DEGANIA MEDICAL DEVICES PVT. LTD.,GURGAON vs. ACIT, GURGAON

This is an appeal filed by the assessee against the order of the Assistant Commissioner of Income Tax, Circle – 1 (1), Gurgaon [hereinafter referred to as ld AO] dated 23.12.2013 for the Assessment Year 2009-10 under section 143 (3) read with section 144C of the income tax act, 1961 (in short The Act) passed in pursuance of direction of the Ld Dispute Resolution Panel – 1, New Delhi (hereinafter referred to as the Ld. DRP) dated 03/10/2013 against objections on draft assessment order passed by the Ld. Assessing Officer on 28/2/2013 wherein the transfer pricing adjustment proposed by the Additional Commissioner of Income Tax, Transfer Pricing, Chandigarh (hereinafter referred to as Ld. Transfer Pricing Officer) vide order under section 92CA(3) of the Act dated 29/01/2013 were incorporated.

The assessee has raised the following grounds of appeal:- “1. The Hon‟ble Dispute resolution Panel has erred in law, facts and circumstances of case by failing to give due consideration to the objections raised by assesse and rejecting almost all objection in pre conceived and mechanical manner without giving any justifiable, logical or cogent reasoning.

The learned TPO, and the learned AO have erred, in law and on facts and circumstances by not making suitable adjustments, on account for differences in the risk borne by the assessee for various risk / functional difference like Marketing, technology, inventory risk, Head office infrastructure support, credit and product liability risk. There is no cogent and logical reasoning for the same.

The learned TPO, and Learned AO have erred, in law and on facts and circumstances of the case by failing to make appropriate adjustments to account for differences in working capital employed by the assessee vis-a-vis comparable companies, as per rule 10B(3) of the Rules. The learned TPO has acted in biased manner with pre conceived notion and has not given any justifiable or cogent reasoning for not allowing working capital adjustment. Comparable have employed huge working capital whereas assesse has negative working capital due to advance from AE instead

Ground No 1 & 2 are general in nature therefore they are dismissed.

Ground No 3 & 4 are contesting two comparable companies included by the ld TPO. Ground no 5 is against the computation of margins of the comparable as well as the assessee company. Ground no 6 and 7 respectively are for risk adjustment and Working capital adjustments. These grounds are contested.

Brief facts of the case are that assessee is a private limited company, which is engaged in the business of import of assembly of component and re-export of assembled medical disposable balloon catheters as 100 % export oriented unit ( EOU). It is providing a captive production to its parent company and its parent company has helped in setting up and expansion of manufacturing facilities by providing technology, training, and finance administrative and marketing support to the assessee. Assessee imports different sub assemble parts i.e. semi finished balloon catheters which includes the purging of holes in the silicon tubing and fixing with wall, rings and the balloon. The final products are being sold only to one customer i.e. the AE of the assessee. 6. For assessment year 2009 – 10, it filed its return of income on 25/09/2008 declaring loss of Rs. 17377228/–. As assessee has entered into international transactions, the case was referred to the Ld. Transfer Pricing Officer under section 92CA (1) of the Income Tax Act. The Ld. Transfer Pricing Officer passed an order under section 92CA (3) on 29/01/2013 proposing an adjustment to the International Transaction of the assessee of Rs. 1762 9070/–. Consequent to that draft assessment order under section 144C of the Income Tax Act was passed on 28/2/2013 wherein the only adjustment was made to the returned loss of Rs. 17377228/– of transfer pricing adjustment to the returned income of the assessee of loss of Rs. 17629070/- and computed total income of the assessee at Rs. 251842/–. The assessee preferred objections before the Ld. Dispute Resolution Panel who gave its direction on 03/10/2013. After considering the direction of the Ld. Dispute Resolution Panel, Ld. Transfer Pricing Officer passed an order under section 144C (10) read with section 92CA(3) proposing adjustments of Rs. 15336400/- on the arm‟s length price of the international transaction entered into by the assessee. Consequent to this, the Ld. Assessing Officer passed final assessment order under section 143 (3) of the Income Tax Act read with section 144 C of the Act on 23/12/2013 assessing the total income of the assessee at Rs. 2040228/-. Assessee is in appeal before us against that order. 7. The assessee has entered into 3, international transactions as under: a. purchase of raw material of Rs. 1 4037 6182/– from its associated enterprise the Degania Silicon Limited , Israel Page | 3 Degania Medical Devices Pvt. Ltd, Vs. ACIT, (Assessment Year: 2009-10)

The Ld. Transfer Pricing Officer rejected the transfer pricing study report of the assessee, on fresh search, selected 6 comparables vide para No. 11 of his order wherein the average PLI of those comparable companies was 9.45% and thereafter the adjustment under section 92CA of Rs. 17629070/- was proposed. Before the Ld. Dispute Resolution Panel assessee objected for the exclusion of South India surgical company. The Ld. Dispute Resolution Panel directed TPO as per Ground No. 6.3 directed the Ld. transfer pricing officer to include it for the comparability analysis. However all other contentions of the assessee were rejected. Vide order dated 05/12/2013, Ld. transfer pricing officer included the above comparable making the total comparable list of 7 companies whose average PLI was 8.215% and thereafter computed the adjustment under section 92CA of Rs. 15336400/–.

Now The issue in dispute is the inclusion of the 2 comparable selected by the Ld. Transfer Pricing Officer of Hindustan Syrengies and medical devices Ltd, which has the PLI of 16.91% and Pregna international Ltd, which is a PLI of 11.57%. Further, the assessee has also disputed the margin of the comparable companies wherein the duty drawback and duty entitlement pass book, foreign exchange fluctuation and other income is required to be adjusted. The assessee has also asked for the working capital adjustment, risk adjustment and abnormal items adjustment. Ground No 3 & 4 are against the inclusion of two comparables. Now we 1st take up the issue 11. on inclusion of the 2 comparables i.e. Hindustan Syringes and medical devices Ltd and Pregnant international Ltd. Page | 4 Degania Medical Devices Pvt. Ltd, Vs. ACIT, (Assessment Year: 2009-10)

Regarding Hindustan Syringes Limited Ld. Transfer Pricing Officer has selected this comparable as the assessee has rejected this comparable in its accept reject matrix on the ground that sufficient financial data are not available. The Ld. Transfer pricing officer stated that the annual report of the company is available, has been perused and it is a medical disposable manufacturer. He further stated that the comparable financial data is also available in the Prowess database because it passes all filters , therefore according to him it is a suitable comparable. The Ld. Dispute Resolution Panel also observed that this company is engaged in manufacturing and sale of medical products such as syringes etc. The items manufactured by the assessee is production of the semi finished medical products into final products of disposable and therefore this comparable is functionally quite close to the assessee company. It was further held by the Ld. Dispute Resolution Panel that TNMM method allows some degree of flexibility and tolerance in the matter of selection of the comparable because under this method the net margins are compared and some amount of functional dissimilarity can be tolerated at the net margin level. According to the Ld. Dispute Resolution Panel as the company is undisputedly engaged in the provision of financial services but qualifies service income filter, hence cannot be excluded. Hence, according to the Ld. Dispute Resolution Panel the functional differences pointed out by the assessee are not significant enough to warrant the rejection of this company as comparable. Hence, the objection of the assessee was rejected.

The Ld. authorized representative placed before us balance sheet of the comparable and submitted that the turnover of this companies Rs. 374.26 crores while the turnover of the assessee is only Rs. 18.53 crores and therefore this is not suitable comparable. He relied upon the decision of the coordinate bench in case of DHL express India private limited versus Assistant Commissioner of Income Tax (ITA 7360/MUM/2010). It was further contested that the companies having export sales less than 10% of the total sales are excluded by the Ld. Transfer Pricing Officer wherein this companies having an 11% export and 89% domestic sales. Therefore, it fails the filter adopted by the Ld. Transfer Pricing Officer. It was further stated that the comparable company is functionally different, which is also be noted by the Ld. Dispute Resolution Panel. However, for the reasons that the assessee has adopted the transaction net margin method (TNMM) the functional dissimilarity have been ignored. He therefore relied on the decision of the Hon‟ble Delhi High Court in case of Rampgreen solutions private limited wherein it is stated that the comparability factors cannot be different in different methods of the determination of the arm‟s length pricing. Page | 5 Degania Medical Devices Pvt. Ltd, Vs. ACIT, (Assessment Year: 2009-10)

Regarding Pregna International Limited the Ld. transfer pricing officer also looked into the accept reject metrics of the assessee wherein this company did not figure. Therefore he included this comparable stating that it is Manufacturer of medical disposable and data for the same is available in the databases. He further held that it passes all filters also therefore this is a suitable comparable. On objection before the Ld. Dispute Resolution Panel assessee contested the functional difference in dissimilarity of the above comparable. However, the Ld. Dispute Resolution Panel held that this company is engaged in the manufacturing and sale of medical products. According to the Ld. Dispute Resolution Panel items manufactured by the assessee are production of semi finished medical products and therefore it was observed that this comparable is functionally quite close to the assessee company. Further, the detailed reason given for 1st comparable of Hindustan syringes medical devices Ltd regarding relatively low degree of proximity acceptable in transaction net margin method were also applied for this and objection of the assessee was rejected.

The Ld. authorized representative submitted before us that this company has turnover from laparoscopic component of 32% which are in electronic Item and 66.94% from implants. He submitted that the implants remain in the human body for a longer duration. Some of the above items are disposable while assessee‟s turnover is 100% from disposable. He therefore submitted that the company which is manufacturing disposable items cannot be compared with the company which is manufacturing implants which remain in the human body. Hence, this comparable company is functionally different. He further submitted that there is a wide difference between the margin of the medical implants as well as the disposable. For this he referred to the newspaper article. 16. The Ld. Departmental Representative vehemently relied upon the order of the Ld. Transfer Pricing Officer which was confirmed by the Ld. Dispute Resolution Panel with respect to both the above comparables and stated that when the comparables are functionally closer and in TNMM method adopted by the assessee and Ld. TPO some of the dissimilarities can be ignored. He therefore submitted that there is no infirmity in the order of the lower authorities in confirming the inclusion of about 2 comparables. 17. We have carefully considered the contentions of the Ld. authorized representative and the Ld. departmental representative on exclusion/inclusion of the above 2 comparables. The functional profile of the company is not disputed by the lower authorities and assessee has also relied upon the same. After comparing the functions of the assessee, we discuss both the above comparables which are contested before us. Page | 6 Degania Medical Devices Pvt. Ltd, Vs. ACIT, (Assessment Year: 2009-10)

In our view, the aforesaid approach would not be apposite. In so far 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 the transactional net margin 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 arm's length price. Therefore, as far as possible, the comparables must be selected keeping in view the comparability factors as specified. Wide deviations in profit level indicator must trigger further investigations/analysis.”[ extracted from ITR online and undelrlined by us] Degania Medical Devices Pvt. Ltd, Vs. ACIT, (Assessment Year: 2009-10)

Therefore, we reject the contention of the Ld. Dispute Resolution Panel because despite admitting the functional dissimilarity of the comparable company with the assessee company above comparable was directed to be included for the comparability analysis of the company. Further there is vast difference in the activities of the company as the comparable company is also using Intangible assets for which royalty is pad, where as the assessee is merely a job worker. Comparable is also engaged in trading activities and which does not have segmental accounts for trading as well as manufacturing activities, where as the assessee is merely a assembler. In view of the above functions, respectfully following the decision of the Hon‟ble Delhi High Court, we direct the Ld. Transfer Pricing officer to exclude Hindustan syringes and medical devices private limited as a comparable company.

Therefore ground no. 3 & 4 of the appeal of the assessee is allowed.

Ground no 5 of the appeal is with respect to the margin of the comparable, Ld. authorized representative submitted that duty drawback has been considered by the Ld. Transfer pricing officer as operational income while comparing the margins of the comparable. He submitted that in case of liberty India Ltd (317 ITR 208) Hon‟ble Supreme Court has held that it is not operational income as it is not and inextricably linked with the business of the assessee. We have carefully considered the contention of the Ld. and failed to understand that how the duty entitlement pass book scheme entity to duty drawback are not part of the operating profit. According to us, both the above incentives are provided to the manufacturer and exporter for the purpose of compensating in the duty component which is already been included in the cost of raw material. Therefore, in fact, they go to reduce the cost of raw model consumed by the assessee and hence, according to us there are part of the operating profit of the assessee and cannot be extruded for the purpose of comparability analysis.

With respect to the foreign exchange fluctuations He submitted that these have been considered as nonoperational items. However, the assessee has considered the foreign exchange loss of Rs. 1953939/– as operational as the issue is those foreign exchanges fluctuations have arisen and because of the adjustment on account of sale or realization of the debts. He further submitted that if the same is excluded from the PLI working of the assessee and considered it as a nonoperational then the margin of the company also increases substantially to 1.20169%. In any way he submitted that this is an operational expenditure and therefore in case of the comparable companies also, it should be included while working out the PLI or it should be excluded in the case of the assessee. With respect to the foreign exchange fluctuation, which is on account of the forward contract with respect to the purchase of material? We fully agree with the contention of the Ld. authorized representative that these are the foreign exchange fluctuations on revenue account and the hedging is also a Page | 10 Degania Medical Devices Pvt. Ltd, Vs. ACIT, (Assessment Year: 2009-10) risk mitigating exercise to reduce the cost of imports and only. Therefore, it should be considered as part of the operating profits and losses of the companies.

With respect to the insurance claim he submitted that in insurance claim cannot be part of the income from manufacturing operating profit and it always pertains to the loss incurred in earlier years. Therefore, the quantitative impact of the above loss is required to be excluded in case of the comparability analysis. We do not find any reason to agree with the contentions of the assessee as insurance claim is on account of the assets employed by the company and may also relate to the working capital , expenditure for restating the assets have already been debited to the profit and loss account hence, such is part of operating results of the company.

He further submitted that the assessee must be granted the working capital adjustment that the assessee is getting advance payment from the buyer for goods sold to them and the working capital of the assessee is always negative, while the working capital of comparable is always positive. He submitted that assessee has given a detailed calculation and has a very strong case but rejected by the Ld. Transfer pricing officer without assigning any reason. He submitted that merely for the reason that the working capital should be computed on the basis of daily average of working capital deployed by the tested party and each of the comparable cannot be the sole reason for rejection of the claim of the assessee. He relied on the decision of the coordinate bench in case of Tata McGraw-Hill education private limited versus ACIT for assessment year 2008 – 09 wherein para No. 20 the coordinate benches held that the objection of the DRP that the average day to day working capital deployment is required to be computed, the bench held that the objection of the Ld. dispute resolution panel cannot be accepted as it is the average working capital deployment which is to be considered and which can be computed with reference to opening and closing balance of working capital deployed. Therefore, respectfully following the decision of the coordinate bench we also direct the Ld. assessing officer/transfer pricing officer to grant working capital adjustment to the assessee provided the assessee submits the relevant detail of working capital adjustment computation. In view of the coordinate bench decision cited before us which is on the same point, we accept the contentions of the assessee and direct the ld AO to compute working capital adjustments only on the opening and closing balance of the working capital employs at the beginning and end of the year. Hence Ground no 6 of the appeal is allowed.