9911796707
TMI Blog2012 (6) TMI 13X X X X Extracts X X X X X X X X Extracts X X X X ..... the learned Assessing Officer erred in law and on facts in disallowing Legal and Professional Expenses of Rs. 24,00,000/-for the proposed expansion of the appellant's business, by holding that the same were pre-operative expenses of a capital nature. 2.1. Facts in brief as emerged from the corresponding orders listed herein above were that the Appellant company is a Manufacturer and Trader of Pharmaceutical goods, diagnostic kits, medical instruments etc. A return of income for the year under consideration i.e. A.Y. 2006-07, the year under appeal, was filed declaring total income at Rs. (-) 42,70,55,684/-, however, income declared U/s 115 JB at Rs. 148,01,16,388/-. It may not be out of place to mention that the said return was later on revised on two occasions and this fact has duly been recorded by the A.O. by referring the revised figures of the income declared. 2.2. About this ground the observation of the A.O. was that under the head 'Pre-operative Expenses' the assessee has charged to revenue a sum of Rs. 4 Million, details as under:- "Particulars Capitalised Revenue Total Legal & Professional Expenses -- 24,00,000 24,00,000 Asthama Project, Moraiya 16,50,000 -- ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... liance was placed on Digvijay cement company 159 ITR 253 (Guj). Reliance was also placed on Assam Bengal Cement 27 ITR 34 (SC) and JK chemicals 207 ITR 985 (Bom). 2.6. We have heard both the sides. For the sake of brevity and considering the length of arguments advanced in respect of the other grounds we consider it proper not to reproduce all those arguments of Ld.AR to decide this ground. Otherwise also both the sides have basically relied either upon the submissions already made or the orders of the Revenue authorities. We have studied the adversary case laws cited by the rival sides. On the basis of the study we have arrived at a conclusion that the issue is; whether the impugned expenditure was incurred for setting up a new 'business' or for setting up a new 'unit' for similar type of business already in existence. Undisputedly the assessee had incurred the legal expenditure to set-up a manufacturing unit at Uttaranchal in the F.Y. 2002-03. The said project could not be started, resultantly it was decided for the year under consideration to transfer the 'pre-operative' expenses to revenue under the head 'Legal & Professional' expenses. The assessee is in the business of manuf ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ition of Rs. 1,35,91,171/- by holding that the Trademark Registration Fees and Patent Registration Fees incurred by the appellant were capital in nature, merely eligible for depreciation u/s.32 and liable to be disallowed as business revenue expenses. 3.1. These two grounds are hereby clubbed and to be decided together. Both these grounds relate to a single issue of treating the impugned expenditures by the AO as 'capital expenditure', however, the appellant has claimed the expenditure(s) as 'revenue expenditure'. In respect of "Product Registration Expenses"(ground no. 2) it was noted by the AO that under the head 'Marketing Expenses' an amount of Rs. 2,68,03,226/-was debited which was related to the "Product Registration Expenses". It was explained that the pharmaceutical products requires registration from Government Drug Regulatory Authority, therefore, the said expenditure was incurred. It was also explained that the pharmaceutical goods could not be exported to other countries unless and until the products are approved and registered with that authorities of the respective countries. The AO's objection was that once the product is registered and approval is granted by that c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ce the goods could not be exported to those countries unless the product is registered, hence the assessee has acquired a benefit of enduring nature and the nature of marketing rights to those countries. The action of the AO was affirmed. 3.4. We are dealing Ground No. 3 simultaneously due to the similarity in the nature of the issue i.e. whether the expenditure in question is 'capital expenditure' or 'revenue expenditure'. The assessee has debited 'Trade Mark Registration Fees' at Rs. 37,92,606/ and 'Patent Fees' at Rs. 1,25,49,880/. In respect of 'Trademark registration fees' the explanation of the assessee was as under; -- "As regard details of 'Trade Marks & Registration Fees', we are enclosing herewith, copy of the said account for the year under assessment, marked as Annexure No.-21. The Assessee Company carries on the business of manufacture and sale of pharmaceuticals which are branded with its distinctive trademarks. It gets said trademarks registered with the Registrar of Trade Marks under the Trade Marks Act fro which certain prescribed fees are required to be paid. All that the registration of trademarks did was to enable the Assessee Company to obtain a speedy and le ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the AO was affirmed. 3.8. Learned counsel Mr. Patel has stated that a pharmaceutical company can sell its product only after obtaining registration and that the expenditure was incurred for the running of the business therefore revenue in nature. That is why the ' Product registration' expense was grouped under ' Other marketing expenses'. For allowability u/s. 37 of the Act case law relied upon were : i. Videsh Sanchar Nigam 81 ITD 456 (Mum.) ii. Vodafone Essar Gujarat 38 SOT 51 (Ahd.) iii. Comsat Max Ltd. 29 SOT 436 (Del.) iv. Core Health Care 308 ITR 263 (Guj.) v. Bombay Steam Navigation 56 ITR 52 (SC) About 'Trademark & Patent' fees the contention was that the products are branded with distinctive trade mark so the assessee has exclusive rights and others are prevented for making use of such patented invention. This is the first year for such an adverse action taken by the A.O; otherwise in the past years it was constantly allowed. Reliance placed as follows: i. Finlay Mills 20 ITR 475 (SC) ii. Brakes India Ltd. 9 TTJ 417 ( Mad.) 3.9. Revenue has argued that an enduring benefit was enjoyed by obt ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e to run the existing business smoothly. Under the facts as narrated to us it is wrong to suggest that an asset either tangible or intangible was acquired by the assessee. The assessee is already in the business of manufacturing of pharmaceutical products. The assessee also carries on scientific research work. For the protection of the result of the research the assessee has to get the patent registered. Rather it is fallacious to presume that an intangible asset was acquired. Enduring benefit is not the only criteria. An enduring benefit has to be coupled with the acquisition of an asset. 3.11. In the case of Shri Digvijay cement [supra] the assessee has incurred expenditure for obtaining a feasibility report for setting up a shipyard. The said expenditure having been incurred with the view to bring into existence an advantage by creating an asset of permanent nature therefore the court has considered that it was for enduring benefit hence capital in nature. On the matter of principle as well as authority we are of the view that the reliance by the learned DR is misplaced. In the case of Maschemeijer Aromatics (supra) the facts have revealed that the payment was for technical kno ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ering for the first time its trademark, then by registration the owner is merely absolved thereafter from obligation to prove his ownership of trademark. As per the Hon'ble Court the expenditure is neither for the creation of an asset nor an advantage for ever. We therefore hold that this precedent has direct application on the present issue, therefore following the same and considering the totality of the factual matrix, we hereby allow the claim. Resultantly, Ground Nos.2 & 3 are allowed. 4. Ground No.4 reads as under:- 4. That the learned Assessing Officer erred in law and on facts in making an addition of Rs. 13,42,49,052/- by holding that the appellant was not entitled to the weighted deduction for expenditure on Scientific Research u/s.35(2AB) in respect of Clinical Trial and Bio-equivalence Study. 4.1. Revenue officer has noted that the assessee has incurred expenditure on 'Research and Development' of Rs. 78,93,71,812/-. The assessee has claimed 150% deduction as prescribed under section 35 (2A B) i.e. Rs. 118,40,57,718/-. It has also been noted by the A.O. that as per a certificate issued by Department of Scientific and Industrial research, New Delhi, revenue expenditur ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... very much eligible for deduction u/s.35(2AB) of the Act. We are enclosing herewith, a copy of 'Clinical Trial Expenses A/c' marked as Annexure No.-5. We are also enclosing herewith, a copy of account of 'Bio-study expenses' incurred in our PTC R&D unit in Ahmedabad, marked as Annexure No.-6." However the AO has held that the enhanced deduction is available on expenditure on scientific research on in-house 'Research & Development' as approved by the prescribed authority as in Sec. 35(2AB)(1), reproduced in the order. According to him as per the language of this section clinical trial has to be in-house, otherwise the use of this terminology in this section would become redundant. It is a settled position of law that no word used in the statute is redundant. The AO has concluded that the clinical trial expenses and bioequivalence study is allowable under Sec. 35(1)(i) only up to 100% and hence the excess deduction by 50% i.e. Rs. 13,42,49,052/- was not allowed . 4.2. After discussion, the DRP has further added that a monitoring mechanism has been prescribed for granting weighted deduction under section 35(2AB). An approval for out side clinical trial is not prescribed in the mecha ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... drug. If two products are bioequivalent, it means that they would be expected to be same. In determining bioequivalence between two products i.e. commercially-available brand product and to-be-marketed generic product, pharmacokinetic studies are conducted whereby each of the preparations are administered to volunteers, generally healthy individuals but occasionally in patients. Ld. A.R. has drawn our attention on page 27 of the paper book where the party wise details of Bio-study research expenses are mentioned. In that list places mentioned are Navi Mumbai, Ahmedabad, Hyderabad, Chennai, Bangalore. There is also party wise details of clinical trial research expenses of Canada and USA. Pages 28 to 47 contain approvals or grant of extensions by The Drug Controller (India) for Bioequivalence Study. Pages 49 onwards are the permissions of clinical trials granted by a Canada authority. Finally our attention was drawn on FORM No. 35 i.e. Order of approval of in-house Research and Development Facility under section 35(2AB) of the I.T. Act. Addresses at which such Research and Development facilities are located have also been mentioned. Placed in the paper book on page 63 is FORM No. 3 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on tax proceedings, reliance placed on Mahendra Mills 36 ITR 350 (S.C.) and Hider Leather 101 ITR 61 (Guj.). 4.5. We have heard both the side and carefully perused the law applicable in the light of the compilation filed and explanation tendered. For the promotion of scientific research so as to give a boost to such activity the Hon'ble Law makers have introduced this section. Further considering the importance of "clinical drug trial" as a part and parcel of the scientific research as also the obtaining of approval from regulatory authority; in their prudence; considered the same as a part of research. It was brought into the Statute through an Explanation, reproduced below for reference:- Sec. 35(2AB)(1) Where a company engaged in the business of biotechnology or in the business of manufacture or production of any drugs, pharmaceuticals, electronic equipments, computers, telecommunication equipments, chemicals or any other article or thing notified by the Board incurs any expenditure on scientific research (not being expenditure in the nature of cost of any land or building) on in-house research and development facility as approved by the prescribed authority, then, there shal ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ur-walls of a ship-yard. An in-house job is that when a job is done within the organization and not by any other organization. The Corporates thus depend upon their own Research Development to be an "inside-job". To innovate new products such Corporates feel that "inside-job" is more dependable. Therefore, an internal research is distinguishable from external research. For doing internal research there can be a possibility to mobilize some external resources. But that external mobilization is only a part of the entire in-house research. 4.8. If we closely examine the language used in section 35(2AB)(1) its says, quote "incurs any expenditure on scientific research on in-house research and development facility", unquote. The significance is that the Statute has used the terminology "on in-house". As per the dictionary, meaning of the word "on" means (i) in contact with and supported by a surface, (ii) to a position in contact with such a surface of, (iii) in a condition or process of, (iv) towards or to, (v) directed towards, (vi) in the direction of, (vii) applied to, (viii) close to, beside, (ix) exactly or very nearly at (x) at the time, date or occasion of, (xi) engaged in and ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... The Drug Controller General (India). Like wise, Directorate General of Health Services (Drug trial section), Nirman Bhavan, New Delhi has informed that the said Directorate continued to accept the protocols and the report of the studies conducted by the assessee's laboratory. Before us, there was a recognition of renewal of scientific and Industrial research issued by the Government of India, Ministry of Science and Technology. The Ministry of Science and technology has extended an approval as R&D company u/s.80-IB(8A) of the I.T. Act. Number of such approvals and acceptance of reports submitted in respect of new drugs are placed on record. Even before us, it was argued that in the case Claris Life Sciences reported at 221 CTR 301(Guj) :: 326 ITR 251, the Hon'ble Gujarat High Court has opined that once the scientific research facility is approved, then the expenditure incurred on research and development facility has to be allowed for weighted deduction u/s.35(2AB) of the I.T. Act. Under the totality of the circumstances of the case and in the light of the material placed before us and the discussion made hereinabove, we are of the conscientious view that the conditions as prescri ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... upra), wherein it was held as under:- "Having thus heard learned counsel for both sides and having perused the orders on record, we find that in the present case assessee had sufficiently explained its investment for borrowed funds pointing out that loan was obtained in assessment year 1997-1998 and its majority of the investment for tax free security were made before the said period. Only a small portion of investment was made subsequently. Assessee had demonstrated that it had other sources of investment and that therefore, according to assessee no part of the borrowed fund could be stated to have been diverted to earn tax free income. When CIT(Appeals) and tribunal both on facts in the present case found that the assessee did not invest borrowed fund for earning interest free income, we are of the view that no applying provision of Section 14A of the Act for taxing such interest was justified. No question of law therefore, is arising for our consideration." 5.4. From the side of the Revenue, ld.DRs Mr. V.K.Gupta & Mr. K.Madhusudan have argued that the onus was on the assessee to establish that the impugned investment was only made out of the non-interest bearing own funds. Acc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to the said exempted income. Rather, the Hon'ble Court was very specific that in case, if no such exercise was carried out by the Assessing Officer then the matter is to be remanded back for afresh investigation. It has also been made clear that the proviso to section 14A of the Act was effective from 2001-02. But the Hon'ble Court has also pointed out the importance of Rule 8D of the I.T. Rules, 1962. It was made clear that sub-section (1) to section 14A was inserted with retrospective effect from 01/04/1962, however, sub-sections (2) & (3) were made applicable with effect from 01/04/2007. The proviso was inserted with retrospective effect from 11/05/2001, however Rule 8D was inserted by the Income Tax (Fifth Amendment), Rules, 2008 by publication in the Gazette dated 24/03/2008, relevant findings are reproduced below:- "(a) The ITAT had recorded a finding in the earlier assessments that the investments in shares and mutual funds have been made out of own funds and not out of borrowed funds and that there is no nexus between the investments and the borrowings. However, in none of those decisions was the disallowability of expenses incurred in relation to exempt income earne ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... alling within the ambit of Section 10(33) of the Income Tax Act 1961, as was applicable for Assessment Year 2002-03 is not includible in computing the total income of the assessee. Consequently, no deduction shall be allowed in respect of expenditure incurred by the assessee in relation to such income which does not form part of the total income under the Act, by virtue of the provisions of Section 14A(1); (ii) The payment by a domestic company under Section 115O(1) of additional income tax on profits declared, distributed or paid is a charge on a component of the profits of the company. The company is chargeable to tax on its profits as a distinct taxable entity and it pays tax in discharge of its own liability and not on behalf of or as an agent for its shareholders. In the hands of the shareholder as the recipient of dividend, income by way of dividend does not form part of the total income by virtue of the provisions of Section 10(33). Income from mutual funds stands on the same basis; (iii) The provisions of sub sections (2) and (3) of Section 14A of the Income Tax Act 1961 are constitutionally valid; (iv) The provisions of Rule 8D of the Income Tax Rules as ins ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n the light of this precedent, hence this ground No.5of the assessee may be treated as allowed but for statistical purposes. 6. Ground Nos.6 & 7 read as under:- 6. That the learned Assessing Officer erred in law and on facts in restricting the deduction u/s.80IC in respect of Baddi Unit to Rs. 45.92 crores as against the appellant's claim of Rs. 116.48 crores. 7. That the learned Assessing Officer erred in law and on facts in restricting the deduction u/s.80IB in respect of Goa Unit to Rs. 17,80,758/- as against the appellant's claim of Rs. 91,15,766/-. 6.1. Both these grounds have common issue as well as mutually argued by Special Counsel Shri G.C.Srivastava therefore consolidated and hereinbelow decided accordingly. It was noticed by the AO that the assessee has claimed a deduction of Rs. 116,48,51,853/- u/s.80IC of IT Act in respect of a Unit situated at Baddi, Himachal Pradesh. It was the second year of the Unit. The assessee has claimed exemption at 100% of the profit of the said Unit. An another fact has also been noted by the AO that the total turnover of the said Unit as per P&L account was at Rs. 199,13,22,749/-. The AO has also compared the overall financial position ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... pany. For Marketing Exp. it was 34.60% of sales ratio and for Corporate Expenses it was 15.20%. A chart was reproduced by the AO in this regard and on that basis it was observed that the direct cost allocated for working out the profits were the manufacturing cost incurred during the year and the depreciation of the assets directly used in the said Unit. The other expenses; namely, marketing expenses, corporate expenses and interest expenses which were incurred by the Head Office were allocated on the sales ratio basis. The AO has also compared that in respect of certain other Units, the expenditure has not been allocated. As per the allegation, no expenditure whatsoever had been allocated to the Baddi Unit on the ground that the said Unit had no business connection with other divisions. The AO has mentioned that although the assessee had shown 'Research Expenses' of Rs. 817 Million, but there was no such allocation. Likewise, other expenses, such as, 'marketing expenses', including 'advertisement expenses' were claimed entirely by the company u/s.37(1) of IT Act. The AO has also made out a chart of 'Research and Development' expenses incurred over a number of years, but according ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of those goods on P2P basis. In some of the products (for e.g. at Sl.No.1 of the chart; namely, OCID-20-CAP) the purchase cost on P2P basis was 4.27, however, average selling rate by the assessee was 30.10 for F.Y. 2003-04 and likewise for F.Y. 2004-05 the purchase cost on P2P basis was 4.28 and the average selling rate was 30.46.The AO has thus computed the overall percentage of profit in respect of the said 27 products, which were stated to be now manufactured in Baddi Unit. For F.Y. 2003-04, the assessee's percentage of profit was 81%(apx.) and for A.Y. 2004-05 it was said to be 80%( apx.). On the basis of the said calculation, it was opined by the AO that the years prior to the setting up of the Baddi Unit, the assessee was having a gross margin of about 80% for those 27 products. The AO has then made out an another list and compared the average selling rate of Baddi Unit with the average selling rate of the products purchased on P2P basis. A list of those 27 products were reproduced in the tabular form in the body of assessment order, however, for the sake of brevity, only limited portion ( first 10), just for example, are reproduced below:- Sr. No. Name of the Product Pac ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ing Division for selling the products, it is the manufacturing cost and a reasonable amount of profit which should have been charged. The reasoning given by the AO, for e.g. is as under:- "8.26. Thus, this additional profit is the only profit which it has earned by setting up the unit at Baddi. It is to be noted that all marketing, selling and distribution and administrative work are being handled by other divisions for which the assessee has done cost allocation. So, when the goods are transferred from the Badi unit to the marketing division for selling the product, it is the manufacturing cost and a reasonable amount of profit which should be charged by the Baddi unit. In the instant case, the branch transfer price can be the price which the P2P supplier was charging for the products, because in all the products, there is a cost saving by the assessee on manufacturing the goods at Baddi. For example, for item no2 of the chart, where the cost of production is Rs. 6.73 the branch transfer cost can be the price charged by the P2P supplier for the same product i.e. Rs. 11.5 similarly for item no3, where the cost of production is Rs. 1.88 the branch transfer cost can be the price cha ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... profit was not correct for the purpose of claiming the deduction u/s.80IC of the IT Act. Relevant paragraph No.8.34 is reproduced below:- "8.34 As per section 80IC(7) r.w. S.80IA(5), the profits of the eligible undertaking are to be computed as if such eligible business were the only source of income of the assessee. On the facts of the case mentioned above, the profits claimed to have been derived by sale of products manufactured from Baddi is not correct. The sale price for the product manufactured at Baddi should consist of cost of production as well as a reasonable amount of profit for the same (which in the instant case can be taken at the price charged by the P2P supplier which included the cost of the product as well as his profit on the same). However, here what the assessee has done is that, it has merged in the 'sale price', the profits derived form the brand value of the products as well as profits derived from marketing network of the products, of which the assessee is the owner and not the Baddi Undertaking. The mandate of Subsection 80IA(5) is that the profits are to be computed as if the eligible business was the only source of income of the assessee. By this manda ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... king, which according to AO, was eligible for deduction u/s.80IC of IT Act. For this proposition, reliance was placed on Rolls Royce PLC v. DDIT 19 SOT 42 and Liberty India v. CIT 317 ITR 218 (SC). The AO has then also discussed the words used in the Statute and quoted that the word "derived from" is narrower in connotation as compared to the word "attributable to". Case law cited was CIT v. Sun Engineering Works Pvt. Ltd. 198 ITR 297. Finally, the AO has computed the profit allegedly derived from Baddi Unit and held that the remaining profit was derived from exploitation of brand and marketing network thus not derived from the Baddi Unit, hence not eligible for deduction. Relevant paragraphs are reproduced below:- "8.48 As discussed above, considering the provisions of section 80IC(1) r.w. subsection (7) thereof w.r. section 80-IA(5) r.w. 80-IA(8), the profits derived from the Baddi Unit are manufacturing profits only. This profit earned/saved could easily be computed by using the product wise quantity Manufactured at Baddi and the product wise profit saved on manufacturing the products at Baddi and not getting it manufactured form P2P supplier. However, despite providing suffici ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... .1. As far as the opinion of the DRP is concerned, the assessee has raised the ground that the AO was not justified in reducing the claim of deductions respectively u/s.80IC and 80IB in respect of the respective Undertakings as follows:- "Nature of claim Claim made by Assessee (Rs.) Claim allowed by the AO (Rs.) u/s.80IC (Baddi Unit) 116,48,51,853 11,94,79,365 u/s.80IB (contrast Media Unit at Goa) 91,15,766 17,80,758" 7.2. After detailed discussion, DRP was of the view that the AO was right in observing that the established marketing network has played a very important role in pricing of the product and the abnormally high profit as shown by the Baddi Unit was also partly on account of free usage of the marketing network of the assessee-company which was created over the period of time. However, the assessee has contested that the AO should not disturb the computation of deduction of an eligible Unit on the ground that the profits earned by the other Unit of the assessee were comparatively lower, reliance placed on ACIT v. Delhi Press Patra Prakashan 103 TTJ 578 (Del.). The DRP was in agreement with the finding of the AO that the profit of the elig ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ukesh Patel and Mr. Hitesh Gajaria appeared and stated that the provisions of section 80IC provides for deduction in respect of "any profits and gains derived by an eligible undertaking". He has fervently argued that the Statute do not suggest any segregation in respect of such profit with regard to different operations, such as, manufacturing operation at one hand and the marketing or brand profit on another hand. He has also argued that the language of 80IC is in respect of "any business" referred in sub-section (2) of section 80IC. The Statute has therefore used a larger connotation, i.e. profits and gains of a business which includes not only the manufacturing gains but ancillary gains having direct nexus with the manufacturing activity are eligible for the claim. Mr. Patel has elaborated that there was no purpose of manufacturing a product if the same is not marketable. Even if sub-section(5) of section 80IA is to be considered, then the profits and gains to be computed as if such eligible business is the only source of income. He has ardently pleaded that the eligible business means the overall activity, i.e. manufacturing of a product along with the marketing activity. In th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... comprise of the ATEN family have in fact contributed to nearly 34% of the total sales and profits of the Baddi unit (referred a Statement). This Branch was purchased by the assessee in 2001 and the related expenditure in the nature of Depreciation (as per I.T. Act) for the year to the tune of Rs. 705 lakhs on its written down value has already been debited to the stand-alone P & L Account. Thus, no dispute could have been be raised on any count to the extent of 34% of the profits claimed for deduction, since no notional expenditure in respect of R & D or Brand Development can be attributed in relation such profits earned from these new products. In respect of other 22 products at Baddi representing self-generated brands, it is pertinent to point out that these Brands were launched by the company during the period 1989 to 2000. The expenditure on R & D in the years preceding the launch of these products was very small and insignificant. Therefore, the emphasis of the learned AO, highlighting that the assessee had incurred huge R & D expenses to promote these products and that the same has not been taken into account, is without any basis or justification. He has also pointed out th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... uction under this section, the profits and gains of such eligible business shall be computed as if the transfer had been made at the market value of such goods as on that date. He has therefore vehemently contested that the profit of a Unit is distinct from profit of the business as a whole. In the present case, profit of the assessee-company depends upon so many factors, such as, good-will of the business, brand value of the business and the market reputation of the products. The profits of the business of the assessee-company also depends upon the marketing strategies adopted. Whereas, for the purpose of claim of deduction u/s.80IC, one has to consider only the manufacturing profit. A Unit engaged in manufacturing or production is therefore expected to draw true profits derived from manufacturing activity only. 9.1 In respect of argument of the assessee that in the past for A.Y. 2005-06 this very claim was allowed by the AO, hence following the Rule of consistency, for this year as well has to be allowed, Mr. Srivastava has pleaded that the principle of res judicata do not apply on tax cases and in support cited a case law, viz. Distributors (Vadodara) Pvt. Ltd. reported at 155 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sferred to the eligible business, in either case, the consideration for such transfer as recorded in the accounts of the eligible business does not correspond to the market value of such goods as on the date of transfer, then for the purposes of the deduction the profits and gains of such eligible business shall be computed as if the transfer in either case, had been made at the market value of such goods as on that date. Ld. Special Counsel has therefore passionately pleaded that this provision of the IT Act empowers the AO to substitute the value of the transaction as recorded in the books of accounts, if in his opinion the said value is not the fair market value of the goods transferred. In the present case, the AO has fairly demonstrated that the sale price of the products which was recorded at the Baddi Unit was not the fair market price because those very products were purchased on P2P basis in the past at a lower cost. The comparative chart of 27 products was duly recorded by the AO, which was by itself explicitly clear and directly convey the stand of the Revenue. 9.3 Ld. Special Counsel Mr. Srivastava has also took shelter of section 40A(2)(a) for the legal proposition th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... only. He has again drawn our attention that the only source of income should be the eligible source of income and not other sources of income, such as, profits of marketing division or profits on account of established brand. For the allocation of profit of manufacturing unit the mandate is very clear because Income Tax Rule, 1962 contains Rule 18BBB wherein as per sub-rule(2) a separate report is to be furnished by each undertaking and that report shall be accompanied by a profit & loss account and balance-sheet of that Undertaking as if the Undertaking is a distinct entity. He has therefore argued that the allocation of the profit of a manufacturing unit should be made on stand alone basis. He has questioned that how the sale price of the products of the Baddi Unit were determined and recorded. Because of the brand value the sale price must have been determined by the management as if the profit is earned by the assessee-company on sale of the products of the Baddi Unit. It was recorded on the presumption that the sales were executed by the Head Office by charging brand value, the name of the product and the goodwill of the Company. In any case, according to Ld. DR, a reasonable ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... following manner : (2) This section applies to any undertaking or enterprise (a) which has begun or begins to manufacture or produce any Article or thing ......... Therefore, 'manufacturing' is the first criteria for the eligibility of the 'business' to qualify for the deduction. Hence the 'profits' are required to be derived from a manufacturing undertaking which is producing the specified article. That 'profit' is inclusive in the 'gross total income'. As already noted, the terminology "profit" has not been defined in this Act therefore we have taken the help of other resources. The basic question is that what is the "profit" of a manufacturing unit? Firstly, the term "Profit" implies a comparison between the stage of a business at two specific dates separated by an interval of a year. Thus fundamentally the meaning is that the amount of gain made by the business during the year. This can be ascertained by a comparison of the assets of the business at the two dates. To determine the "profit" of a manufacturing Unit the accounting standard has given certain guidelines, enumerated in short. In the accounting the "profit" is the difference between the purchase price ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ned separate books of accounts and therefore drawn a separate profit and loss account. In such a situation, whether the AO is empowered to disturb the computation of profit, is always a subject matter of controversy. From the side of the assessee, reliance was placed on ACIT v. Delhi Press Patra Prakashan 103 TTJ 578 (Delhi). In this case, the assessee was claiming deduction u/s.80IA in respect of a Unit No.4. The said Unit was showing profit @ 62%. As against that, AO has noticed that a margin of profit shown by the assessee as a whole was only to the extent of 10%. The AO has therefore recomputed the profit of the said Unit by applying sub-section (10) of section 80IA and restricted the profit of the said Unit to 10% only. While dealing this issue, the Respected Coordinate Bench has concluded that it was not justified to disturb the working of profit merely because the profit rate of eligible unit was substantially higher than overall rate of profit of other Units of the assessee, more so when separate books were maintained by the assessee in respect of the said eligible Unit. In the present case as well the AO has proceeded to disturb the profit of the Baddi Unit and held that o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e facts, since it was found that R&D activities were carried out by the assessee, therefore, 15% of the profit was allocated to the R&D activities and balance of the profit was attributable to the marketing activities in India. The said decision was entirely based upon the connectivity of the marketing operations with the profits. The CBDT Circular No.23 of 1969 dated 23/07/1969 was also taken into account wherein it was opined that where a non-resident's sales to Indian customers are secured through the services of an agent in India then that profit is attributable to the agent's services. Meaning thereby because of the close connection of the agent's marketing activity the proportionate profit was attributed to the said activity. Contrary to this, there was no finding that upto the extent of 80%, the profit was attributed to the assessee-company. The segregation between 80% and 6% was not on account of any evidence through which it could independently be established that the major portion of the profit could be attributed to the assessee-company and rest of the profit could only be attributed to the Baddi Unit. 10.5 The AO has also made out a case that the book profit percentage ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d the provisions of section 80IA. Refer, Sub-section (7) of section 80IC which prescribes as follows:- Section 80IC(7) : The provisions contained in sub-section (5) and sub-sections (7) to (12) of section 80IA shall, so far as may be, apply to the eligible undertaking or enterprise under this section. Due to this reason, our attention was drawn on the provisions of section 80IA(5) of IT Act; reads as under:- Section 80IA(5) : Notwithstanding anything contained in any other provision of this Act, the profits and gains of an eligible business to which the provisions of sub-section (1) apply shall, for the purposes of determining the quantum of deduction under that sub-section for the assessment year immediately succeeding the initial assessment year or any subsequent assessment year, be computed as if such eligible business were the only source of income of the assessee during the previous year relevant to the initial assessment year and to every subsequent assessment year up to and including the assessment year for which the determination is to be made. As per this section, the profits of an eligible undertaking shall be computed as if such eligible business is the only source o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... versy gets minimal. Rather, the intense contention of the Ld.AR is that the facts of the case have explicitly demonstrated that the goods manufactured at Baddi Unit were transported to various C&F agents across the country for sale purpose. Therefore, the eligible business is the manufacturing of pharmaceutical products and the only source of income was the profit earned on sale of the products. 10.8. An interesting argument was raised by ld. Special Counsel that the provisions of section 80IA(8) prescribes the segregation of profit in case of transfer of goods from one Unit to another Unit. But section 80IA(8) reads as follows:- Section 80IA(8) : Where any [goods or services] held for the purposes of the eligible business are transferred to any other business carried on by the assessee, or where any goods [or services] held for the purposes of any other business carried on by the assessee are transferred to the eligible business and, in either case, the consideration, if any, for such transfer as recorded in the accounts of the eligible business does not correspond to the market value of such goods [or services] as on the date of the transfer, then, for the purposes of the deduc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... as per the market price determined by the AO. Both these suggestions are not practicable. If these two suggestions are to be implemented, then a Pandora box shall be opened in respect of the determination of arm's length price vis a vis a fair market and then to arrive at reasonable profit. Rather a very complex situation shall emerge. Specially when the Statute do not subscribe such deemed inter-corporate transfer but subscribe actual earning of profit, then the impugned suggestion of the AO do not have legal sanctity in the eyes of law. 10.9 A very pertinent question has been raised by ld.AR Mr. Patel that what should be the line of demarcation to determine the sale price of a product if not the market price. As far as the present system of fixation of sale price of the product is concerned, a consistent method was adopted keeping in mind the several factors, depending upon the market situation, we have been informed. But if the assessee is compelled to deviate from the consistent method of pricing, then any other suggestion shall not be workable because no imaginary line of profit can be drawn, precisely pleaded before us. So the uncertainty is that on the production cost what ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... eductions to the category of "profit linked incentives". The incentive is linked with generation of 'operational profit'. Therefore, the respected Parliament has confined the grant of deductions only derived from eligible business. Each eligible business constitutes a stand alone item in the matter of computation of profit. The Court has said that because of this reason the concept of "segment reporting" was introduced in Indian Accounting Standards. Ld. Counsel Mr. Srivastava has argued that the deduction u/s.80IC is a profit linked incentive. Only the Operational Profit has to be claimed for 80IC deduction. According to him, each of the eligible business constitutes a stand alone item in the matter of computation of profit. For the computation of profit of an eligible business the word used is "derived" in section 80IC which is a narrower connotation, as compared to the word "attributable". In other words, by using the expression "profits derived by an undertaking", Parliament intended to cover such sources not beyond the first degree, i.e. the first degree of manufacturing activity. The law pronounced by the Hon'ble Supreme Court is final and should not be disputed. However, a j ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e sale proceeds are received or realized. But on the other hand, it was argued that the profits received relate (i) firstly to his business as a manufacture, (ii) secondly to his trading operations and (iii) thirdly to his business of export. On that basis, it was opined that the profit or loss has to be apportioned between these businesses in a business like manner and also according to well established principle of accountancy. This apportionment of profits between a number of businesses which are carried on by the same person at different places determines also the place of accrual of profit. The act of sale is the mode of realizing the profits. If the goods are sold to a third person at Mill premises, one could have said that the profits arose by reason of sale. The Profit would only be ascribed to the business of manufacture and would arise at the Mill Premises. Merely because a Mill owner has started another business organization in the nature of sale depot, that cannot wholly deprive the business of manufacture of its profits, though there may have to be apportionment in such a case between the business of manufacture and business of shop keeping. The question which was answ ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... diction of Indian State. So the Court has observed that to succeed in their claim, it is incumbent upon the assessee to show that there was in fact a part of a business and that the profit had actually accrued or arose in that part of an Indian State. The Court has clearly stated in para-41 that both the elements should found exist and then only the business could be treated as a separate business. However, the said proviso has propounded only deeming provisions, as is apparent from the language of the section itself. For the purpose of the said section, it was deemed to be a separate business. The whole of the profits of which accrue in an Indian State and the other part of the business be deemed to be a separate business. In para-44, the Hon'ble Court has discussed the problem with reference to certain decisions of English Courts and then made an observation that it had been held that if separation is possible in such cases, the proper course is to follow that sever the profits of the two businesses and assess accordingly. The result of the discussion was that the profits of the two businesses were directed to be apportioned. Simultaneously, the Hon'ble Court has also made an obs ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n respect to that part of a business only when apportionment is possible. The Hon'ble Court has said that only on the said assumption that apportionment was possible the said proviso was based upon that presumption only. If no apportionment can be made in respect of the process of a particular business, then that will not be considered to be a part of the business at all and held that the proviso will not apply. It was concluded that the principle of apportionment was implied therein. After this detailed discussion, we thus arrive at the conclusion that the principle of apportionment was the criteria for segregating the manufacturing profit if it was feasible to do so. As against that in the present case the assessee has computed the profit of the Baddi Unit on the basis of the well accepted principle of accountancy that a profit is accrued where a transaction is closed, meaning thereby the profit arises solely at the time of sale. 10.13 After the detailed discussion, before we close the controversy we would like to express that the AO's proposition of segmentation of eligible profit of the manufacturing unit was not altogether meaningless. This approach of the AO cannot be brushe ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nt of expenses incurred. It was also noted that similar reimbursement of expenses for product registration were also made to Zydus Healthcare South Africa and Zydus France, but no "service charges" paid to those Associate Enterprises. The assessee-company has submitted F.A.R. analysis as follows:- "(A) Functions Performed: Cadila is engaged in manufacturing formulations and APIs. It undertakes research and development, manufacturing and product promotion activities. Zydus LLC is involved in registration of pharmaceutical products of Cadila in overseas locations such as USA etc. as well as in providing marketing support services. In relation to the process of obtaining product registration, Cadila supplies all the information / data required for submission to the relevant authorities. Cadila prepares and compiles complete set of registration dossiers for obtaining registration with the concerned regulatory authority in the respective jurisdiction for e.g. US Food & Drug Administration in respect of Us market. Cadila also owns the intellectual Property Rights related to the products registered by Zydus LLC. (B) Risk Assumed : Zydus LLC renders product registration suppo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ursement of expenses incurred on behalf of the assessee for product registration 49,22,532 Zydus France SAS, France Reimbursement of expenses incurred on behalf of the assessee for product registration 15,35,338 The TPO has thus concluded that the services charges @ 10% was recommended for upward adjustment in the following manner:- "5.7 In view of above, the explanation submitted by the assessee is rejected and the transaction is being treated as mere reimbursement of expenses and no mark up is allowed for these zero risk administrative operations i.e. non business operation. In view of above Rs. 32,61,124/- (Zyduc LLC has shown Rs. 32,61,124/- as service charges income which is 10% of total expenses incurred in this behalf of Rs. 3,26,11,245/- in place of Rs. 29,77,402/- shown by the assessee in 3CEB report) is added back to the income. Total upward adjustment Rs. 32,61,124/-" 11.4 Interestingly, when the matter reached to DRP, it was directed to AO to allow a mark-up of 2% instead of NIL as per the following directions:- "1.9. In view of the fact that the assessee had stated vide letter dt. 4/6/2008 that there was no Global Transfer Pricing Policy, no method adopted wit ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... registration and marketing support services C = A + B 32,751,422 Mark-up @ 2# as directed by DRP D = A *2% 595,480 Arm's length price arrived at based on direction of DRP order E = A +D 30,369,500 Applying the 5% benefit as provided in Second Proviso to Section 92C(2) F = E*1.05 31,887,975 Adjustment for difference between the amount paid and the arm's length price after allowing the 5% benefit G = C - F 863,447 However, in this regard, for the purpose of computation of arm's length price u/s.92C first of all most appropriate method is to be decided and thereafter as per the provisions of section 92C(2) the benefit of variation between the arm's length price so determined and the price at which the international transaction has actually been undertaken is prescribed as follows:- 92C(2): The most appropriate method referred to in sub-section (1) shall be applied, for determination of arm's length price, in the manner as may be prescribed: Provided that where more than one price is determined by the most appropriate method, the arm's length price shall be taken to be the arithmetical mean of such prices: Provided further that if the variation between the arm' ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ersion was that in view of clause (f) Explanation-1 to section 115JB the said adjustment should have been made. According to AO, the amount disallowed u/s.14A is liable to be added as per the provision of sec.115JB r.w.Explantion-1, clause (f) which mandates that the expenditure debited to Profit & Loss account a/c. incurred in relation to income exempt u/s.10 is to be added for computation of book profit. However, this very issue now stood settled by Goetze Ltd. 32 SOT 101 (Del.), wherein it was held as under: "We have considered the facts of the case and rival submissions. We may at the outset consider the provisions contained in clause (f) of the Explanation to section 115JA and sub-section (1) of section 14A of the Act. Under the aforesaid clause (f), the amount of expenditure relatable to any income to which any of the provisions of Chapter III applies has to be added to the book profit. Under the provision contained in section 14A, no deduction is to be allowed in respect of expenditure incurred by the assessee in relation to income which does not form part of the total income under this Act. Since we are dealing with the issue of expenditure relating to dividend income, a m ..... X X X X Extracts X X X X X X X X Extracts X X X X
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