2015 (10) TMI 790 - AT - Income Tax

Transfer pricing adjustments - Adjustment towards interest on advances provided to Xiamen Mchem Pharma (Group) Ltd. and Xiamen Mchem Laboratories Ltd. (Associated Enterprises) - DRP direction TPO adopting interest rate of Libor 2% as against interest rate of Libor 1% charged by the tax payer - Held that - Since the DRP has accepted 1% on guarantee commission we do not see any reason to vary as far as the interest charged which is also 1% over and above the LIBOR. It should be accepted that LIBOR rate is a valid CUP available externally. Therefore LIBOR 1% charged by the assessee can be considered as at arms length in the absence of any other comparables where LIBOR 2% is charged. We are of the opinion that assessee charge at LIBOR 1% interest on the trade advances given is at arms length. It is also to be kept in mind that assessee has not advanced any funds as such to the Associated Enterprises and the transaction is on goods supplied on a credit period of 3 months. Therefore on the facts of this case as the DRP accepted similar rate of 1% for guarantee fee vide its order referred above we uphold the assessee s contention that LIBOR 1% is at arms length. However this finding should not be considered as a precedent either in assessee s own case in other assessment years or in any other case as this decision was given in the light of fact that DRP itself has accepted the guarantee commission of 1% on its next objection. - Decided in favour of assessee. Reducing the operating profits of the tax payer being the income from settlement of patent infringement suit credited to profit and loss account - whether the income accounted by the assessee will become operational income for the purpose of arriving at the operational profit? - Held that - The Assessing Officer has excluded the same stating that the same is nothing but notional revenue. We agree with the finding of the Assessing Officer as held by the DRP that the income from settlement of patent infringement cannot become part of operating revenues either on bulk drug manufacturing (API) segment or on product development service (PDS) segment which are two different segments in which assessee is operating and accordingly we agree with the DRP s stand that this income falls under the category of other income and not operating revenue. Not only that the income does not pertain to the relevant financial year nor the costs are incurred in the year under consideration. If without the cost the income is included in the computation of operational profits the same gets skewed because of inclusion of extraordinary items. It was decided in number of cases by the Tribunal that incomes of extraordinary nature are to be excluded and further extraordinary events in any company also make it non-comparable while doing exercise of FAR analysis for comparability purpose. For the reasons stated above we agree with the Assessing Officer/DRP that this income from settlement of patent infringement cannot be considered as operational income while working out the segmental profits or as total profits of the assessee for the purpose of comparison. At best it can be considered as another segment of income for which no expenditure was charged but the same cannot be included in either of the segmental operations of the assessee - Decided against assessee. Transfer pricing adjustment - segmental financials certified by the cost auditors and the profit margins arrived between the AE and non-AE transactions - Held that - We are of the opinion that the DRP s order on this issue is not fully based on the facts. While accepting that the segmental financials certified by the cost auditors and the profit margins arrived between the AE and non-AE transactions are comparable why the DRP did not accept the entire segmental finances furnished with reference to two business segments is not explained. There is no reason to reject the segmental accounts when they are partially accepted for internal comparison as was done by the DRP extracted above. In view of this we are of the opinion that TPO should have based his analysis on the segmental financials reported by the assessee duly certified by cost auditors. Various case law relied upon by the assessee also supports the above which we do not intend to extract in this order. Suffice to say that since assessee operates in two business segments whose profit margins are entirely different the segmental reporting undertaken by the assessee based on the cost audit report should be the basis for necessary analysis by the TPO. Selection of comparable - Held that - TPO should re-do fresh analysis of the comparables and analyse the fresh adjustments after giving due opportunity to the assessee. Since assessee s segmental profits and its profit margins between AE and non-AE are also available the TPO can examine whether the internal CUP available with the one of the business segments can be accepted as such. In case it is not possible to accept then fresh comparables should be selected and PLI has to be determined so as to examine assessee s profit margins. For this purpose we set aside the order of TPO with reference to the determination of ALP on these two segments and direct the TPO to undertake fresh search and compare with the segmental profits submitted by the assessee. However he is free to examine segmental profits - Inclusion and exclusion of some of the receipts and cost claimed are proper or not. TPO s comparison should be based on segmental profits alone and not at the entity level. Moreover the assessee is also objecting to arriving at the cost as far as the PDS is concerned. These objections also should be examined and clear finding should be given while doing the T.P. analysis. Therefore while accepting the assessee s objections in the grounds raised we restore the issue to the file of the TPO for fresh determination based on the segmental profits and selection of comparables if required. Include reimbursement of expenses received by the tax payer as subject to Arms Length pricing under sec.92CA - Held that - this issue required to be examined by the Assessing Officer/TPO in detail whether the said amount claimed to have received by the assessee as reimbursement expenses are indeed reimbursement or not. In case of reimbursement at cost of the expenditure incurred on behalf of the AEs and has not formed part of the expenditure claimed as operating cost of the assessee then the reimbursement should not be considered as part of assessee s sales. The amounts should be excluded in computing the operating profits. Since the Assessing Officer has not examined and it is also not on record whether the said expenditure was not part of claim under section 37(1) of the I.T. Act in the regular computation or not in the interest of justice we remit the matter back to the file of the TPO to examine the facts and to exclude only in the case the said amount is reimbursement of expenditure and there was no claim by the assessee in its computation of income - Decided in favour of assessee for statistical purposes. Non entitlement to deduct expenditure disallowed in the hands of Astrix Laboratories Limited (a resident J.V Company) under sec. 92CA - Held that - there is no dispute with reference to the receipt of these amounts one as an income i.e. management fee of 1.12 crores and other being the reimbursement of expenses of 1.05 crores. As far as the reimbursement of expenditure is concerned we have already directed in the earlier ground to consider the nature of amount and exclude from the computation for the purpose of transfer pricing on verification. Therefore to that extent the claim will be a double claim. With reference to the management fee we are not sure why there is an adjustment in another domestic transaction if contentions of assessee are correct. If transaction is between two domestic companies transfer pricing regulations does not apply in the impugned year. If one domestic company paid to its AE and assessee receives from AE the transactions are different in nature. Whether the same can be allowed in the hands of other domestic company or not has no bearing in the assessee s hands as the said amount was received and was accepted by the assessee to be taxed. We approve the DRP observation that taxability or otherwise of the amount in one hand does not affect the adjustment in other hand unless it is provided so in the Act. - Decided against assessee. Non granting the benefit of the ( /-) 5% standard deduction as per the proviso to Section 92C(2) - Held that - This ground is legal in nature and depending on the facts the Assessing Officer is directed to consider this adjustment of plus or minus 5% as per the provisions of the Act if the ALP determined is within the range. This ground is restored to the file of the Assessing Officer to be examined as the main issue of adjustments were already restored to the TPO against grounds No. 3 to 8. Deduction claimed u/s. 10B in respect of Export Oriented Undertaking situated at Jeedimetla (Unit 3.2) - Held that - The DRP however noticed that the issue is subject to revisional proceedings by the CIT and the writ petition is pending before the Hon ble High Court of A.P. Since the matter is contested at the Higher Forum legally the DRP considered it fit not to interfere with the stand of the Assessing Officer but however directed the Assessing Officer to follow the Judgment of the Hon ble High Court of A.P. as and when issue was decided. It further suggested that demand on account of disallowance of deduction be kept in abeyance till the decision of the Hon ble High Court of A.P. The assessee has raised this issue before us but submitted that the matter is subjudice. Since the DRP has already given clear directions on this issue we uphold the directions of the DRP with an observation that the Assessing Officer should follow the same as and when that issue is decided by the Hon ble High Court of A.P. - Decided in favour of assessee for statistical purposes. Disallowance of amount debited to Profit Loss account in respect of Employee Stock Option Scheme - Held that - he difference (discount) between the market price of the shares and their issue price is expenditure in the hands of the assessee because it is a substitute to giving direct incentive in cash for availing the services of the employees. There is no difference between a case where the company issues shares to the public at market price and pays a part of the premium to the employees for their services and another where the shares are directly issued to employees at a reduced rate. In both situations the employees stand compensated for their effort. By undertaking to issue shares at a discount the company does not pay anything to its employees but incurs the obligation of issuing shares at a discounted price at a future date. This is nothing but expenditure u/s 37(1) -The liability cannot be regarded as being contingent in nature because the rendering of service for one year is sine qua non for becoming eligible to avail the benefit under the scheme. Once the service is rendered for one year it becomes obligatory on the part of the company to honor its commitment of allowing the vesting of 25% of the option. The liability is incurred at the end of the first year though it is discharged at the end of the fourth year when the options are exercised by the employees. The fact that some options may lapse due to non-exercise / resignation etc does not make the entire liability contingent - However the obligation to issue shares at a discounted premium does not arise at the stage the options are granted. It arises at the stage that the options are vested in the employees. The amount deductible has to be determined based on the period and percentage of vesting under the ESOP scheme - Therefore considering the request we restore this issue to the file of the Assessing Officer to examine the claim afresh in the light of decision of the Hon ble Special Bench of the ITAT Bangalore in the case of M/s. Biocon (2013 (8) TMI 629 - ITAT BANGALORE ) - Decided in favour of assessee for statistical purposes. Quantification of amount eligible for deduction under section 10B - common corporate overheads should be apportioned on the basis of ratio of turnover of the unit to the total turnover of the company and in this manner reducing the eligible profits under Sec. 10B as concluded by CIT(A) - Held that - Unit starts production only at the fag end of the year cost of working on that unit throughout the year for establishing / starting production may not result in allocation of actual expenditure if turn over is considered. In view of this since Assessing Officer has not given any rationale in adopting the turnover as the basis ignoring the assessee s method we are of the opinion that allocation of expenditure as was done by the assessee is more rationale and is in tune with the principles laid down by the Institute of Cost Accountants and also for the purpose of Company Law. Therefore considering the detailed objections raised by the assessee as placed in the objections to the DRP we are of the opinion that the allocation by the assessee is to be upheld. Assessing Officer is directed to accept the assessee s allocation of corporate overheads - Decided in favour of assessee. Claim of depreciation on brought forward written down value in respect of non-compete fee - Held that - Since ITAT has already ordered the depreciation to be allowed in assessment year 2002-2003 consequently depreciation has to be allowed by the Assessing Officer in this year. He is empowered to take rectification proceedings in case that order was not upheld by the Hon ble High Court. In view of this to that extent of claim of depreciation amounting to 8, 89, 893/- on brought forward written down value Assessing Officer is directed to allow the depreciation after verifying the WDV figures. The depreciation cannot be allowed on an amount of non-compete fee which was in fact paid to the Managing Director of the Company for not taking any employment. This cannot be considered under section 32(1) as an intangible asset. Disallowance of weighted deduction under section 35(2AB) - Held that - fter considering the submissions of the assessee we agree with the assessee that it is entitled for 150% of the amount actually spent as weighted deduction under the provisions of sec.35(2AB). Since the amount of 32, 73, 07, 418/- was the actual amount certified by the relevant authority the assessee is entitled for the deduction at 150%. Since the Assessing Officer allowed only 100% claimed we direct the Assessing Officer to allow balance 50% thereof - Decided in favour of assessee. Disallowance of deduction @ 100% in respect of the balance R D expenditure for which the prescribed authority denied weighted deduction - Held that - Assessing Officer and DRP has not applied their mind to the amounts involved. Since the entire claim of the assessee was rejected summarily without examining the facts we are of the opinion that this expenditure of 56, 35, 712/- in respect of R D expenditure is to be considered under section 35(1) if not for the weighted deduction under section 35(2AB). Assessing Officer is directed to examine the necessary expenditure and allow the claim. Decided in favour of assessee for statistical purposes.

Summary

Issues Involved:
1. Adjustment of interest on advances to Associated Enterprises (AEs).
2. Exclusion of income from settlement of patent infringement from operating profits.
3. Rejection of segmental results and adoption of entity-level operating margins for Transfer Pricing adjustments.
4. Inclusion of reimbursement of expenses in operating sales.
5. Deduction of disallowed expenditure in a sister concern.
6. Benefit of the +/- 5% standard deduction under section 92C(2).
7. Deduction under section 10B for the Export Oriented Undertaking.
8. Deduction of Employee Stock Option Scheme (ESOP) expenses.
9. Apportionment of common corporate overhead expenses.
10. Depreciation on non-compete fee.
11. Weighted deduction under section 35(2AB).
12. Deduction for R&D expenditure not eligible for weighted deduction.

Detailed Analysis:

1. Adjustment of Interest on Advances to AEs:
The issue was whether the DRP's direction to adopt an interest rate of LIBOR + 2% instead of LIBOR + 1% was correct. The tribunal held that since the assessee charged LIBOR + 1% and the DRP accepted +1% for guarantee fee, there was no reason to vary the interest rate. It was concluded that LIBOR + 1% is at arm's length for trade advances. This decision was specific to the facts of this case and should not be considered a precedent.

2. Exclusion of Income from Settlement of Patent Infringement from Operating Profits:
The assessee included Rs. 26.91 crores from a patent infringement settlement in its operating profits. The tribunal upheld the DRP's decision to exclude this amount, stating it was not operational income and was already taxed in an earlier year. The income was considered extraordinary and not related to the current financial year's costs, thus not suitable for transfer pricing adjustments.

3. Rejection of Segmental Results and Adoption of Entity-Level Operating Margins:
The TPO rejected the segmental results certified by cost auditors and adopted entity-level margins for transfer pricing adjustments. The tribunal found this approach incorrect, directing the TPO to base his analysis on segmental financials and to re-evaluate comparables. The tribunal emphasized the need for segmental analysis due to the distinct business segments of API and PDS.

4. Inclusion of Reimbursement of Expenses in Operating Sales:
The tribunal directed the TPO to examine whether the Rs. 3.05 crores received as reimbursement were indeed reimbursements and not part of the operating sales. If confirmed as reimbursements, they should be excluded from operating profits.

5. Deduction of Disallowed Expenditure in a Sister Concern:
The tribunal rejected the assessee's claim to reduce its adjustment by amounts disallowed in a sister concern, stating that taxability in one entity does not affect the adjustment in another unless specified by the Act.

6. Benefit of the +/- 5% Standard Deduction under Section 92C(2):
The tribunal directed the Assessing Officer to consider the +/- 5% standard deduction as per the Act's provisions if the ALP determined is within the range.

7. Deduction under Section 10B for the Export Oriented Undertaking:
The tribunal upheld the DRP's direction to follow the outcome of the pending High Court decision regarding the eligibility of the unit for section 10B deduction. The matter was considered sub judice and was allowed for statistical purposes.

8. Deduction of Employee Stock Option Scheme (ESOP) Expenses:
The tribunal restored the issue to the Assessing Officer to be examined in light of the Special Bench decision in Biocon Limited, which allowed ESOP expenses as deductible.

9. Apportionment of Common Corporate Overhead Expenses:
The tribunal found the assessee's method of allocating corporate overheads based on cost accounting principles more rational than the Assessing Officer's turnover-based method. The tribunal directed the Assessing Officer to accept the assessee's allocation.

10. Depreciation on Non-Compete Fee:
The tribunal allowed depreciation on the written-down value of non-compete fees paid to Medispan Ltd. but rejected the claim for depreciation on the non-compete fee paid to Concord Biotech Ltd., stating it does not qualify as an intangible asset under section 32(1).

11. Weighted Deduction under Section 35(2AB):
The tribunal directed the Assessing Officer to allow the weighted deduction at 150% of the actual R&D expenditure certified by the prescribed authority, which was Rs. 32,73,07,418/-.

12. Deduction for R&D Expenditure Not Eligible for Weighted Deduction:
The tribunal directed the Assessing Officer to allow the deduction of Rs. 56,35,712/- under section 35(1) for R&D expenditure not eligible for weighted deduction under section 35(2AB).

Conclusion:
The tribunal provided detailed directions on each issue, emphasizing adherence to segmental financials, proper examination of reimbursements, rational allocation of overheads, and compliance with legal precedents for ESOP expenses and non-compete fees. The appeal was partly allowed for statistical purposes.