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Income Tax Appellate Tribunal, DELHI BENCHES : I-2 : NEW DELHI
Before: SHRI R.S. SYAL & SHRI KULDIP SINGH
per the specifications of the AE; and the final product is sold to the AE.
The assessee distinguished itself, being, a contract manufacturer from a `Loan and licence manufacturer’ in whose case inputs are provided by the principal and only the manufacturing part is done by the other party.
It was contended that the assessee manufactured the products at its own though at the instance of its AE and that is the reason for which amount realized from the AEs was shown as ‘Sales.’ The TPO noticed that the assessee also did Contract research and testing for sales and it has the entire manufacturing set up which is subjected to inspections by foreign regulators. He came to hold that the assessee should have applied Comparable Uncontrolled Price (CUP) method for benchmarking this international transaction. The assessee’s contention that no comparable instances were available, was rejected. The TPO observed that the assessee manufactures generic drugs and several such drugs manufacturers are available in the market for comparison. Considering CIMS database available in the public domain, the TPO noticed that such database provides data of retail prices of the drugs by different manufacturers. He, therefore, held that such retail sale prices should be compared with the prices charged by the assessee from its AE with reasonable adjustment. As the prices under CIMS database are available for retailing, and that too in the Indian market, the TPO opined that such retail prices should be adjusted to arrive at the ex-factory price, which is the point of sale by the assessee. For converting the retail price from CIMS database to the ex-factory price, the TPO sought help and guidance from the pricing given by National Pharma Pricing Authority.
As per the pricing policy prescribed, the difference between the retail price and ex-factory price stood at 39.6% on account of retail margins, wholesale margin and taxes etc. He, therefore, took some of the products sold by the assessee to its AE with particular potency, quality and value and found the unit price charged. Then, he took the prices of substituted drugs from CIMS classification. Retail price charged by independent manufacturers was adjusted to the ex-factory price by 39.6% and, thereafter, the adjustment amounting to Rs.55,60,75,740 was worked out as under :-
Table-3
The assessee could not convince the DRP on its point of view. As a consequence, the AO made addition of Rs.55.60 crore, against which the assessee is before us.
We have heard the rival submissions and perused the relevant material on record. It is noticed that the assessee applied TNMM to ALP. The TPO applied the CUP method and proposed the above amount of transfer pricing adjustment. First of all, let us examine if the exercise undertaken by the TPO is in accordance with law?
The TPO in the Table-3 above has started with the Product sold as `Allopurinol’ with potency of 300, which the assessee sold to Merckle GmbH with per unit price at Re.0.85. The TPO took Substituted drug of Alrik from CIMS classification with market price at Rs.3.94 per unit.
Such price was adjusted to Rs.2.38 per unit by reducing 39.6% for bringing the available retail price in CIMS database to ex-factory price, as is the point of sale made by the assessee. It is in this way, that transfer pricing adjustment was proposed at Rs.2,71,20,813/- for this product.
Going in the same manner for some other products sold by the assessee to its AE, the TPO computed total transfer pricing adjustment from this international transaction at Rs.55.60 crore.
It can be seen that for the purpose of comparison of `Allopurinol’ sold by the assessee, the TPO has taken `Alrik’ as a substituted drug with similar potency, whose retail price as per the database charged by Cipla is Rs.3.94 per unit. The ld. AR argued that the CIMS database gives only the current retail prices charged by several manufacturers of the same generic drugs with their own brand names and, as such, the retail prices for the earlier period are not available. This contention has remained uncontroverted on behalf of the Revenue. The ld. AR placed on record CIMS data for other manufacturers of the same product, which shows significant variations in the retail price. For example, a manufacturer `Kamron’ is selling Allopurinol with the trade name of Allgoric at the retail price of Rs.1.20 per unit. Similarly, the retail price charged by a manufacturer `Unkind’ for the same formulation but with its own trade name is Rs.5.20 per unit. The retail price charged by another manufacturer, namely, `Saniti’ with same formulation is Rs.4.99
per unit. Similarly, another manufacturer `Shinto Biotech’ is charging retail price of Rs.12.00 per unit of the same medicine. Another
Bio’ is charging for same product and same potency at Rs.5.20 per unit. The retail price charged by still another manufacturer `Bio Plasma’ for same generic product with same potency is Rs.7.00. The above discussion shows that there is a wide fluctuation in the retail price charged by different manufacturers of the same product but under their respective brand names. The TPO has conveniently picked up only one price of Rs.3.94 per unit, charged by Cipla, by ignoring that the same product is being sold by other manufacturers at varying prices. He did not consider it expedient to take into consideration the other prices of the same product also available from the same database. Similar is the position qua all the products taken note of by the TPO in Table-3.
It was submitted by the ld. AR that all the prices available in the CIMS database are of full-fledged manufacturers as against the assessee being only a contract manufacturer. He vehemently argued, and rightly so, that a full-fledged manufacturer cannot be compared with a contract manufacturer. We agree that whereas a contract manufacturer works on the strength of a sure pre-orders and ordinarily gets remuneration at cost plus, as is the case here, a full-fledged manufacturer has to undertake several risks and there remains uncertainty about profit. All these factors necessarily place a contract manufacturer in a compartment different from a full-fledged manufacturer. One is no match to the other.
Coming back to the Table-3 of the TPO, we find that the first column in horizontal way contains the name of the respective AE to whom the assessee sold the products. Vertically there are eight broad columns below it. Though the TPO has computed transfer pricing adjustment in respect of all the eight vertical columns with further sub- columns, but only four columns contain the name of the AE, viz., Merckle GmbH; ratiopharm Inc.; Teva Operations, Poland; and Teva Pharmaceuticals Works Pvt. Ltd. Company. There is no mention of the name of the AE against the remaining four columns. Thus it is not discernible as to which are the other international transactions in these four columns, which have been benchmarked.
Further, the second horizontal column is `Products sold to AE’.
Against the name of Merckle GmbH, there are six columns, but name of only two products have been mentioned, that is, Alloupurinol and Sildenafil. There is no mention of the product in remaining four columns, though transfer pricing adjustment has been worked for all the six columns. Thus, there is complete dark about the name of the product sold by the assessee to its AE. With no information about the product sold by the assessee, the corresponding columns of substituted drug are also blank, albeit transfer pricing adjustment has been proposed by giving certain prices for comparison. Where from these market prices have emerged is a mystery. Once the product sold and the corresponding comparable product are not ascertainable, we fail to comprehend as to how any comparison can possibly be made for making a transfer pricing adjustment under the CUP method. Similar position prevails in respect of transactions in the remaining seven columns.
There is one more aspect of the matter. It has been noted above as an uncontroverted position that the CIMS data has only current retail
prices of the products. It does not contain prices of earlier dates. As the TPO’s order is dated 14.01.2016, it is, but, natural that the CIMS data taken by him will also be for the same period. The assessment year under consideration is 2012-13, with the year ending 31.03.2012. Thus, it becomes manifest that the TPO compared the prices charged in the so called comparable uncontrolled situations prevalent during the financial year 2015-16 with the prices charged by the assessee from its AEs during the financial year 2011-12. Such a time gap frustrates the comparability, as the prices often fluctuate with the passage of time. The adjustment made by comparing prices of altogether different years patently lacks credibility.
There is still another significant aspect of the matter. The TPO scaled down the retail price charged by comparables to ex-factory price by deducting 39.6%. This 39.6% has been adopted by taking assistance from the pricing policy of Organization of Pharmaceutical Producers of India, which is Annexure-1 to the TPO’s order. We have gone through this document. Para 8 of the same deals with `Pricing’. It states that:
Drugs (Prices Control) Order 1995 (DPCO), in the framework of the Essential Commodities Act.” It has further been stated in para 8 that the NPPA monitors the drug prices by fixing and revising them. `Under the DPCO-1995, there are 74 bulk drugs and their formulations under price control (known as scheduled drugs) covering significant percentage of the total pharmaceutical market in India’. It further provides that: “Only a few OTC actives, e.g., acetylsalicylic acid and ephedrine and its salts, fall under the current DPCO control.” It has further been enumerated that: “the prices of non-scheduled drugs are fixed by the manufacturer subject to a maximum increase of 10% on the prevailing price of a 12- month period.” On going through the contents of para 8, it clearly emerges that price controls are exercised on certain drugs and not all the drugs. Further, the price control mechanism under this Order applies only within the framework of Essential Commodities Act, which regulates the prices charged from customers in India. In contrast, the assessee has only exported its complete range of products to the AEs and there is no domestic sale under this international transaction. Since the export prices are not regulated by the DPCO, it can have no bearing on the arm’s length price of exports. In view of this position, it becomes apparent that the comparable uncontrolled price computed by the TPO by reducing margin of 39.6% from the retail price charged by Indian manufacturers, cannot be justified.
At this stage, it would be apt to note the mandate of Rule 10B (1)(a), which contains the modus operandi for determining ALP under the CUP method, as under :-
`(i) the price charged or paid for property transferred or services provided in a comparable uncontrolled transaction, or a number of such transactions, is identified ; (ii) such price is adjusted to account for differences, if any, between the international transaction and the comparable uncontrolled transactions or between the enterprises entering into such transactions, which could materially affect the price in the open market ; (iii) the adjusted price arrived at under sub-clause (ii) is taken to be an arm’s length price in respect of the property transferred or services provided in the international transaction ;’
Sub-clause (i) of Rule 10B(1)(a) provides for identifying the price, inter alia, paid for property sold. Sub-clause (ii) talks of making adjustments to such price on account of differences, if any, between international transaction and comparable uncontrolled transactions, which could materially affect the price in the open market. Sub-clause (iii) provides that the adjusted price arrived at under sub-clause (ii) is considered as ALP in respect of the property sold.
Adverting to the facts of the instant case, we find that the calculation of the ALP made by the TPO under this method is not passing the prescription of rule 10B(1)(a). Sub-clause (i) talks of identifying the price charged for the property transferred. We have noted above that even the description of property transferred i.e. the drugs sold is not ascertainable in most of the cases. Sub-clause (ii) firstly, requires determining the price charged in comparable uncontrolled situation.
Here again, similar position prevails. Not only there are varying prices charged by different manufacturers as against the TPO taking only one price in an ad hoc manner, even the reduction of margin of 39.6% from such retail price for getting the ex-factory price, is not sacrosanct. Apart from that, no adjustment has been carried out as per sub-clause (ii) on account of exports made by the assessee vis-à-vis the comparable prices relating to domestic sales. Thus, it is clear from the above discussion that the exercise done by the TPO in determining the ALP of the international transaction of `Contract manufacturing’ under the CUP method does not merit acceptance.
Now, we turn to the TNMM applied by the assessee as the most appropriate method.
The ld. AR contended that the assessee, as a `Contract manufacturer’, is compensated by its AEs with cost plus arm’s length profit mark-up. As against the goods sold to several AEs, the ld. AR could produce Agreements with only two AEs. When we consider Annexure-19 at page 216 of the paper book, being the details of international transactions, the explanation so given does not prima facie appear to be correct. This page, inter alia, contains a list of Drugs
AEs. Normally, per unit cost of production, which contains the effect of the fixed, semi-fixed and variable costs, remains the same. If arm’s length mark-up is earned on such costs as is claimed in this case, then it will be some reasonable percentage on such costs. Once costs incurred are same for the similar goods produced and sold to all the AEs and mark-up has also been settled as arm’s length, then by and large the sale price should remain consistent or in close range to each other for different AEs. Turning to the Table on page 216 of the paper book, we find that there is one product, Donepezil with potency of 10 mg., sold by the assessee to its different AEs. Per unit price charged for this product from Merckle GmbH, Germany is Rs.13.22. The same Annexure shows the per unit price charged for the similar product at Rs.9.64 from ratiopharm International GmbH, Germany and Rs.2.67 per unit from ratiopharm Inc. Canada. We fail to appreciate as to how the assessee can justify as being compensated by its AEs with cost plus arm’s length mark-up in the face of such a wide variation in the price charged for the same drug
AEs. In the absence of all the Agreements produced before us, we are unable to verify this contention.
There is one more interest aspect of the matter. It has been noticed above that the assessee, under this international transaction, chose four companies as comparable, namely, Brooks Laboratories Ltd. (OP/OC at 21.56%), Sharon Bio-Medicine Ltd. (OP/OC at 12.37%), Smruthi Organics Ltd. (OP/OC at 10.80%) and Natural Capsules Ltd. (OP/OC at 7.43%). We have noted supra with approval the argument of the ld. AR that a full-fledged manufacturer cannot be compared with a contract manufacturer. Now, let us examine the nature of business carried out by these companies chosen by the assessee as comparable in justifying the determination of ALP of this international transaction under the TNMM.
On requisition, the ld. AR placed on record the Annual reports of these four companies. The first company is Brooks Laboratories Ltd., who is admittedly not a contract manufacturer, but, a full-fledged manufacturer.
Similar is the position regarding second company, namely, Sharon Bio Medicine Ltd. The Annual report of third company, namely, Smruthi
Organics Ltd., has also been placed on record. Page 14 of this report indicates that this company is also a contract manufacturer, in addition to doing non-contract manufacturing. It transpires from its annual report, as has also been candidly admitted by the ld. AR as well, that there is no segmental information available in respect of `Contract manufacturing’.
As such, this company also ceases to be comparable for benchmarking.
Similar is the position regarding last company, namely, Natural Capsules Ltd., which again has no separate segmental information about the contract manufacturing segment. This divulges that going by the yardstick of the argument of the ld. AR, while opposing the action of the TPO, for not treating full-fledged manufacturers as comparable with contract manufacturer, none of these four companies chosen by it can be categorized as comparable. The further argument that comparability can be compromised under the TNMM, in our considered opinion, does not hold water, in view of the direct judgment of the Hon’ble jurisdictional High Court in Rampgreen Solutions Pvt. Ltd vs. CIT (2015) 377 ITR 533 (Del), in which it has been held that selection of comparables does not differ with the method adopted and comparables have to be selected on the basis of similarity, even under the TNMM. By finding all the four companies as incomparable, there does not remain even a single comparable case, whose operating profit margin could be considered for benchmarking. Ergo, it is vivid from the above discussion that the assessee’s determination of ALP of the international transaction of `Contract manufacturing’ is crept with several flaws, which renders it unacceptable.
We are back to square one. The position is that neither the TPO’s determination of ALP under the CUP method nor the assessee’s determination of ALP under the TNMM, can be accepted for the reasons discussed above. Thus, we are left with no alternative but to set aside the impugned order and remit the matter to the file of AO/TPO for redoing the exercise afresh. In such exercise, the first question before the TPO will be to apply which method as the most appropriate method for determining the ALP of this international transaction?
Usually CUP is a method of first choice because it seeks to directly compare the price charged/paid for goods with the price charged/paid in a comparable uncontrolled transaction. Comparison of price paid for goods purchased in contradistinction to the profit rate in other methods - gross or operating - offers best comparison as some times profit may be influenced by certain extraneous factors thereby reducing the reliability of comparability. However, in order to successfully apply this method, it is sine qua non that the products under comparable uncontrolled transaction and the other attending facts and circumstances, must be similar. If these factors in a comparable uncontrolled transaction are not similar or no adjustment can be carried out due to distinguishing factors, then, the CUP ceases to be most appropriate method. We have supra taken note of the reasons which have marred the application of the CUP method by the TPO in the given circumstances. But the fact that this method has been applied in an incorrect manner, does not ipso facto reduce its relevance.
While dealing with the earlier international transaction of `Business support services’, we have noticed that the assessee carried out audit and inspection pertaining to contract manufacturing done by third parties in India for its AE. This prima facie shows that there are certain other third parties in India doing contract manufacturing for the assessee’s AE. The TPO has not taken cognizance of these transactions for ascertaining if they are comparable. As they are also contract manufacturers engaged in manufacturing drugs for the assessee’s AE in India, there may be a possibility of finding comparable uncontrolled transactions in such parties, which skipped the attention of the TPO. If other things are similar, then, the price charged by such third parties from the contract manufacturing done by them for the assessee’s AE, can constitute a good comparable uncontrolled transaction. However, this requires investigation at the end of the AO/TPO before jumping to any conclusion as to the comparability or otherwise of such contract manufacturers with the assessee. We, therefore, hold that in the fresh exercise to be undertaken by the AO/TPO, he should firstly consider if CUP method can be applied w.r.t. the contract manufacturing done by the third parties in India for the assessee’s AE.
If either the relevant CUP data of such contract manufacturers is not available or their transactions turn out to be incomparable, then, the AO/TPO should apply the TNMM for determining the ALP of this international transaction. We have found above that all the four companies chosen by the assessee do not qualify to be considered as comparable. The TPO, in a situation warranting the application of the TNMM, should select fresh companies, engaged in contract manufacturing, which are really comparable and are not full-fledged manufacturers. Needless to say, the assessee will be allowed a reasonable opportunity of being heard in such fresh determination.
III. REIMBURSEMNT FOR REGISTRATION OF PRODUCTS
The next international transaction under dispute is `Reimbursement for the registration of product’. The TPO observed on page 12 of his order that the products which are manufactured as per AEs
specifications are registered by the assessee and only then its ownership is passed on to the AE. He noticed that a sum of Rs.1,31,32,100/- was recovered under this transaction from the AEs without any mark up.
Considering the profit margin from the contract manufacturing segment at 14.26% as a benchmark, the TPO proposed transfer pricing adjustment of Rs.18,72,637/- from this international transaction, which was eventually made by the AO in his final order.
Having gone through the relevant material on record, we find that Annexure-7 on page 227 of the paper book contains details of `Reimbursement of expenses (received)’. There is an entry dated 27.4.2011 for a sum of Rs.1,31,32,100/- with the narration ‘Reimbursement of registration fees paid for the product’. The TPO has proposed transfer pricing adjustment only for this entry. Apart from this entry, there are certain other related costs incurred by the assessee, on which the assessee claims to have earned mark-up. Such a contention has not been disputed by the TPO. The only amount considered by the TPO is the `Registration fees’ paid for the products at Rs.1,31,32,100/-.
As this is a cost incurred by the assessee for and on behalf of its AE and the same was recovered without rendering any service qua the payment of registration fees, in our considered opinion this amount was rightly claimed as `Reimbursement of expenses’ on which no mark-up could have been earned. We, therefore, hold that the addition of Rs.18,72,637/- was wrongly made. The same is directed to be deleted.
IV. REIMBURSEMENT FOR WOUND CARE SERVICES
The last transfer pricing addition is of Rs.4,86,275/- on the international transaction of `Reimbursement receivable for Wound care services’. The TPO noted on the last page of his order that the assessee incurred a sum of Rs.34,10,065/- in the form of Selling expenses, which were categorized under the head ‘Wound care.’ Applying the same margin of 14.26%, the TPO computed transfer pricing adjustment of Rs.4,86,275/-, being the excess of ALP over zero mark-up charged.
Having heard both the sides and perused the relevant material on record, we find that the nature of such reimbursement of expenses is not TPO. The rival parties also could not throw proper light on the exact nature of the amount of Rs.34.10 lac. Under these circumstances, it cannot be properly ascertained as to whether the amount of Rs.34.10 lac is a cost incurred by the assessee without rendering any services to its AE or its involvement was there in incurring such expenses. If the assessee’s involvement was there apart from mere incurring, and there is no compensation for it, then, naturally, some mark-up is required and vice versa. In the absence of this vital information, we set aside the impugned order on this score and remit the matter to the file of AO/TPO for re-doing it afresh.
To sum up, we set aside the impugned order on the issue of addition towards transfer pricing adjustment on three international transactions of `Contract Manufacturing support services and Business development and Procurement support services’; `Contract manufacturing services’; and `Reimbursement Receivable for Wound care services’ and remit the matter to the file of AO/TPO for fresh
ALP in consonance with our above directions.
Needless to say, the assessee will be allowed a reasonable opportunity of being heard in such fresh proceedings.
In the result, the appeal is partly allowed.
The order pronounced in the open court on 06.03.2017.