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TMI Blog2018 (4) TMI 688X X X X Extracts X X X X X X X X Extracts X X X X ..... ropriate method by aggregating the transactions. The CIT (A) is directed to take the remand report from the TPO in this regard and afford the assessee adequate opportunity of being heard in the matter. Management fees addition - comparability analysis in the TP study carried out by the assessee by aggregation of transactions adopting TNMM as the most appropriate method has not been examined by either of the authorities below who have merely concentrated merely on the issue of aggregation / segregation of transactions. The CIT (A) has mechanically accepted the results of the assessee to be at arm’s length by accepting the operating profit / operating cost of the assessee as 25.49% as against non-AE at 5.26%. In that view of the matter, we deem it appropriate to remand the issue to the file of the CIT (A) for examining the correctness of the ALP at the entity level by applying the TNMM as the most appropriate method by aggregating the transactions. The CIT (A) is directed to take the remand report from the TPO in this regard and afford the assessee adequate opportunity of being heard in the matter. Thus Ground of revenue appeal are allowed for statistical purposes. - I.T(TP).A No ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... that may be urged at the time of hearing of the appeal. 03. The grounds of appeal raised by the Revenue for the AY 2010-11 are as under : 1. The order of the CIT (A) is opposed to law and the facts and circumstances of the case. 2. The CIT(A) erred in not upholding the adjustment made by the TPO w.r.t. license fee and management fees. 3. The CIT(A) erred in deleting the impugned adjustment made by the TPO w.r.t. license fee and management fees, by placing reliance on his own decision in assessee's own case in ITA No.l54/CIT(A)-l/CO/14-15 dated 27.04.2015 for A.Y.2009-10, without appreciating the fact that the revenue has not accepted the same and has preferred further appeal against it. 4. The CIT(A) erred in not appreciating the fact that the purpose of payment of license fee and management fee by the assessee to the AE is to suppress the profit margin and shifting of the same to the AE, whereas these expenditures are not part of any transactions involving third parties. 5. The CIT(A) erred in making the deletions without appreciating the observations made by the TPO that the impugned expenditures are not recovered from the AE by way of sales p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to manage its supply arrangement to AIHPL more efficiently. As per the management agreement the assessee was to compensate Medreich SA at the rate of 3% of the net sales (page 240 of the paper book). 07. The assessee has filed the return of income and the case was selected for scrutiny. As there was international transaction, the AO referred the matter to the TPO u/s.92B of the Act for determining the ALP. The assessee in the financials for AY 2008-09 has given the segmental allocation of cost and revenue between the AE and non-AE, as under : Segmental allocation of cost and revenue between AE and non-AE: Particulars Segemental Operating Results Total (A+B+C+D) AE Non-AE AE Manufacture and export of drug formulations Income from contract manufacturing services Regulatory affairs services Corporate/Unallocated (D) Income Sales/Service Income ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... as against the non-AE it was 5.26 %. Thus it was submitted that the international transactions at the entity level for the Manufacture and export of drug formulations , was as under : International Transactions Received Paid 1. Sales of Manufactured Products 603003808 2. Licence Fee 16100000 3. Service Fee 3320309 4. Purchase of Raw Material 15760215 5. Purchase of Fixed assets 2793316 6. Reimbursment of Expenses 3284877 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s proposed to be applied to determine as 'nil' the ALP of the license fee paid by the Company. 1.6 Payment of management fee is at arm's length: - Arm's length price of the transaction should not be considered as 'nil' since as per the Act, the ALP is required to be determined in light of the any of the five prescribed methods (as then existing) in the manner prescribed in Rule 10B. Your goodself has not mentioned as to which method is proposed to be applied to determine as 'nil' the ALP of the license fee paid by the Company. - There is commercial need for the payment of the management fee since the payments directly benefit the Company by enabling it to carry out its business operations more efficiently. - Your approach of enquiring on commercial expediency of the impugned payment is incorrect in law. - In the pharmaceutical industry it is common to procure the services for which the management fee payout is made. 1.7 Transactions relating to license fee and management fee are closely linked to the principal transaction of manufacture and export of drug_ formulations. In this regard, your goodself should note that th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ting. Also, the impact on the taxable profits would be nil. Payment of license fee by the Company meets market conditions 2.14 Your goodself has mentioned that the license fee payment does not meet the market conditions since the scope of procurement of an alternative cost effective know-how is restricted which could be available to the assessee. Your goodself has also mentioned that even if it is a situation that no alternative know-how is available, the conditions cannot be prohibitory in nature. 2.15 The Company submits that the above Contentions are incorrect. We request you to note that the license fee paid by the Company is determined as a percentage of the Net Sales Price as defined in the agreement (and thus, variable) and is not a fixed lump sum. Such an approach for determining license fee payments is typically adopted in independent market conditions. This would have been the scenario even where the know-how had been obtained by the Company from an alternative source (subject to such alternative source being available for the nature of products that are manufactured by the Company). 2.16 It is also submitted that had an alternative know-how source be ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... above, it can be seen that the international transaction with AIHPL comprises of two key elements: (a) obtaining and using knowhow and technology required to manufacture the drug formulations; and (b) awareness of the dynamics of the South African pharma market, the South African pharma regulatory environment and liaisoning with AIHPL, its customer, for production scheduling, budgeting, delivery and timely collection of dues from AIHPL. 4.4 The Company pays a license fee to its AIHPL for a non-exclusive use of the know-how required to manufacture the products requisitioned by AIHPL. The license fee is paid at the rate of 8% of the Net Sales Price (as defined in the inter-company agreement). It can be seen that the royalty is computed having regard to the sale price that relates to the principal transaction relating to manufacture and export of drug formulations to AIHPL. It can also be seen that the royalty is paid to a common source, that is, AIHPL. 4.5 The Company pays management fees to MSPL to liaise with AIHPL and keeping the Company informed of developments within the South African pharma industry. The management fee payable is determined at 3% of the net sales. It ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... transfer pricing principles as enunciated in commentary and guidance. The Appellant has submitted that when these transactions are considered as closely linked, the operating profit margin derived by it on account of the export of pharmaceutical products is 25.49% which are higher than the margins of the comparable companies identified by the Appellant at 9.05%. The comparable companies identified by the Appellant have not been challenged by the TPO and the transaction of export of pharmaceutical products has been found to be at arm s length. 16. In view of the above discussion, I hold that the License fee and management fee paid are closely interlinked to the appellant s activity of manufacture and export of drug formulations to the AE. The same being closely linked to the export activity, the impugned transactions cannot be considered as separate class of transactions for the purpose of transfer pricing analysis. As such, the ground no.2 raised by the Appellant is allowed. Similarly, having regard to the above discussion which covers the ground Nos.4.1,4.2,5.1 and5.2,the said grounds are also allowed. Thereafter the appeals of the assessee were allowed by the CIT (A). ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ity of the assessee and therefore they cannot be separately bench marked. The Ld. AR relied upon the order passed by the CIT (A) and also Ld. AR relies upon the following judgments : 1. Demag Cranes Components (India) (P.) Ltd. v. Dy. CIT[2013] 30 taxmann.com 364 Pune ITAT 2. Cummins India Ltd. v. Addl. CIT[2015] 53 taxmann.com 53 -Pune ITAT 3. Toyota Kirloskar Motor (P.) Ltd. v. Asstt. CIT [TS-217-ITAT-2014-Bang] 4. SC Enviro Agro India Ltd. v. Dy. CIT[2013] 34 taxmann.com 127 Mumbai ITAT 5. CIT v. EKL Appliances Ltd.[2012] 20 taxmann.com 509 Delhi High Court 6. Safran Aerospace India (P.) Ltd. v. Dy. CIT [IT Appeal No. 1261 (Bang.) of 2010] 7. Hive Communication (P.) Ltd. v. CIT[2011] 12 taxmann.com 287 Delhi High Court 8. CIT v. EKL Appliances (20 taxmann.com 509)- Delhi High Court 9. Siemens VDO Automotive Ltd. v. Dy. CIT [IT Appeal No. 923 (Bang.) of 2012] 10. Luwa India Pvt. Ltd. v. ACIT (568/Bang/2012) Bangalore ITAT 16. We have heard the rival contentions, perused the records as also the case laws cited by both the parties. From a reading of the effective grounds raised by the Revenue, it is clear that the fin ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ssity and legislative mandate is evident in the said Rule. 81. Similarly, sub-rule (3) to Rule 10B refers to transactions being compared or comparison of the enterprises entering into such transactions likely to affect the price or cost charged etc. A reading of Rule 10C reassures and affirms that the general principle of plurality is not abandoned or discarded. And coordinate bench decision in the matter of Gulbrandsen Chemicals (P.) Ltd. v. Deputy Commissioner of Income-tax* [2017] 79 taxmann.com 105 (Ahmedabad - Trib.) had held as under 8 .We find that, in the case of Knorr-Bremse India (P.) Ltd. v. Asstt. CIT [2016] 380 ITR 307/236 Taxman 318/[2015] 63 taxmann.com 186 (Punj. Har.), Hon'ble Punjab Haryana High Court has observed that The doubt, if any, in this regard is set at rest by rule 10A(d), which provides that for the purpose of rule 10A and rules 10 B to 10E, 'transaction' includes a number of closely related transactions and that Thus, the closely linked transactions can, in a given situation, be components of single composite transaction . Their Lordships have then added that The assessee would, however, have to prove that a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... by following any of the methods prescribed. Shorn of other details, it would suffice to observe that on a combined reading of Rule 10A(d) and 10B of the Rules, a number of transactions can be aggregated and construed as a single 'transaction' for the purposes of determining the ALP, provided of course that such transactions are 'closely linked'. Ostensibly the rationale of aggregating 'closely linked' transactions to facilitate determination of ALP envisaged a situation where it would be inappropriate to analyse the transactions individually. The proposition that a number of individual transactions can be aggregated and construed as a composite transaction in order to compute ALP also finds an echo in the OECD guidelines under Chapter III wherein the following extract is relevant:- Ideally, in order to arrive at the most precise approximation of arm's length conditions, the arm's length principle should be applied on a transaction-bytransaction basis. However, there are often situations where separate transactions are so closely linked or continuous that they cannot be evaluated adequately on a separate basis. Examples may include 1. Some long te ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... mulatively in selecting the most appropriate method. The reference therein to the terms 'best suited' and 'most reliable measure' indicates that the most appropriate method will have to be selected after a meticulous appraisal of the facts and circumstances of the international transaction. Further, the selection of the most appropriate method shall be for each particular international transaction. The term 'transaction' itself is defined in rule 10A(d) to include a number of closely linked transactions. Therefore, though the reference is to apply the most appropriate method to each particular transaction, keeping in view, the definition of the term 'transaction', the most appropriate method may be chosen for a group of closely linked transactions Two or more transactions can be said to be linked when these transactions emanate from a common source being an order or a contract or an agreement or an arrangement and the nature, characteristics and terms of these transactions are substantially flowing from the said common source. For example, a master purchase order is issued stating the various terms and conditions and subsequently individuals orders a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lity. This section also covers intra-group service transactions, as often the charge for the services were based on cost allocation/ apportionment. Therefore, the benefit test was a necessary part of determining the arm s length price of any intra group services; The benefit needed to be identified from the taxpayer s viewpoint, which could be potential, reasonable, foreseeable, may not be quantifiable in money alone, and may be strategic, but could not be incidental. The benefit also could not have qualifications such as substantial , direct and tangible because these qualifications were not given in section 92(2) of the Act. There are several non-monetary terms other than profitability, like usefulness, enhancement in value, sustainability and enhancement of business interest, which were required to be seen while judging the benefit test. Like in the present case , the licence is required for long term manufacturing of drugs and formulation within know how of the AE further the assessee is Joint venture company therefore TPO cannot lose sight of various benefit which may flow to Indian partner in the absence of provision for making the payment for the use of license In ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... g carried on by the assessee and such closely linked transactions are to be analysed in aggregate to determine the arm's length price. Moreover it is difficult to comprehend the manufacturing of drugs in India without there being any operation in licence to manufacture the drugs from the statutory authorities and for that to have the access on the formulation which is the technical knowledge and domain of AE. The prices charged by the assessee and the amount of licence fees paid to AE cannot be examined on stand-alone basis, because it will have effect of determination the net prizes received by the assessee. Further the charges paid by the assessee ( JV) to AE for acquiring the technical know-how and is a valuable assets. In the present case, TPO has not brought on record any comparable uncontrolled party( JV or otherwise ) which is manufacturing the drugs with the same prices or less prices as that of the assessee without separately charging the license fee, therefore the approach of the Transfer Pricing Officer to compute NIL charges for the license fee cannot be uphold as transfer prices adjustment can be made in accordance with the one of the method provided under the rule ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... .. ( page 40 of TPO order ). TPO had the recorded the contradiction findings inasmuch as it was mentioned that that there was duplication of services as alleged there was no evidence of rendering the services for the Management . In our view taxpayer could only be asked to maintain and produce the evidence of receipt of service which a businessman keeps and maintains regarding services received from a third party. The burden of maintenance of documents/ evidences could not be higher on the taxpayer merely due to the reason that it was receiving services from its AEs further TPO has not held that the similar kind of services was already available with the taxpayer with any concrete evidence. In the absence of any instances of services provided by the AE and from the fact that services availed by the taxpayer from the third parties were similar in nature, the TPO s viewpoint on duplication test was not acceptable. In all. We find that in a materially identical situation in the case of Merck Ltd. v. Dy. CIT [2016] 69 taxmann.com 45 (Mum.), a coordinate bench, has observed, inter alia, as follows: '9. We find that there is a clear contradiction in the findings of the authoritie ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... We do not think benefit test has too much relevance in the arm's length price ascertainment. When evaluating the ALP of a service, it is wholly irrelevant as to whether the assessee benefits from it or not; the real question which is to be determined in such cases is whether the price of this service is what an independent enterprise would have paid for the same. In case TPO can demonstrate that the consideration for similar services, under the CUP method, is NIL, he can very well do so. That's not, however, his case. He only states that these services are not worth the amount paid by the assessee. Such band statements and sweeping generalizations cannot help the case of the revenue authorities. The assessee has benchmarked the transaction on TNMM basis, and unless the revenue authorities can demonstrate that some other method of ascertaining the arm's length price on the facts of this case will be more appropriate a method of ascertaining the arm's length price, the TNMM cannot be discarded. Dealing with almost a similar situation, as we are in seisin of, a coordinate bench of this Tribunal, in the case of AWB India (P.) Ltd. v. Dy. CIT [2015] 152 ITD 770, has obse ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... was also of the view that as against the use of TNMM by the assessee in benchmarking, the right course of action will be to follow CUP method because the value under CUP method will be best indicator of the value of these services. It was in this background that the TPO made certain adverse inferences against the assessee. The TPO was of the view that while the assessee has made a payment of ₹ 20,35,907 towards financial management and reporting services, but the services rendered are negligible compared to the cost incurred . The TPO was also of the view that a minor clarification or seeking of certain guidance on verify basic issue does not call for a payment of ₹ 20 lakhs. Therefore, the ALP of these services was taken as 'NIL'. He further noted that while the assessee has made a payment of ₹ 1,23,476 towards human resources services, the assessee has not furnished any specific input on training and development of human resources and it is also noticed that these services are of routine nature and duplicate at best . Accordingly, the TPO also treated ALP of these services as 'NIL'. As regards the payment of ₹ 96,355 towards 'legal s ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ommercially expedient. As held by Hon'ble jurisdictional High Court in the case of CIT v. EKL Appliances Limited (345 ITR 241), Even Rule 10B(1)(a) does not authorise disallowance of any expenditure on the ground that it was not necessary or prudent for the assessee to have incurred the same . 16. The very foundation of the action of the TPO is thus devoid of legally sustainable merits. There is no dispute that the impugned payments are made under an arrangement with the AE to provide certain services. It is not even the TPO's case that the payments for these services were not made for specific services under the contract but he is of the view that either the services were useless or there was no evidence of actual services having been rendered. As for the services being useless, as we have noted above, it is a call taken by the assessee whether the services are commercially expedient or not and all that the TPO can see is at what price similar services, whatever be the worth of such services, are actually rendered in the uncontrolled conditions. 17. As for the evidence for each of the service stated in the agreement, it is not even necessary that each of the service ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... see gets the relief accord.' 22 . We are in considered agreement with the views so expressed by the coordinate bench and the impugned addition must stand deleted for this short reason alone. In our considered view, the facts of the case before us are materially similar inasmuch as the services are indeed rendered by the AE, as evident from the documentary evidences on record and yet its arm's length value is held to be NIL only because, according to the authorities below, these services were worthless, these services were not required by the assessee, the assessee could have performed these services on its own and the services were not rendered by the group entity. The TPO has rejected the determination of arm's length price on the basis of TNMM, at entity level, but then he has not adopted any other permissible method for determination of arm's length price. Such a course of action, as noted above, is not permissible in law. Just because these services are worthless in the eyes of the revenue authorities, the arm's length price of these services cannot be held to be NIL. Similarly, the findings that no services were rendered and that the assessee could have ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y of being heard in the matter. .Thus Ground nos.3, 4, 5 6 of revenue appeal are allowed for statistical purposes. 23 With respect to the alternative ground i.e no 7 we may record , that the authority of the TPO is to conduct a transfer pricing analysis to determine the ALP and not to determine whether there is a service or not from which the assessee benefits. That aspect of the exercise is left to the AO. This distinction was made clear by the ITAT in Dresser-Rand India Pvt. Ltd. v. Additional Commissioner of Income Tax, 2012 (13) ITR (Trib) 422: When evaluating the arm's length price of a service, it is wholly irrelevant as to whether the assessee benefits from it or not; the real question which is to be determined is whether the price of this service is what an independent enterprise would have paid for the same. Similarly, whether the AE gave the same services to the assessee in the preceding years without any consideration or not is also irrelevant. The AE may have given the same service on gratuitous basis in the earlier period, but that does not mean that arm's length price of these services is 'nil'. Thus, it becomes important to clarify the ext ..... X X X X Extracts X X X X X X X X Extracts X X X X
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