SAMI-SABINSA GROUP LIMITED,BANGALORE vs. DEPUTY COMMISSIONER OF INCOME TAX, CIRCLE-6(1)(1), BANGALORE

PER LAXMI PRASAD SAHU, ACCOUNTANT MEMBER:

This appeal by the assessee is directed against the order of the Dispute Resolution Panel-2, Bangalore dated 28.12.2021 for the assessment year 2017-18. The assessee has raised following grounds of appeal:-

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Page 2 of 30 SI Grounds of Appeal no The Transfer Pricing Officer ("TPO") and Dispute Resolution Panel ("DRP") has erred in not considering the internal TNMM analysis undertaken by your appellant in the Transfer Pricing report prepared by it and has instead erroneously determined PLI at entity level. The TPO and DRP has rejected the segmented financial information furnished in the TP report. 1 The TPO and DRP has failed to appreciate the business arrangement of your appellant with its AE wherein the AE's operate as a limited risk bearing marketing and distribution companies earning arms length return for their 2 activities. The TPO and MP has erred in rejecting Shrey Nutraceuticals & Herbals Private Limited as a comparable to your appellant by applying lower turnover filter of Rs.10 crores instead of Rs.1 crore which was consistently followed by your appellant and the TPO in the earlier years. 3 The TPO and DRP has erred in rejecting Sanat Products as a comparable to your appellant on the contention that it has failed the net worth filter though it had passed that filter. 4 The TPO and DRP has erred in rejecting Gujarat Organic Limited as a comparable to your appellant on the contention that it is functionally different. 5 The TPO and DRP has erred in rejecting Endo Amines Limited as a comparable to your appellant on the contention that it is- functionally different. 6 The TPO and DRP has erred in rejecting Tyche Industries Limited as a comparable to your appellant on the contention that it is functionally different. 7 The TPO and DRP has erred in rejecting Yasho Industries Limited as a comparable to your appellant on the contention that it is functionally different. 8 The TPO and DRP has erred in rejecting Deepak Nitrite Limited as a comparable to your appellant on the contention that it is functionally different. 9 The TPO and DRP has erred in considering Micro labs Ltd as a comparable to your appellant though it is functionally different. 10 The TPO and DRP has erred in considering Neuland Laboratories Ltd as a comparable to your appellant though it is functionally different. 11 The TPO and DRP has erred in considering Granules India Ltd. as a comparable to your appellant though it is functionally different and has failed the 25% Related Party Transactions (RPT) filter. 12 The TPO and DRP has erred in considering Vins Bio Products Ltd as a comparable to your appellant though it is functionally different. 13

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Page 3 of 30 The TPO and DRP has erred in considering Symed Labs Ltd. as a comparable to your appellant though it is functionally different and has failed the 25% Related Party Transactions (RPT) filter. 14 The TPO and DRP has erred in considering Shilpa Medicare Ltd as a comparable to your appellant though it is functionally different, has failed the 25% export turnover filter and has presence of extraordinary events during the year. 15 The TPO and DRP has erred in considering ZCL Chemicals Ltd as a comparable to your appellant though it is functionally different and has failed the 25% export turnover filter. 16 The TPO and DRP has erred in considering Concord Biotech Limited as a comparable to your appellant though it is functionally different. 17 The TPO and DRP has erred in computing the weighted average margin of Natural Remedies Pvt Ltd as 14.31% as against the correct weighted average margin of 13.07%. 18 The TPO and DRP has erred in considering outstanding receivables as a separate international transaction and imputing interest on delayed receipts from Associated Enterprises by considering it as unsecured loans. 19 Without prejudice to Ground 19, the TPO and DRP has erred in considering rate of interest on outstanding trade receivables at 6 months LIBOR + 450 basis 20 The AO had wrongly denied deduction of R&D Expenditure amounting to Rs.3,86,333/- under section 35(1)(i) or 37( l ) of the Act though the same was incurred wholly and exclusively for the purpose of business. 21 The AO has erred in computing interest u/s 234A of the Act though there was no delay in furnishing the return of income by your appellant. 22 Without prejudice to the other grounds, the AO has erred in computing interest u/s 234B as Rs.4,20,07,491/- as against the correct computation of 23 Rs.3,98,01,513/-. For these and other grounds that may be adduced at the time of hearing, the order passed by the AO, TPO and DRP may be set aside to the extent appealed 24 against. Your appellant craves leave to add, amend, alter, vary and/ or withdraw any or all of the above grounds of appeal. 25

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Page 4 of 30 nutraceuticals, specialty chemicals, cosmeceuticals, phytonutrients and probiotics and was filed its original return of income for A.Y. 2017-18 on 29/11/2017 declaring total income at Rs. 41,89,10,390/-. Thereafter assessee company revised its return of income on 29/- 03/2018. The case was selected for scrutiny through CASS for examine the following reasons.

i. Large deduction claimed u/s 35(2AA),35(2AB), 35(CCC) & 35(CCD). ii. Lower amount disallowed u/s 40(a)(ia) in ITR comparison to tax audit report. iii. Large any other amount allowable as deduction" claimed in Schedule BP of return. iv. Custom duty paid as shown in the ITR is less than the duty paid as per Export Import Data. 3. Accordingly. notice u/s 143(2) of the Income Tax Act. 1961 dated. 08/08/2018 was issued and duly served upon the assessee company. Thereafter a reference u/s 92CA(1) of the Act was made to TPO 2(2)(1), Bangalore vide letter dated. 22.07.2019 by the Assessing Officer. After receipt of reference by the ld. TPO he issued letter dated 13.11.2019, the taxpayer was asked to furnish the documents maintained in terms of section 92D alongwith financial details and copies of agreements. The same were furnished vide letter dated 04.12.2019. The TP documents contained 16 comparables in respect of manufacturing of Herbal and chemical products, which were selected by the taxpayer by applying certain filters and TNMM was applied as most appropriate method. On 15.12.2020 , the taxpayer was

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Page 5 of 30 issued a detailed show-cause-notice in respect of the manufacturing of herbal products segments. In response the assessee submitted details vide his letter dated 28.12.2020 and the ld. TPO considered the submissions and objections of the assessee and made adjustment in respect of manufacturing segment.

3.1 He also observed that the assessee has not calculated interest on delayed receivables from its AEs as discussed in his order accordingly interest on the delayed trade receivables is proposed to be computed on invoice basis. To calculate the delay, the assessee (vide the show cause (SCN) issued on 15.12.2020) was asked to furnish invoice wise details of all the trade receivables from AEs during the year. The following details were asked in a particular format: Amount raised in invoice. date of invoice, date of receipt, delay in no. of days. In response to the SCN, the assessee filed its reply on 15.12.2020 in its submission.

3.2 Considering the submissions made by the assessee regarding invoice wise details of all the trade receivables from AEs during the year. Interest is calculated using LIBOR- 6 months + 450 basis points applicable for the FY 2016-17 and which works out to 5.975%.

3.3 Thus. arm's length interest amount to be charged works out to be Rs. 72,92,193/-. The same is treated as adjustment u/s 92CA for interest on delayed receivables

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Page 6 of 30 Sl.No. Description Adjustment u/s 92CA(Rs.) 1 Manufacturing segment 19,63,67,067 2. Interest on delayed receivables 72,92,193 Total 20,36,59,260/-

3.4 Accordingly, an amount of Rs.20,36,59,260/-is proposed as the transfer pricing adjustment to arrive at arm's length price of the international transactions and he passed the order u/s 92CA(3) of the I.T.Act dated. 19/01/2021.

" ……. The TPO has proposed a Transfer Pricing adjustment of of Rs.20.36 crores. We do not agree to this adjustment proposed by the TPO since it contains patents error of facts and law. The TPO has not considered the various factual and legal matters while proposing this adjustment though the same was submitted to him vide detailed submission in response to the show cause notice and also through a virtual hearing. The same is summarized below for ready reference: TPO has erred in considering OP/OC margins at entity level a) instead of considering the margins of the AE segment based on the certified segment financial statements.

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Page 7 of 30 The TPO has erred in rejecting our TP Study though he has b) made a finding in the order that all the filters applied by us are appropriate. The TPO has erred in wrongly conducting a fresh Search and c) applying additional filters d) The TPO has wrongly selected pharmaceutical manufacturing and API Companies, Contract manufacturing entities, Companies having RPT exceeding 25% e) There are also several errors in the computation of margins of companies Further, the TPO has also made certain errors in the computation of margins of the comparable companies selected by him. We are in the process of filing a rectification application seeking rectification of these errors which are apparent on records. The following errors were committed by the TPO in the order passed under section 92CA: a) Our comparable Sanat Products Ltd was wrongly rejected on the ground that its net worth is negative even though its Net-worth is actually positive as per its audited financial statements. b) The TPO has erred in rejecting Shery Nutraceuticals & Herbals Pvt Ltd as a comparable by raising the lower turnover limit from 1 crore(applied by him in the earlier years) to Rs.10 crores. The TPO has erred in being inconsistent in the application of turnover filter which is not in line with the various judicial precedents in the regard. c) There are errors in the margin computation of Normal Remedies Pvt Ltd. and Neuland Laboratories Ltd,done by the TPO. d) Symed Labs Ltd. and Granuls India Ltd selected by the TPO are to be rejected since it fails the TRP filter. e) ZCL Chemicals Ltd selected by the TPO is to be rejected as it is a Contract Manufacturing Company and hence is functionally dissimilar to your assessee company." 4.1 The submission of the assessee was duly considered by the AO but not found acceptable since TPO has passed the

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Page 8 of 30 order after considering the submission of the assessee. Further, the assessee has submitted that it is in the process of filing a rectification application seeking rectification of above errors which are apparent on records. In this regard, it is submitted that, if TPO rectifies the order, effect of the same will be given accordingly. Now , in this regard TPO has proposed adjustment to arrive at Arm's Length Price of the international transactions entered by the assessee with Associated Entities amounting to Rs. 20,36,59,260/-. Accordingly, adjustment is made to total income of Rs. 20,36,59,260/- as suggested by the TPO.

4.2 The AO further observed that the assessee has claimed deduction u/s 35(2AB) of the I T Act. on weitaged average basis of Rs. 22.17 cr. But the Form 3Cl was issued after filling of the Income Tax Return & DSIR had certified a sum of Rs. 1104.60 lakhs, therefore there was difference of Rs. 3,85,000/- which was not accepted by the AO and added into the total income of assessee.

4.3 Aggrived from the Draft Assessment Order the assessee filed objections before the DRP , the ld. DRP after considering the objections paased his order on 28.12.2021.

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Page 9 of 30 Ground 1: Non-consideration of Internal TNMM Analysis undertaken by consideration of Internal TNMM Analysis undertaken by consideration of Internal TNMM Analysis undertaken by the appellant

The TPO has not followed this direction of the DRP though audited segment The TPO has not followed this direction of the DRP though audited segment The TPO has not followed this direction of the DRP though audited segment financials was submitted during the course of the assessment proceedings. financials was submitted during the course of the assessment proceedings. financials was submitted during the course of the assessment proceedings. Refer pages 310-312 312 of the paper book I.

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Page 10 of 30 insufficiency of data in respect of internal comparables, support must be drawn from the external comparables.

4.1 We therefore, direct the Ld.TPO to carry out detailed analysis of the international transactions using TNMM as MAM, based on the materials filed by assessee related to internal comparables. In the event the details filed are satisfactory, the determination must be confined to the internal comparables so filed by assessee. In the event, the details filed by assessee is not verifiable or not in accordance with law, the Ld.AO/TPO is open to carry out analysis in accordance with law. [Emphasis Supplied] 13. The Appellant is an Indian multinational company engaged in research, manufacturing, and sale of nutraceutical products. The Appellant’s economic interests are predominantly in India and the manufacturing facilities are also set up in India. However, bulk of the products manufactured by the Appellant are sold outside India through Appellant’s subsidiaries which largely function as marketing and distribution centres for sale of the products.

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Page 11 of 30 (a) the specific characteristics of the property transferred or services provided in either transaction; (b) the functions performed, taking into account assets employed or to be employed and the risks assumed, by the respective parties to the transactions; (c)…… (d)…” Having regard to the above, the TPO ought to have accepted the internal TNMM analysis undertaken by the Appellant. However, the TPO has not commented on the internal TNMM analysis undertaken by the Appellant and has proceeded to undertake external TNMM analysis, thereby selecting companies operating in pharmaceutical and chemical industry. The DRP has also not made any specific observation or finding on the internal TNMM performed by the appellant. 17. In this regard the Appellant wishes to highlight the difference between nutraceuticals and pharmaceutical industry in the ensuring paragraphs and submits that considering both as similar is not appropriate. 18. It is important to understand that the comparable of nutraceutical industry are companies which are into extraction of contents from food based or plant- based sources and not companies involved in complex function of pharmaceutical industry. 19. Major difference between nutraceutical and pharmaceutical industry is furnished in Page 9 of DRP submissions. It is evident that the nutraceutical industry is drastically different from the pharmaceutical industry in terms of composition, market, research, regulatory requirement and intended use. 20. Specifically, the Appellant in the present case, is a nutraceutical product supplier. Thus, the Appellant is a Business to Business (“B2B”) market player where, the nutraceutical products are supplied by the Appellant to a manufacturer who purchases and uses the Appellant’s products as an input product for producing final product. This is the precise reason why the Appellant had compared the net operating margin earned in the sale of products to AE with the net operating margin earned in sale of products to third party customers (i.e. non AEs). However, this fact is completely ignored by the TPO and DRP in proceeding to compare the functions and operating margin of the Appellant with that of external companies who are not comparable in terms of segment and market that the Appellant belongs to. 21. It is submitted that the Appellant, in its TP study report, had compared itself to companies engaged in nutraceutical products. The same was disregarded by the TPO and a new benchmarking analysis was undertaken

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Page 12 of 30 wherein companies in pharmaceutical industry were selected which was also upheld by the DRP. 22. Given the above differences, the Appellant submits that it’s business and net operating margin cannot be compared to that of the pharmaceutical and chemical companies selected by the TPO. Further, the Appellant submits that internal TNMM is the best and appropriate approach to establish the arm’s length nature of the transaction of sale of nutraceutical products to AEs. 23. In the case of M/s. Agila Specialties Pvt. Ltd. Vs The DCIT (ITAT Bangalore) [Refer Page 3392-3405 of Caselaw compilation (PB VI)] it was held as under in Paras 13-14: 13. We are in conformity and are inclined to follow the decision of the Third Member, ITAT Mumbai Bench in the case of M/s. Tecnimont ICB Private Ltd. (supra) wherein it is held that “…….. The underlying object behind computing ALP of an international transaction is to find out the profits which such enterprise would have earned if the transaction had been with some third party instead of related party. When the data is available showing profit margin of that enterprise itself from a third party, it is always safe and advisable to have recourse to such internal comparable case. ………….” 14. Hence we are of the opinion that the TPO had erred in choosing an external comparable, when there was an internal comparable uncontrolled transaction which the assessee had taken in its TP study……”

round 19: Delayed receipts from AE’s considered as unsecured loans and interest being calculated on it 55. The TPO has benchmarked the delay in receipt of the receivable and imputed interest of Rs.72,92,193/- based on the LIBOR rate during the year.

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Page 13 of 30 marketable securities or any type of advance, payments or deferred payment or receivable or any other debt arising during the course of business”, the TPO treats outstanding receivable as unsecured loan given to AEs and charges interest on overdue period if any.

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Page 14 of 30 62. In this regard, the Appellant highlights the Hon’ble Bangalore Tribunal ruling in the case of Assistant Commissioner of Income Tax vs. Millipore India Limited [80 taxmann.com 12] wherein the Hon’ble Tribunal followed the decision of the Co-ordinate Bench of Mumbai in the case of M/s Goldstar Jewellery Limited Vs. JCIT (53 taxmann.com 353) and deleted the TP adjustment arising on account of notional interest on overdue receivables from AEs. The Hon’ble Tribunal noted that the transaction was an integral part of sale made by the Appellant to its AEs and therefore must be considered among with main transaction. The extract of the ruling is reproduced below for your reference: “However, this transaction of allowing the credit period to AE on realization of sale proceeds is not an independent international transaction but it is closely linked or continuous transaction along with sale transaction to the AE. The credit period allowed to the party depends upon various factors which also includes the price charged by the Appellant from purchaser. Therefore, the credit period extended by the Appellant to the AE cannot be examined independently but has to be considered along with the main international transaction being sale to the AE. As per Rule 10A(d) if a number of transactions are closely linked or continuous in nature and arising from a continuous transaction of supply of amenity or services the transactions is treated as closely linked transactions for the purpose of transfer pricing and, therefore, the aggregate and clubbing of closely linked transaction are permitted under said rule. This concept of aggregation of the transaction which is closely linked is also supported by OCED transfer pricing guidelines. In order to examine whether the number of transactions are closely linked or continuous so as to aggregate for the purpose of evaluation what is to be considered is that one transaction is follow-on of the earlier transaction and then the subsequent transaction is carried out and dependent wholly or substantially on the earlier transaction. In other words, if two transactions are so closely liked that determination of price of one transaction is dependent on the other transaction then for the purpose of determining the ALP, the closely linked transaction should be aggregated and clubbed together. When the transactions are influenced by each other and particularly in determining the price and profit involved in the transaction then those transactions can safely be regarded as closely linked transactions. In the case in hand, the credit period extended to the AE is a direct result of sale transaction. Therefore, no question of credit period allowed to the AE for realization of sale proceeds without having sale to AE. The credit period extended to the AE cannot be treated as a transaction stand-alone without considering the main transaction of sale. The sale price of the product or service determined between the parties is always influenced by the credit period allowed by the seller. Therefore, the transaction of sale to AE and credit period allowed in realization of sale proceeds are closely linked as they are interlinked and the terms and conditions of sale as well as the price are determined based on the totality of the transaction and not on individual and separate transaction.

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Page 15 of 30 Respectfully following the above decision, we hold that there can be no separate international transaction of ‘interest’ in the international transaction of sale. Early or late realization of sale proceeds is only incidental to transaction of sale, but not a separate transaction in nature. Since we hold that the impugned transaction of interest on delayed realization of sale proceeds is not international transaction, it is not necessary to adjudicate upon the additional grounds raised by the Appellant Company. Hence, the appeal is treated partly allowed for statistical purposes. Respectfully following this decision, we hold that no ALP adjustment is permissible on this issue.” (Emphasis supplied) 63. Further, reliance can also be placed in the case of Mastek Ltd. vs. ACIT [21 taxmann.com 173], the relevant extract of the ruling is provided below: “If the AEs are not recovering interests from third parties for late recoveries, then in the instant case it would be too much to expect the assessee to charge the interest from the AEs. There is no rationale to inflict upon the assessee, merely on presumption, that he ought to have charged the interest from it’s AEs. We therefore hold that there was no justification to presume that there was a shift of profit to avoid tax in India.” 64. Further, reliance can also be placed on the ruling of Hon’ble Bangalore Tribunal in the case of M/s Avnet India Pvt. Ltd vs Deputy Commissioner of Income-tax (65 taxmann.com 187 – Pages 3544 to 3555) wherein it has been upheld that there should not be a separate international transaction of interest income for transactions related to sale. The relevant extract of the ruling in Para 8 is reproduced below: “Respectfully following the above decision, we hold that there can be no separate international transaction of ‘interest’ in the international transaction of sale. Early or late realization of sale proceeds is only incidental to transaction of sale, but not a separate transaction in nature. Since we hold that the impugned transaction of interest on delayed realization of sale proceeds is not international transaction, it is not necessary to adjudicate upon the additional grounds raised by the Appellant company. Hence, the appeal is treated as partly allowed for statistical purposes”. (Emphasis supplied) 65. The Appellant places reliance on the Hyderabad tribunal ruling in case of GSS Infotech Ltd. V/s ACIT (70 taxmann.com 356), wherein it is mentioned that RBI provides an year for the amount to be realized, if they are in foreign exchange. The relevant extract of the ruling is provided below –

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Page 16 of 30 “11. We have considered the issue and examined the contentions. As seen from assessee's contentions, assessee is neither charging interest on any of the receivables outstanding. There is also no basis for adopting only two months as credit period. RBI itself allows a year for the amounts to be realised, if they are in foreign exchange. Whether it is AE or non-AE, it is in the interest of business that assessee receives the foreign exchange early so that it can claim deduction u/s. 10A. Therefore, in our view, putting a limit of two months of credit period itself is arbitrary. We are of the opinion that this period is reasonable and so no interest can be levied, just because amounts are shown as 'outstanding'. Accordingly, we cancel the interest levied and allow assessee's contentions. Grounds are considered allowed.” (Emphasis supplied) 66. Further, in the case of Ingersoll Rand (India) Ltd V/s DCIT (67 taxmann.com 328 – ITAT Bangalore – Page 3520 – 3543 of the Case law Compilation (PB VI), wherein the Hon’ble ITAT – Bengaluru Bench in deleting the notional interest on trade receivables stating that no interest liability arises even if payment is made by the AE beyond the credit terms. The relevant extract of the ruling in Para 35 is provided below – “11.4.1 We have heard the rival contentions and perused and carefully considered the material on record, including the judicial decision cited and placed reliance upon. We find that the decision of the ITAT, Mumbai Bench, in the case of Evonik Degussa P. Ltd. V ACIT - 05D, Circle 3(1), Mumbai (ITA No.7653/Mum/2011, dt.21.11.2012) of ITAT, Mumbai Bench is squarely applicable to the facts of the case in the case on hand. In this decision the ITAT, Mumbai Bench at para 28 thereof has held as under: "28. After carefully considering the rival submissions and the orders of the TPO as well as the direction of the DRP, we find that the assessee has no interest liability and it does not have any external borrowings. Even if the payments have been made by the AE beyond the normal credit period, there is no interest cost to the assessee. Moreover, there is no such agreement whereby interest is to be charged on such a delayed payment. From the summary of payment submitted by the learned Counsel, it is seen that the billing is done on quarterly basis and, accordingly, the payment is being received. Therefore, the delay is not wholly on account of late payment by the AEs only. Moreover, the T.P. Adjustment cannot be made on hypothetical and notional basis until and unless there is some material on record that there has been under charging of real income. Thus, on the facts and circumstances of the case, we are of the opinion that addition on account of notional interest relating to alleged delayed payment in collection of receivables from the AEs is uncalled for on the facts of the present case and is, accordingly, deleted. 11.4.2 Following the above decision of the ITAT, Mumbai Bench in the case of Evonik Degussa India P. Ltd. (supra), we also hold that the addition on

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Page 17 of 30 account of notional interest relating to alleged delayed payment in collection of receivables from AEs is not called for. 36. Respectfully following the aforesaid decision of the coordinate Bench of this Tribunal cited supra in assessee's own case for the AY 2006- 07, we are of the view that the lower authorities erred in making TP adjustment on account of notional interest on outstanding receivables from AEs and hence the assessee's ground(s) of appeal on this issue is allowed.” Continuing debit balance is not an international transaction 67.The Appellant submits that accounts receivable is a result of an international transaction and not a separate transaction per se and is accordingly not a transaction under Section 92B(1) of the Act read with Clause (v) of Section 92F. A debit balance only reflects that a payment has become due and has not been paid. 68. However, in an arm’s length scenario, it is not necessary that a payment is made as soon as it becomes due. The payment is typically influenced by a host of factors including the date the invoice was sent to the debtor, time to process invoice both at the end of debtor and the Appellant, and the terms of payment and normal business practices. From an arm’s length perspective what may be examined is the commercial transaction itself, as a result of which the debit balance has come into existence, and the terms and conditions, including terms of payment, on which the said commercial transaction has been entered into. Also, typically, the impact of receivables is factored by independent companies in the sale price and thus no separate compensation or transaction is undertaken. 69. While proposing the notional interest on receivables outstanding from AE, the TPO wants to bring it within the ambit of Section 92, a transaction that is non-existent. In the absence of any specific provision in the Act which seeks to tax any hypothetical income, the Appellant cannot be subject to tax in respect of 'hypothetical income', i.e., to say an income which ought to have been earned-or that the Appellant failed to earn. In the present case, since no income has been earned or can be said to have been earned by the Appellant in respect of interest chargeable from AEs, the question of applying the provisions of section 92 of the Act does not arise. 70. Section 92(1) of the Act provides that, “Any income arising from an international transaction shall be computed having regard to the arm’s length price”. Further, Section 92B(1) of the Act defines an "international transaction" as under: "For the purposes of this section and sections 92, 92C, 92D and 92E, "international transaction" means a transaction between two or more associated enterprises, either or both of whom are non-residents, in the nature of purchase, sale or lease of tangible or intangible property, or provision of services, or lending or borrowing money, or any other

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Page 18 of 30 transaction having a bearing on the profits, income, losses or assets of such enterprises, and shall include a mutual agreement or arrangement between two or more associated enterprises for the allocation or apportionment of, or any contribution to, any cost or expense incurred or to be incurred in connection with a benefit, serviceor facility provided or to be provided to any one or more of such enterprises to mean the ALP in length price under section 92C" 71. As can be seen from the above, the definition of international transaction implies that there should be a 'real transaction' between two AE's, i.e. a transaction involving actual exchange of goods/services to constitute an 'international transaction'. It does not seek to cover any hypothetical transaction which has not taken place between the AEs. Concept of Real Income 72. To examine the transactions that could be subject to tax under the Act, it would be necessary to understand the concept of 'income' under the Act. Section 2(24) of the Act defines 'income'. The definition of 'income' under the Act is of an inclusive nature, i.e. apart from the items listed in the definition, any receipt which satisfies the basic condition of being income is also to be treated as income and charged to income tax accordingly. Additionally, the Act also contains specific provisions which have a deeming fiction on income that could be subject to tax, e.g., Section 115JB (minimum alternate tax). It can be construed that the Act provides for taxing only real income whether received or accrued under the normal provisions and specifically provides for taxation of presumptive incomes. 73. Once arm’s length price is determined in respect of the sale/service transaction, it would be deemed to be covering all the elements and consequences of the transaction of sale/service. After having determined the arm’s length price in a sale/service transaction, it cannot be accepted that separate adjustment is required in respect of interest therefrom. Judicial Precedents 74. The Honorable Supreme Court in the case of Commissioner of Income Tax vs. Bokaro Steel Ltd. 236 ITR 315 1999 SC has held that only real income can be brought to tax and not hypothetical income. In this connection, the Appellant wishes to highlight to the judicial pronouncements in India by the Mumbai ITAT in the case of Nimbus Communications Ltd. (9 taxmann.com 26) wherein the ITAT has also held that debit balances are not an international transaction. ITAT in their order have specifically noted that the international transaction resulting in a debit balance and the debit balance itself should not be analyzed. The relevant extracts of the ruling have been provided as follows: “A continuing debit balance, in our humble understanding, is not an international transaction per se, but is a result of the international transaction. In plain words, a continuing debit balance only reflects that the

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Page 19 of 30 payment, even though due, has not been made by the debtor. It is not, however, necessary that a payment is to be made as soon as it becomes due. Many factors, including terms of payment and normal business practices, influence the fact of payment in respect of a commercial transaction. Unlike a loan or borrowing, it is not an independent transaction which can be viewed on standalone basis. What can be examined on the touchstone of arm’s length principles is the commercial transaction itself, as a result of which the debit balance has come into existence, and the terms and conditions, including terms of payment, on which the said commercial transaction has been entered into. The payment terms are an integral part of any commercial transaction, and the transaction value takes into account the terms of payment, such as permissible credit period, as well. The residuary clause in the definition of ‘international transaction’, i.e. any other transaction having a bearing on the profits, incomes, losses or assets of such enterprises, does not apply to a continuing debit balance, on the given facts of the case, for the elementary reason that there is nothing on record to show that as a result of not realizing the debts from associated enterprises, there has been any impact on profits, incomes, losses or assets of the Assessee. In view of these discussions, in our considered view, a continuing debit balance per se, in the account of the associated enterprises, does not amount to an international transaction under section 92B in respect of which ALP adjustments can be made.” 75. In the case of Dania Oro Jewellery P Ltd Vs DCIT (118 taxmann.com 14 – 118 taxmann.com 14), the Mumbai ITAT held that since no interest was charged from non AEs, adjustment on account of notional interest for delay in realization of sales made to AEs was not warranted. Ground 20: No rationale provided for computing interest at Libor plus 450 basis points 76. Without prejudice to the arguments of the Appellant mentioned in Ground 19 on levy of interest on delayed receivables, the Appellant wishes to submit that the TPO in TP Order has not provided any rationale for imputing a mark-up of 450 basis points to the LIBOR rate. Also, in this aspect, it is highlighted that the TPO has also not followed the prescribed economic analysis to determine a mark-up via any of the prescribed methods as per the Act for determination of mark-up of 450 basis points and therefore the interest rate considered by the TPO is arbitrary and whimsical. Therefore, the adjustment on account of interest imputed on delayed receivables ought to be rejected.

A. Grounds 21-23 Corporate tax adjustments Ground 21: Denial Of deduction of R&D Expenditure u/s 35(1)(i) or 37(1) of the Act

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Page 20 of 30 77. The AO and DRP has erred in law and on facts by not allowing the claim of Rs.3,86,332/- [out of the total disallowance u/s 35(2AB) of Rs.7,72,665/-] either u/s 35(1) or u/s 37 of the Act, without appreciating that the same was incurred for the purpose of business of the appellant even if it did not qualify for weighted deduction u/s.35(2AB). 78. The Appellant has a state-of-the-art in house research facility in Peenya, Bangalore. The Appellant has a modern R&D center supported by a full-fledged pilot plant, testing facilities. R&D facility is also equipped by the latest and modern Medium Pressure Liquid Chromatography's (LC's) and Preparative High-Performance Liquid Chromatography's (HPLC's) for isolation of bioactive molecules. To facilitate the increased demand for innovative application-based products, the company has established this state of the art research facility at Bangalore. Although this is attached to its corporate office in Peenya, it is a clearly demarcated area and the appellant company does not have any manufacturing facilities nearby. Their manufacturing facilities in Karnataka are located in Nelamangala, Kunigal and Dobaspet. They also have a manufacturing facility in Hyderabad. 79. The R&D Centre is recognised by the Department of Scientific and Industrial Research, Government of India for the purposes of Sec 35(2AB) of the Income tax Act, 1961. A copy of Form 3CM issued by DSIR, Ministry of Science and Technology, New Delhi is available in Page 225 of paper book I. The R&D focuses not only on the manufacture of herbal extracts, fine chemicals, specialty chemicals and cosmeceuticals, but also on the research for New Drug Discovery. In addition to the research and development facilities, the company has full-fledged laboratories in the areas of Phytochemistry, Organic Chemistry, Tissue Culture, Biotechnology etc. 80. The details of expenses incurred by the appellant company towards the in-house research and development activities and Auditor’s certificate obtained from a firm of Chartered Accountants in Form 3CLA along with the detailed list of expenditure which was submitted to the AO during the course of the assessment proceedings is available in Pages 209-221 of paper book I. The R&D unit of the appellant company is subject to periodic inspection by the DSIR. All expenses claimed by the appellant company as towards R&D activities are also verified by the DSIR on an annual basis. A copy of Form 3CL issued by the DSIR for AY 2017-18 certifying the quantum of expenses incurred by the R&D unit was also submitted to the AO and is available in Pages 222 – 224 of paper book I.

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Page 21 of 30 Difference Amount considered as Amount claimed ineligible for certified by Particulars in ITR weighted DSIR (Rs. (Rs. in deduction u/s in lakhs) lakhs) 35(2AB) (Rs. in lakhs) Capital Expenditure 233.20 233.20 NIL Revenue Expenditure 875.25 871.40 3.85 Eligible R&D Expenditure u/s 35(2AB) 1108.45 1104.60 3.85 Weighted deduction at 200% 2216.92 2209.20 7.72

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Page 22 of 30 85. The AO ought to have restricted the disallowance only to the extent of weighted deduction claimed by the company to the extent of Rs.386,333/- only [i.e., Rs.7,72,665/- less Rs.3,86,333/-] and not the entire expenditure. Though a specific claim was made during assessment proceedings (Page 204 of the paper book) to allow the same u/s 35(1)(i) or 37(1), the AO had not dealt with it in the draft assessment order. The DRP has also not dealt with this alternate claim of the appellant company. Hence the order suffers from serious infirmity. 86. Disallowance of Rs.3,86,333/- is not warranted merely on the contention that DSIR has not approved the same as eligible for weighted deduction. It is not in dispute that the company has incurred the said revenue expenditure of Rs.3,86,332/- for R&D activities which is wholly and exclusively for the purpose of business of the company. Provisions of section 35(2AB) of the Act requires the DSIR’s approval only for the purpose of claiming weighted deduction under the said section.

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Page 23 of 30 90. DSIR’s approval requires many more conditions to be satisfied apart from being a revenue expenditure incurred for the purpose of business of the assessee. Even if such a strict test required for availing the weighted deduction is not satisfied, it would still qualify for normal deduction @ 100% of the revenue expenditure. In other words, the DSIR’s approval ought to be confined only to the weighted deduction as envisaged u/s 35(2AB) of the Act and not to the claim for normal deduction u/s 35(1) of the Act. DSIR’s approval has no relevance to decide whether an expenditure is eligible for deduction u/s 35(1) or under any other provisions of the Act. If, for any reason, it cannot be allowed u/s 35(1) of the Act, the same may be allowed u/s 37(1) of the Act as the expenditure is incurred wholly and exclusively for the purpose of the business of the assessee company. 91. Accordingly, in view of the intention of providing weighted deduction u/s 35(2AB) of the Act to promote scientific research as well as in the light of the various judicial precedents cited above, the company’s claim for deduction of Rs.3,86,332/- u/s 37(1) of the Act as incurred wholly and exclusively for the purpose of business ought to be allowed and the disallowance be restricted only to the extent of weighted deduction of Rs.3,86,332/- 6. In addition to the above written synopsis, the ld.AR submitted that the lower authorities did not accept the internal TNMM method and internal comparables available and sufficient data was filed before the TPO. Therefore, she prayed that the internal comparable for TNMM submitted by the assessee should be accepted and computed for international bench mark transactions and she also submitted that the AO has not followed the direction of DRP while giving OGE. She further submitted that similar issues have been decided by the coordinate bench in assessee’s own case in ITA 2764/Bang/2017 and 3353/Bang/2018 for assessment year 2013-14 and 2014-15 respectively vide order dated 18/02/2022 and assessee requested that the matter may be send back to the file of AO/TPO in the light of above judgments.

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Page 24 of 30 8. After hearing both the sides and perusing the entire material and examining the assessee’s own case as cited by the ld.AR of the assessee, we observe that the issue raised before us is similar in assessee’s own case cited supra. The relevant part is as under:-

“3. At the outset, it is submitted that assessee bench marked the transaction of sale to the AE using Cost Plus Method (CPM) analysis, however, the Ld.TPO rejected the CPM analysis and used Transactional Net Margins Method (TNMM) as most appropriate method. 3.1 The Ld.AR at this juncture submitted that assessee do not object for the use of TNMM. Accordingly, ground no. 1 stands dismissed. However, she submitted that there are internal comparables available and sufficient data were filed before the DRP which were not considered for purpose of comparability analysis. She prayed that as against the external comparables used by the Ld.AO/TPO, the internal comparables submitted by assessee may be considered in order to bench mark the international transaction for the years under consideration. She submitted that all the details are available in order to assist the revenue authorities to use the internal comparables. 3.2 In support of her submission, she placed reliance on the decision of Hon’ble Special Bench, Mumbai in case of Tecnimont ICB (P.) Ltd. vs. Addl. CIT reported in [2012] 24 taxmann.com 28 (Mum.) (TM). Referring to the said decision, she submitted that when the data is available showing the profit margin of that enterprise itself from third parties, it is always safe and advisable to have recourse to such internal comparable case. The reason is patent that the various factors having bearing on the quality of output, assets employed, input cost etc. continue to remain by and large same in case of an internal comparable. The effect of difference due to such inherent factors on comparison made with the third parties, gets neutralized when comparison is made with internal comparable. Ex consequenti, it follows that an internal comparable uncontrolled transaction is more noteworthy vis-a-vis its counterpart i.e. external comparable. 3.3 The Ld.AR submitted that the proposition laid down by the Hon’ble Mumbai Special Bench has been followed in various decisions of this Tribunal the same principle. 3.4 The Ld.CIT.DR though opposed the use of internal comparables could not controvert the observation by Hon’ble Mumbai Special Bench and various other decisions filed by assessee. We have perused the submissions advanced by both sides in the light of records placed before us.

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Page 25 of 30 4. We note that admittedly, the transactions in a controlled transaction with a related party and an uncontrolled transactions with unrelated parties will result into more appropriate bench marking of arm’s length price. Under the circumstances, if there is availability of sufficient data of internal comparables, the Ld.TPO first should have recourse to such internal compares before moving on to external comparables. Only on insufficiency of data in respect of internal comparables, support must be drawn from the external comparables. 4.1 We therefore, direct the Ld.TPO to carry out detailed analysis of the international transactions using TNMM as MAM, based on the materials filed by assessee related to internal comparables. In the event the details filed are satisfactory, the determination must be confined to the internal comparables so filed by assessee. In the event, the details filed by assessee is not verifiable or not in accordance with law, the Ld.AO/TPO is open to carry out analysis in accordance with law. Ground nos. 2-4 raised by assessee stands allowed for statistical purposes. Ground nos. 5-10 becomes academic at this juncture as the entire assessment in respect of transfer pricing adjustment has been remanded to the Ld.AO/TPO for de novo consideration based on the directions hereinabove. These grounds may be considered by the Ld.AO/TPO afresh in the remand proceedings. Needless to say that proper opportunity of being heard needs to be granted to assessee. Accordingly, grounds raised by assessee stands partly allowed for statistical purposes.” 9. Respectfully following the above decision in the assessee’s own case cited supra we also send back this issue to the file of AO/TPO for de-novo consideration in the above terms and decide the issue as per law. Needless to say reasonable opportunity of hearing to be given to the assessee and the assessee is directed not to seek unnecessary adjournments for early disposal of the case.

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Page 26 of 30 AO/TPO afresh in the remand proceedings. The AO is directed to give sufficient opportunity to the assessee and the assessee is also directed to produce relevant documents/evidences in support of the case and not to seek unnecessary adjournments for early disposal of the case.

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Page 27 of 30 transactions after relying on the judgments as cited by the DRP in his order and the order of the coordinate bench in the case of Outsourcepartners International (P.) Ltd. v. ACIT [2022] 140 taxmann.com 597 (Bangalore - Trib.) 14.1. The head note of the above cited decision of the coordinate bench is as under:-

“Section 92B of the Income-tax Act, 1961 - Transfer pricing - International transaction, meaning of (Lending or borrowing/Capital financing) - Assessment year 2015-16 - Whether interest on receivable is a separate international transaction - Held, yes [Para 13] [In favour of revenue] II. Section 92C of the Income-tax Act, 1961 - Transfer pricing - Computation of arm’s length price (Adjustment - Interest) - Assessment year 2015-16 - Assessee was engaged in business of providing information technology enabled services (ITeS) to its Associated Enterprises (AE) - TPO had held that outstanding receivables from AE was in nature of loans and calculated interest on receivables from AE - DRP upheld adjustment of TPO with respect to interest on receivables with a direction to reduce credit period from 90 days to 30 days - It was found that assessee had entered into a service agreement with its AE with regard to providing ITeS wherein by way of amendment credit period was increased to 90 days - Whether since said fact had not been taken into consideration by DRP, TPO should compute ALP afresh and should consider credit period of 90 days while determining ALP of international transaction of interest on receivables - Held, yes [Paras 12 to 15] [Matter remanded]” 14.2. Respectfully following the above judgments, we also uphold that the interest on delayed receivables is an international transactions, accordingly the adjustment should be made on those receivables which were not realized within the agreements period.. During the course of hearing, it was brought into the notice of both the parties that in respect of rate for calculation of interest is to be considered by the AO/TPO/DRP at libor + 350 basis points considering the nature of business and location of the receivables with the consent of AR. Accordingly this issue is also remitted back to the file of the AO.

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Page 28 of 30 Ground No.21.

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Page 29 of 30 produce necessary documents. This issue is allowed for statistical purposes.

Order pronounced in the open court on 7th Nov, 2022.

Sd/- Sd/- (Beena Pillai) (Laxmi Prasad Sahu) Judicial Member Accountant Member

Bangalore, Dated 7th Nov, 2022. VMS

Copy to:

Asst. Registrar, ITAT, Bangalore.

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Page 30 of 30 1. Date of Dictation ………………………………………

Date on which order goes for Xerox & 9. endorsement……………………………………