SUN PHARMACEUTICALS INDUSTRIES LTD.,,BARODA vs. PR. COMMISSIONER OF INCOME TAX,, BARODA

The assessee, a pharmaceutical company filed its return of income declaring total income of Rs.(-)32,08,64,172/- under normal provisions and book profit u/s.115JB of the Act of Rs.2,66,89,19,663/- which was finalized u/s.143(3) of the Act dated 19/12/2011 whereby and whereunder the income of Sun Pharmaceutical Industries Ltd. Vs. PCIT Asst.Year –2008-09 - 2 - the assessee was assessed at Rs.4,76,42,33,280/- under normal provision and Rs.3,14,81,31,195/- as book profit u/s.115JB of the Act. Further that Assessment Order was finalized u/s.143(3) r.w.s 147 of the Act on 14.02.2014 determining total income at Rs.5,59,68,08,333/- and u/s.115JB of the Act at Rs.3,14,81,31,195/-

The Ld.ACIT disallowed Rs.2,50,44,500/- towards R & D expenses. Subsequently Ld. Pr. CIT, u/s.263 of the Act held the assessment order dated 14.02.2014 is erroneous in so far as prejudicial to the interest of Revenue to the extent of non disallowance of R&D expenditure allocated to Sun Pharmaceutical Industries (partnership firm). The said expenditure has been enhanced at Rs.5,23,16,934/- and added to the total income of the assessee . Hence, the instant appeal before us.

At time of hearing of the instant appeal the Ld.Sr.Counsel appearing for the assessee submitted before us that on merit the issue is squarely covered in assessee’s own case for Assessment Year 2010-11 by the Co-ordinate Bench in for A.Y. 2010-11; copy whereof has also been submitted before us.

However, the Ld.DR, has also not brought anything on record contrary to the argument advanced by the Ld.Sr.Counsel appearing for the assessee.

We have heard the parties, we have perused the relevant material available on record. We find that the addition on account of capital Research & development allocated to Sun Pharmaceutical Industries (partnership firm) has been challenged before us. We have also gone through the order passed by the Sun Pharmaceutical Industries Ltd. Vs. PCIT Asst.Year –2008-09 - 3 - Co-ordinate Bench in for A.Y. 2010-11. While dealing with identical issue and deciding the same in favour of the assessee, the Co-ordinate Bench observed as follows:

We have heard the respective parties, perused the relevant materials available on record. We have also carefully considered the order passed by the Co-ordinate Bench deciding the identical issue in favour of the assessee. The relevant portion thereof is as follows: “39. The issue raised by the assessee in ground No. 7 is that the Ld.CIT (A) erred in confirming the order of the AO by allocating the research and development expenses incurred by it to the other partnership firms and accordingly made the disallowance of such expenses proportionately. 40. The assessee is a partner in two partnership firms namely Sun Pharma Industries and Sun Pharma Sikkim (for short SPI and SPS). Both the partnership firms were engaged in manufacturing the drugs. However, the assessee was carrying out research and development expenses for the drugs manufactured by both the firms. Accordingly, the assessee claimed the deduction for all the research and development expenses incurred by it in its books of accounts. 41. The AO during the assessment proceeding observed that both the partnership firm are claiming deduction under section 80IC of the Act. As such both the partnership firms were showing a huge amount of profit which was allocated to the partners of the firm. The assessee being a major shareholder in the firms received a huge amount as a share of profit which was claimed as exempted under section 10(2A) of the Act. Accordingly, the AO was of the view that the research and development expenses incurred by the assessee on the drugs manufactured by the partnership firms should be allocated to these partnership firms. Thus the AO worked out the research and development expenses pertaining to the firms for Rs.

The aggrieved assessee, preferred an appeal to the Ld. CIT (A) who partly confirmed the order of the AO after having a reliance on the order of his predecessor for the assessment year 2008-09 by observing as under: “12.1. Similar disallowance was made in A.Y. 2008-09 after reopening the proceedings u/s.

The order u/s. 143(3) r.w.s. 147 for A.Y. 2008-09 was passed by the Assessing Officer on 14.02.2014. The above mentioned issue was challenged before the CIT(A)-2, Vadodara. The appeal of the assessee has been decided by my predecessor vide order dated 31.03.2015 contained in Appeal No. CAB/(A)- 2/387/14~15 (A.Y. 2008-09) and his findings recorded in para-7.3 to7.5.2 are reproduced as under:- "7.3 I have considered the appellant's submission and the AO's observations. The appellant's main contention are that that the product technology developed are completely owned by it and no part of ownership of the product technology or processes developed during such R & D work is for any other party. Besides being a working partner, the appellant in pursuance of the obligation undertaken under the partnership deed had provided these services in relations to the manufacturing activities of the firm and that no R & D activity was carried out for SPI. In relation to the these claims, the appellant has also stated that it has received remuneration and share of profit from SPI, credits of which are available to it to the corresponding debit in the books of accounts of the SPI, and hence the profit were not understated. Another related claim made by the appellant is that the expenditure incurred by it for the partnership firm is as good as its own expenditure because ultimately the appellant is going to be the major beneficiary of any profit earned by the partnership firm as a result of this R & D expenditure. 7.3.1 These claims of the appellant are to be examined in view of the different provisions of the IT Act 1961. The share of profit received by the appellant from the firm is exempt from the Income Tax. The remuneration is received from the firm is taxable under the head income from business and profession, as per the provision of clause (v) of section 23 of the IT Act 1961. But the proviso to this section says that where such remuneration or part thereof has not been allowed to be deducted under clause (b) of section 40, the income under this clause shall be adjusted to the extent of the amount not so allowed to be deducted. Now as per the provisions of section 40(b)(i), any payment of salary, bonus, commission or remuneration to any partner who is not a working partner is not allowed as a deduction in computation of the total income of the firm. The explanation 4 to clause (b) says that working partner means an individual who is actively engaged in conducting the business or provision of the firm of which he is a partner. Hence, the appellant being a company cannot be a working partner of a firm for the purposes of provisions of Income Tax Act 1961. Accordingly, any Sun Pharmaceutical Industries Ltd. Vs. PCIT Asst.Year –2008-09 - 5 - remuneration paid to the appellant is not allowable as a deduction in the computation of the total income of the firm and at the same time such remuneration will not form part of total income of the appellant. Thus, both the share of profit and remuneration received by the appellant from the firm will not form part of its total income and accordingly any expenditure incurred by the appellant for earning such share of profit or remuneration cannot be allowed as a deduction in computation of its total income. Hence it is held that the AO has rightly disallowed the R & D expenditure incurred by the appellant, the results of which have been given by the appellant to the firm SPI in the capacity of its partner for manufacturing drugs by this firm. Hence this contention of the appellant is rejected. 7.4 The other contention of the appellant is that as per section 35, R & D expenditure has been incurred by it for its own business and hence same cannot be debited in the books of accounts of SPI. But as already stated, once it is proved that part of such expenditure has been incurred by the appellant for the purpose of earning of share of profit and remuneration from the firm which is not forming part of its own total income, such expenses cannot be allowed as a deduction in computation -of its total income. The AO has disallowed such expenditure only and it is not a case where such expenses have been directed to be debited in the books of accounts of the firm, SPI. Hence, this contention is also rejected. 7.5 The other contentions of the appellant are related to the method adopted by the AO for the purposes of allocation of such R & D expenses to the manufacturing activities undertaken by the appellant and the manufacturing activity undertaken by the firm SPI. In this regard, the appellant has submitted that it had submitted working on unit profitability statement before AO during the course of assessment proceedings vide letter dated 21/11/2011 whereby the bifurcation .of turnover between domestic/export and formulation/bulk is clearly evident. These workings have been submitted by the appellant during the course of the current appellate proceedings also and the same are being utilized for the purpose of deciding this issue. 7.5.1 The first contention of the appellant is that the partnership firm and the appellant company cater to the different sections of business with underline facts. These differences have been submitted by the appellant which have already been reproduced above. The first difference pointed out is that the partnership firm is only into production of formulation drugs for the domestic market, whereas appellant incurred R & D expenditure on bulk drug segment and formulation segment both and that too for domestic market as well as international market and regulated market. It has been submitted that the partnership firm has sold its product in domestic market only. In this regard, the appellant has also submitted the copy of Financial statement for FY 2007-08 of Sun Pharmaceutical Industries. As per this, the turnover of this firm is 1086.2 crore, which is the same figure as adopted by the Ad in his order. Besides in Clause ‘ 8' of the Notes on Financial Statement, it has been mentioned that the firm operates in one reportable geographical segment i.e.

Being aggrieved by the order of the Ld.CIT (A), both the assessee and the Revenue are in appeal before us. The assessee is in the appeal for the allocation of R&D expenses to SPI and SPS whereas the Revenue is in appeal against the direction of Ld.CIT (A) to allocate the expenses excluding export turnover.

The Revenue has raised ground no 6 reproduced as under: “2. On the facts and in the circumstances of the case, learned CIT(A) erred in law and facts in restricting the disallowance of R&D expenses after excluding the export turnover of the assessee for the purpose of computing the allocation of R & D expenses without appreciating that the AO had applied the same pro-rata method of allocating the R & D expenditure which the assessee itself was applying for allocation of the R & D expenditure within the assessee itself was applying for allocation of the R & D expenditure within its units in the ratio of their turnover.”

The Ld. AR before us submitted that in the identical facts and circumstances this ITAT in the own case of the assessee and Revenue bearing and 1663/AHD/2016vide order dated 08-09-2017 deleted the addition made by AO.

Both the Ld. AR and the DR before us relied on the order of respective authorities below as favorable to them.

We have heard the rival contentions and perused the materials available on records. At the outset, we find that in the identical facts and circumstances in the own case of the assessee’s (supra), the ITAT deleted the addition made by the TPO/AO. The relevant extract of the order is reproduced as under: “We have given a thoughtful consideration to the facts in issue before us. There is no dispute that the assessee did incurred expenditure under the head "Research & Development" activity. The only dispute relates to the . A.Y. 2009-10 allegation that part of such expenditure belong to the business activity of the partnership firm SPI. There is also no denying by the lower authorities that the entire Research and Development activities are done by the appellant company only being the flagship company of Sun Pharma Group. In our understanding of the facts, the appellant company had assisted the partnership firm in carrying on its business by using its network for marketing the pharmaceuticals products successively. Since the assessee is holding 97.5% of share in the partnership firm, SPI it becomes the duty of the assessee to promote the business of the partnership firm in the capacity of the majority stake holders. Incidentally, the revenue authorities have not brought anything on record which could suggest that the expenditures have Sun Pharmaceutical Industries Ltd. Vs. PCIT Asst.Year –2008-09 - 11 - not been incurredfor the purposes of business. Be it assessee's business or the business of the partnership firm where the assessee is a majority stake holder. In our understanding of the law an expenditure is allowable if it is incurredfor the purposes of the business of the assessee. Finding that the assessee is having 97.5% share in the profits of the firm SPI, we do not find any merit in the disallowance made by the A.O. and confirmed by the First Appellate Authority. We, accordingly, direct the A.O. to delete the addition of Rs. 5,30,29,5255/-. Ground no. 12 is accordingly allowed”

Regarding the Revenue appeal, the relevant finding of the ITAT in ITA 1663/AHD/2016 in its order is extracted below: “137. Similar issue has been considered and decided by us in assessee's appeal (supra) vide ground nos. 9 to 11 of that appeal. For our detailed discussion therein, ground no. 11 is dismissed.”

In the result, assessee’s appeal is allowed.