MEDREICH LIMITED ,BANGALORE vs. ASSISTANT COMMISSIONER OF INCOME TAX, CENTRAL CIRCLE-1(2) , BANGALORE

Facts

The assessee, Medreich Limited, is appealing against an assessment order dated 16/07/2024 for Assessment Year 2020-21. The appeal concerns transfer pricing adjustments related to manufacturing segments, amounting to Rs. 27,65,85,891.00. The assessee, a public company, manufactures and exports pharmaceutical formulations and also provides R&D services. During the year, it engaged in international transactions with Associated Enterprises (AEs), including manufacturing and export of pharmaceutical formulations, corporate guarantees, commission payments, interest on loans, and recovery of expenses. The Transfer Pricing Officer (TPO) computed the profit level indicator (PLI) at 9.68%, compared to the assessee's computation of 7.56%. The TPO rejected the assessee's comparables and selected 12 comparables, arriving at a 35th percentile of 10.82% and a median of 11.84%. An adjustment of Rs. 20,52,96,829/- was proposed.

Held

The Tribunal held that the assessee's Ground No. 13, relating to depreciation on software, is allowed. The Tribunal found that the definition of 'computer software' in Appendix I, Part A, Item 5 of the Income Tax Rules, 1962, read with Note 7, is inclusive and does not distinguish between system and application software. Any program stored on a device is to be considered software for depreciation purposes. The Tribunal agreed with the assessee that software is integral to a computer's function and that confining 'integral software' only to Microsoft Office, as done by the AO, is too narrow. Therefore, the software acquired by the assessee is considered computer software eligible for 40% depreciation. The disallowance of excess depreciation made by the AO and confirmed by the DRP is directed to be deleted. The appeal is partly allowed. The judgment does not provide a final decision on the transfer pricing issues (Grounds 2-10), as the relevant portion of the judgment was omitted. However, the overall result indicates a partial allowance, implying that the depreciation issue was decided in favour of the assessee.

Key Issues

1. Whether the Transfer Pricing Officer (TPO) erred in applying the Transactional Net Margin Method (TNMM) at the entity level to the entire turnover, including transactions with unrelated parties, instead of only international transactions with Associated Enterprises (AEs), as per Section 92C of the Income Tax Act, 1961? 2. Whether the assessee's segmental analysis, showing higher profitability in the AE segment compared to the non-AE segment, should have been accepted, thereby negating the need for any transfer pricing adjustment? 3. Whether the TPO was justified in rejecting the assessee's comparables and selecting a different set of comparables for benchmarking? 4. Whether various software purchased by the assessee should be treated as 'computer software' eligible for depreciation at 40% under Appendix I to the Income Tax Rules, 1962, or as intangible assets eligible for depreciation at 25%? Assessee's Contentions: - The TPO erred by applying TNMM at the entity level to the entire turnover, including non-AE transactions, which is contrary to Chapter X of the Act. The law permits adjustments only for AE transactions. - The assessee provided segmental accounts showing the AE segment was more profitable (10.29% operating margin on revenue) than the non-AE segment (8.51% on revenue), indicating arm's length pricing and negating any adjustment. - The TPO's rejection of comparables and selection of new ones was erroneous. - Software is 'computer software' as defined in the Rules and eligible for 40% depreciation, citing precedents like Amway India Enterprises and Netscribes (India) Pvt. Ltd. Special provisions for software prevail over general provisions for intangibles. Revenue's Contentions: - The judgment records no specific contentions for the revenue on the transfer pricing issues. On the depreciation issue, the revenue, through the Assessing Officer (AO) and the Dispute Resolution Panel (DRP), argued that only programming software integral to the computer's functioning is eligible for 40% depreciation, and application software is not.