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Income Tax Appellate Tribunal, Hyderabad ‘ A ‘ Bench, Hyderabad
Before: Smt. P. Madhavi Devi & Shri B. Ramakotaiah
Per Smt. P. Madhavi Devi, J.M.
This is assessee’s appeal for the A.Y 2009-10 against the order of the AO dated 10.01.2014 passed u/s 143(3) r.w.s. 92CA(3) and 144C of the I.T. Act.
Brief facts of the case are that the assessee company, which is in the business of research and development services in relation to bio-analytical and formulation development, furnished its return of income for the A.Y 2009-10 on 30.09.2009 declaring total income of Rs.2,97,67,240. During the assessment proceedings u/s 143(3) of the Act, the AO noticed that the assessee has entered into international transactions with its AE and therefore, for the purpose of determination of the ALP of the
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said transactions, the case was referred to the TPO u/s 92CA of the Act. The TPO passed an order dated 22.01.2013 and in accordance with the same, a draft assessment order was passed. The assessee filed its objections before the DRP, which was allowed in part, and in accordance with the directions of the DRP, the final assessment order was passed. Against the final assessment order, the assessee is in second appeal before us by raising the following grounds of appeal:
“1. That the order of the Deputy Commissioner of Income Tax, Circle 16(1), Hyderabad (hereinafter referred to as 'AO') in pursuance of the directions of the Dispute Resolution Panel (hereinafter referred to as 'DRP'), Hyderabad in so far as it is prejudicial to the Appellant, is contrary to law, facts and circumstances of the case. 2. Transfer Pricing Adjustments 2.1 General Grounds 2.1.1 The assessment order passed by the Learned AO under section 143(3) read with section 144C and read with the order passed by the Learned Transfer Pricing Officer (hereinafter referred to as 'TPO'), under section 92CA(3) of the Income Tax Act, 1961 (hereinafter referred to as 'the Act') is bad in law and void ab-initio. 2.1.2 That the Learned DRP / AO erred by not accepting the price of international transaction of contract research & development services of Rs. 18,91,47,004 shown by the Appellant and determining the Arm' s Length Price (hereinafter referred to as 'ALP') at Rs.19,93,79,360 and thereby making transfer pricing adjustment of Rs.1,02,32,356 to the Total Income of the Appellant. 2.1.3 That the Learned DRP/AO erred in rejecting the economic analysis undertaken by the Appellant in accordance with the provisions of the Income Tax Act, 1961 (hereinafter referred to as 'the Act') read with the Income-tax Rules, 1962 (hereinafter referred to as 'the Rules') and consequently making adjustment under section 92CA of the Act to the total income of the Appellant.
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2.2 Grant of Working Capital Adjustment
2.2.1 Based on the facts and the circumstances of the case and in law, the Learned AO/DRP/TPO erred in not granting the working capital adjustment to the net profit margins of the comparable companies as provided under Rule 10B(l)(e) read with Rule 1 10B(2)(b).
2.2.2 Based on the facts and the circumstances of the case and in law, the Learned DRP/AO/TPO erred in not allowing working capital adjustment to the margins of the comparable companies by ignoring the fact that the Appellant is a captive service provider and furnished the quantum of working capital adjustment.
2.3 Filters
2.3.1 The Learned AO/DRP erred in confirming the TPO's stand in rejecting functionally comparable companies by applying diminishing revenue/ persistent losses filter for the period under consideration.
2.4 Comparables
2.4.1 The Learned AO/DRP erred in confirming the TPO's selection of Suven life sciences limited as a comparable company, even though, it is functionally dissimilar to the Appellant.
2.4.2 Without prejudice to ground no. 2.4.1, the Learned AO/DRP erred in not allocating unallocated research & development expenses while computing the segmental profitability of Suven life sciences limited to arrive at the arm's length price.
2.4.3 The Learned AO/ DRP erred in rejection of Jubilant Biosys Limited as a comparable company selected by the Appellant in its transfer pricing study on the grounds of diminishing revenue filter and persistent loss filters. 2.4.4 The Learned AO/DRP erred in accepting the incorrect margins of the following comparable companies as computed by the TPO, while determining the ALP:
2.4.4.1 TCG Lifesciences Ltd 2.4.4.2 Manipal Acunova Limited 2.4.4.3 Choksi Laboratories Ltd.
2.4.5 The Learned AO/DRP erred in confirming the TPO's stand in considering the provision for bad and doubtful debts and bad debts as non-operating expenses for the
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purpose of margin computation of the comparable companies.
2.5 Incorrect computation of margin of Appellant
2.5.1 Based on the facts and the circumstances of the case and in law, the DRP/AO erred in confirming the action of the TPO in considering the foreign exchange loss as operating.
2.6 Use of multiple year data
2.6.1 The Learned AO/DRP erred in rejecting the multiple year analysis for computing the operating margins earned by the alleged comparable companies.
2.5 Risk Profile for captive service provider
2.5.1 The Learned AO/DRP/TPO ought to have appreciated that margins earned by the Appellant (being a captive service provider) were reflective of the functions performed and proportionate with the risks assumed while determining the ALP of the international transactions of the contract research & development service business of the Appellant.
2.5.2 The Learned AO/DRP/TPO erred in disregarding the differences in risk profile of the Appellant and the alleged comparable companies selected by him, by not allowing the risk adjustment claimed by the Appellant
2.5.3 Without prejudice to ground no. 2.5.2, the Learned AO/DRP erred in not granting an adjustment of 1 per cent which was granted by the Jurisdictional Tribunal in case of Hellosoft India Private Limited (ITA No. 645IHYD/2009), which is binding on the Learned AO I DRP I TPO.
The Learned DRP erred in law and on facts by summarily rejecting the Appellant's objections and disregarding the material placed on record thereby not following the procedure laid down u/s l44C(5), 1 44C(6) & l44C(7) of the Act.
The Learned AO/DRP erred in computation of interest liability under sections 234B and 234C.
The Appellant craves leave to add, alter, amend, substitute and/or modify in any manner whatsoever all or any of the foregoing grounds of appeal at or before the hearing of the appeal”.
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At the time of hearing, the learned Counsel for the assessee submitted that the assessee does not wish to press ground of appeal No.2 which is general in nature and also other grounds of appeal except for the Ground Nos. 2.2, 2.3 and 2.4.
As regards Ground No.2.2, brief facts are that while computing the ALP of the international transaction, the assessee requested for working capital adjustment and relied on the provisions of Rule 10B(1)(e)(iii) of the Rules. The assessee submitted that there exists differences in the debtors and creditors of the assessee as well as the comparables selected by the Department; which are materially affecting their net profit margin. The assessee carried out the working capital adjustment at 5.39% but the TPO did not accept the same by observing that the exact details of the debtors, inventories and the creditors is not available and that according to the OECD guidelines of 2010, working capital benefit cannot be given automatically, but can be given only in a situation, where there is a greater chance of increasing the comparability levels of the assessee. A perusal of the balance sheet of the comparable companies led to the conclusion of the AO that there is no uniformity in the items under the receivables and payables, as these are the categorised differently in different companies. He, therefore, observed that in the absence of any correct characterization of the element constituting the same, it would not be feasible to accept the figures on the face value. Further, he observed that where a company is having multiple segments, it is difficult to pinpoint as to which pertains to which segment and the anomalies involved in the whole exercise would result in factually incorrect results. He
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observed that the other liabilities have not been included and no break up is available in the AR (Annual Reports) of the comparables, as to what it constitutes and whether some part could be included or not is also not known. Therefore, he refused to allow the benefit of working capital adjustment. The DRP also confirmed the order of the TPO and the assessee is in appeal before us.
The learned Counsel for the assessee has drawn our attention to Page No.105 of the Paper Book, which is the working capital adjustment as computed by the assessee and submitted before the TPO and also to page 1 of the Paper Book being the copy of the submissions made by the assessee before the DRP, wherein the assessee has given in detail the procedure for computation of working capital adjustment. He submitted that though the assessee has given detailed submissions, none of the authorities below have considered the same. Therefore, he prayed that the authorities may be directed to consider the submissions of the assessee at length.
The learned DR, however, supported the orders of the authorities below and submitted that the TPO has given reasons as to why the working capital adjustment benefit cannot be given for the international transaction of the assessee.
Having regard to the rival contentions and the material on record, we find that though the TPO has given reasons as to why the working capital adjustments cannot be given to the
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assessee, the assessee has filed detailed submissions addressing the TPO’s concerns point by point before the DRP in its grounds of objection in Annexure-3. But we find that the DRP has failed to consider and adjudicate the same. The DRP has merely confirmed the order of the TPO without discussing as to why the assessee’s contentions cannot be accepted. Therefore, we deem it fit and proper to set aside the issue to the file of the DRP for reconsideration of the issue in accordance with Rules and precedents on the issue and thereafter, the DRP is directed to pass a speaking order thereon. Ground of appeal No.2.2 is accordingly treated as allowed for statistical purposes.
As regards Ground of appeal No.2.3, the learned Counsel for the assessee, except for placing reliance on the said ground, did not advance any specific argument on any of the filters, leave alone the diminishing revenue/persistent losses filter. It has been held by various Benches of the Tribunal that for determination of ALP, companies which are functionally comparable to the assessee only have to be adopted and in such analysis, companies incurring persistent losses or having diminishing revenue during the earlier years, cannot be taken as comparables to the assessee. In view of the same, we do not see any reason to interfere with the order of the AO. Therefore, Ground of appeal No.2.3 is rejected.
As regards Ground of appeal No.2.4.2 which is against non-allocation of unallocated research and development expenses while computing the segmental profit of Suven Life Sciences Ltd,
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we find that Suven Life Science has been adopted by the assessee also in its TP study as a comparable, but during the TP proceedings, assessee had argued that that it has been wrongly considered as a comparable, as it was functionally different. According to the assessee, under the segmental reporting, Suven Life Sciences has identified three business segments i.e. (a) manufacturing; (b) services and; (c) research & development and business segment was considered erroneously by the TPO for comparison and has also erred in computing the operating margin of Suven Life Science, by not considering research and development segment expenditure which was not apportioned to any segment for apportionment between the two segments of manufacturing & services. The TPO however, did not accept the assessee’s contention. He observed that the comparable has described R&D as an independent segment i.e. research and development. Thus, according to him, the expenditure on R&D need not be apportioned to Drugs Discovery and Development Support Services (DDDSS) and manufacturing segment. However, the unallocated loss of Rs.73,31,47,000 was apportioned between the segments on the basis of revenue. The DRP also confirmed the order of the TPO and the assessee is in appeal before us.
The learned Counsel for the assessee submitted that the assessee undertakes R&D activities relating to pharmaceuticals and biotechnological products which include Bio-analytical services; and Formulation development and analysis. It was submitted that under the Bio-analytical services, the assessee assists the AE to develop and validate the method for measuring drugs in animal and humans plasma/tissue samples
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and after the development and validation of the methods, a written report summarizing the findings is submitted to its AE in US, which then reviews the findings and adopts the same if found acceptable. It is also submitted that under Formulation development and analysis, the assessee undertakes formulation development in small dosage forms for further research by its AE undertaking in US and once such dosage form has been developed and accepted in US, then the assessee may prepare/test the composition that are suitable for administration to animals/humans. It was submitted that the assessee has a well equipped pilot lab for performing these services. According to the assessee, the services rendered by Suven Life Sciences under the DDDSS are entirely different from the activities of the assessee as enumerated above. According to him, the services under drug discovery involve not only testing but also developing new drugs. He referred to the 20th Annual Report of Suven Life Sciences wherein at page 2 of its report, it has been reported that the lifeblood of its business is R&D and there is nothing or nothing else and that they have to continuously create new innovation that leads people do something they did’nt think they could do the day before. It is also mentioned that they are consistently spending more than 20% of the revenue on the risk/reward bearing drug discovery activity to develop new drugs for unmet medical needs in Central Nervous System arena that are affecting many millions of elderly population. Thus, according to the learned Counsel for the assessee, the activity of Suven Life Sciences is much more complicated than the activities of simple testing of drugs undertaken by the assessee. He also drew our attention to Page No.392 of the Paper Book wherein it is
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mentioned that Suven Life Sciences has been granted total of 189 patents in CNS arena and 10 inventions till March, 2009. He has also drawn our attention to page No.401 and 402 of the Paper Book to demonstrate that the said company had incurred huge expenditure on R&D and by use of technology in drugs discovery and innovations, it was generating new novel leads for further development and therefore, is not comparable to the assessee and thus, according to him, Suven Life Science has to be excluded from the list of comparables.
The learned DR however, supported the orders of the authorities below.
Having regard to the rival contentions and the material on record, we find that the assessee is into simple drug testing, whereas Suven Life Science is undertaking not only drug discovery, but is also involved in development of new drugs. Therefore, these activities are clearly functionally distinguishable. The TPO as well as the DRP have chosen to retain Suven Life Sciences as a comparable because the assessee itself has taken the company as a comparable and further because, Suven Life Science is also into R&D. But as seen from the TP order, the segmental details of drug discovery activity (DDDSS) of Suven Life Science have been considered. But, Suvel Life Science is also involved in the complex and complicated activity of R&D and drug discovery for diseases in Central Nervous System (CNS) arena. Therefore, the difference of these activities have to be considered. We find that there is no bifurcation of expenditure and revenue
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amongst drug testing and drug discovery in the case of Suven Life Sciences. Therefore, in our opinion, these differences cannot be overlooked nor can there be adjustment made for these differences. Therefore, we direct the AO to exclude this company from the list of comparables. Ground of appeal No.2.4.1 is thus allowed and Ground No.2.4.2 is not adjudicated at this stage as it would only result in an academic exercise. The learned Counsel for the assessee did not advance any arguments in respect of ground No.2.4.3 and therefore, it is rejected as not pressed.
Further, as regards Grounds No.2.4.4 and 2.4.5 and the assessee’s contention that incorrect margin has been adopted by the TPO with regard to TCG Life Science Ltd, Manipal Acunova Ltd by considering the provisions for bad and doubtful debts as non-operating expenses, we find that the TPO has considered the provision for doubtful debts as part of operating expenses, only when the said expenses are incurred every year for the last three years upto and including the financial year 2008-09 and that where these expenses are incurred at almost consistent level in terms of its ratio with the turnover. Further, TPO also did not consider bad debts as operating expenditure for the reason that the bad debts are exceptional items.
Rebutting this findings of the TPO, the learned Counsel for the assessee, submitted that the provisions for bad and doubtful debts has been reduced from the sundry debtors and has been included in the operating and other expenses. He submitted that while computing the margins of the comparables
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also, similar treatment should be given to the provision for bad and doubtful debts for determination of ALP. He has drawn our attention to page No.382 of the paper book, which is the annual report of Choksi Laboratories Ltd wherein the bad debts written off of Rs.10,49,481 crores has been reported. Therefore, according to him, the provision for bad and doubtful debts and the bad debts written off have to be taken into consideration and suitable adjustment should be made while computing the ALP.
The learned DR however, supported the orders of the authorities below.
Having regard to the rival contentions and the material on record, we find that every component which is likely to have an effect on the operating revenue or the operating cost of the international transaction and also the margin of the assessee and the comparables has to be looked into and suitable adjustment has to be made. The assessee has drawn our attention to the fact that the assessee has reduced the provision of bad and doubtful debts from the sundry debtors and has also claimed the same as expenditure. Similarly, in the case of Choksi Laboratories Ltd, there was a provision for bad and doubtful debts which was written off and claimed as an expenditure during the relevant A.Y. Thus, suitable adjustments on account of such transactions have to be made. Therefore, we remand the matter to the file of the TPO, with a direction to analyse the impact of such an entry on the margins of the assessee as well as the comparables and make
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suitable adjustments to bring the companies on par with each other for determination of the ALP.
In the result, ground of appeal No.2.4.4 & 2.4.5 are treated as allowed for statistical purposes.
As regards Ground No.2.5 with regard to forex loss considered by the TPO and the DRP as operating loss, we find that this issue is covered against the assessee by various decisions of the Tribunal. However, the learned Counsel for the assessee submitted that the loss arising subsequent to the date of invoice should not be considered as operating revenue. We find some strength in the said argument and deem it fit and proper to remand the issue to the file of the AO for verification and only the loss arising subsequent to the date of invoice, shall not be considered as operating loss. Thus, ground of appeal No.2.5 is also treated as allowed for statistical purposes.
The other grounds are not being adjudicated as not pressed by the assessee.
In the result, assessee’s appeal is treated as partly allowed. Order pronounced in the Open Court on 3rd August, 2018.
Sd/- Sd/- (B. Ramakotaiah) (P. Madhavi Devi) Accountant Member Judicial Member Hyderabad, dated 3rd August, 2018. Vinodan/sps
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Copy to:
1 M/s. Nektar Therapeutic (India) Private Limited,Sy. No.101/02 Lalgadi Malakpet, Genome Valley, Shameerpet, Hyderabad 500078 2 Dy. Commissioner of Income Tax, Circle 16(1), Hyderabad 3 DRP, 2nd Floor, IT Towers, 10-2-3, AC Guards, Hyderabad 500004 4 Director of Income Tax (International Taxation), IT Towers, 10-2- 3, AC Guards, Hyderabad 500004 5 The DR, ITAT Hyderabad 6 Guard File
By Order
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