2016 (12) TMI 1894 - AT - Income Tax

TP Adjustment - inclusion of reimbursed expenses in the cost base for the purpose of mark-up - Comparable - HELD THAT - Comparable i.e. whether Lotus Labs's RPT is significant or not deserved to be examined properly for this ay and hence this issue needs to be remitted back to the TPO. As already mentioned, the assessee found that the TPO while recomputing the ALP has wrongly considered recovery of expenses as part of the cost base and hence it sought a rectification u/s 154 but did not get any response from the TPO/AO. On its objections before the DRP, the DRP directed the TPO/AO to examine the factual position if the assessee's averments are correct, then to re-compute the mark-up suitably and to dispose the petition u/s 154 within 15 days of receipt of its order. It appears that the TPO/AO has not given effect to the directions of the DRP. In the facts and circumstances, this issue also needs to be remitted back to the TPO for proper examination and due adjudication. Thus, both these issues remitted to the TPO who after affording due opportunity to the assessee would decide them in accordance with law. To this extent, the appeal grounds are treated as allowed. Expenses by pharma companies - AO has disallowed the impugned claims in the light of the prohibition imposed by Medical Council of India (MCI)I the CBDT Circular dated 1st August 2012 and held that such expenses being prohibited by MCI is not an admissible deduction under section 37(1) - HELD THAT - The CBDT circular is issued to clarify the allowability of expenses on medical freebies which are prohibited by MCI. Expenses incurred and claimed by an assessee but prohibited by law, cannot be allowed as deduction neither under section 37(1) nor under any other provisions of Act. The CBDT circular only reiterates and clarifies the allowability of expenses prohibited under MCI guidelines. Therefore, CSDT circular is clarificatory and hence it is retrospective in operation. however, the CBDT circular has no application for a period in which the MCI guidelines are not operative. AO has not disputed the genuineness of the expenses claimed. The only reason for the disallowance is that the impugned expenses are prohibited by MCI guidelines and therefore they are illegitimate. Therefore, the deduction claimed by the assessee other than the cost of samples distributed for the period prior to MC guidelines, is an admissible deduction and accordingly, the AO is directed to allow them. As held by the DRP in the assessee's own case for a y 2010-11 and ay 2011-12 , the cost of samples distributed is also an allowable claim based on the rationale of the decision of Eskayef 2000 (7) TMI 1 - SUPREME COURT and accordingly the AO is directed to allow it too. In the result, the grounds of appeal on these issues are allowed.

Summary

Issues Involved:
1. Characterization of the assessee as a Clinical Research Organization (CRO).
2. Inclusion of reimbursed expenses in the cost base for the purpose of mark-up.
3. Disallowance of expenses on distribution of samples, sponsorship, fees, and equipment donation based on CBDT Circular No 5/2012.

Issue-wise Detailed Analysis:

1. Characterization of the Assessee as a Clinical Research Organization (CRO):
The assessee, engaged in the manufacture and sale of pharmaceutical products and coordination of clinical trial services, was remunerated on a cost-plus mark-up of 9%. The Transfer Pricing Officer (TPO) re-characterized the assessee as a CRO, rejecting the comparability analysis and adopting Lotus Labs as a comparable, leading to a recomputed ALP at 43.73% on operating cost. The Dispute Resolution Panel (DRP) upheld this characterization. The Tribunal noted that in previous years, the TPO had accepted the assessee's characterization as a coordinator of clinical trial activities and excluded Lotus Labs due to significant Related Party Transactions (RPT). Consequently, the Tribunal remitted this issue back to the TPO for proper examination and adjudication.

2. Inclusion of Reimbursed Expenses in the Cost Base for the Purpose of Mark-up:
The TPO included Rs. 146,521,126/- as part of the cost base in computing the mark-up for coordination of clinical trial segment, which the assessee argued was incorrect. The DRP directed the TPO/AO to examine the factual position and, if the assessee's averments were correct, to recompute the mark-up suitably. The Tribunal found that the TPO/AO had not given effect to these directions and remitted the issue back to the TPO for proper examination and due adjudication.

3. Disallowance of Expenses on Distribution of Samples, Sponsorship, Fees, and Equipment Donation Based on CBDT Circular No 5/2012:
The Assessing Officer (AO) disallowed expenses amounting to Rs. 41,488,035 based on the CBDT Circular No 5/2012, which the assessee contended was not applicable for the assessment year 2009-10 as the amendment to the Indian Medical Council (Professional Conduct, Etiquette and Ethics) Regulations, 2002 (IMC Regulations) was effective from 10th December 2009. The Tribunal held that the CBDT circular should not be applied retrospectively and that the expenses incurred before the effective date of the IMC Regulations were allowable. The Tribunal directed the AO to allow the deduction of these expenses, including the cost of samples distributed, based on the rationale of the Supreme Court's decision in Eskayef vs CIT 245 ITR 116.

Conclusion:
The Tribunal allowed the assessee's appeal, remitting the issues of characterization as a CRO and inclusion of reimbursed expenses in the cost base back to the TPO for proper examination. On the corporate tax front, the Tribunal directed the AO to allow the disallowed expenses, including the cost of samples distributed, as they were incurred before the effective date of the IMC Regulations and were not prohibited by law. The order was pronounced in the open court on 27th December 2016.