HOSPIRA HEALTHCARE INDIA PRIVATE LIMITED,CHENNAI vs. DCIT, CHENNAI

आदेश / O R D E R

PER ABRAHAM P. GEORGE, ACCOUNTANT MEMBER

This is an appeal filed by the assessee is directed against an

order dated 29.01.2016 of Deputy Commissioner of Income Tax,

Corporate Circle 2(2), Chennai pursuant to directions issued by the

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Dispute Resolution Panel (in short the ‘’ld. DPR’’) u/s.144C of the

Income Tax Act, 1961 (herein after referred to as ‘the Act’).

may be convenient, to briefly capture the facts relating to the case.

Assessee is engaged in manufacturing and selling of generic injectable

drugs to its group entities and certain other concerns called as distribution partners. It was incorporated on 17th November, 2009 as

a subsidiary of Hospira Pte. Ltd, Singapore. Assessee had on

15.12.2009 acquired the generic injectable pharmaceutical business of

M/s. Orchid Chemicals & Pharmaceuticals Ltd (in short ‘’Orchid India)

as a going concern on a slump sale basis. For the limited purpose of

applying a non compete clause, one Shri.K. Raghavendra Rao who

was Managing Director of Orchid Chemicals & Pharmaceuticals Ltd was

also made a party to this agreement. Consideration agreed was

approximately $400,000,000. By virtue of this slump acquisition,

various agreements entered between M/s. Orchid India and

distribution partners were inherited by the assessee. Such type of

agreements were named as legacy agreements. In support of the

consideration paid for the injectable drug division taken over by the

assessee from M/s. Orchid India, assessee had filed a valuation report

prepared by one M/s. R.B. Shah & Associates who as per assessee

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were the merchant bankers authorized to make such valuation. The

price paid were for the tangible assets as well as the intangible assets

like customer relationships, contract manufacturing, developed

products, in-process research and development and goodwill. For

raising the capital that was required for acquiring the unit from Orchid

India, assessee had issued inter corporate convertible debentures

(ICCD) for which interest was payable at 10.5%. The ICCD series

was subscribed by its Associated Enterprise namely Hospira Pte Ltd,

Singapore.

Since the injectable drug unit acquired by the assessee used 3.

certain Active Pharmaceutical ingredient (API) produced by certain

other divisions of Orchid India, assessee had entered into a supply agreement on 30th March, 2010 with Orchid India for ensuring

continued supply of such API. Pursuant to this agreement, assessee

paid a sum of �27,13,20,000/- for capacity expansion of Orchid India

and assessee was entitled for assured supply of two intermediary

drugs namely Meropenem and Imipenem for a ten year period. In the

accounts, this sum was amortized and the charge for the relevant

previous year was �32,30,000/- only. However, assessee claimed the

whole of the amount as Revenue outgo for tax purpose.

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India for acquiring its injectable drug unit, as already mentioned by us,

Shri. K. Raghavendra Rao, Managing Director of that company was

also a party and he was paid a compete fee �4,55,31,000/-. This was

also claimed by the assessee as a Revenue outgo.

following sales to its Associated Enterprises abroad:-

Name of the Associated Location Amount (INR) Enterprise

Hospira Inc USA 1,224,648,753 Hospira Enterprises BV Netherlands 1,606,777,998 Hospira Australia Pty. Ltd Australia 6,513,055

Assessee also had similar transactions with one M/s. Apotex Corp and

Apotex Inc Signet and the value of shipment to these parties during

the relevant period are as under:-

Name of the Party Value of shipment

Apotex Corp 183,78,66,285 Apotex Inc Signet 18,08,60,138

The business model adopted by the assessee and its trading partners

mentioned above were on profit sharing basis. Profits were worked

out by deducting from the sales effected by the entities abroad cost of

products sold and marketing cost. Associated Enterprise abroad who

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were selling assessee’s products were entitled for marketing cost of

7.5% on the total sale price. Cost of the products deducted was based

on the billings by the assessee. Resulting profit was shared in the ratio

of 50% each. The basis of this model was the agreement already

entered by M/s.Orchid India with the above enterprises abroad, which

agreement became the legacy of the assessee when they acquired the

unit of generic injectable drugs from M/s. Orchid India. It is to be

noted that M/s. Orchid India was supplying pharmaceuticals products

to two other companies named Northstar and Actavis also under the

same formula.

Ld. Assessing Officer while completing the assessment for 6.

the impugned assessment year disallowed the claim of depreciation

on intangible assets transferred to the assessee by M/s. Orchid India

on acquisition of generic injectable unit and also the claim of non

compete fee paid to Mr. K. Raghavendra Rao. Ld. Assessing Officer

also disallowed the claim of unamortized expenditure in the nature of

payments affected to M/s. Orchid India for its capacity expansion. Ld.

Assessing Officer also went by the ld.TPO recommendation with

regard to adjustment for the profit shared on sale on the

pharmaceuticals products with its Associated Enterprise products and

also for the rate of interest paid by the assessee on inter corporate

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convertible debentures (ICCD) issued to its Associated Enterprise

abroad.

shared between the assessee and its Associated Enterprise abroad, ld.

TPO treated M/s. Apotex Corp and Apotex Inc Signet also as

Associated Enterprises of the assessee. Ld. TPO relied on an order

dated 28.03.2012 of Income Tax Settlement Commission in the case of

M/s.Orchid India for the assessment years 2006-07 to 2010-2011 for

coming to a conclusion that Apotex Corp and Apotex Inc Signet were

Associated Enterprises of the assessee and profit split ratio between

assessee and its Associated Enterprise should be 60:40 and not 50:50.

Ld. DRP did not make any modification with respect to the proposals

made by the ld. Assessing Officer except for directions on Revenue

expenditure relating to scientific research and correction of the

amount computed as profit share of Associated Enterprise.

grounds of appeal in liue of its original grounds.

‘’1.1 The impugned Order which includes the contentions of the Learned Assessing Officer ('Ld. AO') and the Learned Transfer Pricing Officer ('Ld. TPO'), based on the directions issued by Honourable Dispute Resolution Panel ('Hon'ble DRP'), to the extent prejudicial to the Appellant, is contrary to the law, facts, and circumstances of the case and is violative of principles of equity and natural justice.

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2.1 The Ld. AO and the Hon'ble DRP erred in disallowing the claim of depreciation of INR 99,19,84,875 by holding that developed products, in-process research and development, customer relationship and contract manufacturing acquired by the Appellant pursuant to acquisition of business from Orchid Chemicals and Pharmaceuticals Ltd ('Orchid India') are not intangible assets eligible for depreciation under section 32 of the Act on the basis: • That the apportionment of cost paid over the value of fixed assets is not on a scientific basis. • That the advantage is a restricted one and does not confer an exclusive right to carry on the primary business activity and that such right can be asserted only against Orchid India. •That the intangible assets cannot be independently sold.

2.2 Without prejudice to the above, in case value of any of the above intangible assets are reduced, the reduction to that extent would be construed as "Goodwill" and consequently, depreciation under Section 32 of the Act ought to be allowed on the same.

2.3 The Ld. AO and the Hon'ble DRP erred in disallowing the claim of depreciation of INR 1,13,82,750 on the non-compete fee paid to Mr. K Raghavendra Rao, the principal shareholder of Orchid India are not intangible assets eligible for depreciation under section 32 of the Act on the basis: •That the value it fetches will not be available to the Appellant if it is sold separately in the open market. •That it is not an intangible asset as per Accounting Standard 26.

• That the advantage is a restricted one and does not confer an exclusive right to carry on the primary business activity and that such right can be asserted only against Mr. K Raghavendra Rao.

2.4 Without prejudice to the above, the Ld.AO erred in not considering the alternate plea of allowing the non-compete fee as "revenue expenditure" since appropriate taxes have also been withheld on the payment or to allow the expenditure as deduction over the period of the agreement in line with the accounting treatment. 3. Disallowance of expenses paid towards capacity expansion of

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Orchid India 3.1 The Ld. AO and Hon'ble DRP erred in disallowing the claim of expense paid of INR 26,80,90,000 to Orchid India towards Orchid's manufacturing capacity on the basis that it is a capital expenditure. 3.2 Without prejudice to the above, depreciation should be granted under Section 32 of the Act on the above expenditure. 4.Erroneous downward adjushnent for difference between cost of shipment with standard price 4.1 The Ld. TPO and the Hon'ble DRP erred in making downward adjustment of INR 1,23,67,271 for difference between cost of shipment with standard price by cherry picking transactions where the export prices were lower than the original standard price as per the agreement, while ignoring cases where the export prices were higher.

5.1 The Ld. TPO and the Hon'ble DRP erred in making a downward adjustment of INR 22,14,66,575 for interest paid on ICCD. 5.2 The order of the Ld. TPO was erroneous for the following reasons: • The search strategy adopted for benchmarking the interest on ICCD using the NSDL database was not provided • The Ld. TPO discarded his own comparables when the Appellant demonstrated that the interest paid was at arm's length even if his set of comparable companies are appropriately used. •The Ld. TPO disregarding the supplementary benchmarking analysis provided by the Appellant using the same NSDL database. The Ld. TPO concluded on TPG Wholesale Private Limited as a comparable company.

Erroneous adoption of Order ofHon'ble Settlement Commission (,HSC 6. Order') in the case of Orchid India for AY 2006-07 to 2010-11 without assessing the facts of the Appellant independently

6.1 The Ld. TPO and Hon'ble DRP erred in applying HSC Order of Orchid India to

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make the adjustment of INR 18,79,11,517 in the hands of the Appellant. Further, the adjustment is violative of principles of equity and natural justice as the copy of the HSC Order, unavailable in public domain, was not provided to the Appellant.

6.2 Without prejudice to the above, the order of the Ld. TPO and Hon'ble DRP is not sustainable as it fails to demonstrate that Hospira Group was considered as a deemed Associated Enterprise (AE') even as per the HSC Order, which anyways cannot have a precedential or persuasive value for the Appellant's case and the method adopted for the adjustment is not one of the prescribed methods under the Act.

6.3 Without prejudice to the above, the Ld. TPO and the Hon'ble DRP erred in disregarding the corroborative methodology (i.e. TNMM analysis) provided by the Appellant upon request of the Ld. TPO during the assessment proceedings.

7.1 The Ld. TPO and the Hon'ble DRP erred in treating Apotex as a deemed AE and making an adjustment of INR 6,01,46,813 on account of revising the pricing arrangement by adopting the ratio provided in the HSC order. The above exercise is violating the provisions of the Act and also does not consider the functional differences between the agreements’’.

Ground No. 1 is general in nature needing no specific 9.

adjudication.

Ld. Counsel for the assessee assailing the orders of the 10.

lower authorities disallowing the claim of depreciation on intangible

assets submitted that assessee had given a valuation done by the

Merchant Banker, wherein tangible assets and intangible assets were

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separately valued. As per ld. Authorised Representative ld. Assessing

Officer had given depreciation on goodwill which was the balancing

figure, after setting off the identified values of the tangible and

intangible assets from the slump sale consideration paid. As per ld.

Authorised Representative ld. Assessing Officer had erroneously

applied Accounting Standard 26AS which was applicable only to self

generated assets. Reliance was placed on the judgment of Hon’ble

Delhi High Court in the case of Areva T & D India Ltd vs. DC IT 345

ITR 421 and also decision of Co-ordinate Bench in the case of Hinduja

Foundries Ltd vs. ACIT (ITA No. 1590 to1593/Mds/2015, dated

19.02.2016).

Per contra, ld. Departmental Representative submitted that 11.

there was no scientific basis on which valuer had given the valuation.

As per ld. Departmental Representative value of the tangible assets

were artificially reduced so as to enhance the value of intangible assets

to take advantage of higher depreciation available to intangible

assets. Thus, according to him, disallowance of depreciation on

intangible assets was rightly made.

We have considered the rival contentions and perused the 12.

orders of the authorities below. The purchase price allocation by M/s.

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R.B. Shah & Associates, for the unit acquired by the assessee from

M/s.Orchid India was as under:-

Assets Description Valuation of methodology Estimated fair Estimated value (USD in Fair Value Millions) (INR In Millions)* Net Property Fixed Assets of Sales Comparison / 98.6 4,431.4 and orchid Income Approach/ Cost Equipment Chemicals & Approach Pharmaceuticals Ltd include Land, Building, Plant and Machinery, Furniture & Fixtures Debt-Free Net (Stocks, Book Value (adjusted for 24.6 1,103.8 Working Debtors, Loans fair value of inventory) Capital and Advances, Cash and Bank Balance) (Creditors, provisions) Customer Excellent Inocme Approach – 4.9 218.1 Relationships relationship Difference in ‘’with’’ and maintained with ‘’without’’ customer customers of relationships orchid Chemicals & Pharmaceuticals Ltd Contract The Oral Ceph Income Approach 0.1 4.5 Manufacturing Fill/ Finish Agreement binds Hospira to perform contract manufacturing services on behalf Orchid during the upcoming years. Developed Injectable Income Approach 82.8 3,719.6 Products Generics Viz Cephalosprins, 11.8Penicillins. In process of Awaiting FDA Income Approach 11.8 530.3

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research & approval Viz. development Penems and (IPR &D) new molecules Products of Cephalosporins Goodwill Arising out of Excess of Cost of 159.2 7,156.4 the transaction Acquisation over net of assets acquired and the liabilities assumed

Ld. Assessing Officer had disallowed depreciation on brand and

trademark. The value of these intangible assets has been taken by the

ld. Assessing Officer at �396,79,39,500/-. However, this figure is not

apparent from the valuation report relied on by the assessee.

Whether the valuer namely M/s. R.B. Shah & Associates who assessee

has claimed to be a merchant banker was having the authority to

make a valuation under Income Tax Act, also requires verification. No

doubt as mentioned by ld. Authorised Representative accounting

standard AS 26 applies only for internally generated intangible assets.

The conditions set out by the ld. Assessing Officer at para 5.3 of his

order apply only to internally generated intangible assets and not to

the intangible assets acquired by payment of consideration. We

therefore remit the issue regarding depreciation on intangible assets

back to the file of the ld. Assessing Officer for consideration afresh in

accordance with law.

Adverting to, disallowance of non compete fees paid to Shri. 13.

K Raghavendra Rao, ld. Authorised Representative contented that it

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was purely a business expenditure allowable as revenue outgo. As per

ld. Authorised Representative by virtue of clauses 8.6.1 to 8.6.4 of the

tripartite agreement between assessee, M/s. Orchid India and Shri. K.

Raghavendra Rao, both Orchid India as well as Shri. K. Raghavendra

Rao were barred from engaging in any business which would compete

with the business of the assessee for a period of ten years. Further, as

per ld. Authorised Representative there was a separate agreement

entered by the assessee with Shri. K. Raghavendra Rao, through which

this restriction was made absolute. As per ld. Authorised

Representative amount payable to Shri. K. Raghavendra Rao was 10

million USD and it was purely a revenue outgo. Reliance was placed

on the judgment of Hon’ble Jurisdictional High Court in the case of

Pentasoft Technologies Ltd vs. DCIT 264 CTR 187.

these were all part of a single understanding that assessee had with

M/s. Orchid India for transferring their injectable drug division to the

assessee.

orders of the authorities below. Ld. Assessing Officer had treated non

compete fees as not eligible for depreciation. As per ld. Assessing

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Officer it could not be considered as an intangible asset. Now the

submission of the ld. Authorised Representative is that such payments

should be considered as a revenue outgo. However, we find that

assessee had not preferred any such claim before ld. Assessing Officer.

No doubt in the case of Pentasoft Technologies (supra) Jurisdictional

High Court had held that non compete clause under an agreement

transferring a division exclusively, should be read as a supporting

clause and should be considered as an intangible assets. However,

what we find in the instant case is that clause 8.6.1 to 8.6.4 of the

tripartite agreement between the assessee, Orchid India and Shri.

K. Raghavendra Rao and the bipartite agreement between assessee

and Shri. K. Raghavendra Rao were not carefully verified by any of the

lower authorities. What is required to be seen is whether the payment

of non compete fee was a supporting one to the transfer of the

injectable drugs division. We are of the opinion that this issue also

requires a fresh look by the ld. Assessing Officer . We therefore set

aside the orders of the lower authorities with regard to disallowance

of depreciation an intangible assets and remit it back to ld. Assessing

Officer for to considering afresh, in accordance with law. Concise

ground No.2 of the assessee is allowed for statistical purpose.

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Representative submitted that by paying �27,13,20,000/- to Orchid

India, assessee could ensure continued supply of essential API. As per

ld. Authorised Representative, ld. Assessing Officer as well as ld. DRP

had held it to be capital outgo even though the expansion of business

was that of Orchid India and not of assessee. Further as per ld.

Authorised Representative assessee obtained enduring benefit only in

the revenue field and not in capital field. M/s. Orchid India had

committed to continuous supply of the intermediary drugs Meropenem

and Imipenem. This only improved the business chain of the assessee

but did not add to any of its capital asset. Reliance was placed on the

judgment of Hon’ble Apex Court in the case of Empire Jute Co. Ltd vs.

CIT 124 ITR 1 and L.H. Sugar Factory and Oil Mills (P) Ltd vs. CIT 125

ITR 293.

when assessee ensured a continuous supply of essential raw material

through a lumpsum payment to a supplier and when such payment

were in addition to the cost it had to pay for such rawmaterials, then

such payment could be considered only as a capital outgo.

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orders of the authorities below. It is not disputed that capacity

expansion was of Orchid India and not of the assessee. Orchid India

was not an Associated Enterprise of the assessee. The payments made

by the assessee to ensure continuous supply of rawmaterial did not

enhance its own asset structure in any way. Assessee was obliged to

pay price charged by M/s. Orchid India apart from the lumpsum it had

affected. Agreement between assessee and M/s. Orchid India placed

at paper book page No.964 clearly places an obligation on M/s. Orchid

India to maintain sufficient capacity and supply the projected needs of

the assessee during the term of the agreement. In our opinion, the

payments made by the assessee to M/s. Orchid India was only in the

revenue field to ensure the supply of its raw material on a long term

basis. Expenditure was primarily and essentially related to

manufacturing operation of the assessee which ensured its profit

earning capability. It was only an outlay of business in order to carry

it on in an efficient manner. In our opinion, the expenditure was

allowable as revenue outgo. Treatment of the assessee in its books of

accounts does not have substantial bearing when the claim is

specifically made by the assessee and allowable under the Act. In the

result, we allow ground No.3 of the assessee.

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pricing issues.

Ld. Authorised Representative adverting to ground No.4 20.

submitted that ld. TPO had recommended an upward adjustment of

�1,23,67,271/- for deficiency in the pricing of its supplies to its

Associated Enterprise namely Hospira Group abroad; As per ld.

Authorised Representative, ld. TPO did a cherry picking of the items

supplied. Ld. Authorised Representative submitted that there were

large number of items which were issued at a price higher than what

was agreed between Orchid India and Hospira group concerns.

Contention of the ld. Authorised Representative was that revision of

the prices was done in line with the legacy agreement between M/s.

Orchid India and Hospira group, which assessee had inherited. In any

case according to him, only negative differences were considered,

ignoring positive difference. This gave a skewed and erroneous

result.

Contra, ld. Departmental Representative submitted that 21.

assessee did not produce documentation to show that it had incurred

higher or lower cost of production than what was agreed in the legacy

agreement. When assessee supplied at a lower price than what was

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agreed with its Associated Enterprise then as per ld. Departmental

Representative differences were rightly considered for addition by the

ld. TPO.

orders of the authorities below. As already noted by us, assessee had

taken over generic injectable drugs division of Orchid India through a

slumpsale. By virtue of this, it was obliged to honour the agreements

entered by M/s. Orchid India with various third parties in relation to

such unit. The business model as already explained by us, was one in

which ultimate profit was shared between the Associated Enterprise

abroad and assessee. Once the Associated Enterprises had sold the

products supplied by the assessee, the profit was gross realization less

the cost of production which was billed by the assessee on its

Associated Enterprise and distribution commission of 7.5% retained by

the Associated Enterprise. Cost of production that was to be billed by

the assessee for the supplies was to be worked out based on certain

conditions set out in an agreement earlier entered between M/s.

Orchid India and M/s. Hospira group of concerns. However, for certain

items assessee had billed the Associated Enterprise a price lower

than the agreed one. Claim of the assessee is that the legacy

agreement was subject to revision of prices for inflation. Further, as

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per the assessee billing for a number of items were at a price higher

than the agreed ratio. Be that as it may, when the assessee had

supplied a number of items to its Associated Enterprise abroad, prices

of some of which were lower than the agreed price rates and some

were higher than the agreed rates, then, in our opinion, considering

only the items where there was a deficient pricing was not appropriate.

Assessee has produced a chart at paper book page no.587 to 589

which interalia show that some of the items were charged at higher

than the agreed rates. We are of the opinion that even though an

adjustment can be made, such adjustment has to consider both

positive as well as negative price difference. We are of the opinion that

this issue requires a fresh look by the ld. Assessing Officer. We

therefore set aside the orders of the lower authorites with regard to

adjustment for difference in pricing between cost of shipment and

standard price, back to the file of the ld. Assessing Officer /TPO for

consideration afresh in accordance with law. Ground No.4 of the

assessee is allowed for statistical purpose.

submitted that ld. TPO while recommending a downward adjustment

of �22,14,66,575/- on interest paid by the assessee to its Associated

Enterprise for ICCD, had relied on the interest rates on ICCD paid by

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two companies namely Parsvnath Estate Developers Private Limited

and TPO Wholesale Private Limited. As per the ld. Authorised

Representative the interest rate paid by the assessee was erroneously

bench marked considering the interest charged by these two

companies on ICCD. Ld. Authorised Representative submitted that

ICCD rate for TPG Wholesale Private Limited was considered by the

TPO at 0.5%. According to him, TPG Wholesale Private Limited was

not a good comparable since their rate of interest on debentures was

based on a corporate restructuring. Relying on the balance sheet of

TPG Wholesale Private Limited, ld. Authorised Representative

submitted that Debenture rate of the said company was 50% and not

0.5%. Relying on the audit report of the said company, ld. Authorised

Representative submitted that it had acquired the assets and liabilities

of One M/s.Vishal Retail Limited as a going concern during the

relevant previous year and such high rate of interest on debentures

was due to this acquisition.

supported the orders of the authorities below.

We have considered the rival contentions and perused the 25.

orders of the authorities below. It is not disputed that assessee had

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provided for interest at the rate of 10.5% on its ICCD. Ld. TPO had

selected two companies for comparison of which one company was

having ICCD interest rate of 15.5% and the other company 0.5%.

Contention of the assessee is that M/s.TPG Wholesale Private Limited

for which ld. TPO had taken ICCD interest at 0.5% had actual interest

rate of 50%. In our opinion there is a wide disparity between what is

stated in the Balance sheet and the schedule of M/s. TPG Wholesale

Private Limited filed before Registrar of Companies and the rate

considered by the TPO. The rate 0.5% as well as 50% prime- facie

appear to be incorrect, unless there were other conditions which

constrained the said company to pay a interest which was significantly

different from normal market rate for convertible debentures. The

question of comparability of TPG Wholesale Private Limited for bench

marking the ICCD interest rate of the assessee in our opinion requires

a fresh visit by the ld. Assessing Officer/TPO. We set aside the orders

of the lower authorities with regard to downward adjustment of

�22,14,66,575/- and remit the issue back to the ld. Assessing

Officer/TPO for consideration afresh in accordance with law. Ground

No.5 of the assessee is allowed for statistical purpose.

Representative submitted that lower authorities blindly followed a

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Settlement Commission order dated 28.03.2012, in the case of Orchid

India for the assessment years 2006-2007 to 2010-2011. As per ld.

Authorised Representative there were two limbs of argument based on

which he was assailing the adjustment made by the lower authorities

on the profit sharing ratio between assessee and its Associated

Enterprise. In the first place, according to him, M/s.Apotex Corp and

M/s. Apotex Inc Signet were not Associated Enterprise of the

assessee. According to ld. Authorised Representative ld. TPO erred in

applying Sec. 92A(2)(i) of the Act for considering these companies as

Associated Enterprises of the assessee. Ld. Authorised Representative

submitted that there was no common controlling interest of

shareholders or directors. According to him, unless conditions set out

in and until Sec. 92A(1) satisfied, Sec. 92A(2) of the Act could not be

brought into play. Contention of the ld. Authorised Representative was

that direct/indirect participation in the management or control or

capital of one enterprise in the other at enterprise level was required

for establishing a relationship of association. Relying on the decision

of Co-ordinate in the case of Orchid Pharma Ltd vs DCIT (ITA No.

771/Mds/2016, dated 30.11.2016) for the very same assessment year,

ld. Authorised Representative submitted that the type of influence

mentioned in Sec. 92A(2)(i) of the Act was a dominant influence and

not a passive one, which happen in course of ordinary business.

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Otherwise, according to him, even a solitary transaction could be

treated as one which gives rise to a relationship of Associated

Enterprise. Further, according to him, Bangalore Bench of the Tribunal

in the case of Page Industries Ltd vs DCIT, 159 ITD 680 had held that

for becoming an Associated Enterprise, parameters in both sub

section (1) and (2) of Section 92A had to be satisfied. As per ld.

Authorised Representative, assessee did not have either defacto or

dejure control over Apotex Corp and Apotex Inc Signet. Once these

two enterprises were treated as non Associated, then the pricing of the

products and sharing of profit with them, became automatically at

Arms Length and a perfect basis for applying Uncontrolled Price

(CUP). Vis-à-vis other transactions of the assessee with its Associated

Enterprise, namely Hospira group entities, as per the ld. Authorised

Representative the same profit sharing ratio was to be adopted.

According to him there was no occasion for making any adjustment in

the Arms Length Pricing. As per ld. Authorised Representative lower

authorities erred in going by the decision of Settlement Commission in

the case of Orchid India for the assessment years 2006-07 to 2010-

2011. Decision of the settlement commission, as per the ld. AR did not

lay down a precedent which was required to be followed in subsequent

years. According to him, assessee was not a party in the proceedings

before settlement commission. Further, according to

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him, the common thread permeating through clauses (a) to (f) of Sec.

92A(2) of the Act was control by Associated Enterprise over the

assessee or by the assessee on the Associated Enterprise. Such

control if it was to be construed from the influence exerted on pricing,

then it had to be clearly brought out by the Revenue. Thus, according

to him lower authorities erred in considering Apotex Corp and Apotex

Inc Signet as Associated Enterprise and further erred in applying the

ratio of 60:40 in splitting the profit between the assessee and its

Associated Enterprises namely Hospira group concerns. According to

him, relevant agreements were conveniently ignored by the lower

authorities, and an artificial profit sharing ratio thrusted on the

assessee.

Per contra, ld. Departmental Representative submitted that 27.

dominant influence is not mentioned in Sec. 92A(2)(i) of the Act.

What was required was only ‘influence’. Once there was a legal

agreement which was the basis for supplying goods by the assessee to

Apotex Cort and Apotex Inc Signet, and pricings were influenced by

the latter, they became Associated Enterprises of the assessee. In so

far as splitting of the profit was concerned, ld. Departmental

Representative submitted that assessee did not bring in any material

to justify splitting of profit in the ratio 50:50. According to ld.

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Departmental Representative, risks were all borne by the assessee

and not the trading partners. This was the reason why the settlement

commission recommended profit splitting in the ratio of 60:40.

orders of the authorities below. First, we have to deal with the issue

whether Apotex Cort and Apotex Inc Signet were Associated

Enterprise of the assessee. Contention of the assessee is that clause

(1) and (2) of Section 92A of the Act should not be applied

independently. In other words as per the assessee influence in

pricing should be such that, an element of control is apparent

therefrom. Interpretation of Sec. 92A(2)(i) was an issue which was

considered by the Co-ordinate Bench in the case of Orchid Pharma

Limited (supra). There one M/s.Northstar with which Orchid India has

having a similar profit sharing arrangement was considered as an

Associated Enterprise of M/s. Orchid India, by the ld. TPO.

Interpreting Sec. 92A(2)(i) of the Act, the Co-ordinate Bench held as

under:-

‘’12. It is in this background that we have to address ourselves to the scope of Section 92A(2)(i) which provides that “……two enterprises will be deemed to beassociated enterprises…………when the goods or articles manufactured or processed by one enterprise, are sold to the other enterprise or to persons specified by the other enterprise, and the prices and other conditions relating thereto are influenced by such other enterprise”.

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As we do so, we may take note of the fact, as discussed earlier as well, that the definition of associated enterprises in the cases covered by Section 92A(1), which refers to the participation in management, control or capital of the other enterprises, extend only to such extent as covered by Section 92A(2). In other words, even when it is an admitted situation that the assessee has participated in control, capital or management of the other enterprise, the assessee will not be treated as an AE of the other enterprise unless the conditions set out in one of the clauses of Section 92A(2) are satisfied. It is in this sense that both the limbs of Section 92A are required to be read together. However, the situation that we are dealing with is exactly contrary to the situation so visualized by us. We have a case in which wordings of Section 92A(2) are admittedly satisfied, but the mandate of Section 92A(1) is not satisfied inasmuch as the scale of inter se business relations between the two enterprises is so insignificant, at less than 5% of entire sales, that there is no element of de facto control over the other enterprise so as hold that two enterprises are associated enterprises. 13. We may, at this stage, take note of decision of a coordinate bench of this Tribunal, in the case of Page Industries Limited Vs DCIT [(2016) 159 ITD 680 (Bang)]. That is a case in which the coordinate bench has held that even though the provisions of Section 92A(2)(g) are satisfied in a case, the assessee cannot be treated as an associate enterprise of the non resident company granting it licence to manufacture its products, because the provisions of Section 92A(1) are not satisfied. 14. As evident from the limited narration of facts in the said decision, the assessee-company (i.e. Page Industries Ltd; PIL in short) was “a licensee of the brand- name 'Jockey' for exclusive manufacture and marketing of goods under license agreement” but “the assessee-company owns entire manufacturing facility, capital investment of Rs.100 crores and 15000 employees” and “there is no participation of JII (i.e. Jockey International Inc., USA) in the capital and management of the assessee-company”. On these facts, the coordinate bench has held that JII and PIL are not associated enterprises as there is no participation by JII in “management or capital of PIL(emphasis supplied by us)”. We have our reservation, whatever be it’s worth, on the conclusions arrived at in this case but that does not dilute our highest respect for an important principles of law laid down by the coordinate bench. The reasons for this approach are as follows. The expression ‘control’ appearing in Section 92A(1) is very crucial and the manner in which

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control is exercised could go well beyond capital and management, but the coordinate bench had no occasion to deal with the “control” aspect at all. As held in the case of Diageo India Pvt Ltd Vs DCIT [(2011) 47 SOT 252 (Mum)], even when an enterprise exercise control over the other enterprises by way of controlling the supply of raw material or use of trade marks, this also constitutes ‘participation in control’ leading to the status of associated enterprises under section 92A(1). It appears that this aspect of the matter has not been brought to the notice of, or pleaded before, the bench. While the conclusion arrived at by the bench clearly overlooks the specific mention of the word “control” in both limbs of the basic rule under section 92A(1) (i) as also under section 92A(1)(ii), and to that extent we are unable to concur that in the absence of participation in capital or management, two enterprises cannot be ‘associated enterprises’ under section 92A, what is important to us is that the coordinate bench has, inter alia, also held that, “….in order to constitute relationship of an AE, the parameters laid down in both sub-.sections (1) and (2) should be fulfilled” and justified this approach by observing that “if we were to hold that there is a relationship of AE, once the requirements of sub-sec.(2) are fulfilled, then the provisions of sub-sec.(1) renders otiose or superfluous” and that “it is well settled canon interpretation of statutes that while interpreting the taxing statute, construction shall not be adopted which renders particular provision otiose”. The coordinate bench then further observed that “when interpreting a provision in a taxing statute, a construction, which would preserve the purpose of the provision, must be adopted”. The legal position thus summed up by the coordinate bench is that in a situation in which the conditions, with respect to a set of enterprises, set out in section 92A(1) are clearly not fulfilled, even if the conditions under one of the clauses of section 92A(2) are fulfilled, such enterprises cannot be treated as associated enterprise under section 92A. To the limited extent of the principle so laid down by the coordinate bench, we are in considered agreement with the views of the coordinate bench, and it is this principle which is relevant for the purposes of our adjudication. It does directly affect the issue in appeal before us inasmuch as we are also dealing with a situation in which admittedly words of section 92A(2)(i) are clearly satisfied on the facts of this case, the scale of commercial relationship is so insignificant vis-à-vis total business operations of the assessee that there is admittedly no participation in control by one of the enterprise over the other enterprise so as to satisfy the mandate of Section 92A(1).

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“…..in various countries, the concept of associated enterprises may even cover relationships between independent enterprises, for instance, where a foreign buyer has a strong negotiating power. For example, an Indian software company has a customer in Netherlands which is responsible for more than 90% of turnover of Indian software developer. The Dutch customer is able to dictate the prices to Indian software developer. The Indian software company is, therefore, able to charge a price with 1% margin/mark up, which is very low compared to his Indian counterparts (which apply, for instance, 6% mark up).

According to the Indian transfer pricing law, if the gods or articles manufactured or processed by one enterprises, are sold to other enterprise abroad or to person specified by such other enterprise, and the prices and other conditions relating thereto are influenced by such other enterprises, the two enterprises shall be deemed to be associated enterprises [See section 92A(2)(i) of the Indian Income Tax Act, 1961]. The Indian tax authorities consider the Indian software developer and its Dutch customer to be associated. They may adjust the prices and tax an unrealized profit, i.e. difference between real results and results based on prices derived from other software developers in India. The Netherlands does not consider the companies to be associated as it applies a narrow concept that does not include “de facto control” as a criterion for association. “Control” in the absence of company law based relationship or in the absence of any formal right to exercise control can be described as “de facto” control. Participation in capital and management can be characterized as “de jure” concepts; concepts covered by company law.

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[Emphasis, by underlining, supplied by us] 16. While the above observations do seem to be at variance with the plain words of the statutory provision inasmuch as it refers to influence by way of “strong negotiating power” rather than an influence simplictor- as is the apparent scheme of the statutory provision, what is immediately discernible from the above extracts is that the ‘de facto’ control is the foundation of the wider approach to the concept of ‘associated enterprises, and, of course, the impression that one of the ways in which use of expression ‘influence’, in concept of associated enterprises under the transfer pricing, can be rationalized is as dominant influence in the nature of defacto control. The definition of ‘associated enterprise’, as the above academic analysis shows, has two approaches- wider approach and narrow approach. A narrow approach to the concept of associated enterprises takes into account only “de jure” association i.e. though formal participation in the capital or participation in the management. A wider approach to the concept of ‘associated enterprises’ takes into account not only the de jure relationships but also de facto control, in the absence of participation in capital or participation in management, through other modes of control such as commercial relationships in which one has dominant influence over the other. This wider concept is clearly discernible from the principles underlying approach to the definition of ‘associated enterprises’ in the tax treaties and has also been adopted by the transfer pricing legislation in India in an unambiguous manner. There is no other justification in the Indian transfer pricing legislation, except the participation in capital of an enterprise, management of an enterprise or control of an enterprise, which can lead to the relationship between enterprise being treated as ‘associated enterprises’. What essentially follows is that clause (i) of Section 92A(2) has, at its conceptual foundation, de facto control by one of the enterprise over the other enterprise, on account of commercial relationship of its buying the products, either on his own or through any nominated entities, from such other enterprise and in a situation in which it can influence the prices and other related conditions. The wordings of clause (i), however, do not reflect this position in an unambiguous manner inasmuch as it does not set out a threshold of activity, giving de facto control to the other enterprise engaged in such commercial activity, in percentage terms or otherwise- as is set out in clause (g) and (h) or, for that purpose, in all other operative clauses of Section 92A(2). If the words of this clause are to be interpreted literally, as the authorities below have read, even if there is one isolated transaction with an enterprise in

ITA No.821/Mds/2016. :- 30 -:

such an enterprise can influence the prices, such an enterprise is to be treated as an associated enterprise- whether or not this commercial relationship amounts to control on the other enterprise. That will clearly be an incongruous result. However, as Section 92A(2)(i) is to be read alongwith Section 92(A)(1), in such a situation in which an enterprise does not participate in (a) capital, (b) management, or (c) control of other enterprise, and thus does not fulfil the basic rule under section 92A(1), even if the conditions of Section 92A(2)(i) are fulfilled, these enterprise cannot be treated as ‘associated enterprise’. In the case before us, it is not even the case of the revenue that the assessee has any participation in management or capital of the other enterprise, nor there is anything to even remotely indicate, much less establish, that one of the enterprise, by way of this commercial relationship, participates in control over the other enterprise. Viewed thus, Northstar, even if it is assumed that it can influence prices and other conditions relating to sale, cannot be treated as associated enterprise of the assessee before us. It is also important to bear in mind the fact that given the context in which the expression “prices and other conditions relating thereto are influenced by such other enterprise” appears in Section 92A(2)(i), this influence has to be something more than influence in the ordinary course of business and in the process of negotiation, because, even in the course of ordinary every business and in the course of day to day negotiation, selling prices as also conditions of sale are invariably, in a way, influenced by the buyer. Therefore, even when a customer offers terms to someone with a ‘take it or leave it’ message, such an approach, by itself, cannot be termed as ‘influence’, for our purposes, unless the seller is in such a position and under such an influence that he has to simply accept the dictated terms. Any other view of the matter will result in all the enterprises dealing with each other as every party to a transaction has an influence over the price and conditions relating to the sale, and will lead to a situation in which all the enterprises dealing with each other on negotiated prices will have to be as associated enterprises. That again is a clearly absurd and unintended result, and it is only elementary that law is to be interpreted in such a manner as to make it workable rather than redundant. This principle is expressed in the latin maxim “utres magis valeat quam pereat”. Explaining this principle, Hon’ble Supreme Court has, in the case of CIT Vs Hindustan Bulk Carriers [(2003) 259 ITR 449 (SC)], has observed that “A construction which reduces the statute to a futility has to be avoided” and that “A statute or any enacting provision therein must be so construed as to make it effective and operative on the

ITA No.821/Mds/2016. :- 31 -:

principle expressed in maxim utres magis valeat quam pereat i.e., a liberal construction should be put upon written instruments, so as to uphold them, if possible, and carry into effect the intention of the parties. [See Broom’s Legal Maxims (10th Edition), p. 361, Craies on Statutes (7th Edition) p. 95 and Maxwell on Statutes (11th Edition) p. 221.]” It is, therefore, important that the expression ‘influence’ is given a sensible meaning so as to make the provisions of Section 92A(2)(i) workable rather than adopting a literal meaning which will lead to wholly incongruous results. 17. Viewed in this perspective, we must adopt a sensible meaning of expression ‘influence’ which advances the scheme of the transfer pricing provisions rather than making these provisions unworkable. That meaning had to be a dominant influence which leads to de facto control over the other enterprise rather than an influence simplictor. If we are to adopt literal meaning of influence, as has been adopted by the authorities below, all the transactions on negotiated prices will be hit by the provisions of Section 92A(2)(i). In the light of the discussions above, the expression ‘influence’, in the present context, must remain confined to dominant influence which amounts to de facto control. Acceptance of terms of the buyer on commercial considerations, as in this case, cannot be treated as influence of the buyer. It is a commercial decision whether to accept the terms of the buyer, with respect to the price or related conditions, or not. It becomes influence, for the purpose of Section 92A(2)(i), when the seller is placed in such a situation that he has no choice, because of buyer’s dominant influence, but to accept it. It is thus clear that context in which a reference is made to the expression ‘influence’ in section 92A(2)(i) requires this expression to be read as a dominant influence in the sense of control by one enterprise over the other. Given the fact that the assessee’s exports through the distribution part constitutes less than 5% of its entire exports, and less than 6% of its entire sales, Northstar is certainly not in a position to exercise any dominant influence, over the assessee. The assessee’s decision to accept the terms set out by Northstar, even if that be so, may be justified on account of commercial expediencies or warranted by business exigencies or may simply be compulsion of this somewhat unique and complex business model, but it cannot, by any stretch of logic, be on account of dominant influence of Northstar as a customer. It may even be a sound business strategy to accept a rather passive and back seat role, if one can term it that way, in day to day decision making under this business model, but cannot be on account of dominant influence that Northstar

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exercises on buying of products from the assessee. The influence of Northstar, given the scale of business through Norrthstar as a distribution part, is too modest to make it a dominant influence in the nature of control. In this view of the matter, as also bearing in mind the earlier discussions on the issue, the assessee and Northstar can not be treated as ‘associated enterprises’ under section 92 A. We uphold the plea of the assessee’’.

influence appearing in Sec.92A(2)(i) of the Act is a type of dominant

influence which lead to a defacto control over the other enterprise. Co-

ordinate Bench had held that M/s. Northstar was not in a position to

exercise any such dominant influence since M/s. Orchid India had also

exported through various other distribution partners and dealings with

M/s.Northstar constituted less than 5% of the entire exports and less

than 6% of the entire sales of M/s.Orchid India. As against this

admittedly, in the case before us, the entire sales of the assessee

were to Apotex Cort/ Apotex Inc Signet and M/s. Hospira group,

concerns of which the latter admittedly were Associated Enterprises

of the assessee. The profit share which came to the assessee from

these parties were as under:-

Party Name Profit Share Amount

Apotex Corp 29,21,54,195 Apotex Inc 85,79,870 Total 30,07,34,065 Hospira Enterprises BV 95,19,26,971 95,19,26,971 Grand Total 125,26,61,036

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The total sales to Hospira group as already mentioned by us at para 5

above, aggregated to �283,79,39,806/-. It can be safely concluded

from the above data that more than 20% of assessee’s sales were to

Apotex Corp and Apotex Inc. The profit shared earned by the

assessee from them aggregated to �30,07,34,065/- out of the total

profits of �125,26,61,036/-. We are therefore of the opinion that M/s.

Apotex Corp and Apotex Inc were in a position to exercise a dominant

influence over the assessee. A person who purchased more than

1/5th of the total sales of the assessee, in our opinion, would have a

distinctly dominant influence on the pricing and can exercise a defacto

control. In the circumstances, we are of the opinion that lower

authorities were justified in treating M/s. Apotex Corp and Apotex Inc

as Associated Enterprise of the assessee.

Now coming to the issue of profit split ratio, it is not disputed 30.

that legacy agreement based on which assessee was entitled for the

profit share was entered by M/s. Orchid India. It has been noted by

the Settlement Commission at para 2.2.4.17 of its order dated

28.03.2012 in the case of Orchid India that M/s. Orchid India had an

agreement with one M/s.Par Pharmaceuticals also which was similar to

what it had with M/s.Northstar and Apotex. Profit splitting with M/s.

Par Pharmaceuticals was in the ratio 60:40. M/s. Par

ITA No.821/Mds/2016. :- 34 -:

Pharmaceuticals was also in same US market and in the same line of

business. The ld. TPO in the case of M/s. Orchid India for assessment

years 2006-07 to 2010-2011 had recommended a profit split ratio of

70:30: This was lowered to 60:40 by Settlement Commission

considering the expenditure incurred by M/s. Orchid India for its R& D

in developing the products sold. It was held that 60:40 ratio of

splitting of the profit was appropriate, considering this aspect also. In

the case before us, the agreements based on which, assessee was

receiving the share of the profit, were all legacy of M/s. Orchid India,

entered prior to the sale of its generic injectable drugs division to the

assessee. Assessee had no case that it had spent R& D expenditure of

a scale comparable to the M/s. Orchid India. None of these aspects

were considered by the lower authorities. At this juncture, it is

necessary to have a look at Rule 10B(d) of the Income Tax Rules,

1962.

‘’d) profit split method, which may be applicable mainly in international transactions involving transfer of unique intangibles or in multiple international transactions which are so inter-related that they cannot be evaluated separately for the purpose of determining the arm's length price of any one transaction, by which- (i) the combined net profit of the associated enterprises arising from the international transaction in which they are engaged, is determined ;

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(ii) the relative contribution made by each of the associated enterprises to the earning of such combined net profit, is then evaluated on the basis of the functions performed, assets employed or to be employ-ed and risks assumed by each enterprise and on the basis of reliable external market data which indicates how such contribution would be evaluated by unrelated enterprises performing comparable functions in similar circumstances ; (iii) the combined net profit is then split amongst the enterprises in proportion to their relative contributions, as evaluated under sub-clause (ii) ; (iv) the profit thus apportioned to the assessee is taken into account to arrive at an arm's length price in relation to the international transaction:’’

In our opinion, lower authorities had failed in properly applying the

above rule, though what was effectively applied was a profit split

method. Essential elements that are required to be verified for

applying the said method was never considered by the lower

authorities while considering the profit split ratio at 60:40. Considering

all these facts, while holding that M/s. Apotex Corp and M/s. Apotex

Inc were Associated Enterprise of the assessee, the matter regarding

bench marking Arms Length Pricing of the profit share, in our opinion

requires a fresh visit by the ld. Assessing Officer/TPO. We therefore set

aside the orders of the lower authorities and remit the issue regarding

adjustment of profit share back to the file of the ld. Assessing

Officer/TPO for consideration afresh in accordance with law. Ground

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no.6 of the assessee is allowed for statistical purpose whereas its ground no.7 is partly allowed for statistical purpose.

In the result, appeal of the assessee is partly allowed for 31. statistical purpose.

Order pronounced on Tuesday, the 28th day of February, 2017, at Chennai.

Sd/- Sd/- (एन.आर.एस. गणेशन) (अ�ाहम पी. जॉज�) (N.R.S. GANESAN) (ABRAHAM P. GEORGE) लेखा सद�य/ACCOUNTANT MEMBER �या�यक सद�य/JUDICIAL MEMBER चे�नई/Chennai �दनांक/Dated:28th February, 2017 KV आदेश क� ��त�ल�प अ�े�षत/Copy to: 1. अपीलाथ�/Appellant 3. आयकर आयु�त (अपील)/CIT(A) 5. �वभागीय ��त�न�ध/DR 2. ��यथ�/Respondent 4. आयकर आयु�त/CIT 6. गाड� फाईल/GF