2011 (7) TMI 143 - AT - Income Tax

Arms length price - assessee is engaged in the business of manufacturing and sale of pharmaceutical products and formulations - During the course of assessment proceedings the assessee-company furnished various details in support of income declared and claims made in the return of income - It was found by TPO that the assessee has over invoiced purchases from its AEs with respect to Netilimicin Sulphate and Mometasone Furoate - DRP noted that in the case of manufacture and sale of medicines they have to go through stringent quality control norms in respect of each medicine whether general or otherwise irrespective of the cost to user of the medicines and therefore the argument that manufacturers which were considered as comparable were of inferior quality is not a valid argument - It is an undisputed fact that similar issue that arose in the preceding years has not yet attained finality and is pending before learned CIT(A) - Since the various arguments now putforth by the learned counsel for the assessee requires verification at the level of the Assessing Officer we in the interest of justice deem it proper to restore the issue relating to ALP adjustment of Rs. 3, 09, 21, 351to the file of the Assessing Officer for fresh adjudication Regarding upward adjustment - in relation to international transaction of import of formulations is concerned this in our opinion also requires fresh adjudication at the level of the Assessing Officer in view of various distinguishing features brought before us by learned counsel for the assessee in the synopsis and the list of fresh searches for the same financial year - Appeal is allowed by way of remand

Summary

Issues Involved:
1. Re-computation of Arm's Length Price (ALP) for the import of Active Pharmaceutical Ingredients (API).
2. Re-computation of ALP for the import of formulations.
3. Methodology for determining ALP (TNMM vs. CUP).
4. Comparability of generic and originally researched drugs.
5. Allocation of common expenses.

Issue-Wise Detailed Analysis:

1. Re-computation of ALP for the Import of Active Pharmaceutical Ingredients (API):
The assessee challenged the decision of the Dispute Resolution Panel (DRP) and the Assessing Officer (AO) in re-computing the ALP for the import of APIs, resulting in an adjustment of Rs. 3,09,21,351. The Transfer Pricing Officer (TPO) applied the Comparable Uncontrolled Price (CUP) method instead of the Transactional Net Margin Method (TNMM) used by the assessee. The TPO found that the assessee over-invoiced purchases from its Associated Enterprises (AEs) for Netilimicin Sulphate and Mometasone Furoate based on data from customs and inquiries under section 133(6) of the Income-tax Act, 1961. The assessee argued that the CUP method's standard of comparability is very high and that the prices paid by unrelated parties might not be for similar products. The DRP upheld the TPO's findings, noting that the assessee did not demonstrate that generic products imported by other companies were of inferior quality or that there were transactional differences. The Tribunal decided to restore the issue to the AO for fresh adjudication, emphasizing the need for the AO to verify the assessee's claim that it acts as a secondary manufacturer akin to a value-added distributor.

2. Re-computation of ALP for the Import of Formulations:
The assessee also contested the adjustment of Rs. 4,13,72,000 made by the TPO in relation to the import of formulations. The TPO compared the internal margin of the AE segment with the Non-AE segment, concluding that the internal margin provided a better comparison than external comparable companies. The DRP supported this approach, rejecting the assessee's contention that benchmarking should be done as a whole rather than on a segmental basis. The Tribunal found that this issue also required fresh adjudication at the AO level, considering the distinguishing features and fresh searches presented by the assessee.

3. Methodology for Determining ALP (TNMM vs. CUP):
The TPO rejected the TNMM method adopted by the assessee and applied the CUP method, leading to significant adjustments. The assessee argued that the CUP method requires stringent comparability, and any differences in third-party prices and international transaction prices warrant appropriate adjustments. The Tribunal noted that the TPO should not rely solely on past years' orders and should apply his mind afresh each year. The Tribunal directed the AO to reconsider the methodology for determining the ALP, taking into account the assessee's arguments and evidence.

4. Comparability of Generic and Originally Researched Drugs:
The TPO compared the purchase price of originally researched APIs with generic APIs, leading to the adjustment. The assessee contended that originally researched drugs are costlier and of higher quality than generic drugs. The DRP dismissed this argument, stating that all medicines, whether generic or otherwise, must go through stringent quality control norms. The Tribunal highlighted the need for the AO to verify the comparability of the products and the quality differences claimed by the assessee.

5. Allocation of Common Expenses:
The TPO found discrepancies in the allocation of common expenses between the AE and Non-AE segments. The TPO allocated these expenses based on net sales, while the assessee used a "fair allocation" method without providing a clear explanation. The Tribunal instructed the AO to reassess the allocation of common expenses, ensuring a fair and reasonable distribution based on turnover or other appropriate criteria.

Conclusion:
The Tribunal allowed the appeal for statistical purposes, directing the AO to re-examine the issues related to the ALP adjustments for the import of APIs and formulations. The AO is to verify the assessee's claims, consider fresh evidence, and provide a fair opportunity for the assessee to present its case. The Tribunal emphasized the need for a thorough and fresh adjudication to ensure compliance with transfer pricing regulations and accurate determination of the ALP.