costs including but not limited to investigators fee, drug charges, laboratory fees, legal & professional charges, translation cost, related travel & conveyance expenses, and any other expenses incurred by the PICRPL (Appellant) which are ultimately payable by the Sponsor on a cost to cost basis to PIC (AE) or any other contracting affiliate. The Parties agree that PICRPL will not load any margin on the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... clinical trial process, explained herein below: * A clinical trial is required for testing the efficacy and safety of a pharmaceutical product developed by a pharmaceutical company. * The pharmaceutical company ('Sponsor'), who intends to undertake the clinical trial, enters into a clinical trial agreement with the Parexel Group (AEs) or a similar vendor. * A clinical trial typically entails undertaking the following phases/ steps: − Preparation of study protocol: A 'study protocol' is a document which defines the medical issues sought to be examined and the statistical tests that are to be conducted; the processes and parameters which are to be considered for conducting the clinical trial. - Pre-clinical trials: Pre-Clinical trials are test tube and animal studies conducted to establish the relative toxicity of the drug. - Phase I clinical trials: Phase I trials consist of testing the basic safety with approximately 20 to 80 human subjects, usually healthy volunteers. - Phase II clinical trials: Phase II consists of trials to test the basic efficacy (effectiveness) and dose-range test, sometimes with 100 to 200 patients afflicted with a specific dis ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... gulations Site visit in India and data collection The Appellant does site visit of the investigation sites in India only to collect the data and information Filing for Drug Approval Sponsor performs this function Post market surveillance Parexel Group performs this function 20. The ld. AR submitted It is very clear from the above table that he entire risk of conducting the clinical trial and its success/ failure lies with the Sponsor/ AEs and the assessee is insulated, in the sense that, irrespective of the success / failure of the trial, the assessee will be remunerated at a cost plus 15% mark-up. It will be necessary to appreciate that a clinical trial activity is a complex process involving huge costs and which runs over several years. Irrespective of such huge risks involved in the entire process, the assessee operates in a risk-free environment. 21. Based on the aforesaid transaction flow and functional analysis, the assessee submitted the FAR of the assessee vis-à-vis the 'Investigators'. Functions undertaken by Parexel India and Investigator: 22. It was submitted as seen from the above, the role of Parexel Group and Parexel India is to facilitate t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... estigators actually perform the clinical trial and assume the risk of the trial being conducted as per set protocols. It is the Investigator who is responsible for trial-related decisions. In fact, Schedule Y of the Drugs and Cosmetics (IInd Amendment) Rules, 2005 which is the key document that governs clinical research in India, provides that the "Investigator shall be responsible" for the conduct of the entire clinical trial activity. The relevant extract of the >aid rule is reproduced below: "The Investigator(s) shall be responsible for the conduct of the trial according In the protocol .and the GCP Guidelines and also for compliance as per the undertaking g is in Appendix VII. Standard operating procedures are required to be documented by the Investigators for the tasks performed by them. During and following a subject's participation in a trial, the investigator should ensure that adequate medical care is provided to the participant for any adverse events. Investigator(s) shall report all serious and unexpected adverse events to the Sponsor within 24 hours and to the Ethics Committee that accorded approval to the study protocol within 7 working days qt. their occurrence" ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ia should be determined taking into consideration only the cost incurred by the assessee for value added functions i.e., its own internal costs. Doing otherwise would result into a fallacy where the Appellant is being expected to earn a mark-up on costs incurred on behalf of third parties. 33. It was further submitted that it is an accepted principle that service providers need not apply a mark-up on pass through expenses which are recharged to third parties. This principle is fully supported by the Transfer Pricing Guidelines for Multinational Enterprises and Tax Administration (OECD Guidelines) which provide that:- "When an associated enterprise is acting only as an agent or intermediary in the provision of services, it is important in applying the cost-plus method that the return or mark-up is appropriate for the performance of an agency function rather than for the performance of the services themselves. In such a case, it may not be appropriate to determine arm's length pricing as a mark-up on the cost of the services but rather un the costs of the agency function itself or alternatively, depending on the type of comparable data being used, the mark-up on the cost of se ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t rather on the cost of agency function itself, or alternatively, depending on the type of comparable data being used, the mark-up on the cost of services should be lower than that would be appropriate for the performance of the services themselves. In these type of cases, it will be appropriate to pass on the cost of rendering advertising space, to the credit recipient without a mark-up and to apply a mark-up only to the costs incurred by the intermediary in performing its agency function. In the light of ITS 2009 Transfer Pricing Guidelines, it would be clear that a mark-up is to be applied to the cost incurred bp the assessee company in performing its agency function and not to the cost of rendering advertising space on behalf of its AEs. Further, the method adopted by the assessee while submitting transfer pricing study based on net revenue has been accepted by the Department in earlier year and, therefore, there is no reason to depart from that stand already accepted by the Department in earlier year." 36. It was submitted that a similar view has also been upheld by the Mumbai Tribunal in FedEx Express Transportation and Supply Chain Services India Private Limited (Merged Fed ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ld be wrong on the part of the income tax authorities to take a position and infer notionally about recovery of mark-up or profit element in the hands of assessee. 38. The jurisdictional Tribunal in Tesco Hindustan Service Centre Pvt Ltd vs. DCIT (IT(TP)A No.1317/Bang/2010) has held that when a taxpayer acts solely as an agent for a group company it would be not be appropriate to charge mark-up on the cost of services acquired from an arms' length party. The relevant portion of the order is reproduced below:- "35. We have considered the rival submissions. As observed in the OECD commentaries referred to in the Circular of the Canada Customs and Revenue Agency, it is important to distinguish between the situation of a taxpayer who renders services for the other members of a group; and a taxpayer who acts solely as an agent on behalf of the group to acquire services from an arm's length party. In the latter situation, the arm's length compensation would be limited to rewarding the agency role. In such a case, it would not be appropriate to determine an arm's length charge by referring to a mark-up on the cost of the services acquired from an arm's length party. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ding, but not limited to personnel costs, general and administration expenses, depreciation and amortization based on the financial statements of PICRPL. For avoidance of doubt, Operating Expenses shall not include any financing costs, extraordinary expenses, prior period cost, capital expenses and pass through cost." 41. Therefore, the allegation of the TPO that the assessee has not charged mark-up on such costs is completely baseless. 42. The TPO at para no. 7.6.2 has concluded that the assessee has been charging a mark-up on the investigator costs upto the preceding years and accordingly, a mark-up ought to be imputed in the current year as well. 43. It is submitted that just because the assessee was receiving a markup on the pass-through costs until the preceding year, it cannot be a basis to impute a mark-up in the current year as well. Adjustments are to be made based on transfer pricing principles and in the present case, no third party would have paid a mark-up on the costs, which are not incurred by the assessee to provide its intermediary functions. The assessee should not be expected to earn a margin based on the classification of costs as "internal" or "external' ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... er incidental costs are to be considered as a part of the operating expenses and operating revenue for benchmarking the transaction relating to provision of coordination and facilitation services (pursuant to set-aside as per the earlier years orders), there ought not to be a separate adjustment by way of imputation of markup on investigator and incidental costs as the same would result into double adjustment. A direction in this regard was also prayed for. 48. On the other hand, the ld. DR drew our attention to the following facts recorded by the Tribunal in IT(TP)A No.254/Bang/2016 & 292/Bang/2017 for the AYs 2011-12 & 2012-13 as under :- "4. The assessee is a subsidiary of Parexel International Holdings BV, Netherlands. The assessee company is registered as clinical research agency and is engaged in providing clinical research services in India. The group and parent company of assessee are also clinical research organizations based in USA & UK respectively and are assigned the work of conducting clinical trials by sponsoring pharmaceutical companies. The Associated Enterprise (AE) in turn, have outsourced the work of clinical trial and research services in India to the assess ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ntion of the assessee is that assessee has not undertaken any risk and all risk was taken over by Paraxel International GmbH Germany and relied on the Addendum dated 19.9.2007. However, the fact is that the assessee acted as coordinator and facilitator in selecting the investigator so as to conduct clinical trial. Selection of the investigator demonstrates that clinical trial is important task in the whole work undertaken by the assessee. The assessee invested considerable time and resources in this. The plea of assessee is that assessee has not received any amount as fee for doing this coordinator and facilitator job. In our opinion, this is an inter-group services provided by the assessee to its parent company and assessee must charge some fee as it would have, had the services been provided to a third party. The contention of the ld. AR is that remuneration for these services has already been included in the provision of clinical trial services and no separate fee is charged for coordinating and facilitating with the investigators. As per OECD guidelines, this is an intra-group services provided by the assessee to its parent company for which the assessee is entitled to remunera ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... shall be communicated between the parties in writing and such written communication shall be considered as addendum to this agreement. Any taxes leviable in India on the above fees shall be borne by PIC. Further, PIC may withhold taxes to the extent required to do so as applicable in its jurisdiction. 4.5 Sponsor, for the purposes of section 4.3, shall mean and refer to a customer / 'company who have entered into a contract with PIC for the provision of Clinical Services. 4.6. Investigator, for the purposes of section 4.3, shall mean and refer to a physician, medical doctor, medical consultant, or a hospital, which has entered into an investigation contract with PICRPL and/or Sponsor to administer pharmaceutical drugs for the purposes of clinical research trials. 4.7. PIC shall pay the remuneration on the basis of invoices duly issued by PICRPL within 3o (thirty) days after the end of the month. PICRPL shall maintain true and accurate books of accounts and records reflecting the services and cost incurred in connection therewith. PIC may from time to time request for the detailed breakup of cost incurred and PICRPL agrees to provide details as and when requested. 4.8. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... AO is justified in finding out the real intention of the parties by ignoring the apparent and the conceded intention was to evade the tax liability. The lower authorities merely removed the facade to expose the real intention of the parties cleverly cloaked and discovered the real intention was to evade the taxes and Addendum cannot be given effect and the overall arrangement made by the assessee was to evade the taxes. We are well aware that all commercial arrangements and documents or transactions have to be given effect even though they result in avoidance of tax liability, provided that they are genuine, bonafide and not colourable transaction. 53. In the present case, in the immediate earlier AY 2012-13, the assessee has shown investigator payment with mark-up and in this year on the basis of Addendum entered by the parties as discussed earlier, made the investigator payment as 'pass through costs' and claimed as reimbursement without any profit element, which is against the agreed norms in the earlier years which cannot be effected and accepted as genuine agreement. Accordingly, we are of the opinion that this intra-group services rendered by the assessee to the parent comp ..... X X X X Extracts X X X X X X X X Extracts X X X X
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