2013 (1) TMI 60 - AT - Income Tax

Arms length price - provision of research and development support services - upward adjustment of Rs. 68,47,532/- to the income - assessee contested against inclusion of the two comparable companies viz. Celestial Labs Ltd. and Biocon Ltd. - Held that - Celestial Labs Ltd. is engaged in the business of supporting pharmaceutical and biotechnology companies with customised information technology solution. It is mainly engaged in the software development in drug designing tool, bio informatic service and data warehousing. More than 96% of its revenue is from this service which are mostly in the nature of drug designing tools and Sap services. The profile of the company, as highlighted shows that its functions are entirely different from that of the assessee company which is mainly into testing and analytical service in R&D., therefore, it cannot be included for comparability analysis in the set of comparables taken by the TPO. Inclusion of Biocon Ltd - two subsidiary of Biocon Ltd. i.e., Clinigene International Ltd. and Syngene International Ltd. The former company cannot be included at all for the preliminary reason that its related party transaction is approximately 38% of its sales, therefore, it cannot be held to be a fit case for comparison of a controlled transaction with an uncontrolled transaction. Insofar as Syngene International Ltd., this company is again 99% subsidiary of Biocon Ltd. and is engaged as a custom research service provider in the drug development process from discovery to supply of development compounds. From annual report, it is seen that the company has two sets of income - one from contract research fees and sale of compounds. However, in the absence of segmental information regarding contract research and manufacturing activities, it is difficult to analyse its main revenue and profit margin from the contract research work. Thus its functional profile is different with that of the assessee company, hence this company is directed to be excluded from the set of comparables. Various diagnostic companies excluded by the TPO viz. Dolphin Medical Services Ltd., Transgene Biotek Ltd. and N.G. Industries Ltd., that not only the functional profile of these companies are different but the characteristic of the services rendered are also different. Dolphin Medical Services Ltd. is engaged in diagnostic services like CT scan, MRI, colour Doppler, etc., which is entirely different from R&D, testing and analytical services performed by the assessee. Transgene Biotech is engaged in the business of pre-clinical and clinical research service for biopharma involved in developing human vaccines and has patent rights of various products and vaccines developed by it. & as is the case of N.G. Industries Ltd. which is also purely a diagnostic and medical company and its services are entirely different from that of assessee. Risk adjustment on account of difference between the risk profile of the comparables - Held that - As neither the TPO nor the DRP has dealt with the assessee s contentions, thus in the interest of justice the matter needs to be restored back to the file of the TPO, who will examine the assessee s contentions on this score and decide the issue afresh in accordance with the law. Notional addition towards interest on the amount receivable from the A.E. - Held that - As assessee has no interest liability and it does not have any external borrowings. Even if the payments have been made by the A.E. beyond the normal credit period, there is no interest cost to the assessee. Moreover, there is no such agreement whereby interest is to be charged on such a delayed payment. From the summary of payment submitted by the assessee it is seen that the billing is done on quarterly basis and, accordingly, the payment is being received. Therefore, the delay is not wholly on account of late payment by the A.Es only. Moreover, the T.P. adjustment cannot be made on hypothetical and notional basis until and unless there is some material on record that there has been under charging of real income. Thus, addition an account of notional interest relating to alleged delayed payment in collection of receivables from the A.Es, is uncalled for on the facts of the present case and is, accordingly, deleted. Network access charges - revenue v/s capital - Held that - The assessee has made the payment for availing e-mail infrastructure like lotus notes accounts for the employees, usage of VPN, network infrastructure excess service which are owned by the parent company and not by the assessee. The assessee is making the payment for using this e-mail infrastructure facilities for communication between employees of the assessee and outside business partners. Such facilities of secured internet facilities, facilitates the day-to-day business operation of the assessee and does not bring into an existence any enduring benefit or creation of a new asset to the assessee. It is not a capital software expenditure as held by the Assessing Officer even though the same has been classified under the head software expenditure . Thus,such an expenditure is purely revenue in nature and is allowable under section 37(1)

Summary

Issues Involved:
1. Upward adjustment of Rs. 68,47,532/- to the income of the Appellant in respect of provision of research and development support services.
2. Notional addition of Rs. 9,83,383/- towards interest on perceived delay in collection of receivables from the associates enterprises.
3. Treatment of network access charges as capital expenditure and disallowance under section 37(1) of the Income Tax Act, 1961.
4. Alternative ground for depreciation at the rate of 60% on network access charges.

Issue-Wise Detailed Analysis:

1. Upward Adjustment of Rs. 68,47,532/-:

The assessee, a fully owned subsidiary of Evonik Degussa GmbH, provided support services to its AE and had shown a profit margin of 20.75% on operating costs. The Transfer Pricing Officer (TPO) directed the use of current year's financial data, leading to the inclusion of 19 comparable companies with an arithmetic mean margin of 27.30%, resulting in an upward adjustment of Rs. 34,81,318. The Dispute Resolution Panel (DRP) further modified the set of comparables, enhancing the adjustment to Rs. 68,47,532. The assessee contested the inclusion of Celestial Labs Ltd. and Biocon Ltd., arguing they were not functionally comparable. The Tribunal found Celestial Labs Ltd. engaged in software development and bio informatic services, and Biocon Ltd. involved in contract research with significant related party transactions, thus not comparable. The Tribunal directed the exclusion of these companies and upheld the TPO's rejection of diagnostic companies, confirming the inclusion of Choksi Labs Ltd., Vimta Lab Ltd., G.V.K. Biosciences P. Ltd., and TCG Lifescience Ltd. for comparability analysis. The Tribunal also remanded the issue of risk adjustment back to the TPO for fresh examination.

2. Notional Addition of Rs. 9,83,383/-:

The TPO noted delays in payments from the AE beyond the stipulated credit period and computed notional interest at 1% per month, resulting in an addition of Rs. 9,83,383. The assessee argued it was a zero-debt company with no interest liability and no agreement to charge interest on delayed payments. The Tribunal found that the assessee had no interest cost, and the delay was not solely attributable to the AE. It held that transfer pricing adjustments should not be made on a hypothetical basis without evidence of undercharging real income, thereby deleting the notional addition.

3. Treatment of Network Access Charges as Capital Expenditure:

The Assessing Officer treated network access charges of Rs. 12,60,835 as capital expenditure. The assessee contended these were payments for using email infrastructure and VPN services provided by the parent company, necessary for day-to-day business operations and not resulting in any enduring benefit or creation of a new asset. The Tribunal agreed, holding the expenditure as revenue in nature and allowable under section 37(1) of the Act.

4. Alternative Ground for Depreciation at 60%:

Given the Tribunal's finding that the network access charges were revenue in nature, the alternative ground for depreciation became infructuous and was dismissed.

Conclusion:

The appeal was partly allowed, with the Tribunal directing the exclusion of certain comparables, deletion of notional interest addition, and allowing network access charges as revenue expenditure. The issue of risk adjustment was remanded to the TPO for fresh consideration.