9911796707
TMI Blog2013 (11) TMI 468X X X X Extracts X X X X X X X X Extracts X X X X ..... : "The ld. CIT(A) has erred in law and on facts reducing the adjustment of TPO to Rs.2,20,80,690/- against the addition rate order u/s. 143(3) of Rs.2,69,06,690/- which is correctly workout by the AO. The ld. CIT(A) has erred in law and facts reducing the adjustment of purchase of goods from AE Rs. 2,68,986/-" The grounds raised by the assessee for the assessment year 2005-2006 are also reproduced below because the grounds raised by the assessee are interconnected with the grounds raised by the Revenue. 1. (a) The Ld. CIT (A) grossly erred In facts and in law, in upholding/ recomputing the upward transfer pricing adjustment to the extent of Rs.47,26,000/- in respect of international transactions of sale of goods to associated enterprises, by taking operating profit margin to be 5% on operating cost and by comparing the same with the operating profit margin earned by the appellant in prior years rather than by comparing the operating profit margin of comparable entity (ies) for the year under review. (b) The method of recomputation of adjustment is contrary to his own findings in the order in detail and is also contrary to the provisions of law on transfer pricing In India. The ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ssessee had filed its return of income for the present year i.e. A.Y.2005-2006, declaring total income of Rs. 100.79 lakhs. The assessment in this case was made by the AO, by determining the income at Rs. 3,69,85,950/- wherein the additions were made by the AO on account of the Transfer Pricing adjustment under Section 92 of the IT Act. The TPO had rejected the assessee's Transfer Pricing report, and has proposed adjustment of Rs. 2,65,37,704/- on the basis of adopting the "AE" as tested party and IDA, Switzerland as comparable. The TPO has worked out the adjustments on the basis of those transactions, in which, the margin percentage on sale reported by the "AE" was more than 11.94%, being the margin percentage on sales earned by the comparable i.e. IDA, Switzerland ("IDA" for short), and he has ignored those transactions where the margin percentage on sale of the "AE" was less than 11.94%. In addition to this, the TPO has also recommended the addition of Rs.3,68,986/- on account of purchase of goods by the assessee from the "AE" by adopting the margin rate of 15.74%, by way of mark up of the cost of goods purchased by the assessee from the "AE", because, it was found by the TPO th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ase: i. Mission Pharma Logistics (I) Pvt Ltd (MPL) is a manufacturer of medicine kits. The kits are manufactured by the company by sourcing generic medicines from established suppliers, preparations of kits which contain desired medicines and other items packaged to avoid deterioration of the products in extreme circumstances and ensure safety during movement. ii. The entire manufacturing is done as per the orders of its AE and parent company M/s Mission Pharma AS (MPAS), Denmark, which is engaged in obtaining orders from multilateral agencies, government bodies and NGOs for such supply of medical kits on a global in various under-developed/epidemic affected countries. MPAS competes with other similarly placed suppliers like IDA, Netherlands and secures such orders which are then passed on to MPL which then prepares the necessary kits and supplies them dispatches to the ultimate destination to the end-user in the name of MPAS. As claimed by MPL in earlier years of its functioning, it has been able to create an efficient sourcing and logistic system for prompt and efficient response to emergency orders. The billing and subsequent receipt of consideration is also done by MPAS. B: ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ced by CIT(A) on the orders of AY 2003-04 and 2004-05: The CIT(A), at para 5.27, has wrongly placed reliance on the earlier year TP orders to accept the selection of tested party. Perusal of the TP documentation of the assessee company reveals that the assessee has tried to change the character of the activity in India from that of a manufacturer in AY 2004-05 (Ref page 15 of the TP document placed at annexure III) to that of an assembly unit in AY 2005-06 inspite of the fact that there is prima facie no change in the functioning or pattern of the appellant. Wrong characterization of the functions of the appellant renders it liable to rejection of the TP documentation. The CIT(A) has failed to appreciate this fact and has relied on the acceptance of assessee's characterization of its functions in earlier years by the department as a valid reason for retaining the tested party. iii. Rejection of Tested Party The CIT(A) has failed to appreciate that the transaction which needs to be benchmarked here is the kit manufacturing business of the assessee. Hence, the other turnover of the AE is immaterial in determining which party should be the tested party. The TPO has elaborately dealt ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... products (eg. a product line) which is impractical to determine pricing for each individual product or transaction." It is clear, in the current case, that the preferred method would be transaction by transaction method unless the compelling circumstances mentioned above are present. In the current case, it is perfectly possible to delink the transactions. The Indian party is operating as a independent manufacturer. Hence, the CIT(A)'s decision that the transactions are interlinked, is without any basis. The very fact that the TPO has been able to deal with the transactions independently reveals that it is possible to handle them separately. At para 6, the CIT(A) has wrongly concluded that since there is a long term relationship between the two parties, aggregation is essential. The OECD talks about long term contract for supply of commodities or services and not long term relationship. There is no such contract between the two parties and the pricing of the products is not being done on the basis of any contract. In the case of Tara Ultimo Pvt Ltd 47 SOT 401 (Mum), it has been held by the ITAT, Mumbai that the benchmark profit (mean profit) is to be applied to each transaction e ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... that the medicines have been purchased from MPAS at high cost and sold to MPAS at lower cost in some instances. ii. The TPO has applied the arm's length margin determined by him on these transactions to arrive at the correct price which should have been charged by the assessee. iii. In spite of there being a clear evidence of wrong pricing of products while purchasing it from AE as well as misrepresentation of facts, the CIT(A) has wrongly resorted to estimation of arm's length price without basis. The TPO has adopted a reasonable approach in trying to arrive at a reasonable arms length price based on the average net margin being earned by the appellant. E: Benefit of 5% price range: i. The price band is allowable to the assessee only if there is determination of average price based on a number of comparables where the arm's length prices determined is different in each case. Since in the current case, there is only one comparable, there is no averaging of the arm's length prices. The subsection 2A refers to arithmetic mean of the various prices determined. If there is no arithmetic mean, then no benefit of the provision can be allowed to the assessee." 6. As against this, th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e to the claim of the assessee that the assessee should be considered as a tested party, and IDA is to be excluded from the list of comparable. Regarding this claim that the profit margin of the "AE" for this year in respect of the transactions with the assessee is 11.68%, he submitted that the same is 11.68%, and in support thereof, he will file a certificate of Chartered Accountant very shortly. 8. We have considered rival submissions and perused the material on record and gone through the orders of the authorities below and judgments cited by both the sides. We find force in the submissions of the learned AR of the assessee that, even if, it is accepted that the "AE" of the assessee is a tested party, and IDA is comparable, then also, no addition is justified in this year, if the margin for the aggregate transactions is considered. Because, the profit margin of the IDA i.e. comparable is considered on yearly average basis, the profit margin of the tested party should also be adopted on similar basis, i.e. yearly average in respect of all the transactions, and it cannot be on the basis of only those transactions where margin reported by the "AE" i.e. tested party is more than th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d the appeal for the assessee for A.Y.2005-2006 is allowed. 11. Now, we take up the appeal of the assessee for A.Y.2006-2007. The grounds raised by the assessee are as under: On the facts and in the circumstances of the case and in law, the Assessing Officer ('AO') grossly erred, in conformity with the directions of Hon'ble Dispute Resolution Panel ('DRP'). Ahmedabad under section 144C(5) of the Income-tax Act, 1961 ('the Act'), in making the upward transfer pricing adjustment of Rs. 84,580,4861/- in respect of appellant's international transaction of sale of medical kits (comprising genericLpharmaceutical products, hospital supplies and disposables) to its associated enterprise ('AE') Missionpharma AIS. Denmark ('MPAS'). The appellant submits that no transfer pricing adjustment is warranted in its case and wishes to raise the following grounds of appeal, which are without prejudice to each other: (i) The Hon'ble DRP erred in upholding the transfer pricing adjustment made by the Ld. Transfer Pricing Officer ('TPO) without appreciating that such action of Ld TPO is without jurisdiction as it was undertaken without complying with the conditions prescribed in Section 92C(3) of the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... by attributing the excess profits retained at the level of the AE (i.e. MPAS). to the Appellant. x. The orders of the Hon'ble DRP/Ld.TPO/Ld. AO are untenable in law because they suffer from factually incorrect statements, observations and conclusions." 12. In this year, the basic facts are similar, because, in this year also, the assessee has undertaken similar activity, and the TPO proposed the addition in respect of sales by the assessee to the "AE" by adopting the "AE" of the assessee as tested party, and adopting IDA as comparable. The only difference is this that, in this year, the assessee has provided various other comparables, also before the DRP, but the same were rejected by the DRP. For rejecting some of the comparables, the basis given by the DRP is this that, such comparable are engaged in the manufacturing activity, and therefore cannot be considered as comparable. In respect of some of the comparables, the basis given by the DRP is this that, comparable had no export sales, whereas the assessee's transactions are only for export. In some cases, this is also a basis adopted by the DRP that the turnover of the comparable is very high or very low and in one case, this ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... A.Y. 2006-2007. The written submissions of the learned DR are reproduced below: "Defects in the TP study carried out by the assessee: FUNCTIONAL DIFFERENCE Without prejudice to the fact that the FAR analysis carried out by the assessee is incomplete and faulty, as pointed out in the order made by the TPO, it is seen that, even after assuming the assessee's own FAR analysis to be correct, the following pertinent defects are noted: i. The assessee does not perform any of the critical functions being carried out by a "wholeseller", as per its own FAR analysis. The relevant function which can be identified are : * Development of market and/or distribution chain; * Procurement of material; * Development of procurement chains including the negotiations related to identification of purchaser, quantity to be sourced and the price of the product; * Management of funds; * Development of efficient supply chain including logistics ;etc As a matter of fact, it is claimed that these function are being performed by the AE. Thus, as per the assessee's own FAR analysis, the functional profile does not match with that of a "wholeseller" drug distributor. ii. A wholesale trader is also req ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the case. The honourable bench in the case of Interra Information Technologies (India) Pvt. Ltd. I.T.A. Nos.5568/Del/2010 & 5680/Del/2011 has even cautioned that the applicability of a decision in the case of transfer pricing proceedings depends upon the particular facts of the case and the ruling in one may not be blindly followed in the other. The discussion on this issue is made in para 64 to 66 of the order. 3.1 As already discussed above, since the functional profile, on the basis of which the search process is carried out by the assessee, is erroneous from the beginning, even the remaining entities, after removing the loss makers, are not comparable. This becomes clear from the statement made by the assessee in para 5.2.2 on page 5 of the summary provided to the honourable members, and whereby it is claimed that the transactions between the assessee and the AE are so priced that it is ensured that the assessee did not suffer any operational loss. EXPORT EARNINGS 4. The assessee objected to the rejection of companies selected by it in its Transfer Pricing report having low export earnings. The assessee submitted that it is a captive provider to its associate enterprise and ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ide India is bound to be more than the margins earned by rendering services within India, due to the higher price of service in the export sector by using the same low costs, it is clear that non application of this filter will lead to inadequate comparison. 4.3 The assessee's argument is that the geographical source of the revenues will not have any impact on the prices charged or the margins earned. However, as per Sub-Rule (1) of Rule 10B, the comparability of an international transaction with an uncontrolled transaction shall be judged with reference to conditions prevailing in the markets, the geographical location, the size of the market, costs of labour, overall economic development, level of competition etc. In this regard, the relevant portion of Rule 10B is reproduced as under : "conditions prevailing in the markets in which the respective parties to the transactions operate, including the geographical location and size of the markets, the laws and Government orders in force, costs of labour and capital in the markets, overall economic development and level of competition and whether the markets are wholesale or retail" Further, the OECD guidelines regarding economic c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... o support above quantitative criteria. The relevant portion is reproduced as under:- "B.4 Economic circumstances 28. The question arises as to how to determine if economic circumstances are indeed comparable. In practice, both quantitative and qualitative criteria can be used to include or reject third party transactions depending on whether or not they are carried out under comparable economic circumstances. The most common quantitative criteria are: - Size criteria in terms of Sales, Assets or Number of Employees: they are used to test whether or not companies, due to their size, are in significantly different economic situations; - Intangible-related criteria such as Net Value of Intangibles/Total Net Assets Value, or ratio of R&D/Sales where available: they make it possible for instance to exclude companies with significant intangibles or R&D activities when the tested party is a contract manufacturer which does not own significant manufacturing intangible nor participate in R&D; - Criteria related to the importance of export sales (Foreign sales/total sales), when relevant; - Criteria related to inventories in absolute or relative value: they can be used, for instance, t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... al in the case of Deloitte Consulting India Pvt. Ltd wherein the use of this filter was approved by the Hon. Tribunal in para 39 of the judgment, reproduced below: 39. The next ground is with regard to rejection of independent comparable companies by TPO/CIT (A) on the basis that they do not have any foreign exchange revenue. We find that the TPO, in the case of back office services segment, has rejected the following five companies on account of the fact that these companies do not generate foreign exchange revenue. (i) C.S. Software Enterprise Limited (ii) Ideaspace Solutions Limited (iii) MCS Limited (iv) Tata Share Registry Limited (v) Vakrangee Softwares Limited We find that the domestic BPO is much smaller business segment than the export BPO. The productivity and return in domestic segment is also much less than the export segment. The TPO clearly demonstrated in his order at page-9 that the earnings per seat in domestic segment is 0.45 lakhs as against 2.37 lakhs in the export segment which works out to 5.27 times more than the domestic segment. In the export segment, the earnings will be more due to the fact that they have advantage of time zone and higher productiv ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... submission by mentioning that vending of information and rendering services to call centre are activities different from running a call centre. Therefore, the functional profile of the two companies were different. 15.1 Before us, the ld. counsel mentioned that the information vending is nothing but customer support or a contract centre. Thus, Shreejal Info Hubs Ltd. is imparting information of supplier of goods and services to prospective customers. As per director's report, it is carrying out the business of information vending by employing calling agents under the brand name "Ask Me", which is essentially a call centre/contract service centre. Therefore, functional profile is same i.e., to furnish information about the client-company. On the other hand, the case of the ld. DR is that Shreejal Info Hubs Ltd. is working for the clients in India while the assessee is providing services in USA, thus, business territories are totally different. 15.2 We have considered the facts and the submissions made in this behalf. We are of the view that territory of the business is a material factor in deciding comparability of the cases. The assessee renders services in USA while Shreejal In ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... pared to "wholesale drug distributors". TURNOVER DIFFERENCE 6. In this respect it is to be stated that the use of turn over criteria is important element to select the comparables in line with FAR analysis of the assessee. The use of such turn over criteria is approved in a number of cases by the Hon. Tribunal. The relevant judgments delivered in this respect are reproduced below: i. Quark Systems Pvt Ltd. 2010-TIOL-31-ITAT-CHD-SB- In this case the turnover of the assessee company was Rs 13.96 crore and in this context it was held by the Hon'ble Tribunal that a broad turnover basis of Rs 1 crore to infinite is not correct. The relevant portion is reproduced below: "25................In our considered view, it is improper to proceed on the basis that the turnover of Rs. 1 crore to infinite is a reasonable classification as turnover base....................". ii. Egain Communication Pvt Ltd. 2008-TIOL-282-ITAT-Pune - In this case the turnover of the assessee company was Rs 10.25 crore and in this context it was held by the Hon'ble Tribunal that the CIT(A) had correctly taken companies lying between Rs 5 to 25 crore. iii. Sony India Ltd 114 ITD 448(Del) -The turnover filter appl ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... unt of risk and working capital. As discussed above, the adjustments are required to be made in respect of all the differences listed above in respect of the assessee and the alleged comparables. TESTED PARTY 8. Even though the there cannot be any dispute on the proposition that tested party should be considered to be the entity for which reliable information is available and the reliable information about the comparables are also easily available. However, the selection of the tested party cannot be made by sacrificing the requirement of matching of FAR of the tested party and the comparables. By selecting itself as the tested party, the assessee tried to carried out a search using the comparables available in the Indian market. For the reasons detailed above, such selection of comparables carried out by the assessee was faulty and incorrect. Further, further detailed reasons mentioned in his order, the TPO has found that the assessee invested substantial amounts in establishing supply line with reputed Indian generic drug manufacturers by negotiating the best prices and confirmed supplies. As a matter of fact the assessee had taken the services of purchase experts from the AE a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f single group's concerns while there is no such risk in the case of the comparables. Hence, it is not that the assessee will get eternal business from its AE and also that its revenues will increase year by year is not borne by the above provisions of the agreement. If the parent company goes into liquidation or bankruptcy due to unfavourable economic or other conditions, the business of the assessee comes to stand still. The agreement can be terminated unilaterally by the AE without any cause. Even the assessee is not protected with any compensation if the agreement is terminated unilaterally. Thus, there is neither the guarantee of assured business/turnover nor of the tenure. The only guarantee is of no operating loss. So, there is more risk in the case of assessee who is dependent on a single customer when compared to comparables who may not depend on single customer. Consequently, it cannot be claimed that the assessee was having low risk and thus it is less complex among the two (assessee and AE). SELECTION OF MPAS AS COMPARABLE. As already discussed above, it is seen that the transfer pricing study carried out by the assessee suffers from various pertinent defects and cons ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ical assistance is provided by way of supervision of kit assembly by deputing skilled and experienced personnel to the plant in India. Yes. Reason: As it has to bid for tenders and fulfil the requirements of tenders (vi) Warehousing and inventory management Based on the production planning of medical kits, MPAS monitors inventory level of major products and MPL assist in maintaining proper inventories. They also provide necessary system support and its expertise developed over last thirty years. Yes. (vii) Logistics MPAS develops logistic framework and engages third party agencies. It also undertakes or arranges for logistic functions outside india and within India. Expert guidance is provided on account of its expertise in logistics developed over more than thirty years. Yes. (viii) Market and distribution The Mpas and its various products are registered in various countries and various developmental agencies. They participate in international tenders. Therefore, MPAS carries out function relating to identification, development and promotion of market and distribution. Yes. Reason: As mentioned in the website. (ix) Management of funds and maintenance of accounts ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... usiness risk, etc. which is fully on MPAS , there is risk of capital investment Yes. Consequently, the action of the TPO in considering IDA as comparable to MPAS is correct. * Comparison of IDA with the MPAS (Objections). ○ Not for profit-As per the details in website it is not as if no profit is made by this entity but the profit so made is channelized back to the customers. ○ The final sale price is fixed as it also participates in tenders as with the MPAS. Thus profit potential in both the cases is the same. Being stated as "not for profit" does not mean no profit is being made. As stated the profit is being channelized back. ○ No marketing required by IDA ○ IDA also has local offices across the globe. In India an office was opened in Mumbai in 2006 with a dedicated Quality Affairs department which focuses specifically on matters such as quality assurance, procurement from Indian sources, drug registration, laboratory testing and quality control monitoring. (Source website of IDA foundation:- http://www.idafoundation.org/we-are/local-presence.html).these facts indicate that Ida is also engaged in carrying out marketing activities. Further a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... oducts (in the form of medical kits) by MPL to MPAS 780,764,326 2 Purchase of capital goods by MPL from MPAS 761,178 3 Recovery of expenses and services charged by MPL 586,811 4 Purchase of pharmaceutical products and packing materials by MPL from MPAS 12,209,096 3. Approach adopted by the Appellant in the Transfer Pricing Study In the Transfer Pricing study undertaken by the Appellant for the subject financial year, the following approach was adopted: * MPL was considered as the tested party. * Indian companies predominantly engaged in wholesale trading activities in drug and medicine, allied products etc. were considered as comparable companies based on detailed search process undertaken with the help of the Prowess database * Transactional Net Margin Method ("TNMM") was applied as the most appropriate method ("MAM") for the determination of the arms length price for the international transactions * Operating Profit as a percentage of Operating Cost was considered as the appropriate Profit Level Indicator * Based on the detailed search process undertaken by MPL, the arithm ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ines for Multinational Enterprises and Tax Administrations 2010 issued by the OECD ("OECD Guidelines") and US Treasury regulations have provided some guidance on this subject. Based on the above, the following principles would need to be kept in mind in selecting the tested party: * The party that is the least complex in terms of functions performed, assets employed and risks undertaken should be selected as the 'tested party' i.e., the party to the international transaction whose functions are simpler to evaluate, which does not own valuable non routine intangible assets and does not undertake substantial business risks. * Reliable information about the 'tested party' must be more easily and readily available and should be capable of being verified independently. * Reliable information about the 'comparables' must be more easily and readily available and should be capable of being verified independently. * The available information on 'tested party' and 'comparables' shall be sufficient to carry out reliable adjustments for material differences, if any. The above principles have also been upheld in the Indian Transfer Pricing context in the case of Development Consultants (P ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... that the various product registrations with Governmental and non-Governmental organisations, licenses/approvals held by MPAS cannot amount to intangibles as these registrations and licenses are required to be obtained as a matter of procedure. Hon'ble DRP reiterated and confirmed these observations of the TPO. 5.2 Submissions of the Appellant The Appellant submits that the Hon'ble DRP/TPO has erred in considering MPAS as the tested party and makes following submissions on various aspects of Functions, Assets and Risks:- 5.2.1 Functions Performed * The Functions performed, Assets employed and Risks assumed (FAR) analysis undertaken by the Appellant clearly lead to conclusion that MPL is the least complex entity and MPAS is a more complex entity as it carries out larger share of functions in the chain of entire business function, bears most of the risks and owns significant non-routine intangibles. A summary of the FAR as captured in the transfer pricing documentation maintained by the Appellant has been enclosed for reference as Annexure 1. * Based on review of the FAR analysis, significant economic activities in the supply chain such as research and development, bidding for t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... it is ensured that the Appellant does not suffer any operational loss. Therefore, although the Appellant incurs a profit or loss arising due to the fluctuation in the foreign exchange rate, it is compensated for the same through the inter company pricing policy followed. Therefore, the Appellant does not bear the foreign exchange fluctuation risk. * The Appellant, since the commencement of its operations in India, has been making profits irrespective of the performance of the pharmaceutical industry in India. The Appellant does not bear the risk of incurring losses due to under utilization of capacity or insufficient business from MPAS, as under an overall policy framework for pricing the transactions, it is generally ensured that the Appellant does not suffer any operational loss. * The TPO erred in facts, by concluding that the Appellant bears all the entrepreneurial risks by merely analysing the inventory balances and the profit/ loss incurred due to fluctuations in the foreign exchange rate. The entrepreneurial risk comprises not just foreign exchange risk and inventory risk, but primarily includes market risk, financial risk, product liability risk, R&D risk, credit risk, et ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... onal guidelines, resolving cultural issues, etc.). During the subject financial year MPL has not made any payment to MPAS for visits of expatriates. * As regards product registrations and licenses, the Appellant highlights the fact that MPAS is registered as a supplier with various Governments, UN agencies, NGOs, etc as well as product registrations in various customer countries has taken number of years and has been made possible by consistent and reliable supply of quality products in addition to incurring significant expenses on the part of MPAS. It is the goodwill that has been created/ developed by MPAS over a period of more than three decades that has made it a pre-qualified partner among large number customers and organizations. 5.2.4 Availability of reliable data of tested party and comparables The TPO has categorically mentioned in the impugned order that for selecting one of the controlled party as tested party, one has to keep in mind availability of comparable data which can be used for comparison purpose. It will be unwise to select a simpler company as tested party which has no comparable company in the database or whose functional profile does not match with any o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the entities being compared are such that could not be quantified then such potential comparable entity shall be ignored. Therefore, in these circumstances, the AE (MPAS) cannot be considered to be the "tested party" and the IDA Foundation, Netherland cannot be held comparable to AE. Further, the reliable information that is required for carrying out requisite analysis under transfer pricing is more readily and easily available in respect of the Appellant as compared to its AE. Besides, it is seen that in AY 2003-04 and AY 2004-05, the Appellant has been adopted as the "tested party" and the TPO has approved the same without any variation. Since, the TPO in the present assessment year has not brought on record any new fact and legal inputs, I do not find any reason to deviated from the findings recorded in this regard in AY 2003-04 and AY 2004-05 when the facts and circumstances are similar in the year under reference. In view of this, I hold that the Appellant has correctly been selected as the tested party." Considering all of the above, Appellant submits that MPL should be considered as the tested party for the purpose of determination of arms length nature of the internatio ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... adopted in order to ensure that such an approach is fair with a reasonable degree of objectivity and transparency. The quality of comparability analysis can only be assessed if it is reproducible i.e., in particular, the process followed to identify the comparables and criteria used to select or reject comparables is reproducible by the person who wishes to assess it. The TPO has made a vague reference to Google search conducted on internet for identifying companies dealing with similar business activity as that of MPAS. Further, though the Appellant had made a specific request to the TPO to share the approach adopted in terms of search process undertaken, filters adopted, etc, the same was not shared by the TPO with the Appellant. * The Appellant submitted that economic profile of MPAS and IDA Foundation is quite different. While MPAS is a "for profit" commercial organisation, IDA Foundation is a "not-for-profit" organisation. This is evident from following extract from website of IDA Foundation http://www.idafoundation.org/we-are.html: "As an independent and self-supporting not-for-profit organisation, we do not have any shareholders looking for return on their investment; any ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... hat IDA Foundation cannot be considered as a comparable company on account of its persistent operating losses. This is evident from the statement made by the directors in the Annual Report of IDA placed at pages 255 to 282 (this statement appears on page 257 of paper book). * The location of both these entities in the same geography does not have any bearing on their economical comparability for the purpose of transfer pricing evaluation, especially when the trade is done on a global basis. Therefore, viewed from an economic perspective, location of both these entities in Europe does not establish their comparability. * The TPO has considered the consolidated financial statements of IDA Foundation and MPAS for the purpose of comparability analysis. In this regard, the Appellant submits that the use of consolidated financial statements include not only the revenues and expenses of IDA Foundation, but would also include the aggregate revenues and expenses of the entire IDA Group, some of entities within the group may be engaged in completely different business. * Further, the geographical markets in which one of the subsidiaries of IDA is located, is different from that of MPAS. W ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... le 10B to account for difference in FAR of these companies. 7.2 Submissions of the Appellant 7.2.1 Comparability with Indian wholesale distributors The Appellant is primarily engaged in procuring pharmaceutical products from various suppliers and reselling them on a wholesale basis, packed in different types of kits as per the requirements of the AE. Medical Kit preparation process broadly involves procurement of requisite pharmaceutical products as per customers' order, putting them into corrugated boxes as per customers' specifications, packing the box, affixing the label and dispatching the medical kits as per customers' instructions. The above tasks such as putting products in boxes, packing the box, labeling, dispatching, etc. are carried on by most wholesalers/traders/distributors operating in the open market and these activities are in no way unique or extra-ordinary for the TPO to conclude that these render the Appellant's business as "completely functionally different" as compared to wholesale distributors. In fact, in the context of appellant's claim of tax exemption u/s. 10A, the income - tax department itself has in prior years contended that the Appellant's busine ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he TPO. In fact, the above issue was already addressed by the Appellant before the TPO. 7.2.3 Negative arithmetic mean of comparable companies As regards the comment of the TPO on negative arithmetic mean of comparable companies, the Appellant contends that functions/business activities undertaken, the risks borne and the assets employed are the broad determinants of comparability and not the profits/ losses of the entities. Furthermore, it appears irrational to reject the entire comparable set merely because some companies forming part of the set have operating losses. As mentioned in the transfer pricing documentation submitted to the TPO, the Appellant had used certain acceptance/rejection criteria for screening the comparable companies. One of the rejection criteria used by the Appellant was to reject companies that have made persistent operating losses for more than five years. The Appellant believes that loss makers (other than companies persistently incurring losses) should not be excluded from the comparable set. This view also finds support from the decision of Special Bench, Chandigarh in the case of M/s Quark Systems Private Limited (38 SOT 207) wherein the Tribunal ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... EZ. Hence, appellant's situation is akin to an Indian wholesaler operating in a domestic market. (e) It is not the case that all the Indian comparable companies selected by the appellant are not having export sale. Some of them are also having export sale. For Example, companies (i) Rajat Pharmachem Ltd; (ii) Indosol Drugs Limited; (iii) Sharon Bio-medicine does have export sale. 7.2.5 Related Party transactions The TPO has rejected the entire comparable set contending that most of these companies are associated/ related companies of major pharmaceutical companies in India and that the other companies also have huge related party transactions. The Appellant highlights the fact that related party transactions cannot be assumed/ deemed to exist merely because of a parent subsidiary relationship. It is necessary that a transaction takes place between the parent and subsidiary to result in a related party transaction. While the TPO has made a sweeping statement that comparable companies are having huge related party transactions, he has not provided any factual evidence to justify this claim. Even if one were to apply the related party transactions > 25% of operating revenues fil ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... comparable companies are wholesale trader only and not manufacturer. This fact is evident from published audited annual reports of these companies which are placed at pages 1 to 256 of the additional Paper Book. All these comparable companies being listed entities, their Annual reports are publically available. Hence, Hon'ble DRP's observation that these annual reports are not available in public domain does not hold ground. 7.2.7 Turnover Differences For rejecting appellant's set of comparable companies, the TPO/DRP also observed that appellant has selected companies which have too high turnover or too low turnover not comparable to the turnovers of the appellant and accordingly, these companies are liable to be rejected as comparable. The appellant's contentions in this regard are as follows: (a) It is not a sacrosanct principle or legal rule that turnover filter should be applied in every case. Only if differences in level of operations/turnover have material impact on the profit or prices of the companies within a particular industry, the turnover filter would have any relevance. (b) Unlike manufacturing industry or service industry where level of operations/turnover (i.e ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t the Appellant has not carried out any adjustments to the net operating margins of the comparable companies which is required as per Rule 10B(e)(iii) for differences in the FAR analysis of each of these companies. In this regard, the Appellant's contends that the TPO has not demonstrated how, if at all, the various differences cited by him have a material impact on the determination of ALP, thereby warranting an adjustment. Further, if at all an adjustment is warranted, it is required to account for the differences in the working capital and risk profile of the Appellant vis-à-vis the comparables. With respect to the risk adjustment, there needs to be a downward adjustment as the Appellant bears relatively lower risks in comparison with the independent comparable companies. Similarly, if the adjustment for working capital is considered, then the Appellant's 'return on operating cost' will be higher as most of its working capital requirement is financed by MPAS and accordingly, its level of working capital deployment is comparatively lower than comparable entities. 8 Excess profit retained at the level of AE 8.1 Hon'ble DRP/TPO held that AE MPAS should not have gross pro ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the consolidated level may be due to the efforts of the other subsidiaries as well. Given this, it is incorrect to attribute all the excess profits (if any), of MPAS at the consolidated level to its transactions with the Appellant. c. Apart from MPL, MPAS has few other office/entities in other parts of the world, which also undertake procurement function for the group. For Ex: MPAS has one such centre in China. Given that these offices/entities (including the Appellant) provide procurement assistance to MPAS, each of them could potentially lay claim to the entire excess profits at the AE level. d. It is to be noted that only MPAS is involved in revenue generation activity. Apart from having complete packing facilities of its own, MPAS is the customer contracting entity responsible for developing and maintains customer relationships. The Appellant would not be commercially able to offer products directly to customers as it does not have the required customer relationships, proven track record in international supply of medical kits, internationally recognised brand name, required product registrations, governmental and non-governmental approvals etc. in various countries across t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... all other terms of supply of goods. Then it advises MPL to place order. Therefore, critical and important part of this function is carried out by MPAS. (v) Preparation of medical kits. The facilities are established at plant in KSEZ. However, the plant lay out and other technical parameters were jointly agreed upon and decided. The preparation of medical kits is a labour oriented activity and is carried out with contract labour. Technical assistance is provided by way of supervision of kit assembly by deputing skilled and experienced personnel to the plant in India. (vi) Warehousing and inventory management The entire warehousing and inventory management is being done at plant. This includes handling of goods, safe storage of goods, maintenance of necessary records, etc Based on the production planning of medical kits, MPAS monitors inventory level of major products and MPL assist in maintaining proper inventories. They also provide necessary system support and its expertise developed over last thirty years. (vii) Logistics The company is handling the inward and outward of goods and materials, delivery of export of consignment to MPAS designated shipping agencies, cleara ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... and depressed market conditions are mainly attached to the MPAS. (ii) Credit risk All the payments for goods supplied by MPL to MPAS are received in advance. Therefore, there is no question of bad debt or default risk, etc. The supplies are made to various development/international aid agencies where payment terms involve no/low advance payment. Risk of bad debts/default is wholly upon MPAS. (iii) Product risk -Design and development product, obsolescence of product after sales service and product liability risk. In case of medical kits, assembly operations is carried out only after receipt of firm order from MPAS and therefore design risk and obsolescence in medical kits does not arise. However, rejection during assembling is on MPL's account and compliance of prescribed quality standards is mandatory. All risks connected with rejection of goods, quality issues, shortages at customers place are to be borne by MPAS only. After sales services, if any are to be provided by MPAS at customers place in various countries. The risk of product liability in terms of international regulations as well as in terms of laws of the country where supply is made is on the shoulders of MPAS ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ousing and inventory management, accounts and administration. * MPAS deploys tangible assets in the form of warehousing and storage facilities, development facilities, international communication and connectivity systems, product delivery monitoring systems and administrative facilities, etc at Denmark and in the countries of its customers, apart from skilled work force. Intangible Assets Major intangible assets are by way of goodwill and business establishment in the international market which solely belongs to MPAS. The "Missionpharma" is an economically significant brand/name in international market in this segment of business. The goodwill has been created/developed by MPAS over a period of more than three decades and MPAS has to incur significant cost and efforts to ensure that goodwill and credentials so created are maintained. Registration of suppliers with various Governments, UN agencies, NGO's etc as well as product registration in various countries made by MPAS has taken number of years of consistent and reliable supply of quality products in addition to incurring of various expenses." 17. We have considered rival submissions and have gone through the orders of the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ncorporation of the assessee-company in India, and the same were submitted before the DRP, and are also placed in the paper book before us at page no.266 to 269. It is also submitted that even purchase order to be placed on Indian suppliers is sent by the "AE" and copy of such purchase order is place in paper book at page no.259 to 265. It is submitted that these facts goes to show and establish that the assessee-company had not created any intangible in terms of local supplier list. Regarding this allegations of the TPO that there are various services charges paid by the assessee-company to the "AE" for visits of expatriate personnel to India, it was submitted that most of the personnel visited India to provide operational support to the assessee-company for training of employees, assistance in establishment of accounting and other controls, formulation of operational guidelines, resolving cultural issues etc., and during the present year, the assessee-company did not make any payment to the "AE" for visits of the expatriate. 19. We find that neither the TPO nor the learned DR of the Revenue could controvert the factual submissions of the assessee before the TPO, DRP and before u ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d as tested party, whereas the TPO had decided for adopting the "AE" of the assessee-company as tested party, and the view of TPO was approved by DRP. 22. Second aspect to be decided by us, is selection of comparable. First of all, we have to decide as to whether IDA can be accepted as a comparable or not. In fact in the TP study undertaken by the assessee and submitted before the TPO, the assessee itself has selected IDA as comparable. Later on it was submitted by the assessee that the IDA cannot be considered as comparable, because, the IDA is not working for profit motive. As against this, it was submitted by the learned DR of the Revenue that since the IDA is also having surplus, it cannot be accepted that IDA is not working for profit motive and it is a charitable institution. These arguments of the learned DR of the Revenue are neither here nor there, because even all the charitable trusts and institutions in India are also having some surplus, and for this reason alone, it cannot be said that they are not for charitable purpose, or that, they are working for profit motives. Generating some surplus is a different issue, but whether one is working for profit motive is altoget ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ion of these three parties, the assessee has worked out that arithmetic mean margin ("AMM" for short) of remaining six comparables is minus 1.74%. Out of these six comparables, two compares are having minus OP/cost percentage i.e. Duchem Laboratories Ltd., and Indosol Drugs Ltd. Without holding this that loss making comparable has to be excluded in all cases, we find that, even if we exclude these two comparables, then also the "AMM" for the remaining four comparables works out to 4.27%. The margin of the assessee-company for the present year is reported at 1.15%. 24. Now, we examine the acceptability of these four companies i.e. Aditya Medisales Ltd., Adinath Bio-labs Ltd., Rajat Pharmachem Ltd., and Shamrock Industrial Co. Ltd. Regarding the first party, Aditya Medisales Ltd., the objection of the DRP is noted at page no.69 of the DRP order. Regarding this company, one of the objections of the DRP is this that, this company is having very high sale turnover of Rs.959 crores. The second objection is this that this company has no export sales. Now question is whether these objections are sufficient to reject the comparable. 25. The submissions of the learned AR of the assessee ar ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... participates in the global tender and whatever order it gets, it selects supplier of the same also on the basis of its past link with supplier and simply directs the assessee-company to take delivery of the specified goods from specific suppliers and for packing the same as per the specific requirements and despatch the same to a specified party at a specified address. Even the investment is not made by the assessee-company and whatever inventory is lying with the assessee-company is financed by either the credit provided by the supplier selected by the "AE" or advance payment is made by the "AE" to the supplier or to the assessee, and the assessee is neither carrying on inventory risk or any other type of risk. Under these circumstances, how the assessee-company can command export profit, which is generally available to a true exporter ?. A true exporter is in fact locates customers as well as suppliers. He has to make payments to suppliers, and he has to finance supplies till the payment is received from the foreign buyers. He also undertakes the risk of timely delivery, foreign exchange fluctuations, quality, standard etc. If the supplier commits a mistake, the goods will be re ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d. Since there is no other objection for this comparable, we hold that the Aditya Medi-sales Ltd. should be accepted as a comparable in the present case. 28. The second comparable is Adinath Bio-Labs Ltd. We find that one of the objections of DRP is this that, this company is basically engaged in manufacturing of pharmaceuticals raw-materials and chemicals. Regarding this company, it was also submitted by the learned AR of the assessee that as per the profit & loss account of this company, available at page no.45 and other details in the paper book, it can be seen that out of the total turnover of Rs.2101.03 lakhs, that company is having manufacturing turnover of only Rs.798.57 lakhs and hence, it can not be said that manufacturing is the main activity of this company. We have examined relevant pages of the paper book, and we find that this contention of the learned AR of the assessee is correct. The majority of the turnover is in respect of trading activity of pharma products or domestic software sales or the software system services, and since the assessee-company is also rendering the services to its "AE" in respect of pharmaceutical items, which includes medical kits, in our c ..... X X X X Extracts X X X X X X X X Extracts X X X X
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