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TMI Blog2023 (3) TMI 189X X X X Extracts X X X X X X X X Extracts X X X X ..... as a limited risk bearing marketing and distribution companies earning arms length return for their activities. 3 The TPO and MP has erred in rejecting Shrey Nutraceuticals & Herbals Private Limited as a comparable to your appellant by applying lower turnover filter of Rs.10 crores instead of Rs.1 crore which was consistently followed by your appellant and the TPO in the earlier years. 4 The TPO and DRP has erred in rejecting Sanat Products as a comparable to your appellant on the contention that it has failed the net worth filter though it had passed that filter. 5 The TPO and DRP has erred in rejecting Gujarat Organic Limited as a comparable to your appellant on the contention that it is functionally different. 6 The TPO and DRP has erred in rejecting Endo Amines Limited as a comparable to your appellant on the contention that it is- functionally different. 7 The TPO and DRP has erred in rejecting Tyche Industries Limited as a comparable to your appellant on the contention that it is functionally different. 8 The TPO and DRP has erred in rejecting Yasho Industries Limited as a comparable to your appellant on the contention that it is functionally different. 9 The TP ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... come by your appellant. 23 Without prejudice to the other grounds, the AO has erred in computing interest u/s 234B as Rs.4,20,07,491/- as against the correct computation of Rs.3,98,01,513/-. 24 For these and other grounds that may be adduced at the time of hearing, the order passed by the AO, TPO and DRP may be set aside to the extent appealed against. 25 Your appellant craves leave to add, amend, alter, vary and/ or withdraw any or all of the above grounds of appeal. 2. The brief acts of the case are that the assessee is engaged in business of manufacturing and export of standardized herbal extract, fine chemical, nutraceuticals, specialty chemicals, cosmeceuticals, phytonutrients and probiotics and was filed its original return of income for A.Y. 2017-18 on 29/11/2017 declaring total income at Rs. 41,89,10,390/-. Thereafter assessee company revised its return of income on 29/- 03/2018. The case was selected for scrutiny through CASS for examine the following reasons. i. Large deduction claimed u/s 35(2AA),35(2AB), 35(CCC) & 35(CCD). ii. Lower amount disallowed u/s 40(a)(ia) in ITR comparison to tax audit report. iii. Large any other amount allowable as deduction" c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... delayed receivables 72,92,193 Total 20,36,59,260/- 3.4 Accordingly, an amount of Rs.20,36,59,260/-is proposed as the transfer pricing adjustment to arrive at arm's length price of the international transactions and he passed the order u/s 92CA(3) of the I.T.Act dated. 19/01/2021. 4. Thereafter, notice u/s 142(1) of the I.T. Act was issued to the assessee company for various details/documents on 02/02/2020 and asked to explain as to why no addition as per TP adjustment of Rs. 20,36,59,260/- should not be made as suggested by the TPO vide order u/s 92CA(3) of the I.T.Act. In response to said notice, assessee vide letter dated 10/02/2021 has submitted its submission . Relevant portion as under:- " ....... The TPO has proposed a Transfer Pricing adjustment of of Rs.20.36 crores. We do not agree to this adjustment proposed by the TPO since it contains patents error of facts and law. The TPO has not considered the various factual and legal matters while proposing this adjustment though the same was submitted to him vide detailed submission in response to the show cause notice and also through a virtual hearing. The same is summarized below for ready reference: a) T ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... roposed adjustment to arrive at Arm's Length Price of the international transactions entered by the assessee with Associated Entities amounting to Rs. 20,36,59,260/-. Accordingly, adjustment is made to total income of Rs. 20,36,59,260/- as suggested by the TPO. 4.2 The AO further observed that the assessee has claimed deduction u/s 35(2AB) of the I T Act. on weitaged average basis of Rs. 22.17 cr. But the Form 3Cl was issued after filling of the Income Tax Return & DSIR had certified a sum of Rs. 1104.60 lakhs, therefore there was difference of Rs. 3,85,000/- which was not accepted by the AO and added into the total income of assessee. 4.3 Aggrived from the Draft Assessment Order the assessee filed objections before the DRP , the ld. DRP after considering the objections paased his order on 28.12.2021. 5. Against the DRP order , assessee is in appeal before us, and filed written synopsis containg page no. 1 to 31, the relevant parts for deciding the issue before us are as under:- Main disputes involved - Adjustment done to manufacturing segment Rs.19,63,67,067/- Ground 1: Non-consideration of Internal TNMM Analysis undertaken by the appellant 8. The Appellant had sele ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... external comparables 4.1 We therefore, direct the Ld.TPO to carry out detailed analysis of the international transactions using TNMM as MAM, based on the materials filed by assessee related to internal comparables. In the event the details filed are satisfactory, the determination must be confined to the internal comparables so filed by assessee. In the event, the details filed by assessee is not verifiable or not in accordance with law, the Ld.AO/TPO is open to carry out analysis in accordance with law. [Emphasis Supplied] 13. The Appellant is an Indian multinational company engaged in research, manufacturing, and sale of nutraceutical products. The Appellant's economic interests are predominantly in India and the manufacturing facilities are also set up in India. However, bulk of the products manufactured by the Appellant are sold outside India through Appellant's subsidiaries which largely function as marketing and distribution centres for sale of the products. 14. Since the Appellant is engaged in dealing with nutraceuticals products, in benchmarking the international transaction, the Appellant ought to be compared with companies dealing with nutraceutical products. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ex function of pharmaceutical industry. 19. Major difference between nutraceutical and pharmaceutical industry is furnished in Page 9 of DRP submissions. It is evident that the nutraceutical industry is drastically different from the pharmaceutical industry in terms of composition, market, research, regulatory requirement and intended use. 20. Specifically, the Appellant in the present case, is a nutraceutical product supplier. Thus, the Appellant is a Business to Business ("B2B") market player where, the nutraceutical products are supplied by the Appellant to a manufacturer who purchases and uses the Appellant's products as an input product for producing final product. This is the precise reason why the Appellant had compared the net operating margin earned in the sale of products to AE with the net operating margin earned in sale of products to third party customers (i.e. non AEs). However, this fact is completely ignored by the TPO and DRP in proceeding to compare the functions and operating margin of the Appellant with that of external companies who are not comparable in terms of segment and market that the Appellant belongs to. 21. It is submitted that the Appellant, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ked the delay in receipt of the receivable and imputed interest of Rs.72,92,193/- based on the LIBOR rate during the year. 56. As per the explanation to Section 92B (inserted by Finance Act, 2012 with retrospective effect from 01.04.2002) of the Act, term international transactions includes "Capital financing including any type of long-term or short-term borrowing, lending or guarantee purchase or sale of marketable securities or any type of advance, payments or deferred payment or receivable or any other debt arising during the course of business", the TPO treats outstanding receivable as unsecured loan given to AEs and charges interest on overdue period if any. 57. The inclusion in the Explanation to Section 92B of the Act of the expression 'receivables' does not mean that every item of 'receivables' appearing in the accounts of an entity, which may have dealings with foreign AEs would automatically be characterized as an unsecured loan leading to benefit the AEs. The intent behind including the above clause within the ambit of Section 92B of the Act is to penalize the taxpayers who does not repatriate the money for an indefinite period and not to automatically characterize ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ant to its AEs and therefore must be considered among with main transaction. The extract of the ruling is reproduced below for your reference: "However, this transaction of allowing the credit period to AE on realization of sale proceeds is not an independent international transaction but it is closely linked or continuous transaction along with sale transaction to the AE. The credit period allowed to the party depends upon various factors which also includes the price charged by the Appellant from purchaser. Therefore, the credit period extended by the Appellant to the AE cannot be examined independently but has to be considered along with the main international transaction being sale to the AE. As per Rule 10A(d) if a number of transactions are closely linked or continuous in nature and arising from a continuous transaction of supply of amenity or services the transactions is treated as closely linked transactions for the purpose of transfer pricing and, therefore, the aggregate and clubbing of closely linked transaction are permitted under said rule. This concept of aggregation of the transaction which is closely linked is also supported by OCED transfer pricing guidelines. I ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... xmann.com 173], the relevant extract of the ruling is provided below: "If the AEs are not recovering interests from third parties for late recoveries, then in the instant case it would be too much to expect the assessee to charge the interest from the AEs. There is no rationale to inflict upon the assessee, merely on presumption, that he ought to have charged the interest from it's AEs. We therefore hold that there was no justification to presume that there was a shift of profit to avoid tax in India." 64. Further, reliance can also be placed on the ruling of Hon'ble Bangalore Tribunal in the case of M/s Avnet India Pvt. Ltd vs Deputy Commissioner of Income-tax (65 taxmann.com 187 - Pages 3544 to 3555) wherein it has been upheld that there should not be a separate international transaction of interest income for transactions related to sale. The relevant extract of the ruling in Para 8 is reproduced below: "Respectfully following the above decision, we hold that there can be no separate international transaction of 'interest' in the international transaction of sale. Early or late realization of sale proceeds is only incidental to transaction of sale, but not a separate tr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Bench at para 28 thereof has held as under: "28. After carefully considering the rival submissions and the orders of the TPO as well as the direction of the DRP, we find that the assessee has no interest liability and it does not have any external borrowings. Even if the payments have been made by the AE beyond the normal credit period, there is no interest cost to the assessee. Moreover, there is no such agreement whereby interest is to be charged on such a delayed payment. From the summary of payment submitted by the learned Counsel, it is seen that the billing is done on quarterly basis and, accordingly, the payment is being received. Therefore, the delay is not wholly on account of late payment by the AEs only. Moreover, the T.P. Adjustment cannot be made on hypothetical and notional basis until and unless there is some material on record that there has been under charging of real income. Thus, on the facts and circumstances of the case, we are of the opinion that addition on account of notional interest relating to alleged delayed payment in collection of receivables from the AEs is uncalled for on the facts of the present case and is, accordingly, deleted. 11.4.2 Fo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... le from AEs, the question of applying the provisions of section 92 of the Act does not arise. 70. Section 92(1) of the Act provides that, "Any income arising from an international transaction shall be computed having regard to the arm's length price". Further, Section 92B(1) of the Act defines an "international transaction" as under: "For the purposes of this section and sections 92, 92C, 92D and 92E, "international transaction" means a transaction between two or more associated enterprises, either or both of whom are non-residents, in the nature of purchase, sale or lease of tangible or intangible property, or provision of services, or lending or borrowing money, or any other transaction having a bearing on the profits, income, losses or assets of such enterprises, and shall include a mutual agreement or arrangement between two or more associated enterprises for the allocation or apportionment of, or any contribution to, any cost or expense incurred or to be incurred in connection with a benefit, serviceor facility provided or to be provided to any one or more of such enterprises to mean the ALP in length price under section 92C" 71. As can be seen from the above, the def ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... international transaction. In plain words, a continuing debit balance only reflects that the payment, even though due, has not been made by the debtor. It is not, however, necessary that a payment is to be made as soon as it becomes due. Many factors, including terms of payment and normal business practices, influence the fact of payment in respect of a commercial transaction. Unlike a loan or borrowing, it is not an independent transaction which can be viewed on standalone basis. What can be examined on the touchstone of arm's length principles is the commercial transaction itself, as a result of which the debit balance has come into existence, and the terms and conditions, including terms of payment, on which the said commercial transaction has been entered into. The payment terms are an integral part of any commercial transaction, and the transaction value takes into account the terms of payment, such as permissible credit period, as well. The residuary clause in the definition of 'international transaction', i.e. any other transaction having a bearing on the profits, incomes, losses or assets of such enterprises, does not apply to a continuing debit balance, on the given facts ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r isolation of bioactive molecules. To facilitate the increased demand for innovative application-based products, the company has established this state of the art research facility at Bangalore. Although this is attached to its corporate office in Peenya, it is a clearly demarcated area and the appellant company does not have any manufacturing facilities nearby. Their manufacturing facilities in Karnataka are located in Nelamangala, Kunigal and Dobaspet. They also have a manufacturing facility in Hyderabad. 79. The R&D Centre is recognised by the Department of Scientific and Industrial Research, Government of India for the purposes of Sec 35(2AB) of the Income tax Act, 1961. A copy of Form 3CM issued by DSIR, Ministry of Science and Technology, New Delhi is available in Page 225 of paper book I. The R&D focuses not only on the manufacture of herbal extracts, fine chemicals, specialty chemicals and cosmeceuticals, but also on the research for New Drug Discovery. In addition to the research and development facilities, the company has full-fledged laboratories in the areas of Phytochemistry, Organic Chemistry, Tissue Culture, Biotechnology etc. 80. The details of expenses incur ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... SIR. 84. The amount of Rs.1108.45 lakhs has been claimed on the basis of actual expenditure incurred towards R&D. Form 3CL is issued only after the ITR is filed by the appellant company, as a copy of the Acknowledgement for having filed IT Return is to be submitted to the DSIR in order to claim the deduction. Hence the ITR was filed on the basis of the certificate issued by the auditors. The certified Form 3CL was received only in December 2019 after the ITR V along with the Auditors Certificate and other supporting documents were filed with the DSIR in November 2017. The DSIR certified a sum of Rs.1104.60 lakhs as eligible for weighted deduction at 200%. 85. The AO ought to have restricted the disallowance only to the extent of weighted deduction claimed by the company to the extent of Rs.386,333/- only [i.e., Rs.7,72,665/- less Rs.3,86,333/-] and not the entire expenditure. Though a specific claim was made during assessment proceedings (Page 204 of the paper book) to allow the same u/s 35(1)(i) or 37(1), the AO had not dealt with it in the draft assessment order. The DRP has also not dealt with this alternate claim of the appellant company. Hence the order suffers from seri ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rred for the purpose of business of the assessee. Even if such a strict test required for availing the weighted deduction is not satisfied, it would still qualify for normal deduction @ 100% of the revenue expenditure. In other words, the DSIR's approval ought to be confined only to the weighted deduction as envisaged u/s 35(2AB) of the Act and not to the claim for normal deduction u/s 35(1) of the Act. DSIR's approval has no relevance to decide whether an expenditure is eligible for deduction u/s 35(1) or under any other provisions of the Act. If, for any reason, it cannot be allowed u/s 35(1) of the Act, the same may be allowed u/s 37(1) of the Act as the expenditure is incurred wholly and exclusively for the purpose of the business of the assessee company. 91. Accordingly, in view of the intention of providing weighted deduction u/s 35(2AB) of the Act to promote scientific research as well as in the light of the various judicial precedents cited above, the company's claim for deduction of Rs.3,86,332/- u/s 37(1) of the Act as incurred wholly and exclusively for the purpose of business ought to be allowed and the disallowance be restricted only to the extent of weighted deduct ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... enterprise itself from third parties, it is always safe and advisable to have recourse to such internal comparable case. The reason is patent that the various factors having bearing on the quality of output, assets employed, input cost etc. continue to remain by and large same in case of an internal comparable. The effect of difference due to such inherent factors on comparison made with the third parties, gets neutralized when comparison is made with internal comparable. Ex consequenti, it follows that an internal comparable uncontrolled transaction is more noteworthy vis-a-vis its counterpart i.e. external comparable. 3.3 The Ld.AR submitted that the proposition laid down by the Hon'ble Mumbai Special Bench has been followed in various decisions of this Tribunal the same principle. 3.4 The Ld.CIT.DR though opposed the use of internal comparables could not controvert the observation by Hon'ble Mumbai Special Bench and various other decisions filed by assessee. We have perused the submissions advanced by both sides in the light of records placed before us. 4. We note that admittedly, the transactions in a controlled transaction with a related party and an uncontrolled t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... seek unnecessary adjournments for early disposal of the case. 12. Ground No.19 to 20 relates to interest on delayed trade receivables from AEs . The ld.AR of the assessee has submitted detailed written submissions from para No.55 to 76, in which he has strongly contested interest on delayed receivables should not be considered as international transactions and notional interest computed by the AO/TPO/DDRP which is libor +450 basis points, therefore the adjustment should not be made for the interest on delayed receivables. 13. The ld.DR relied on the order of the lower authorities and submitted that in view of the amendment inserted by way of Explanation (II) sec.92B, with retrospective effect from 01/04/2002, the term international transaction would specifically include within its ambit, "deferred payment are receivables or any other debt arising during the course of business' and various High Courts have been decided this issue that the interest on delayed receivables is an international transaction to which the ld.DRP has rightly dealt the issue in his order. The lower authorities have rightly taken the libor + 450 basis points considering to the nature and trade practice adop ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sessment proceedings, it was observed that the assessee has claimed deduction u/s 35(2AB) of the Act of Rs.22,16,92,665/- as per the weighted average deduction allowed under this Act. As per the letter of the assessee dated 10/02/2021, it was submitted that a sum of Rs.1108.45 lakhs was incurred towards research and development expenditures. The Form No.3CL was issued after the filing of income-tax return. The ITR was filed on the basis of certificate issued by the auditors . The form No.3CL was issued in the month of December 2019 and the DSIR certified sum of Rs.1104.60 lakhs was admissible for deduction. Accordingly the difference of Rs.3,86,332/- was not approved by the DSIR which relates to certain miscellaneous revenue expenditure incurred in connection with research and development work, therefore, the AO disallowed the weighted average deduction of Rs.7,72,665/- and added into the total income of the assessee. Considering the submission made by both the sides, we are remitting this issue back to the file of the AO for verification of the nature of expenditure incurred by the assessee in terms of sec.37(1) of the Act, if the AO finds that these expenditures are covered u/s 3 ..... X X X X Extracts X X X X X X X X Extracts X X X X
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