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TMI Blog2017 (5) TMI 529X X X X Extracts X X X X X X X X Extracts X X X X ..... that benchmarking of ALP should be LIBOR + 200 basis points and TPO should not determine the ALP by taking into consideration the market rate prevailing in the respective countries. Even for A.Y. 2008-2009, the Hyderabad Bench accepted in principle that LIBOR + 200 basis points can be adopted as ALP. Under these circumstances, we set aside the matter to the file of the A.O. who is directed to adopt the LIBOR rate applicable for the years under consideration + 200 basis points to arrive at the ALP. This issue is disposed of accordingly. Allowability of claim of depreciation on goodwill - Held that:- It is not in dispute that this very issue was considered by the ITAT in assessee’s own case for the A.Y. 2007-08 wherein the Bench allowed the plea of the assessee to allow depreciation on goodwill. Allowability of business expenditure - Held that:- We direct the A.O. to verify the nature of the expenditure and disallow only such expenditure which was not incurred for the purpose of business of the assessee. This ground is accordingly treated as allowed for statistical purposes. Allocation of corporate overheads expenses to tax holiday units - Held that:- We direct the A.O. to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rm view that the agreement between DRL, India and DRL SA cannot be doubted. We direct the A.O. accordingly. - ITA.No.294/Hyd/2014, ITA.No.458/Hyd/2015, ITA.No.463/Hyd/2015 - - - Dated:- 28-4-2017 - SHRI D. MANMOHAN, VICE PRESIDENT AND SHRI S. RIFAUR RAHMAN, ACCOUNTANT MEMBER For The Assessee : Shri K.R. Sekhar For The Revenue : Shri P. Chandrasekhar ORDER PER D. MANMOHAN, V.P. These appeals are directed against the orders passed by ACIT, Circle-17(1), Hyderabad under section 143(3) r.w.s.144C(5) of the I.T. Act, 1961. The first two appeals are filed by assessee for the A.Y. 2009-2010 and 2010-2011 whereas ITA.No.463/Hyd/2015 is a crossappeal filed by Revenue for the A.Y. 2010-2011 on the following grounds: 1. The order of DRP is erroneous both in law and facts of the case. 2. Whether on the facts and in the circumstances of the case, the DRP is correct in law in holding that the profit-sharing ratio of 50:50% between the taxpayer and the A.E, DRL Inc USA is reasonable without appreciating the analysis made by the TPO and arriving at the conclusion merely on the assessee s legal and marketing expenses incurred which have no basis and is withou ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... loss on hedging contracts amounting to ₹ 22.7 crores in computation of income whereas in the revised return this claim was withdrawn. Similarly, assessee claimed deduction of ₹ 333.01 crores under section 10B of the Act which is enhanced to ₹ 416.53 crores. The enhanced claim of deduction was on account of the fact that assesseecompany took into account export proceeds received upto 31.03.2010 whereas in the original return the export proceeds received upto 30.09.2009 were considered. 4.1. In the meantime, the case was selected for scrutiny under CASS. During the scrutiny proceedings the A.O. noticed that assesseecompany entered into international transactions with it s A.E. and the amount of transactions were more than ₹ 15 crores as per 3CEB report. Consequently, the case was referred to the Transfer Pricing Officer ( TPO ), with the prior approval of CIT-I, Hyderabad, for determining the Arms Length Price ( ALP ) of the international transactions entered into by assessee-company. While passing the order under section 92CA of the Act, the TPO observed that assessee had a full-fledged in-house research and development division, engaged in research on ne ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ble i.e., at arms length, assessee cannot be relieved of the burden of establishing that it is at arms length, for the purpose of transfer pricing requirements. The TPO, therefore, proceeded to consider each loan independently. It may be noted that out of the loan transactions with 5 A.Es, in the case of three loan transactions, the interest charged was higher. The loan transactions with Falcon Mexico and Lacock Holdings are subject matter of dispute for A.Y. 2009-2010. 5.2. Loan to Lacock Holdings Limited : It is wholly owned subsidiary of the tax payer which was established for the purpose of acquisitions from the funds received by the A.E, - in the form of loan given by the tax payer as well as equity. Lacock Holdings Ltd., Cyprus gave loan to its wholly owned subsidiary i.e., Reddy Holding GmBH, Germany @ 6.5%. Since the loan was given in Euros, TPO sought to compare the transactions with the prevalent Euribor rate which was 4.37% and added suitable risk premium and finally arrived at arms length rate of 6.5% as against 5% charged by assessee and accordingly adjustment was made. 5.3. Similarly, with regard to A.E. Falcon Mexico, the loan was given in Mexican Peso by charg ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Member. In otherwords, it can be termed as Intra Group Services which needs to be properly benchmarked. In order to find the corporate guarantee fee at arms length, the most common method used is Yield Approach or Benefit to the Owner Approach which is popularly used by Canadian Tax Authorities. The other approach is of using interest rates on Credit Defaults Swaps for which it is difficult to obtain reliable data. He therefore, proposed to adopt yield approach for determining the arms length fee for the corporate guarantee given by the tax payer to the lender bank of the A.E. 6.1. It is not in dispute that the A.E. enjoyed lower interest rate to the tune of 1.3 percentage points but the tax payer did not receive any benefit either tangible or intangible. The main contention of the assessee is that there is no expenditure or loss in this year on account of guarantee provided to A.E. and hence it cannot be considered as international transaction. In the alternative, assessee submitted that during the A.Y. 2008-09 DRP has adopted 0.7% of guarantee commission based on risk adjusted internal CUP. Reliance was also placed upon the decision of ITAT, Mumbai Bench in the case ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ic and Industrial Research) to D.G. (Exemptions) assessee was held to be not entitled to weighted deduction. However, assessee was held to be entitled to 100% deduction in respect of both the capital and revenue expenditure under section 35(1) of the Act, as the expenditure was incurred on scientific research relating to the assessee s business. In otherwords, excess claim i.e., 50% of the expenditure representing weighted deduction was disallowed. 11. Assessee claimed certain expenditure which according to the A.O. was capital in nature. It was claimed under the head Repairs and Maintenance of Plant and Machinery and Repairs and Maintenance Others . Out of the total expenditure of ₹ 66,32,629, an amount of ₹ 50,20,503 was disallowed by the A.O. after allowing depreciation at ₹ 16,12,126. 11.1. The A.O. however observed that even in earlier years certain capital expenditure was disallowed and depreciation was only allowed. Therefore, the depreciation claimed on these items also was allowed. EXPENDITURE INCURRED ON DOCTORS MEETINGS ETC., : 12. Assessee debited expenditure in the nature of sponsorships for meetings of Doctors and other guests which w ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... given to MANAVA SEVA DHARMA SAMVARDHINI TRUST AND INDIAN RED CROSS . Therefore, the claim referable to those two donations was not accepted. ALLOCATION OF CORPORATE OVERHEADS : 14. The assessee claimed deductions under section 10B, 80IB and 80IC without apportioning corporate overheads. In this regard, the A.O. observed that the overheads incurred in the corporate office cannot be viewed in isolation of the special units. Proper allocation has to be made for determining the correct income of the eligible units. In otherwords, the A.O. was of the opinion that the allocation of overheads to each unit is mandatory for the purpose of arriving at the profits under those sections. He accordingly determined the eligible deductions under sections 10B, 80IB and 80IC of the Act. TAX CREDIT RELATING TO INTEREST INCOME FROM CYPRUS : 15. During the course of draft assessment proceedings, assessee submitted that it should be allowed tax credit amounting to ₹ 14.88 crores being 10% of the interest income earned by the Company from its subsidiary i.e., M/s. Lacock Holdings Ltd., Cyprus. This credit was not claimed in the return. However, similar claim was accepted by the DRP in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nd therefore, the interest rates prevalent in respective countries would be the correct indicator. In the case of Lacock Holdings it was noticed that funds were received from the assessee-company through equity and loans whereas the A.E. has given the loan to its subsidiary @ 6.5% p.a. as against 5% p.a. charged by the assessee. Similarly, the TPO determined the arms length price of the interest on loans to Mexican A.E. as 12% p.a. This was also based upon the rate applicable in Mexico. Therefore, the DRP observed that the TPO s approach is in line with the principle laid down by the Hyderabad Bench of ITAT in the case of Foursoft Ltd., 142 TTJ 358 (Hyd.). 17.1. With regard to corporate guarantees, the Panel observed that in assessee s own case for the A.Y. 2008-09 A.O. was directed to adopt 0.7% of the loan amount as ALP and therefore, similar direction was given for this year also. 17.2. As regards disallowance on account of ESOPs the Panel followed the decision of ITAT, Special Bench, Bangalore in the case of Biocom Ltd., and directed the A.O. to work-out the deduction accordingly. For A.Y. 2010-2011 assessee-company debited ₹ 19,29,83,505 to the P L A/c as expendi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Dr. Reddy Laboratories, along with it s A.Es (DRL, USA) developed a generic drug for the patented drug (Sumatripton) of Glaxo Smithkline USA (hereinafter referred to as GSK ). A suit was filed by the GSK against DRL disputing the rights of DRL to sell the generic drug in the USA territory. Through an out of Court settlement in 2006, before the US District Court, DRL and GSK agreed that Sumatripton will be manufactured by GSK but marketed by DRL USA with all the support from DRL (India). In lieu of its contribution, it was agreed that the profit shall be shared between the DRL USA and DRL India equally. Another A.E. i.e., DRL, Switzerland agreed to bear certain risks like post-sales liabilities of DRL USA, as per MOU with DRL India, in May, 2008 and in consideration thereon, the assessee agreed to part 50% of its share of profit to DRL, Switzerland. According to the assessee, the payment represents profit share with Swiss A.E. Hence, DRL USA passed-on 50% of share of DRL India to DRL Switzerland. Under these circumstances, assessee had offered only net profit in marketing and distribution, received from DRL USA. The TPO as well as the A.O. observed that business arrangement betwee ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sions of Section 37 are not applicable because profit share is not an expenditure as per Section 37, the amount received from DRL USA is paid to DRL Switzerland towards their share of profit based on the functions and risks undertaken. In short, Dr. Reddy s India has not incurred any expenditure under the ambit of Section 37 of the Act. 18.5. The Panel considered the issue in great detail. With regard to the preliminary objection concerning the power of DRP, it referred to the provisions of section 144C of the Act to point out that the DRP is empowered to confirm, reduce or enhance the variation in the draft order and the variation shall include any matter arising out of the assessment proceedings relating to the draft order notwithstanding that such matter was raised or not by the eligible assessee . Thereupon, the Panel observed that the issue which is the subject matter of the show cause notice has arisen out of the assessment proceedings of the assessee and therefore, it has power to consider the issue which had come to their notice. Thus the objection of the assessee, challenging the jurisdiction of the DRP, was rejected. 18.6. With regard to the sharing of profit betwe ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d as NIL and the amount already paid by the assessee was treated as excess payment to the A.E. Adjustment was accordingly made. According to the A.O/TPO the share of the tax-payer company should be 60% of the gross profit earned from the marketing and distribution of Sumatripton generic drug. 20.1. The same was objected before the DRP. Since identical issue was considered by the TPO/A.O. in the immediately preceding assessment years, the Panel directed the A.O. to treat only 50% of the share as profit of the assessee-company instead of 60% sought to be adopted by the A.O. 20.2. Further, the claim of the assessee that the payment made to Swiss AE was on account of commercial expediency, was rejected by the Panel. 21. With regard to other issues also DRP adopted the same approach for the A.Y. 2010-2011. Accordingly assessment was completed for the A.Y. 2010-2011 by determining total income at ₹ 779.33 crores after T.P. adjustments. 22. Aggrieved by the order of the DRP, Revenue preferred an appeal contending that the DRP erred in law in holding that the profit sharing ratio between DRL India, DRL USA is 50% 50% overlooking the fact that TPO has made detailed analy ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... . At any rate, it is not correct on the part of the assessee to raise an additional ground by stating that corporate guarantee is not covered under the definition of International Transaction , under section 92B of the Act. It was also submitted that it is an international transaction within the meaning of Explanation (c) to Section 92B, introduced by the Finance Act, 2012 with retrospective effect from 01.04.2002. The Explanation merely elaborates the legislative intent to bring into fold the Corporate Guarantee as international transaction it is not necessary to incur any expenditure in the year under consideration to treat it as an international transaction. Detailed submissions were made by the D.R. by referring to various case law on this aspect. 27. On the other hand, the Learned Counsel, appearing on behalf of the assessee, submitted that principles of resjudicata are not applicable to income tax proceedings and each year being a separate unit, what is decided in one year need not be applied in the following year. He submits that it is a pure legal issue, on a proper analysis of all the provisions of the Act, which can be raised at any point of time to highlight that ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 016). The Bench observed that transfer pricing is a legislation seeking the tax-payers to organise their affairs in a manner compliant with the norms set-out. In short, it is an anti abuse legislation which tells you as to what is the acceptable behaviour but it does not trigger levy of tax in a retrospective manner because no party can be asked to do an impossibility. Analysing further the Bench observed that though Explanation to Section 92B is stated to be clarificatory, it has to be necessarily treated as effective from the A.Y. 2013-2014 and in this regard, relied upon the observations of the Hon ble Delhi High Court in the case of Skies Satellite. We have also analysed the case law relied upon by the Ld. D.R. and also the provisions of the Act. In our considered opinion, the view taken by the Delhi Bench of ITAT in the case of Bharati Airtel Ltd., (supra) is one of the possible views on the matter and so long as there is no binding decision of any other Higher Forum taking a contrary view, the one which is favourable to the assessee has to be adopted even though other Benches have taken a different view. We, therefore, hold that the Explanation to Section 92B cannot be applie ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 6,24,373 Confirmed TPO s ALP DRL Swiss 1.3% 7% LIBOR + 200 BPS 9,45,98,323 Confirmed TPO s ALP DRL Brazil 1.64% 7% LIBOR + 200 BPS 3,61,20,148 Confirmed TPO s ALP Total 21,33,42,845 31.1. Before us, the Learned Counsel for the Assessee contends that as per the decision of the ITAT, Hyderabad Bench in the case of Four Soft Limited 164 TTJ 561 whenever a loan was given in foreign currency LIBOR interest rate should be considered for benchmarking the interest and not local interest rates of the respective countries. Reliance was placed upon the decision of the Coordinate Bench in assessee s own case for the A.Y. 2006-07 (ITA.No.1605/Hyd/2010 read with M.A.No.217/H/13) wherein the Tribunal accepted LIBOR+ 2% as the comparable rate for benchmarking the interest. The DRP for the A.Y. 2008-2009 has accepted LIBOR+ 2% as ALP. 32. On the other hand, the Ld. D.R. submitted that in assessee s own case f ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 14) 148 ITD 433 Hyd); in both the cases the matter was remitted to the file of the A.O. to verify the actual average LIBOR prevailing in the financial year relevant to the assessment year under consideration. 34. The case of the Revenue on the other hand was that the assessee having accepted 7% in the earlier years, it cannot now claim that the rate of interest charged by the assessee, which is below 7% is appropriate. It was further submitted that the assessee has charged higher rate in the case of Falcon Mexico which shows that the LIBOR + 2% rate is not an appropriate method for benchmarking. Further, the TPO/A.O. was justified in taking into consideration prime lending rate prevalent in the respective countries. Reliance was placed upon the following decisions : 1. Cheil India (P) Ltd., vs. DCIT (2014) 46 Taxmann.com 90 (Del.) (Tribu.) 2. Mylan Laboratories Ltd., vs. ACIT (2015) 63 Taxmann.com 179 (Hyd.) (Tribu.) 3. Tricom India Ltd., vs. ITO (2014) 51 Taxmann.com 405 (Mum.) (Tribu.) 35. The case of the assessee on the other hand was that the decision in the case of Cheil India (P) Ltd., (supra) is with regard to levy of interest where there is delay in receiving ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... preciation on goodwill. 39. Vide ground Nos. 22 for the A.Y. 2009-2010 and ground No.16 for the A.Y. 2010-2011, the assessee contends that the treatment of repairs and maintenance expenditure as capital expenditure is not in accordance with law. During the course of hearing, Learned Counsel for the Assessee submitted that assessee-company is not interested in pressing this ground as the A.O. has allowed depreciation apart from the fact that in assessee s own case for the A.Y. 2007-08 this issue was decided and it was treated as capital expenditure. Under the circumstances, grounds urged by the assessee for both the years are dismissed. 40. Vide ground No.23 for the A.Y. 2009-2010 and ground No.17 for the A.Y. 2010-2011 the assessee challenges the order of the A.O. with regard to disallowance of expenditure incurred towards travel, stay, participation fee in the pharmaceutical conferences etc., The case of the assessee was that the expenditure was incurred during the conference of the Doctors which is necessary to improve the knowledge of the Doctors on the latest development in medicine field, therapeutics areas etc., which benefits the business of the assessee company. The s ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nostic Centre Pvt. Ltd., 25 taxmann.com 92 (P H) (HC) (2) CIT vs. Pt. Viswanath Sharma 182 taxman 63 (All.) (HC). 42.1. The case of the Learned Counsel for the Assessee, on the other hand, is that the issue is squarely covered in favour of the assessee in assessee s own case for the A.Ys. 2007-08 and 2008-09 wherein the Tribunal remitted the issue to the file of the A.O. with a direction to verify the nature of expenditure and disallow only such expenditure which is not incurred for the purpose of business. Learned Counsel for the Assessee relied upon the decision of the ITAT, Mumbai Bench in the case of DCIT vs. PHL Pharma P. Ltd., (ITA.No.4605/Mum/2014 dated 12.01.,2017) wherein reference was made to the decisions of Liva Health Care as well as the decision rendered by Hon ble Himachal Pradesh High Court (supra) and distinguished those case law on the ground that the payments therein are genuinely opposed to public policy and such payments should be discouraged as it is not a fair practice. Elaborating further the Bench observed that physicians samples are necessary to ascertain the efficacy of the medicine and introducing it in the market for circulation and for such pur ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e which is not directly related to the undertaking should not be allocated to such undertaking on adhoc basis. The A.O. observed that for the A.Y. 2003-04 the ITAT upheld the apportionment of corporate overheads since the overhead expenditure incurred in corporate office cannot be viewed in isolation of the special units. Instead of incurring such overheads in each of the special units, the assessee, through the establishment of corporate office, incurred the expenditure centrally. Therefore, the allocation of corporate overheads has to be made for determining the correct income of the eligible units. Accordingly, eligible deduction was re-worked out. 46. Ld. D.R. on the other hand submits that this issue was considered in assessee s own case for the A.Y. 2007-08 and the Tribunal held that in the absence of identifying expenditure of export division, there is no basis other than allocating the total indirect cost on the basis of the turnover and accordingly directed the A.O. to apportion the expenditure on the basis of turnover of various units. The ITAT has considered the matter again for the A.Y. 2006-07 wherein the A.O. was directed to apportion the expenditure on the basis o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... set aside to A.O. for allocation of corporate overheads on the basis of turnover of eligible units and requested for similar direction even in this year. Without prejudice, it was also contended that only the net expenditure of corporate entity (i.e., corporate overhead (-) income) should only be allocated amongst all the units based on the turnover. 49. We have considered the rival contentions and perused the record. In assessee s own case for the A.Ys. 2007-08 and 2008-09 (supra), the Tribunal vide para 64 set aside the matter with the following observations : 64. The Learned Counsel for the Assessee submitted that it is only the net expenditure and not the gross expenditure which should be allocated amongst all the Units. We agree with the contention of the assessee and direct the A.O. to allocate the only net expenditure of the corporate entity amongst all the units on the basis of the turnover. Thus, the alternate contention of the assessee is allowed. 50. Facts being identical in this year also, we direct the A.O. to allocate net expenditure of the corporate entity amongst all the units on the basis of turnover. This ground is disposed of accordingly. ISSUE ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d DRL US to launch the product as an authorized generic agent during the unexpired patent period. 6. Pursuant to the court settlement GSK will exclusively manufacture the drug for DRL India. Further, DRL India is required to undertake the product liability insurance for not less than USD 25 million and price fall risk as per the settlement agreement. 7. As DRL India does not have marketing network in USA, DRL India entered into agreement with DRL US which is having a strong distribution network in United States as Distributor, which in turn markets the product manufactured by GSK in United States (Please refer Page NO.724 to 727 of Paper Book Volume II). As per the said agreement, DRL US retain 50% of the profits earned on marking the product in USA and the balance 50% profit would be transferred to DRL India as a compensation for losing the manufacturing facility of the drug developed by DRL India, which would have been otherwise manufactured by DRL India. 8. Further DRL India has approached DRL Swiss to take product liability insurance and shelf-stock adjustment risk (i.e. risk of price fall after completion of exclusive period) because of its inability to t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nd made an addition of ₹ 159 crores towards disallowance u/s 92CA and u/s 37(1) of the Act on the amounts transferred to DRL Swiss. Our Submissions 10. The Appellant submits that as per the agreement between DRL India, DRL US and GSK provides for product liability insurance (means an insurance that indemnifies the Manufacturer, Distributors against third party liability arising out of the sale of products) for a minimum sum assured of USD 25 million is undertaken by DRL Group and GSK will not be responsible for any product liability claims except for manufacturing defects. 11. The Appellant submits that the risk of SSA (means the price fall risk after the exclusive period) will be equally undertaken by DRL US and DRL Swiss. 12. The Appellant submits that as per para 1, 2 of agreement between the DRL India and DRL Swiss, the product liability claim is to be undertaken by DRL Swiss (refer page 728 of Paper book Volume -II). Product liability claim is the claim arising from a third party on manufactures or distributors on selling of products by which any loss is incurred to the consumer. To mitigate the risk the companies will take product liability ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f the Assessing Officer to enable him to complete the assessment. (6) The Dispute Resolution Panel shall issue the directions referred to in sub-section (5) after considering the following, namely:- (a) draft order; (b) objections filed by the assessee; (c) evidence furnished by the assessee; (d) report, if any, of the Assessing Officer, Valuation Officer or Transfer Pricing Officer or any other authority; (e) records relating to the draft order; (f) evidence collected by, or caused to be collected by, it; and (g) result of any enquiry made by, or caused to be made by, it. (7) The Dispute Resolution Panel may, before issuing any directions referred to in sub-section (5),- (a) make such further enquiry, as it thinks fit; or (b) cause any further enquiry to be made by any income-tax authority and report the result of the same to it. (8) The Dispute Resolution Panel may confirm, reduce or enhance the variations proposed in the draft order so, however, that it shall not set aside any proposed variation or issue any direction under sub-section (5) for further enquiry and passing of the assessment order. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... P has no jurisdiction to consider the new issue. Further, we submit that if the DRP allows AO, then there would be no end to the assessment proceedings which was not the intention of the DRP. 22. The Appellant submits before your Honour that in the present case the DRP has issued notice under section 37(1) of the Act for disallowing profit share to DRL Swiss, but they have disallowed under section 92CA of the Act. 23. Section 92CA(1) of the Act provides as under:- Where any person, being the assessee, has entered into an international transaction or specified domestic transaction in any previous year, and the Assessing Officer considers it necessary or expedient so to do, he may, with the previous approval of the [Principal Commissioner or] Commissioner, refer the computation of the arm's length price in relation to the said international transaction or specified domestic transaction under section 92C to the Transfer Pricing Officer. 24. The Appellant submits that on a perusal of section 92CA(1) of the Act it is clear that the power to determine Arm s Length Price ( ALP ) in an international transactions is vested with Transfer Pricing Officer ( TPO ) ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... gh Court in CIT v. Dalmia Cement (Bharat) Ltd. [2002] 254 ITR 377 that once it is established that there was nexus between the expenditure and the purpose of the business (which need not necessarily be the business of the assessee itself), the Revenue cannot justifiably claim to put itself in the arm-chair of the businessman or in the position of the board of directors and assume the role to decide how much is reasonable expenditure having regard to the circumstances of the case. No businessman can be compelled to maximize its profit. The income tax authorities must put themselves in the shoes of the assessee and see how a prudent businessman would act. The authorities must not look at the matter from their own view point but that of a prudent businessman. As already stated above, we have to see the transfer of the borrowed funds to a sister concern from the point of view of commercial expediency and not from the point of view whether the amount was advanced for earning profits. In the case of CIT Vs. Dalmia Cement (P.) Ltd [2002] 254 ITR 377 (Delhi) , the Hon ble High Court of Delhi held that at para no. 7 as under: It is to be noted that, in the present case, the qu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... how much is reasonable expenditure having regard to the circumstances of the case. It further held that no businessman can be compelled to maximize his profit and that the income tax authorities must put themselves in the shoes of the assessee and see how a prudent businessman would act. The authorities must not look at the matter from their own view point but that of a prudent businessman. 14. Applying the aforesaid ratio to the facts of this case as already noted above, it is manifest that the advance to M/s. Hero Fibres Limited became imperative as a business expediency in view of the undertaking given to the financial institutions by the assessee to the effect that it would provide additional margin to M/s. Hero Fibres Limited to meet the working capital for meeting any cash loses. 30. In the present case the DRP has disallowed profit share to DRL Swiss on the ground disqualification as an expenditure u/s 37(1) of the Act is not sustainable. 31. We also submit that DRL India does not have marketing network in USA, DRL India entered into agreement with DRL US which is having a strong distribution network in United States as Distributor, which in turn marke ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ested with the powers of enhancement of variations proposed in the draft assessment order, apart from others. Further, the power of DRP with regard to enhancement of income has been further widened by virtue of Explanation to Sec. 144C(8), to all the matters arising out of assessment proceedings relating to draft order passed irrespective of the fact whether such issues raised or not by the assessee. This explanation has been inserted by Finance Act, 2012 with retrospective effect from 01.04.2009. The relevant portion of the Statute is reproduced for ready reference: Explanation.- For the removal of doubts, it is hereby declared that the power of the Dispute Resolution Panel to enhance the variation shall include and shall be deemed always to have included the power to consider any matter arising out of the assessment proceedings relating to the draft order, notwithstanding that such matter was raised or not by the eligible assessee. (Emphasis supplied) As seen from the above, the hitherto limited scope of enhancing the variations proposed in the draft order has been expanded to encompass any matter arising out of the assessment proceedings relating to the draft order. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... oreover, it was the contention of the assessee that the DRP has power only to enhance or reduce the adjustment that has already been carried out u/s 92CA. In other words, it was the learned AR's submission that the DRP has no power to treat transactions in respect of which either no adjustment was proposed by the learned TPO or such transaction does not form part of the report u/s 92E. This submission of the learned AR is devoid any merits, in view of the Memorandum explaining the intention behind introduction of explanation below s. 144C (8) which read as under: Power of the DRP to enhance variations Dispute Resolution Panel (DRP) had been constituted with a view to expeditiously resolve the cases involving transfer pricing issues in the case of any person having international transactions or in case of a foreign company. It has been provided under sub-section (8) of section 144C that DRP may confirm, reduce or enhance the variations proposed in the draft order of the assessing officer. In a recent judgment, it was held that the power of DRP is restricted only to the issues raised in the draft assessment order and therefore it cannot enhance the variation proposed in th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... present case continues to remain the same, being the adjustment flowing from the TPO's order, we find no force in the contention that the DRP ought not to have ventured to increase the variation to the prejudice of the assessee in a reference made by the assessee for reduction of the amount of adjustment made in the draft assessment order. 7. The Id. DR pressed into service Explanation ta sub-section (8) of section 144C for bolstering his submission in support of the enhancement. At this juncture, it would be prudent to note the Finance Act, 2012 has inserted this Explanation with retrospective effect from 01.04.2009 which provides as under.- For the removal of doubts, it is hereby declared that the power of the Dispute Resolution Panel to enhance the variation shall include and shall be deemed always to have included the power to consider any matter arising out of the assessment proceedings relating to the draft order, notwithstanding that such matter was raised or not by the eligible assessee. 8. A cursory look at the language of the Explanation divulges that the power of enhancement of the DRP has been further widened to all the matters arising out of the asses ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of Dredging International NV Vs. ACIT (supra) which in turn relied upon the decision of Hon'ble Karnataka High Court in the case of GE India Technology Centre Pvt. Ltd. Vs. DRP (supra) was rendered prior to insertion of Explanation to sub-section (8) of Sec. 144C. Accordingly, those decisions have no relevance to the facts of the case on hand and law applicable thereof. Further, the Hon'ble ITAT in the case of Himalaya Drug Company (supra) has considered the decision of GE India Technology Centre (supra) and differentiated the same on account of facts as well as amended provisions of Sec. 144C(8). 5. Accordingly, it is humbly submitted that in view of newly inserted Explanation to sub-section 144C(8), the DRP is empowered to take cognizance of any new issue, which comes to the notice of the DRP during the course of the proceedings either suo-moto or on account of reference made by the Assessing officer/TPO. Accordingly, on the basis of such new issue, the DRP is empowered to enhance the variations arising from the income of the assessee. Further, such new issues cannot be confined to TP issues alone, but all the issues including regular additions and disallowances un ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d such information and made available of the same to the assessee for its comments. After having afforded adequate number of opportunities of hearing to the assessee and admitting the arguments and evidences furnished by the assessee, the DRP enhanced the variation proposed in the draft assessment order. 8. The argument of the assessee's counsel that the AO has no power to furnish information to DRP is not tenable inasmuch as there is no provision in Income Tax Act preventing the Assessing Officer from sharing the information with the DRP in connection with draft assessment order pending for adjudication on the basis of objections raised by the assessee. For this purpose, the demand for legislative sanction is overstretching the argument beyond limitation. As explained above, it is the prerogative of the DRP either to consider such information or reject the same. But, at the same time, there is no prohibition as far as AO sharing the information with DRP. 9. In continuation of Ground No.19 i.e. Not undertaking any economic analysis and determining the price of the transaction at Rs. Nil , during the course of arguments, the AR of the assessee has raised an issue th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... % on net sales was not at ALP. While doing so, the ITAT observed that royalty agreements were periodically approved by RBI and Ministry of Industry and the assessee was paying the amounts as per the agreements. 11. On the other hand, in the instant case, a clear cut finding has been recorded by the DRP that no services had been rendered by the AE warranting payment of 50% of profit share to DRL SA due to peculiar set of facts and circumstances of the case. Similarly, the agreement entered into by the assessee with DRL SA was not approved either by the RBI/ Ministry of Industry or any other Government Authority / Agency to vouch the genuineness and legitimate requirement of the transaction with the AE - DRL SA. Accordingly, the reliance placed by the appellant is not applicable to the case on hand. 12. In continuation to Ground No. 26 i.e. The AO erred in disallowing the amount of profit share to DRL SA under section 37 of the Act , during the course of argument, the AR of the assessee has contended that the AO cannot decide that how much is the reasonable expenditure u/s. 37 of the I.T. Act . Regarding this ground, it is submitted that the issue was discussed ela ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... no debit to the P L account of ₹ 159,48,72,040/-. Only the net amount of ₹ 159,48,72,040 is disclosed in the P L account under the head License fees, net''(please refer to page Nos. 103 127 of assessee's paper book Vol. I). vii. As per statutory Audit report u/s 44AB of IT Act., in Form No. 3CD, it is mandatory to report the details of related party transactions i.e., particulars of payments made to persons specified u/s 40A(2)(b). In the instant case, the auditor/assessee ought to have reported the transactions the assessee had with both the AEs i.e DRLI USA and DRI SA. However, the said transactions have not been reported in Annexure 6 of the report (please refer to page Nos. 217 234 of assessee's paper-book Vol. I). viii. As per statutory Audit report u/s 92E of IT Act, in Form No 3CEB, it is mandatory to report particulars relating to all international transactions. In the instant case, the auditor/assessee have failed to report the transaction with DRLI USA DRI SA in annexure 4A of the report( please refer to page no 252 264 of assesse's paper-book).Only the net amount received from DRLI USA is reported in auditors TP M ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... there is no scope of any risk relating to the litigation pending in the Civil Case. However, in the said MoU, it is stated that DRL SA has undertaken to take risk on account of legal issue pending in the case. Under the circumstances, it is submitted that DRL SA has no role to play in the litigation with GSK as it came into existence only in the FY 2007-08 and the settlement with GSK was completed in the month of May, 2006. xiii. Further, in the written submissions filed by the appellant before the Hon'ble ITAT, it is stated that DRL SA has undertaken product reliability risk, fall in price risk and also share of cost of development of the product and legal cost. As such, there is a difference between what is mentioned in the MoU and what is stated by the appellant in the written submissions with regard to scope of the agreement between the assessee and DRL SA. In this regard, it is submitted that at the time of development of the product by the assessee group Le. prior to FY 2006-07, DRL SA was not in existence. Accordingly, there is no truth in the assessee's submission that DRL SA has shared development cost of the product. Similarly, there is no scope on the part ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ent, representation or warranty of GSK or a GSK Party contained in this Agreement; (ii) Any violation of applicable Law by GSK, or a GSK Party, in connection with the performance of GSK's or its Affiliates; obligations under this Agreement; or (iii) Product Claims only to the extent arising out of a manufacturing defect of GSK Supplied Product . (emphasis supplied) Further, in the same agreement under Section 8.4 : Insurance, at c1ause(b), it is once again stated that GSK shall take full responsibility with regard to insurance for product liability and general liability. The relevant portion of the same is reproduced below: Section 8.4 Insurance. (a) For the Term, and for a period of five (5) years after the expiration of this Agreement or the earlier termination thereof, Dr. Reddy's shall maintain at its sale cost and expense, product liability and other insurance for itself in amounts, respectively, which are reasonable and customary in the United States Pharmaceutical industry for companies of comparable size and activities at the respective place of business of Dr. Reddy's, provided in no event shall the product liability ins ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n compensated by the assessee directly to the distributors / consumers rather than assigning the same to a fledgling such as DRL SA which has no exposure to this kind of activities. Further, it is very important to note that, there was no impact on price during the FY 2008-09 under reference inasmuch as the end of the exclusivity period of 180 days happened in subsequent FY 2009-10 relevant to AY 2010-11. Accordingly, there is no cost attributable to price risk born by the assessee in the AY 2009-10 in order to assign the same to DRL SA. xviii. Further there is a violation of the terms and conditions mentioned in the Settlement agreement between GSK and the assessee dated 06/10/2006 wherein at page 6, para 11 at of agreement, it is stated that This Agreement and the rights herein shall not be assigned or otherwise transferred without the written consent of all Parties Each of the Parties represents and warrants that it has not sold or conveyed or otherwise transferred any claim, demand or cause of action related to the District Court Case that it has or had against any Party. As such, the assessee has assigned certain rights emanating from the agreement to DRL SA with ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... . However, it has created a legal framework by way of entering into an agreement in writing and thereafter transfer of money to DRL SA. Also, the assessee has failed to produce any evidence in regard to actual expenditure incurred during the financial year relevant to assessment year under reference in connection with risks assigned to the DRL SA i.e.- 1) what is the amount of post sale liability attributable to marketing, distribution and selling functions of the assessee group; 2) What is the amount of legal expenses incurred in connection with Civil Case pending, if any, subsequent to entering into agreement during the financial year under reference; and 3) What is the amount of expenditure incurred in connection with fall in price after the termination of exclusivity period. In this regard, it is pertinent to note that as the exclusivity period is falling during the financial year 2009-10 relevant to subsequent assessment year, neither assessee nor its AE should have incurred any expenditure. 4) Any other expenditure incurred in connection with the transactions referred to above. Further, it is clearly brought out that DRL SA is not capable of performing ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ctions assigned to it is furnished, but simply 50% of their income share from DRL USA has been earmarked towards such services payable to DRL Switzerland. 16. On the other hand, it is submitted that in the case of Dalmia Cements (supra) itself, it is held by Hon'ble High Court of Delhi that contractual payment relating to business need not be disallowed unless it suffers from the vice of collusiveness or colourable device . The relevant portion of the same is reproduced below: For the allowance under section 37(1), the following conditions are to be satisfied, i.e. : (a) there must be expenditure, (b) such expenditure must not be of the nature described in sections 30 to 36, (c) the expenditure must not be in the nature of capital expenditure or personal expenses of ,the assessee, (d) the expenditure must have been laid out or expended wholly and exclusively for the purposes of the business or profession. The word wholly refers to the quantum of expenditure, while the word exclusively refers to the motive, objective and purpose of the expenditure. An expenditure to which one cannot apply an empirical or subjective standard is to be judged from the point of vie ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... existence and the payments might have been mode, it was still open to the Incometax Officer to consider the relevant factors and determine for himself whether the commission said to have been paid to the selling agents or any part thereof was properly deductible under section 37. Prima facie, all the findings of the Tribunal were findings of fact and, therefore, the Tribunal was justified in not stating a case for opinion of High Court under section 256(1) and High Court was justified in not calling for a statement of case under section 256(2). 19. Further, the Hon'ble Supreme Court in a recent decision in the case of Ganapati Co Vs. CIT (2016) 381 ITR 363 (copy enclosed) has held that failure on the part of the assessee to produce proof of service rendered during the assessment year in question with regard to service charges paid to firm having common partners would attract disallowance of such service charges u/s. 40A(2) rws 37(1). Further, the Hon'ble Gujarat High Court in the case of Jayesh Roychand Shaw Vs. ACIT (2014) 360 ITR 387 (copy enclosed) has held that in view of finding recorded that payments were not made exclusively for the purpose of business, the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d Party Disclosures(Continued) iii. Due to related parties ( included in current liabilities) Dr. Reddy s Laboratories SA, Switzerland 1,464 Page no. 272 of Paper Book Volume-I to for the AY 2009-10 wherein the transaction with DRL Swiss is made available in the Transfer Pricing report of the Appellant. c. We submit that the transaction has been disclosed in the financials as well as Transfer Pricing report filed before the AO. Hence, we submit that there is no failure on the part of the Appellant in disclosing the transaction. The reason for disclosing the transaction on net basis is the share of profit to DRL Swiss is connected with the share of profit received from DRL USA as these are originating from the marketing and sale of product Sumatriptan in USA. From the above, it may be observed that there is no intention on the part of Appellant not to disclose the said transaction with DRL Swiss. d. Further, with respect to the contention of the Ld. DR on nondisclosure of the transaction in report u/s 44AB of the Act, we submit that clause 18 of tax audit report (Form 3CD) requir ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nours attention to para 8.4 of Pg. 701 of volume-II of paper book, where in it is mentioned that DRL is sole responsible to undertake Insurance. The relevant paragraph from the supply and distribution agreement between DRL India, DRL USA and GSK is reproduced below for your ease reference:- Insurance . For the Term and for a period of five (5) years after the expiration of this Agreement or the earlier termination thereof, Dr. Reddy s shall maintain at its cost and expense, product liability and other insurance for itself in amounts, respectively, which are reasonable and customary in the United States pharmaceutical industry for companies of comparable size and activities at the respective place of business of Dr. Reddy s, provided in no event shall the product liability insurance amounts be less than Twenty- Five Million U.S. Dollars (U.S. $ 25,000,000) per occurrence (or claim) and Twenty-Five Million U.S. Dollars ( U.S. $ 25,000,000) in the aggregate limit of liability per year, with a self-insured retention of Five Million U.S. Dollars (U.S. $5,000,000). Such insurance shall insure against all liability, including personal injury, product liability, physical inj ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ard, we request your honours attention to page no. 3 of our written submission made on profit share on 24 January 2017, wherein the 50% price fall adjustment was borne by DRL Swiss and not by DRL India. n. Further, the Ld DR argued that the Appellant has not submitted any evidence towards post sales liability, development of product, legal cost, fall in price in connection with marketing, distribution, and sale of the product. o. In this connection, we submit that the post sales liability towards price fall occurred in AY 2010-11 and DRL Swiss has already undertaken the liability amounting to ₹ 57 Crs. This matter was duly examined by the AO and necessary effect was duly given in the assessment order of AY 2010-11. Similarly, legal and development cost details are duly furnished and recorded in the T.P. order for A.Y. 2009-10. (Please refer para 8 at page 23 above). As per the assessment order passed by the AO for Ay 2010-11, The assesses also submitted that as per clause 1.3 of the agreement with Dr.Reddy s USA and DRL India, the gross profit means Net sales reduced the price fall adjustment etc., and as per clause 2 of the agreement, 50% of the p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nuary 2017, which is enclosed herewith for ready reference Annexure -2 s. In the written submissions filed by the DR before the ITAT, it is stated that the Appellant should have entered into an agreement with renowned insurance companies or any companies located in USA rather than assigning the insurance functions to its AE. t. In this regard, we submit that the decision of the Appellant should be viewed in the contest of business expediency and the AO cannot step into the shoes of the Appellant. It may be noted that the DRL Swiss has not only undertaken the insurance liability but also has undertaken the 50% of Shelf-stock adjustment risk. If there was no such arrangement, DRL India would have borne the entire costs towards shelf-stock adjustment, which was borne by DRL Swiss in the AY 2010-11. We reiterate that in addition to business reason that the undertaking of product liability insurance with an Indian Insurance Company for a product to be sold in USA is not possible as the insurance amount is USD 25 million, as per the FEMA Regulations no person resident in India shall take any general policy issued by an Insurer outside India without specific approval f ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d we rely on the judgement of Jauamal Jayantilal Thakore Vs Chief Commissioner of Income- tax [230 ITR 142] , where in the Hon ble High Court of Gujarat held that It will, thus, be seen that the Assessing Officers have important statutory functions to discharge. It can never be said that their powers to make assessment or to ascertain whether there has been full and true disclosure are powers which are not coupled with duty, to discharge those functions. The Assessing Officers must in accordance with the statutory provisions discharge their functions and it cannot be said that an Assessing Officer can refuse to discharge his function even when the statutory provisions require him to act in a particular way. In the very nature of the things empowered to be done and in the very nature of the object for which the provisions of the Act are enacted as also the conditions in which the powers are to be exercised by the Assessing Officers under the Act, it is clear that these powers are coupled with a duty to exercise them when the statutory provisions warrant their exercise. If a statute invests a public officer with an authority to do an act in a specified set of circumstances, it is ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ctioned any provisions of Income-tax Act and hence the appellant submits that adjustment made by DRP should be considered as null and void. 53. We have carefully perused the rival contentions and perused the record. In respect of A.Y. 2009-2010 assessee raised a preliminary objection with regard to the jurisdiction of the DRP in considering the matter of allowability of deduction referrable to profit share with DRL Swiss. The case of the assessee is that the DRP can only consider the matters which emanate from the orders passed by A.O./TPO. 54. The Ld. D.R. on the other hand pointed out that the provisions of section 144C were amended w.e.f. 01.04.2009, by inserting Explanation to Section 144C(8) by Finance Act, 2012, whereby the DRP was given wider powers i.e., to consider Any matter arising out of the assessment proceedings relating to the draft order notwithstanding that such matter was raised or not by the eligible assessee. In otherwords, even the matters not agitated by the assessee before the DRP can be considered for the purpose of enhancement. In fact, the DRP had issued a notice to assessee in 2013 by which time the Explanation to section 144C(8) was already in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... and Shelf Stock Adjustment (in short SSA ) risk. It is not in dispute that assessee entered into an agreement with DRL Swiss whereby DRL Swiss had undertaken the insurance for product liability and SSA risks. It is also not in dispute that DRL Swiss paid an amount of 22 Million Dollars towards 50% of legal and development cost incurred by DRL, India. DRL, SA had also incurred expenditure to the extent of 13 Million dollars towards SSA. As rightly pointed out by the Learned Counsel for the Assessee there are restrictions for an Indian Company to take any General Insurance Policy outside India unless there is specific approval from Central Government. Since DRL, SA had undertaking the product liability insurance as well as SSA risk of 50% it cannot be said that DRL SA had not rendered any service to earn 25% share out of profits. 58. The contention of the Revenue is that DRL, SA has come into existence in 2007 and there is no reason as to why it should reimburse 50% costs of R D expenditure to DRL, India. It is also the case of the Revenue that the litigation with regard to who should manufacture the product and market in USA ended in a settlement in 2006 by which time DRL, USA ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... has to be considered by taking into consideration the facts in its entirety. In the instant case, in the later part of the exclusivity period there was price fall which resulted in sharing of loss between DRL, US and DRL, India and because of the understanding between DRL, India and DRL, SA, the liability amounting to ₹ 57 crores was adjusted by DRL, SA which could be noticed from the following observations of the A.O. in the assessment order for the A.Y. 2010-2011. 1.1. The assessee vide letter dated 14.03.2014 submitted that the TPO while determining the ALP in respect of the profit share on marketing and distribution of Sumatriptan - Switzerland made an adjustment ₹ 64,92,01,592 which is the Gross Profit share of the marketing distribution of the above product and ignored the price fall adjustment amounting to ₹ 56,90,93,756/-. However, as per the agreement of M/s. DRL India with M/s. DRL Switzerland, M/s. DRL Switzerland has undertaken to bear the risk of price fall adjustment as a result of which only an amount of ₹ 8,01,07,837 was transferred as profit share to M/s. DRL Switzerland. The assessee also produced copies of the Debit Notes Credi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ent with DRL, SA. It is thus seen that there is sufficient evidence to show that the assessee entered into an agreement with DRL, SA in the interests of business and once it is established that an expenditure is incurred for the purpose of business it is not always necessary to prove that assessee is assured of getting more profit than what is expended. In the instant case, assessee had not actually incurred any expenditure. On the contrary, DRL, SA come forward to share R D expenditure and legal costs and also agreed to undertake the insurance liability and SSA risk. If there is no such arrangement, DRL, India would have borne the entire costs towards SSA which, in the instant case, was borne by DRL, SA in the A.Y. 2010-2011. 62. Having regard to the overall circumstances of the case, we are of the firm view that the sharing of profits between DRL, India and DRL SA is for bonafide business purposes and therefore, assessee is entitled to claim deduction on this count. It may not be out of place to mention that the A.O. was of the view that the assessee has a major role in product development and therefore, in the process of sharing profits between DRL US and DRL, India, assess ..... X X X X Extracts X X X X X X X X Extracts X X X X
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