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TMI Blog2014 (2) TMI 1070X X X X Extracts X X X X X X X X Extracts X X X X ..... de to AE towards reimbursement of R & D expenditure is within arm’s length - when the department is contradicting, then it is for the department to bring on record material to show that such facilities are available in India and what would be cost of research and development work with regard to this particular research work - without bringing sufficient evidence on record to prove that the transaction between the assessee and its AE is not genuine, the conclusion arrived at by the TPO/DRP that it is a sham transaction, cannot be accepted - The efforts of the TPO to justify the transaction as not genuine, the TPO has failed to examine and make necessary enquiry to find out whether the expenditure incurred towards outsourcing R & D work is within arm’s length – thus, the matter remitted back to the AO for fresh consideration. Disallowance u/s 40(a)(i) of the Act – Held that:- DRP has completely misdirected itself while coming to such conclusion - A perusal of the certificate dated 6-7-2007 clearly shows that assessee was permitted to pay an amount of Rs.20 crores to its AE towards reimbursement of expenditure incurred on assessee’s behalf without deducting tax at source – thus, no ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ad For the Respondent : Shri P. Somasekhar Reddy ORDER Per Saktijit Dey, J. M: These two appeals filed by the assessee are directed against assessment orders passed u/s 143(3) read with section 144C(5) of the Act pertaining to the assessment years 2007-08 and 2008-09. Since common and identical issues are involved in these two appeals these are taken up together and disposed of by this combined order for the sake of convenience. 2. The assessee has raised 10 grounds. Ground No.1 and 10 are general in nature hence, they do not require adjudication. 3. Ground No.2 is also dismissed as not pressed. 4. Ground No.3 is in two parts. In ground No.3(a), the assessee has challenged the addition of Rs.8,33,45,495/- by treating the arms length price as nil. 5. Briefly the facts are, the assessee is a company registered under the Company s Act, 1956. The assessee is a subsidiary of Indigene Pharmaceuticals Inc. USA. The business activity of the assessee is in research development works in the fields of chemicals, agrochemicals, bulk drugs etc. For the assessment year under dispute i.e. for 2007-08, the assessee filed its return of income on 26-102007 declaring a loss ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nd fixed capital requirements. The main source of funds is by way of financial support from Department of Science and Technology (DST), Government of India. Indigene India used the appropriate technologies for executing the project and the choice of technologies to be used is done only by Indigene India without any input from Indigene USA. In the process of R D activities carried out, Indigene India has outsourced certain R D support activity in the nature of special lead development to Indigene USA on pure cost reimbursement basis towards following services:- a) Initial Pharmaceuticals b) Pre-clinical development studies c) Formulation development and stability studies d) Clinical studies e) CGMP studies f) Common Technical documentation g) Global Regulatory Requirements h) Any other activities related to lead candidate development 6. The TP report also stated that Indigene USA does not carry out any advance marketing function for marketing the products to be launched after completion of the project. For carrying out the R D support activities, Indigene USA claims reimbursement from Indigene India in respect of actual cost incurred by it. Out of the R D a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... above said programme having project cost at Rs.24.87 crores. Out of the soft loan of Rs.17 crores sanctioned by the DST, an amount of Rs.10 crores would be disbursed at the beginning of the first year and the second instalment of Rs.7 crores would be disbursed after first monitoring meeting. As per the terms and conditions of the agreement with DST, the loan will be unsecured loan carrying a simple interest of 3% per annum and clause- 2.4 of the agreement stipulates product implementation period will be the moratorium period and will not be liable for repayment of instalments and interest. Clause- 2.6 of the agreement provides that the assessee should timely repay the loan along with instalment of interest as per the schedule notified and any delay in repayment will entail payment of penal interest @12% per annum compounded monthly for the period of delay and successive two defaults will entail recall of the total outstanding loan immediately. Clause 2.8 of the agreement specified that Industrial Partner i.e., assessee shall utilise the loan only for the purpose of the project and not for any other purpose including civil constructions and renovation of the R D and associated fac ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Diversion of funds to other purposes will entail cancellation of the loan and immediate payment of outstanding amount with a penalty interest at the rate of 12% compounded monthly. The TPO analysing the financials of the assessee noted that during the financial year ending March, 2006, share application money of Rs.8,70,20,000 has been received. This amount has been kept with banks which is reflected as cash/bank balances at Rs.8,47,74,281. An amount of Rs.86,04,949 has been received as advance. 9. However, the share application money and trade advance of USD 450000 have been refunded back to Indigene USA in the financial year 2006-07 and no reason has been shown why this money is returned back to Indigene USA. Indigene India from the year, 2002 has claimed that it is engaged in R D work and as per the P L account, some expenditure towards the same has been debited. However, in the financial year 2006- 07, R D to the tune of Rs.8,33,45,495/- out of total operating expenses of Rs.12,59,21,902 has been claimed to have been outsourced. On considering the above fact, the TPO noted that DST has advanced soft loan to Indigene India to promote research activities within the countr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... is-a-vis transfer price of reimbursement made to AE when the assessee has undertaken to do such research work at the designated laboratory stipulated by DST for obtaining short term loan under PRDSF programme. He noted that there is no documentation available with the assessee to show that the work outsourced is work useful and identifiable with reference to the research work mandated by DSIR, Government of India. The TPO noted that agreement dated 2-1-2006 under which the R D work was outsourced to the AE is of general nature and not a specific one. The agreement states that the first party i.e., the assessee would request the second party i.e. AE to conduct the key development steps on a need basis in USA and Europe. Further clause 3 of the said agreement states that the Indigene USA may carry out any of the activities which are outsourced either in its own research facilities, employing its personnel for carrying out the research activities or it can also outsource some of the activities to other consultants, institutions, and companies. However, the basis of pricing of the so called outsourced work is not spelt out in the agreement. The agreement do not indicate/mention as to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... that if the AE has outsourced its own R D work to third parties in USA and Canada, the taxpayer failed to explain with any cogent reasons as to why the so called research work has not been outsourced directly to third parties in USA and Canada. The TPO observed that the assessee could not substantiate with proper documentation to prove the nexus between the so called outsourced work and actual work carried out elsewhere so as to say that Indigene India has benefitted from such work. The aforesaid issues were raised in a show cause notice issued to the assessee. Though the assessee submitted a detailed reply but the TPO was not convinced with the same and concluded that no significant R D work was undertaken by the assessee in the country against which loan has been granted by the DST. The claim of the assessee that R D work was outsourced to its AE is not verifiable as there is no documentary evidence available with the assessee with reference to the services actually carried out and delivered. He noted that the assessee has failed to explain as to what are the benefits that are going to accrue out of such payment. Therefore, he inferred that the funds given to its AE assume ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ommittee of DPRP. Therefore, the conclusion arrived at by the TPO in terming it a sham transaction is without any basis. It was also contended by the assessee that it is not a fact that entire R D activities were outsourced to the AE. In fact, the R D work which could be carried out in the laboratories in India i.e., relating to development of innovative and intellectual property backed prescription (Rx) Medicines in the area of metabolic disorders (such as diabetes) was carried out in India. Only R D work relating to respiratory disorder (such as Allergy Rhinitis) was outsourced to AE as no facility for such work is available in India. It was contended by the assessee that the TPO without properly verifying the documents submitted before him and without properly reconciling the actual work done by the assessee as well as by its AE should not have considered the transaction as sham and determined the ALP at Nil. The DRP after considering the submissions of the assessee negated all the contentions. The DRP endorsed the view of the TPO that the assessee was required to have R D centre with the recognition of DSIR and soft loan of Rs.17 crores were disbursed by the DST to prom ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sisted of employees and consultants of its AE. In view of similarity of work carried out by the assessee and its AE, it becomes important to know as to how the cost has been allocated between the two. The DRP on the basis of the aforesaid facts finally concluded that the finding arrived at by the TPO cannot be interfered with. The DRP further went on to observe that even assuming that the reimbursement of expenditure is within arm s length, the expenditure cannot be allowed as there is no compliance of provisions contained u/s 195 of the Act. The DRP held that the payment made towards research and development work is in the nature of fees for technical services requiring deduction of tax at source as per section 195 of the Act. Since the assessee has not deducted any tax at source, the expenditure is not allowable as per section 40(a)(ia) of the Act. Accordingly, the DRP upheld the addition of Rs.8.33 crores. 15. The learned AR submitted that in the year 2003 to 2006, R D work relating to Phase-A of the Project was carried out. The appellant has submitted all the documents in connection with R D expenses incurred like proposal to DST for phase B portion of the project, loan agr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... submitted documents before the TPO and the reasons why R D work pertaining to allergic rhinitis disease was outsourced outside India. Both DPRP and DST have duly acknowledged the fact that the R D activities need to be carried out outside India to meet regulatory requirements. He submitted that it is to be appreciated that as per the Joint Committee (Expert Committee under Drugs Pharmaceuticals Research Programme (DPRP) and the Assessee's R D team) the CMC, pre clinical and clinical safety and efficacy studies of the project were to be conducted in only accredited and compliant laboratory and testing facilities under the US-FDA and EMEA guidelines. This was done to avoid any undue repetition of the work done due to non- compliance reasons. Any repetition of work due to non-compliance reasons would result in significant delay and increased cost. Therefore in order to mitigate both time and cost overrun in the project Indigene India had outsourced selected studies of the project to Indigene USA. It is also to be kept in mind that the proposal submitted by the assessee to Department of Science and Technology for securing the loan clearly specifies that all CGMP, GLP, GCP work / will ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ts and the work was carried out by them in hired facilities. He submitted that various submissions and documentation furnished would show that only R D activities pertaining to respiratory disorders were outsourced whereas other R D activity was carried out in India only. What could not be carried out in India was only outsourced and not the entire activity. This is evident from the fact that even in India substantial amount of R D expenditure was incurred. It was submitted, all documentary evidence in the form of debit notes, agreements with AE showing details of expenses incurred were submitted to the TPO. Learned AR submitted that the test of commercial expediency for determining whether the expenditure was necessary and reasonable has to be adjudged from the point of view of the businessman and not of the revenue. Expenditure can never be linked to the income earnings ability or the value addition the expenditure has bought into the business as the same cannot be quantified. Hence, the legitimacy of expenditure cannot be questioned. In support of such contention, the learned AR relied upon the following decisions:- i) Mumbai ITAT in the case of Dresser-Rand India (P) Ltd Vs A ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... relevant materials on record. The Company had a project associated with the Research and Development of Innovative and Intellectual Property backed Prescription (Rx) Medicines in the areas of Respiratory Disorders (such as Allergy Rhinitis) and Metabolic Disorders (such as Diabetes) for global markets. Initially the R D efforts of this project have been initiated as part of Phase A of the project during 2003 to 2006. During the Financial Year 2007-08, under Phase-B of the project, there were two types of R D work carried out viz., the Rx drug candidate for the effective treatment of Diabetes (Metabolic Disorders); and the new Rx drug candidate for the effective treatment of Allergic Rhinitis (Respiratory Disorders). During the financial year 2007-08 under Phase-B, there were two types of R D works carried out relating to molecular combination based healthcare products for global prescription(Rx) and consumer health care (CHC) markets. On perusal of the order of the TPO as well as DRP, it becomes abundantly clear that they have refused to accept the transaction as genuine on the following reasons:- I) The assessee has not shown the reasons why it had returned back the share app ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nce amount of Rs.8,33,44,475/- has been diverted in the garb of R D work which in reality was never outsourced. The funds available from DST are placed at the disposal of the parent company while interest at the rate of 3% was paid to the DST. As against this, it is the contention of the assessee that the assessee has submitted all documents in connection with R D expenses before the TPO. It is contended that the assessee has taken a business decision of conducting the development work in India and abroad to ensure that all development work is in compliance with the standard fixed by the Regulatory Authorities. It is also contended by the assessee that the DST and the monitoring committee have endorsed such outsourcing of work to its AE. 20. A perusal of the loan agreement between the DST and assessee, relevant clauses of which have been dealt with herein before, show that there is no restriction in the agreement that the research and development work cannot be outsourced to an outside country. Only thing it says is, the assessee must have arranged the facility with the regulatory standard to undertake such R D income. It is the contention of the assessee that the entire ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tainly have recalled the entire loan amount for violation of loan condition. Nothing of that sort has happened as appears from the materials on record. Therefore, when neither the DST nor the monitoring committee have made any adverse remark with regard to the R D activity carried on by the assessee itself or by outsourcing to its AE, the TPO or DRP cannot term the transaction between the assessee and its AE as sham merely on presumption without bringing any cogent evidence to prove so. 22. When the assessee has taken a business decision of outsourcing a part of the R D activity it is not for the department to question it. It is for the assessee to decide what is best for his business interest. The department cannot step into the shoes of a businessman and ask him to conduct his business in a particular manner or advice him what to do or not. The Income-tax Appellate Tribunal, Mumbai Bench in case of Dresser Rand P. Ltd. Vs. Addl. CIT (supra) has held as under:- "We find that the basic reason of the Transfer Pricing Officer's determination of ALP of the services received under cost contribution arrangement as 'NIL' is his perception that the assessee did not need these ser ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sis in the earlier period, but that does not mean that arm's length price of these services is nil . The Hon ble Delhi High Court in case of CIT vs. EKL Appliances Limited (24 Taxman . com 1999) held as under:- 19. There is no reason why the OECD guidelines should not be taken as a valid input in the present case in judging the action of the TPO. In fact, the CIT (Appeals) has referred to and applied them and his decision has been affirmed by the Tribunal. These guidelines, in a different form, have been recognized in the tax jurisprudence of our country earlier. It has been held by our courts that it is not for the revenue authorities to dictate to the assessee as to how he should conduct his business and it is not for them to tell the assessee as to what expenditure the assessee can incur. We may refer to a few of these authorities to elucidate the point. In Eastern Investment Ltd. v. CIT, (1951) 20 ITR 1, it was held by the Supreme Court that "there are usually many ways in which a given thing can be brought about in business circles but it is not for the Court to decide which of them should have been employed when the Court is deciding a question under Section 12(2) of t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ion37(1) required that the expenditure should have been incurred "wholly, necessarily and exclusively" for the purposes of business in order to merit deduction. Pursuant to public protest, the word "necessarily" was omitted from the section. 21. The position emerging from the above decisions is that it is not necessary for the assessee to show that any legitimate expenditure incurred by him was also incurred out of necessity. It is also not necessary for the assessee to show that any expenditure incurred by him for the purpose of business carried on by him has actually resulted in profit or income either in the same year or in any of the subsequent years. The only condition is that the expenditure should have been incurred "wholly and exclusively" for the purpose of business and nothing more. It is this principle that inter alia finds expression in the OECD guidelines, in the paragraphs which we have quoted above. 22. Even Rule 10B(1)(a) does not authorize disallowance of any expenditure on the ground that it was not necessary or prudent for the assessee to have incurred the same or that in the view of the Revenue the expenditure was un-remunerative or that in view of the conti ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... third party for their services, we direct the AO to allow the expenditure as claimed after due verification. With these directions the orders of the TPO and DRP on the issue are set aside and examination of the expenditure/claim of reimbursement is restored to the file of the AO. The grounds 5 to 7 raised on this issue are allowed for statistical purposes. 23. If we apply the principles laid down as aforesaid, the only thing that the TPO is required to examine is whether the payment made to AE towards reimbursement of R D expenditure is within arm s length. With regard to the question raised by the TPO and DRP to the effect that USFDA compliant laboratories when are available in India what is the need for outsourcing such work, the specific contention of the assessee is there are no such facility available in India for research and development work of respiratory disorders. Therefore, when the department is contradicting such contention then it is for the department to bring on record material to show that such facilities are available in India and what would be cost of research and development work with regard to this particular research work. In the aforesaid circumstances, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... )(i) is concerned, in our view the DRP has completely misdirected itself while coming to such conclusion. A perusal of the certificate dated 6-7-2007 issued by the DCIT, Circle 2(1), Hyderabad a copy of which is at page 186 of paper book, clearly shows that assessee was permitted to pay an amount of Rs.20 crores to its AE towards reimbursement of expenditure incurred on assessee s behalf without deducting tax at source. That being the case, no disallowance could be made u/s 40(a)(ia). That apart it is the consistent stand of the assessee that reimbursement of expenditure is on cost to cost basis and there is no income to the AE. That apart, payment is towards services rendered outside India. In these circumstances, conclusion of the DRP is untenable. 25. Ground No.3(b) reads as under:- The learned ACIT/DRP is not justified in law in observing that the assessee company is still in the pre-commencement stage and thereby disallowing the entire scientific research expenditure incurred in India amounting to Rs.4,25,76,407 26. Briefly the facts are, during the scrutiny assessment proceedings, the Assessing Officer noticed that the assessee had claimed deduction of Rs.12,59,29,902 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s engaged in scientific research activity which is catering to the needs of business carried on by the AE. He therefore held that the relationship of the said expenditure on scientific research which is not in connection with the assessee s business but for others is not covered u/s 35(1)(i) of the Act. He therefore disallowed the total expenditure of Rs.12,59,21,902/- including the expenditure of Rs.4,25,76,407/- relating to research activities in India. The assessee objected to such disallowance before the DRP. The DRP after considering the submissions of the assessee was of the view that as per section 35(1) of the Act only in case where in house research relates to its business, the same can be allowed. The pre-commencement period expenses for the earlier three years before commencement of business are deductible in the previous year in which the business is commenced. The DRP further observed that in order to claim deduction the assessee should produce the certificate from the prescribed authority i.e. DGIT(E) in concurrence of Secretary, department of Science and Technology. The DRP further observed that even with regard to capital expenditure for in-house research conducted, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... meaning of scientific research, provided u/s 43(4) the expenditure incurred by the assessee on research and development is an eligible expenditure. In this context, the learned AR relied upon the decision in case of Ayushakti Ayurved P Ltd. Vs. ACIT (37 SOT 313) wherein the Income-tax Appellate Tribunal, Mumbai Bench held that the object behind the enactment of section 35 of the Act is to encourage research and development activities. As an incentive, the legislature has given this benefit by way of deduction in respect of the capital expenditure incurred by the assessee. The provision being for the benefit of the assessee, if the assessee incurs capital expenditure for the purpose of research and development then revenue should not deprive the assessee of the benefit of deduction under the provisions of section 35 of the Act. The assessee also relied upon the decision of Mumbai Tribunal in the case of Transweigh (India) Limited vs. ITO (22 SOT 338). The learned AR further submitted that in the subsequent assessment year i.e., Asstt. Year 2008-09 though the assessee has claimed similar deduction of expenditure, the Assessing Officer has allowed the expenditure incurred in India. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... bursement of expenses to its AE amounting to Rs.8.33 crores. 34. Brief facts relating to the aforesaid issue are during the proceeding before the TPO, he held that since the reimbursement of expenditure to its AE amounting to Rs.8.33 crores was a diversion of funds and not for the purpose of the business of the assessee, it is in the nature of a interest free loan to the AE. The TPO therefore held that interest at the rate of 14% should be treated as the amount chargeable by the assessee on the amount of Rs.8,33,45,495/- advanced to the AE should be treated as ALP of the interest on funds given to the AE. Accordingly, he made an adjustment of Rs.1,16,68,369/- on this account. The DRP though held that there is no direct evidence on record to show that the transaction was a loan transaction, however the DRP endorsed the view of the TPO that the money expended is not for the purpose of business of the assessee and the R D activities carried out is not established. The DRP therefore opined that the funds that are passed on to the AE is for other than business purposes. Once the funds are paid for non business purposes, interest expenditure is to be disallowed corresponding to the f ..... X X X X Extracts X X X X X X X X Extracts X X X X
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