DEPUTY COMMISSIONER OF INCOME TAX CENTRAL CIRCLE -5(1), MUMBAI vs. USV LIMITED , MUMBAI

ORDER PER N.K. PRADHAN, A.M. The captioned cross appeals- filed by the assessee as well as Revenue – are directed against the order of the Commissioner of Income (Appeals)-58, Mumbai [in short CIT(A)] and arise out of the order passed u/s 143(3) of the Income Tax Act 1961 (the ‘Act’). As common issues are involved, we are proceeding to dispose them off by this consolidated order for the sake of convenience. We begin with the assessment year (AY) 2010-11.

Assessment Year: 2010-11 (Assessee’s Appeal) 2. The assessee is a leading health care company engaged in the business of research, development, manufacture, marketing and sale of various drugs, dosage forms, active pharmaceutical ingredients (APIs) and other products. It & Ors 3 M/s USV Private Limited manufactures bulk drugs, drug intermediates, tablets & capsules, cream liquids and powders. It's focus is in the areas of branded generics, APIs and bio-similars. The therapeutic segments covered in India by it include diabetes, cardiovascular, nutritional, respiratory, dermatology, gynecology, pediatrics and CNS.

The assessee filed its Return of Income for AY 2010-11 on 29.09. 2010 declaring total income of Rs.95,84,64,170/-. Thereafter, it revised the same on 14.02.2011, reporting a total income of Rs.87,30,88,182/- under normal provisions of the Act and Rs.2,66,38,60,976/- under MAT.

The Ld. CIT(A) has erred in not appreciating that the Indian Medical Council 1 (Professional Conduct, Etiquette and Ethics) Regulations, 2002 ('MCI Regulations') were not applicable to the Appellant and accordingly, no disallowances under Circular no. 05/2012 dated 1 August 2012 issued by the CBDT can be made; Without prejudice to the above, The Ld. CIT(A) has erred in not appreciating 2 that the Circular no. 05/2012 dated 1 August 2012 issued by Central Board of Direct Taxes ('CBDT) is not applicable for AY 2010-11 and accordingly, no disallowances can be made under the CBDT circular read with the MCI Guidelines; The Ld. CIT(A) has erred in disallowing an amount of Rs.4,74,63,002/- (Net 3 disallowance after 80-IC deduction is Rs.3,13,63 552/-) under section 37(1) incurred under various heads of expenses such as doctors' spends, gifts & external and internal conference, etc. when such expenditure was not incurred by the Appellant for any purpose which is an offence or which is prohibited by law.

Further it is explained that the said Circular shall be applicable prospectively w.e.f. the date of Circular i.e. 01.08.2012 has held in the case of & Ors 6 M/s USV Private Limited Syncom Formulations v. DCIT (ITA No. 6429 & 6428/Mum/2012); Macleods Pharmaceuticals Ltd. v. ACIT (161 ITD 291) (Mumbai Tribunal); UCB India (P.) Ltd. v. ITO [ITA No. 6681 of 2013 (Mumbai Tribunal)]; Cadila Pharmaceuticals Ltd. [2017] 85 taxmann.com 354 (Ahmedabad Tribunal). Thus it is stated that the MCI Regulations do not apply to the assessee and hence, no disallowance u/s 37(1) of the Act r.w. Circular No. 5 of 2012 dated 01.08.2012 issued by CBDT can be made.

Stating that neither the Ld. CIT(A) nor the Department have held/argued that the expenses incurred towards payments to the doctors is not a business expenditure, the only question is whether the expenditure is disallowable under the Explanation to section 37(1) of the Act being violative of MCI guidelines or not. It is explained by him that when it is agreed that an expenditure is an allowable business expenditure as per the provisions of the Act, then by invoking the provisions of MCI guidelines, ad-hoc disallowances cannot be made to the total income without any basis. Reliance is placed by him on the order of the Tribunal in Johnson & Johnson Ltd. (35 CCH 275) (Mum-Trib.) accepted by the Department before the Bombay High Court (ITA No. 2441 of 2013 dated 04.07.2016), wherein it has been held that after the expenditure is held to be for the purpose of business, then ad-hoc disallowances cannot be made treating the same as non-business expenditure. Thus it is stated by the Ld. counsel that the AO be directed to delete ad-hoc disallowances of expenses amounting to Rs.3,13,63,552/- which has been upheld by Ld. CIT(A).

It is well-settled that the code of conduct laid down in MCI regulation applies only to medical practitioners and not to pharmaceutical companies or allied health sector industries. This is also confirmed by the executive committee of MCI that the code of ethics is applicable to individual medical practitioners and not society or an association. Further, there is a separate uniform code for Pharmaceutical Marketing Practice, which needs to be adopted and complied by Pharmaceutical Industry. Hence, had MCI & Ors 8 M/s USV Private Limited regulations been applicable to Pharmaceutical Companies or medical device companies, there would not be any need for a separate code for the Pharmaceutical Industry. There is no dispute that in the decisions relied on by the Ld. counsel mentioned at para 6 hereinabove, it is held that MCI regulations are not applicable to Pharmaceutical Companies.

Also it is well-settled that the CBDT Circular No. 5 of 2012 shall be applicable prospectively w.e.f. the date of Circular i.e. 01.08.2012. There is no dispute that in the decisions relied on by the Ld. counsel mentioned at para 6 hereinabove, it is held that CBDT Circular is applicable prospectively. Therefore, no disallowance u/s 37(1) of the Act r.w. Circular No. 5 of 2012 dated 01.08.2012 issued by CBDT can be made.

In the instant case, neither the Ld. CIT(A) nor the Department have held/argued that the expenses incurred towards payments to the doctors is not a business expenditure. The only question is whether the expenditure is disallowable under the Explanation to section 37(1) of the Act, being violative of MCI Guidelines or not.

We are of the considered view that when an expenditure is an allowable business expenditure as per the provisions of the Act, then by invoking the provisions of MCI Guidelines, ad-hoc disallowance cannot be made to the total income without any basis. In this regard, we rely on the order of the Tribunal in the case of Johnson & Johnson Ltd. (supra) accepted by the Department before the Hon’ble Bombay High Court (ITA No. 2441 of 2013 dated 04.07.2016), wherein it has been held that after the expenditure is held to be & Ors 9 M/s USV Private Limited for the purpose of business, then ad-hoc disallowances cannot be made treating the same as non-business expenditure.

In view of the above factual scenario and position of law, we direct the AO to delete the disallowances of expenses upheld by the CIT(A).

Thus the 1st, 2nd and 3rd grounds of appeal are allowed.

4 The Ld. CIT(A) erred in not allowing weighted deduction of expenditure of Rs.19,93,51,575/- claimed by the Appellant under section 35(2AB) of the Act; 5 The Ld. CIT(A) erred by inadvertently referring to para 6 of the order of Income Tax Appellate Tribunal ('ITAT') in the Appellant's own case in AY 2009-10 [which is in context of certain eligible expenses of Rs.21,87,858/-(i.e. setting-up of effluent treatment plant, etc.) incurred by the Appellant but not considered by Department of Scientific and Industrial Research (DSIR)], while adjudicating the issue of weighted deduction for expenditure incurred on clinical trials, foreign patent filing fees and foreign consultancy fees which are discussed by ITAT in para 3.4, 4 and 4.1 of the said order, 6 The Ld. CIT(A) erred in not following the decision of ITAT for AY 2008-09 and AY 2009-10,wherein the ITAT has allowed weighted deduction for expenditure incurred on clinical trials, foreign patent filing fees and foreign consultancy fees and AY 2007-08, wherein the ITAT has allowed weighted deduction for expenditure incurred on foreign patent filing fees under Patent Act and foreign consultancy fees; 7 The Ld. CIT(A) erred in allowing weighted deduction under section 35(2AB) of the Act on the total R&D expenditure incurred by the Appellant after netting off of income of Rs.33,84,325/- from sale of products emanating from R&D work and Rs.1,34,227/- from sale of R&D assets. & Ors 10 M/s USV Private Limited 10. In view of the rectification order passed by the Ld. CIT(A), the 5th & 6th ground of appeal becomes infructuous. We turn to the 4th and 7th ground of appeal.

The assessee has earned income from sale of products emanating from R & D work amounting to Rs.33,84,325/- and sale of R&D assets amounting to Rs.1,34,227/-. It had filed additional ground before the Ld. CIT(A) on weighted deduction u/s 35(2AB) stating that relief be granted for gross expenditure without netting off income from sale of products emanating from R&D work of Rs.33,84,325/- and sale of R&D assets of Rs.1,34,227/-.

The Ld. CIT(A) disallowed the claim of not netting off the receipts of Rs.33,84,325/- on the basis that no evidence was furnished in respect of the nature of income. Placing reliance on the order of the Tribunal in the case of Microlabs Ltd. (2015) 62 taxmann.com 60 (Bang-Trib.), later on approved by the Karnataka High Court, he rejected the claim of not netting off receipts on sale of R&D assets of Rs.1,34,227/-.

It is submitted by the Ld. counsel that the same issue was adjudicated upon by the Tribunal in assessee’s own case for AY 2008-09 and AY 2009-10. Based upon an assessment of all facts, the Tribunal in Para 9 of the order has restored back the matter to the AO for statistical purposes. The Tribunal held as under :

The AO is directed to verify the claim of the assessee and allow the same after verification in the light of the decision of the Tribunal in the case of ACIT v. Wockhardt Ltd. in ITA No. 71/M/07. The additional grounds are treated as allowed for statistical purpose.

Pursuant to the direction of the Tribunal, the order giving effect for AY 2008-09 and AY 2009-10 was passed. After, the directions provided by the ITAT, the Department has not preferred an appeal before the High Court. Thus it is stated that in view of the finality of the issue, the assessee’s appeal for allowing expenditure on gross basis may be allowed.

In respect of sale of products acquired emanating out of research and development work done in an approved facility, the sale proceeds need not be reduced from the research and development expenditure. In our view, the reason for not including sales realization arising out of products emanating out of research and development work done and sold is because such sales would be reflected as receipts by the assessee in its books of accounts and income from business would be computed treating such sale as part of business receipts.

As mentioned earlier, the same issue was adjudicated upon by the Tribunal in assessee’s own case for AY 2008-09 and AY 2009-10. The Tribunal in para 9 of the order has restored back the matter to the AO for statistical & Ors 13 M/s USV Private Limited purposes. Pursuant to the direction of the Tribunal, the AO passed order giving effect for the above assessment years. After the directions provided by the Tribunal, the Department has not preferred an appeal before the High Court. Thus the issue having attained finality in assessee’s own case, we direct the AO to allow expenditure on gross basis. We make it clear that this finding is specific to the present appeal only. Thus the 4th and 7th grounds of appeal are allowed.

8 The Ld. CIT(A) erred in confirming that the provisions of section 50C of the Act was applicable while computing capital gains on transfer of leasehold rights in land by the Appellant; 9 The Ld. CIT(A) failed to appreciate that the provisions of section 50C of the Act would be applicable only to transfer of a capital asset being land or building, or both and not to leasehold rights/assignment of leasehold rights; 10 The Ld. CIT(A) failed to appreciate that the sale consideration of Rs.2,87,00,000/- determined for transfer of leasehold rights in land was as per the rates prescribed by the Maharashtra Industrial Development Corporation (MIDC) regulations; 11 Without prejudice to the above, the Ld. CIT(A) erred in not restricting the application of provisions of section 50C to the value of building only;

During the year under consideration, the assessee entered into deed of assignment dated 25 January 2010 with M/s Roha Carbonates Pvt. Ltd ('Roha') wherein the leasehold rights in land admeasuring 34,263 Sq Mtrs, factory building having built up area of 3,427.63 Sq Mtrs and residential building having built up area of 1,249 Sq. Mtrs were transferred to Roha for a lump sum consideration of Rs.2,87,00,000/- after obtaining approval from MIDC. The stamp value of the property was Rs.3,87,97,500/-. The stamp duty authorities have considered Rs.2,87,00,000/- towards leasehold land and Rs.1,00,97,500/- towards the factory and residential building standing thereon.

During the assessment proceedings, the assessee realized that they had omitted offering capital gains earned on transfer of leasehold land in the return of income and therefore voluntarily offered the same to tax before the AO. Further, the assessee placed reliance on various judicial precedents and stated that the provisions of section 50C of the Act were applicable only to transfer of a capital asset being land or building or both and not to leasehold rights and hence adopted the value of Rs.2,87,00,000/- as the sale consideration for computing capital gains.

However, the AO was not convinced with the above submission and held that assessee had not only sold the leasehold rights and the land but also the leasehold rights in the building standing on it. Therefore, he treated the & Ors 15 M/s USV Private Limited sale/assignment of leasehold rights as transfer of capital asset being land or building or both. Accordingly, he concluded that the provisions of section 50C of the Act were applicable and accordingly adopted stamp duty valuation as sales consideration amounting to Rs.3,87,97,500/- instead of Rs.2,87,00,000/- as considered by the assessee.

On the other hand, the Ld. DR relies on the order of the Ld. CIT(A).

And whereas MIDC has by its letter number MIDC/ROM/ROHA/18/475/04 dated 31 March 2004 granted its permission for the transfer and assignment of the said property by the Assignor to the Assignee.

After acquisition of land, the factory and the residential building, the assessee agreed in the agreement dated 31.03.2004 that it would obtain permission from MIDC for demolishing the superstructure of the said land. In page No. 3 of the deed of assignment entered into between the assessee and Bombay Dyeing, we come across the following para :

And whereas since the factor building and residential staff building are old and in dilapidated condition and not of any use to the Assignee, the Assignee after obtaining permission of the MIDC for the transfer of assignment of the leasehold interest in the lease dated December 14, 1983, will demolish the factory building and residential staff building.

Thus it is crystal clear that the assessee had no rights to construct or sub-plot or assign the rights to anyone without obtaining approval from MIDC. In fact the assessee only had limited rights to undertake construction on the said land. The assessee has assigned the leasehold rights only after obtaining approval from MIDC.

In Shavo Norgren (P.) Ltd. (supra), relied on by the Ld. CIT(A), the Tribunal based on the reading of deed of assignment observed that even though the document was a deed of assignment, but on perusal of terms of the document, substantial and absolute power over the property including the development right were transferred to the assessee. The Tribunal, in absence & Ors 17 M/s USV Private Limited of having documents on record, remanded the matter to the AO directing him to determine whether the assessee has transferred the plot of land or only the leasehold right in the plot of land and accordingly determine applicability of section 50C.

However, in the instant case, the assessee did not have the right to construct/transfer/sub-plot or assign the property without obtaining the approval from MIDC and accordingly the assessee had limited rights in the leasehold property unlike the complete right for development of property available to the assessee in Shavo Norgren (P.) Ltd. (supra). Therefore, the present case is distinguishable from the above decision.

In Atul G. Puranik (supra) the taxpayer who was allotted by CIDCO leasehold rights in respect of plot of land for 60 years transferred to third party for consideration of Rs. 2.5 crore. For AY 2006-07, the AO invoked section 50C and computed capital gains by adopting stamp duty value at Rs. 2.88 crore. ITAT accepted taxpayer's contention that transfer or assignment of leasehold rights is not transfer of land per se and hence provisions of section 50C will have no applicability to case of leasehold interest. ITAT also accepted the contention that section 50C being deeming fiction should be construed strictly to apply only to case of transfer of land or building per se. Department has not contested the aforesaid judgment before the High Court which is referred by Bombay High Court in Heatex Products Private Limited (ITA 270/2014) dated 26 July 2016.

In the case of Greenfield Hotels & Estate (P.) Ltd. (supra), the Hon’ble Bombay High Court held that the provisions of section 50C cannot be invoked & Ors 18 M/s USV Private Limited to compute capital gains arising on transfer of leasehold rights in land and building.

In view of the above factual scenario and position of law, we direct the AO to delete the addition made by applying the provisions of section 50C of the Act. Accordingly, the 8th to 11th grounds of appeal are allowed.

12 The Ld. CIT(A) erred in re-computing the Arm's Length Price ('ALP') of the international transaction pertaining to sale of pharmaceutical products by the Appellant to its AE and confirming an adjustment of Rs.1,06,49,598/-to the income of the Appellant u/s 92CA(4) of the Act; 13 The Ld. CIT(A) erred in rejecting the Transactional Net Margin Method ('TNMM') adopted by the Appellant for determination of arm's length price in connection with its international Transaction relating to sale of pharmaceutical products to its AE; 14 The Ld. CIT(A) erred in adopting Comparable Uncontrolled Price ('CUP') method, which requires high degree of similarities in products, functions, risks etc. for determining the arm's length price in respect of Appellant's international transaction relating to sale of pharmaceutical products to its AE; 15 The Ld. CIT(A) failed to appreciate that CUP cannot be applied in sale of pharmaceutical products to AE vis-a-vis Non-AEs due to differences inter alia including manufacturing process, regulatory regime, channel of distribution, quantity differences, FOB vs CIF basis of sale, marketing & distribution function, geographical & product differences, etc. and also credit risks borne, market size, contractual terms, growth, competition intensity and other dissimilarities; 16 without prejudice to the above, the Ld. CIT(A) should have compared the net margin earned for sale of Metformin to AE in US vis-a-vis Non-AE's in European & Ors 19 M/s USV Private Limited and regulated market thereby applying internal TNMM as most appropriate method; 17 without prejudice to the above, the Ld. CIT(A) erred in not granting an adjustment for differences between sales made to AEs vis-a-vis Non-AEs while applying CUP method, inter-alia including the following. a marketing expenses computed based on individual strength of product Metformin vis-a-vis the currently granted adjustment considering all strengths of product Metformin together; b profit attributable to entrepreneurial risk undertaken for sales made to Non-AEs vis-a-vis sales made to AEs; c quantity of product Metformin sold to AEs vis-a-vis Non-AEs.

Particulars Rate p/u Adjustment for Metformin 1000 mg Sale price per tablet to non-AEs used as A 1.17 CUP by the learned TPO Adjustment on account of marketing and B 0.16 other expenses Mark-up on marketing expenditure C = B*11% 0.0176 Adjustment on account of marketing D 0.01 personnel cost Therefore, adjusted CUP Price per tablet E = A-B-C-D 0.98 Price per tablet of AE F 0.85 5% as per section 92 (C) G = F*5% 0.04 Difference in the price per tablet charged H = E-F 0.13 to AE and adjusted CUP price per tablet Transfer Pricing adjustment (for I=0.13* 47,01,047 1000mg) 3,61,61,900 Adjustment for Metformin 500 mg Sale price per tablet to non-AEs used as J 0.68 CUP by the learned TPO Adjustment on account of marketing and K 0.09 other expenses Mark-up on marketing expenditure L=K*11% 0.0099 Adjustment on account of marketing M 0.01 personnel cost Therefore, adjusted CUP Price per tablet N = J-K-L-M 0.57 Price per tablet of AE O 0.51 5% as per section 92 (C) P=O*5% 0.03 Difference in the price per tablet charged Q = N-O 0.06 to AE and adjusted CUP price per tablet Transfer Pricing adjustment (for R= 0.06* 44,63,830 500mg) 7,44,80,500 Adjustment for Metformin 850mg Sale price per tablet to non-AEs used as S 1.15 CUP by the Ld. TPO Adjustment on account of marketing and T 0.17 other expenses Mark-up on marketing expenditure U=T*11% 0.0187 Adjustment on account of marketing V 0.01 personnel cost Therefore, adjusted CUP Price per tablet W=S-T-U-V 0.95 Price per tablet of AE X 0.79 5% as per section 92 (C) Y=X*5% 0.04 Difference in the price per Tablet Z=W-X 0.16 charged to AE and adjusted CUP price per tablet Transfer Pricing adjustment (for A1=0.16* 16,67,968 850mg) 1,04,24,800 Total Transfer Pricing adjustment I+R+A1 1,08,37,845 However, the Ld. CIT(A) held that (i) the assessee has failed to adduce any evidence that the chemical variations or use of different bulk drugs results in higher price for the drug sold in European markets vis-à-vis those sold in US markets, (ii) the basic chemical composition as well as the process for manufacturing is similar ; the registration of dossiers may have different processes but that does not require any additional process which would result & Ors 21 M/s USV Private Limited in increase in cost ; the fact that the two products cannot be sold in alternate markets would not mean that they are functionally different, (iii) the assessee has not brought any evidence on record to substantiate that the variation in volume between the amounts sold to AE and non-AEs would invite volume discounts, (iv) the drug regulation in US is very stringent and starts from the manufacturing level itself and is very closely monitored; the registration requirements at USFDA as well as costs of legal challenge are substantially higher in US markets than in EU markets ; hence ordinarily, the price of drugs sold in US markets are generally higher than the price of drugs sold in EU markets, (v) the claim of the assessee that it is forced to sell the drugs at lower margins in US because of higher competition is not found tenable as the margins of the AE in US is found to be significantly higher than that of the assessee itself, in spite of limited functions performed by the AE, (vi) the Rules allow use of a method, after making suitable adjustments while comparing the transactions; the adjustments effected by the AO are correct, (vii) the dossiers are prepared by the assessee and then passed on to the AE for registration in the country of sale ; the dossiers do not shift the risk of the assessee as they are integrally connected with the facility where the drugs are manufactured ; both the R&D, the clinical study and the manufacturing have been done by the assessee and it has entire onus with reference to the drug sold in the market; the assessee has not provided copy of dossiers or any document filed with USFDA, which indicates transfer of risks as claimed by the assessee ; (viii) having a USFDA complaint manufacturing facility is expensive and critical for US markets and hence it is wrong to conclude that testing requirements are higher in EU as compared to such US requirements and hence the pricing of EU markets would be higher; (ix) it is possible to make accurate adjustments & Ors 22 M/s USV Private Limited with regard to the AE sales on FOB basis while the EU sales are on CIF; (x) the TPO has allowed credit for the functional difference while computing adjustment using CUP method ; (xi) as regards the various risks claimed by the assessee the TPO has concluded that such risks are not of a nature that they would require adjustment in prices of the product; (xii) the price of the product with suitable adjustments, would be a fair and acceptable CUP for the AE transactions in respect of the project; (xiii) the segmental margin arrived by the assessee are not acceptable and hence TNMM adopted by the assessee cannot be accepted; (xiv) regarding the contention of the assessee that marketing activities are a separate and important function and therefore a mark up of 11% should be allowed towards the value added marketing function of the assessee, it is held that that a return of 11% on cost is found to be reasonable.

As evident from the 12th ground of appeal, the assessee is aggrieved by the above order of the Ld. CIT(A) re-computing the ALP of the international transaction pertaining to sale of pharmaceutical products by the assessee to its AE and confirming an adjustment of Rs.1,06,49,598/- to the income of the assessee u/s 92CA(4) of the Act.

Thus it is stated by the Ld. counsel that for the purpose of applying CUP, minor differences in contractual terms or economic conditions can materially affect the comparability and will not produce reliable data; as per the Rules, if & Ors 24 M/s USV Private Limited there are significant differences in the products being compared, and if reasonably accurate adjustments cannot be made to eliminate the effect of such differences, the CUP method will not apply; accordingly, CUP cannot be applied in case of the assessee given that there are significant product differences, and that reasonable accurate adjustments cannot be made to account for such differences. Additionally, it is submitted that there is no question of shifting profits outside India, considering that all profits earned by the assessee are taxed in India and it is only a timing difference as the AE’s profits are ultimately received back in India; taxation in the US is at a higher rate than in India, and the assessee is also paying tax on dividend received.

Thus the Ld. counsel explains that since CUP requires a strict and high degree of comparability, even the slightest differences identified, between the functions and risks or even the product themselves, while undertaking transfer pricing analysis would render CUP method as not applicable.

Bringing out the difference in nature of transaction i.e. (i) business model, (ii) specifications and (iii) price comparison and likely differences in risks assumed i.e. (a) market risk and (b) credit risk, it is stated that there are key differences between the assessee and the case of Serdia Pharmaceuticals (India) Pvt. Ltd. (ITA No. 2469/Mum/06, 3032/Mum/07 & 2531/M/08) upon which the TPO has placed reliance.

It is stated that the audited segmentals including net margins of the product Metformin for its AE and non-AE segment as a part of additional evidence was filed before the Ld. CIT(A). The actual price charged for Metformin sales to AE in US market is less than the price charged to non-AEs & Ors 25 M/s USV Private Limited in the Europe market. However, as the assessee has earned a net operating margin of 24.6% from Metformin sales to AE, which is higher than the net operating margin of 23.3% from Metformin sales to non-AEs and thus the same could be concluded to be at arm’s length. Thus it is stated that internal TNMM is to be considered as most appropriate method for benchmarking the international transaction in question.

Without prejudice to the above, it is submitted that even in case CUP is considered as most appropriate method as proposed by the TPO/Ld. CIT(A) various adjustments on account of significantly higher functions and risks undertaken by the assessee in Europe versus US market should be allowed. In this connections, reliance was placed on the decision by the Hon’ble Delhi High Court in the case of Rolls Royce PLC v. DIT (339 ITR 147), wherein 35% of the total profit has been attributed to market activities undertaken. Also it is stated that the volume of products sold have a direct impact on the sale price i.e. the higher the volume of sales, the lower the sale price. Again it is stated that there are huge differences in the quantity sold to non-AEs in Europe vis- à-vis in US.

To sum up, the Ld. counsel submits that CUP cannot be applied in case of the assessee given that there is significant product, functional risk, geographical, quantity, price etc. differences and accordingly, the analysis undertaken by the assessee considering TNMM as the most appropriate method and comparing its net margins with other comparable companies in India should be upheld. & Ors 26 M/s USV Private Limited However, without prejudice to the above, the Ld. counsel submits that even if CUP is to be adopted as MAM, the assessee should be allowed the abovementioned adjustments because of differences in sales made to AE vis-à- vis non-AEs.

21.1 Broadly stated, the arguments of the Ld. counsel are that the comparability analysis undertaken by the assessee was based on well accepted transfer pricing principles, in the absence of any information to the contrary; therefore, it is inappropriate to reject the comparability analysis which was undertaken by the assessee in accordance with the provisions of the Act r.w. the Rules. It is stated that the Ld. CIT(A) confirmed the adjustment made by the AO/TPO in respect of only part of the total products and accepted the remaining exports made by the assessee at arm’s lengths and therefore, he cannot accept TNMM for only part of the same transaction. The Ld. counsel relies on the decision in Amphenol Interconnect India Pvt. Ltd. (302 ITR 131) (Bom HC); Wrigley India (ITA No. 5648/Del/2012) (Del Trib.); UCB India Pvt. Ltd. (121 ITD 131) (Mum) ; Dishman Pharmaceuticals & Chemicals Ltd. (45 SOT 37) (Ahd Trib.).

On specific functional differences, the Ld. counsel relies on the decision in Aztech Software & Technology Services Ltd. v. ACIT (249 ITR (AT) 32) Bang ITAT Special Bench, Mentor Graphics (Noida) Pvt. Ltd. v. Deputy Commissioner of Income Tax (109 ITD 101) Del ITAT, Firmenich Aromatics (India) (P.) Ltd. [2019] 106 taxmann.com 166 (Mumbai-Trib.) Firmenich Aromatics Production (India) Private Limited v. Income Tax Officer-9(3)(2) Mum ITAT, Internet India Private Limited (2010) 39 SOT 93 – Mum ITAT, DCIT/ACIT, Circle 4(1), Kolkata v. M/s Emami Limited (1065 & 1066/Kol/2017), Delhi ITAT in the & Ors 27 M/s USV Private Limited case of Moser Baer India (TS-624-ITAT-2015(Del)-TP] and Kolkata Tribunal in the case of Emami Limited [ITA No. 1066/Kol/2017].

The Ld. counsel submits that without prejudice to the above, if adjustment on account of marketing expenses and entrepreneurial risks are adopted, transfer pricing adjustment reduces to Rs.20,61,578/- in AY 2010-11 and Rs. Nil in AY 2011-12.

Finally, it is submitted by the Ld. counsel that the assessee has earned a net operating margin of 24.6% from sale Metformin to its AE whereas the net operating margin from sale of Metformin to non-AE is 23.3% and since the margins earned from AE segment is more than the margins earned from non- AE segment, the transactions were held to be at arm’s length as required under the Indian Regulations.

Further, the Ld. DR submits that the assessee has not brought any evidence on record to substantiate that the variation in volume between the amounts sold to AE and non-AEs would invite volume discounts. Explaining that the drug regulation in US is very stringent and companies planning for drug sales in US have to invest heavily in USFDA approved facilities, it is stated by him that the assessee has not demonstrated that because of the cap on lower prices or because of market forces, the street price of drugs sold by the assessee is lower in US and higher in EU.

In addition to the above, the Ld. DR submits that the assessee has not provided to the Ld. CIT(A) the copy of dossiers or any document filed with USFDA which indicates transfer of risks as claimed by the assessee.

Thus it is summarized by him that in case of a generic drug, the manufacturers would be selling drugs in each market and hence, the prices would not vary significantly and therefore, the price of the product, with suitable adjustments would be a fair and acceptable CUP for the AE transactions in respect of this product.

With the above submissions, the Ld. DR submits that the order passed by the Ld. CIT(A) be affirmed.

In the instant case, we find that the TPO has straight proceeded to apply CUP method. The TPO has not examined the applicability and relevance of TNMM.

23.1 At this juncture, it would be relevant to discuss the TNMM. It is also necessary to refer to Rule 10B of the Income Tax Rules, 1962 which provides for determination of ALP under Section 92C of the Act. Sub-rule(1) of Rule 10B contains provisions in relation to various methods of calculation of ALP as provided under Section 92C of the Act and TNMM reads as under:— "10B. (1) For the purposes of sub-section (2) of section 92C, the arm's length price in relation to an international transaction or a specified domestic transaction shall be determined by any of the following methods, being the most appropriate method, in the following manner, namely :— (e) Transactional net margin method, by which,- i. the net profit margin realised by the enterprise from an international transaction or a specified domestic transaction entered into with an associated & Ors 30 M/s USV Private Limited enterprise is computed in relation to costs incurred or sales effected or assets employed or to be employed by the enterprise or having regard to any other relevant base; ii. the net profit margin realised by the enterprise or by an unrelated enterprise from a comparable uncontrolled transaction or a number of such transactions is computed having regard to the same base; iii. the net profit margin referred to in sub-clause (ii) arising in comparable uncontrolled transactions is adjusted to take into account the differences, if any, between the international transaction or the specified domestic transaction and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect the amount of net profit margin in the open market; iv. the net profit margin realised by the enterprise and referred to in sub-clause (i) is established to be the same as the net profit margin referred to in sub-clause (iii); v. the net profit margin thus established is then taken into account to arrive at an arm's length price in relation to the international transaction or the specified domestic transaction.”

23.2 We refer here to Rule 10B(2), which reads as under:— "(2) For the purposes of sub-rule (1), the comparability of an international transaction or a specified domestic transaction with an uncontrolled transaction shall be judged with reference to the following, namely:— 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. the contractual terms (whether or not such terms are formal or in writing) of the transactions which lay down explicitly or implicitly how the responsibilities, & Ors 31 M/s USV Private Limited risks and benefits are to be divided between the respective parties to the transactions; d. conditions prevailing in the markets in which the respective parties to the transactions operate, including the geographical location and size of the markets, the laws and Government orders in force, costs of labour and capital in the markets, overall economic development and level of competition and whether the markets are wholesale or retail."

23.3 The Hon’ble Delhi High Court in the case of Rampgreen Solutions (P.) Ltd. v. CIT (2015) 60 taxmann.com 355 (Delhi) has held that :

20. In order for the benchmarking studies to be reliable for the purposes of determining the ALP, it would be essential that the entities selected as comparables are functionally similar and are subject to the similar business environment and risks as the tested party. In order to impute an ALP to a controlled transaction, it would be essential to ensure that the instances of uncontrolled entities/transactions selected as comparables are similar in all material aspects that have any bearing on the value or the profitability, as the case may be, of the transaction. Any factor, which has an influence on the PLI, would be material and it would be necessary to ensure that the comparables are also equally subjected to the influence of such factors as the tested party. This would, obviously, include business environment; the nature and functions performed by the tested party and the comparable entities; the value addition in respect of products and services provided by parties; the business model; and the assets and resources employed. It cannot be disputed that the functions performed by an entity would have a material bearing on the value and profitability of the entity. It is, therefore, obvious that the comparables selected and the tested party must be functionally similar for ascertaining a reliable ALP by TNMM. Rule 10B(2) of the Income Tax Rules, 1962 also clearly indicates that the comparability of controlled transactions would be judged with reference to the factors as indicated therein. Clause (a) and (b) of Rule 10B(2) expressly indicate that the specific characteristics of the services provided and the functions performed & Ors 32 M/s USV Private Limited would be factors for considering the comparability of uncontrolled transactions with controlled transactions.

[Emphasis underlined by us] Further, their Lordships concluded that :

“43. In our view, the aforesaid approach would not be apposite. Insofar as identifying comparable transactions/entities is concerned, the same would not differ irrespective of the transfer pricing method adopted. In other words, the comparable transactions/entities must be selected on the basis of similarity with the controlled transaction/entity. Comparability of controlled and uncontrolled transactions has to be judged, inter alia, with reference to comparability factors as indicated under rule 10B(2) of the Income Tax Rules, 1962. Comparability analysis by TNMM method may be less sensitive to certain dissimilarities between the tested party and the comparables. However, that cannot be the consideration for diluting the standards of selecting comparable transactions/entities. A higher product and functional similarity would strengthen the efficacy of the method in ascertaining a reliable ALP. Therefore, as far as possible, the comparables must be selected keeping in view the comparability factors as specified. Wide deviations in PLI must trigger further investigations/analysis.

[Emphasis underlined by us] 23.4 In UCB India (P.) Ltd. (supra) relied on by the Ld. counsel, the Tribunal has quoted at length the following paragraphs of TP Guidelines for Multinational Enterprises and Tax Administrations issued by OECD:

“70. Section 92C(1) refers to arm's length price in relation to an international transaction. Rule 10B(1)(e) read with section 92C deals with TNMM, and it refers to only net profit margin realized by an enterprise from an international transaction or a class of such transaction, but not operational margins of enterprises as a whole. Paragraph 3.26 of Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations issued by OECD reads as follows :

3.26 The transactional net margin method examines the net profit margin relative to an appropriate base (e.g., costs, sales, assets) that a taxpayer realizes from a controlled transaction (or transactions that are appropriate to aggregate under the principles of Chapter I). Thus, a transactional net margin method operates in a manner similar to the cost plus and resale price methods. This similarity means that in order to be applied reliably, the transactional net margin method must be applied in a manner consistent with the manner in which the resale price or cost plus method is applied. This means in particular that the net margin of the taxpayer from the controlled transaction (or transactions that are appropriate to aggregate under the principles of Chapter I) should ideally be established by reference to the net & Ors 34 M/s USV Private Limited margin that the same taxpayer earns in comparable uncontrolled transactions. Where this is not possible, the net margin that would have been earned in comparable transactions by an independent enterprise may serve as a guide. A functional analysis of the associated enterprise and, in the latter case, the independent enterprise is required to determine whether the transactions are comparable and what adjustments may be necessary to obtain reliable results. Further, the other requirements for comparability, and in particular those of paragraphs 3.34 to 3.40, must be applied.

3.42 An analysis under the transactional net margin method should consider only the profits of the associated enterprise that are attributable to particular controlled transactions. Therefore, it would be inappropriate to apply the transactional net margin method on a company-wide basis if the company engages in a variety of different controlled transactions that cannot be appropriately compared on an aggregate basis with those of an independent enterprise. Similarly, when analyzing the transactions between the independent enterprises to the extent they are needed, profits attributable to transactions that are not similar to the controlled transactions under examination should be excluded from the comparison. Finally, when profit margins of an independent enterprise are used, the profits attributable to the transactions of the independent enterprise must not be distorted by controlled transactions of that enterprise.

23.5 Having regard to the above well-settled principles delineating the ingredients of TNMM and keeping in mind the facts in the present case, we set aside the order of the Ld. CIT(A) on the above grounds of appeal and restore the matter to the file of the TPO/AO to pass an order afresh as per Rule 10B. We hold that TNMM is the most appropriate method in the present case and while using TNMM, the search for comparables may be broadened by the & Ors

35. M/s USV Private Limited assessee as well as revenue by including comparables. However, this can be done only if (a) the functions performed by the tested party and the selected comparable entity are similar including the assets used and the risks assumed; and (b) the difference in services/products offered has no material bearing on the profitability. We direct the assessee to file the relevant documents/evidence before the TPO/AO. As the above grounds of appeal are restored to the file of the TPO/AO, we are not adverting to the case laws referred by the Ld. counsel.

Thus the 12th to 17th grounds of appeal are allowed for statistical purposes.

24. The assessee has filed an additional ground stating the following :

“On the facts and circumstances of the case and in law, the appellant submits that deduction in respect of education cess on income tax paid during the year ought to be allowed as a deduction while computing the total income”. The above additional ground is a purely legal one and following the decision in NTPC v. CIT (1998) 229 ITR 383 (SC), we admit it for adjudication. The Hon’ble Bombay High Court in the case of Sesa Goa Ltd. (Tax Appeal No. 18 of 2013) has held that ‘education cess’ is an allowable business expenditure and not subject to disallowance u/s 40(a)(ii) of the Act. Also the Hon’ble Rajasthan High Court in the case of Chambal Fertilizers & Chemicals Ltd. (102CCH 0202) (2018) has held that education cess liability is eligible for deduction while computing the total income.

In view of the above direct decision, we allow the additional ground of appeal. & Ors 36 M/s USV Private Limited 25. In the result, the appeal filed by the assessee is partly allowed.

Assessment Year: 2010-11 (Revenue’s Appeal) 26 The 1st ground of appeal reads as under :

1. Whether the Ld. CIT(A) has erred in facts and law in deleting the disallowance of Rs.4,24,334/- and Rs.51,41,416/- (10% of Rs.42,43,338/- and 20% of Rs.52,62,07,082/- respectively) made on account of brand reminders holding that no direct benefit has been passed on to doctors when the assessee company itself submitted that such items were randomly distributed.

In view of the above facts, we affirm the order of the Ld. CIT(A) and dismiss the 1st ground of appeal.

2. Whether the Ld. CIT(A) has erred in facts and law in allowing the claim of weighted deduction under section 35(2AB) of the IT Act made by the assessee company during the course of assessment proceedings (and not in the return of income) in respect of expenditure not approved by the DSIR and incurred by the assessee on foreign patent filing fees and clinical trials conducted outside the R & D facility.

3. Whether the Ld. CIT(A) has erred in facts and law in allowing the claim of weighted deducting u/s 35(2AB) of the IT Act made by the assessee company in respect of expenditure not approved by the DSIR and incurred by the assessee on foreign consultancy obtained from outsider the R & D facility.

……..Merely because the prescribed authority segregated the expenditure into two parts, namely, those incurred within the in-house facility and those that were incurred outside, in our opinion, by itself would not be sufficient to deny the benefit to the assessee under section 35(2AB) of the Act. It is not as if that the said authority was addressing the issue for deduction under section 35(2AB) of the Act in relation to the question on hand. The certificate issued was only for the purpose of listing the total expenditure under the Rules……

(Emphasis underlined by us)

Following the above decisions, we uphold the order of the Ld. CIT(A) and dismiss the 2nd & 3rd ground of appeal.

relating to (i) Disallowance of expenditure u/s 37(1) of the Act; (ii) Weighted deduction u/s 35(2AB) and (iii) Transfer pricing are similar to the concerned grounds of appeal for AY 2010

11. (ITA No. 4845/M/2017).

For AY 2011-12 (ITA No. 4915/M/2017) in the case of Revenue’s appeal, the 1st, 2nd, 3rd grounds of appeal are similar to AY 2010-11 (ITA No. 4914/M/2017). & Ors 39 M/s USV Private Limited

34. Facts being identical, our decision for the AY 2010-11 applies mutatis mutandis to AY 2011-12.

To sum up, for AYs 2010-11 and 2011-12, the appeal filed by the assessee is partly allowed, whereas the appeal filed by the Revenue is dismissed.

Order pronounced in the open Court on 05/03/2021