WATSON PHARMA P.LTD, MUMBAI V. DCIT 8(3), MUMBAI

ITA 1423/MUM/2014

• Counselvise Citation: 142319914 RSA 2014
• Duration Of Justice: 10 month(s) 9 day(s)
• Appeal Type: Income Tax Appeal
• Pronouncement Date: 09-01-2015
• Appeal Filed By: Assessee
• Order Result: Partly Allowed
• Bench Allotted: K
• Next Hearing Date: 30-10-2014
• Assessment Year: 2009-2010
• Appeal Filed On: 28-02-2014
• Result in Favour of: Partly Allowed
• Court: TRIBUNAL
• Department Lawyers: KISHAN VYAS
• Keywords: Related party transaction; Capital asset; Business income; Depreciation; Transfer pricing; International transaction; Additional evidence; Wholly owned subsidiary; Benefit of exemption; Unabsorbed depreciation
• Section: 92C; 80C; 10B

Judgement Text

IN THE INCOME TAX APPELLATE TRIBUNAL MUMBAI BENCH K, MUMBAI , ,, , BEFORE SHRI R.C. SHARMA, ACCOUNTANT MEMBER AND SHRI VIVEK VARMA, JUDICIAL MEMBER ITA NO. : 1423/MUM/2014 (ASSESSMENT YEAR: 2009-10) M/S WATSON PHARMA PVT LTD, 51 KALPATARU SQUARE, 21/22, KONDIVITA LANE, OFF ANDHERI KURLA ROAD, ANDHERI (EAST), MUMBAI -400 059 .: PAN: AAACW 6074 D VS DY COMMISSIONER OF INCOME TAX -8(3), MUMBAI (APPELLANT) (RESPONDENT) ITA NO. : 1565/MUM/2014 (ASSESSMENT YEAR: 2009-10) DY COMMISSIONER OF INCOME TAX - 8(3), MUMBAI VS M/S WATSON PHARMA PVT LTD, MUMBAI (APPELLANT) (RESPONDENT) APPELLANT-ASSESSEE BY : MS. KARISHMA R PHATARPHEKAR MR. PRASHANT MAHESHWARI MR. VARUN SANKHESARA MS. KEERTHIGA PADMANABHAN RESPONDENT-REVENUE BY : SHRI. KISHAN VYAS !' # $% /DATE OF HEARING : 30-10-2014 &'( # $% / DATE OF PRONOUNCEMENT : 09-01-2015 ORDER , , , , : :: : PER VIVEK VARMA, JM: CROSS APPEALS HAVE BEEN FILED BY THE ASSESSEE AND THE DEPARTMENT AGAINST THE ORDER OF DISPUTE RESOLUTION PANEL II, MUMBAI, DATED 31.12.2013, PASSED U/S 144C(5) OF THE INCOME TAX ACT, 1961. M/S WATSON PHARMA PVT LTD ITA 1423/M/2014 ITA 1565/MUM/2014 2 ITA NO. : 1423/MUM/2014 : ASSESSEES APPEAL : 2. THE BASIC FACTS OF THE CASE ARE THAT THE ASSESSEE IS A WHOLLY OWNED SUBSIDIARY OF WATSON LABS, CARONA CALIFORNIA, USA. THE ASSESSEE HAD ITS FACILITY FOR RESEARCH AND DEVELOP MENT, LOCATED AT AMBERNATH, DOMBIVLI AND MUMBAI. IN AUGUST, 2007, THE ASSESSEE RECEIVED APPROVAL TO MANUFACTURE PRODUCTS AT THE SOLID DOSAGE MANUFACTURING FROM GOA. THE ASSESSEE, FROM ITS FACILITIES MANUFACTURE OF RAW MATERIALS, API & INTERMEDIATE TO SUPPORT IS INTERNAL PRODUCT DEVELOPMENT. ASSESSEES FACI LITIES ALSO DEVELOPS APIS FOR THIRD PARTIES AS WELL. ON THE WHOLE, THE ASSESSEE PROVIDES CONTRACT MANUFACTURE, CONTRACT RESEA RCH AND DEVELOPMENT TO ITS PARENT AE AT THE US. THE PARENT AE IN THE US IS ENGAGED IN DEVELOPMENT, MANUFACTURE AND SALE AND DISTRIBUTION OF PROPRIETARY AND OFF PATENT GENERIC PHARMACE UTICAL PRODUCTS. 3. THOUGH THE PARENT AE AND ITS ASSOCIATES DEVELOP MANUFACTURE THE PRODUCTS IN THREE CORE AREAS, I.E. SPECIALT Y PRODUCTS, NEPHROLOGY PRODUCTS AND GENERIC PRODUCTS, ITS ASSOCIATION WITH THE ASSESSEE SUMMARILY RALLIES AROUND CON TRACT RESEARCH AND DEVELOPMENT SERVICES, CONTRACT MANUFACTUR ING AT THEIR FACILITIES AND COMMERCIAL SALES. 4. SINCE THERE IS INVOLVEMENT OF INTERNATIONAL TRANSACTION S BETWEEN THE AES THE ASSESSEE JUSTIFIES ITS ALP WITH ITS A E BY USING TNMM METHOD. 5. IN SO FAR AS R&D ACTIVITIES WHICH INCLUDED MANPOWER RECRUITMENT ARE CONCERNED, THE ASSESSEE EXPLAINED TO TH E REVENUE AUTHORITIES WITH REGARD TO ITS FUNCTIONS RELATING T O GENERIC PHARMA PRODUCTS, ITS SELLING AND MARKETING FUNCTIONS . BASED OR THIS FUNCTIONAL ANALYSIS, TO JUSTIFY ITS TRANSACT IONS WITH AES, THE ASSESSEE IDENTIFIED 6 COMPARABLE COMPANIES, THAT W ERE M/S WATSON PHARMA PVT LTD ITA 1423/M/2014 ITA 1565/MUM/2014 3 ENGAGED IN SIMILAR CONTRACT R&D ACTIVITIES, COMPUTED MEAN PROFIT MARGIN AT 14.50%, AGAINST 17.43% DECLARED BY THE ASSESSEE. 6. IN RESPECT OF CONTRACT MANUFACTURING ACTIVITY, THE ASS ESSEE UNDERTAKES TRIAL PACKS IN ITS R&D LABORATORY WHERE DETA ILED TESTS ARE UNDERTAKEN AND ON COMPUTATION OF SUCH TESTS , THE ASSESSEE FILES ITS RESULTS WITH US FDA. AFTER GETTING THE A PPROVAL, THE ASSESSEE MANUFACTURES THE PRODUCTS FOR ITS AE. THE ASSESSEE TO JUSTIFY ITS ALP ADOPTED TNMM AND IDENTIFIED 7 COMPARAB LES, WHOSE MEAN PROFIT MARGIN MARKED OUT AT 11.90% AGAINST ITS PROFIT MARGIN TAKEN AT 15.66%. 7. THE ASSESSEE, THEREFORE, SUBMITTED BEFORE THE REVENUE AUTHORITIES THAT IN BOTH THE ABOVE ACTIVITIES, THE BENCH M ARK WAS WELL WITHIN 5% AND THEREFORE, WERE AT ARMS LENGTH. 8. IN THE PROCEEDINGS BEFORE THE TPO, THE TPO AFTER CONSIDERING THE REPORTS SUBMITTED BY THE ASSESSEE CHAN GED THE COMPARABLES IN RESPECT OF CONTRACT MANUFACTURING AND WOR KED OUT THE MEAN PROFIT MARGIN AT 23.61% AGAINST ASSESSEE PR OFIT MARGIN OF 17.43%. HE, THEREFORE, COMPUTED THE ADJUSTMENT A T 1.93 CRORES. 9. IN RESPECT OF PRODUCT DEVELOPMENT AND R&D ACTIVITY, THE TPO COMPUTED THE ADJUSTMENT ON LOCATION SAVING. THE TPO WORKED OUT THE ADJUSTMENT OF PRODUCT DEVELOPMENT ON T HE BASIS OF THE FACT THAT MANUFACTURING ACTIVITY WHICH WERE BEING UNDERTAKEN IN THE US AND EUROPEAN COUNTRIES/LOCATIONS W ERE BEING TRANSFERRED TO INDIAN LOCATIONS SUBJECT TO FDA NOR MS. THIS TRANSFER OF MANUFACTURING PROCESS TO INDIA GAVE AVERAGE COST ADEQUATE AT MERELY 40%. SINCE THE AE ENJOYED LOCATIONAL ADVANTAGE ON PRODUCT DEVELOPMENT AND R&D ACTIVITY, THE COMPUTATION OF DIFFERENTIAL COSTS WERE WORKED OUT AT RS. 25 .19 M/S WATSON PHARMA PVT LTD ITA 1423/M/2014 ITA 1565/MUM/2014 4 CRORES ON CONTRACT MANUFACTURING SEGMENT AND RS. 9.04 C RORES ON R&D SEGMENT. 10. AGAINST THESE DIRECTIONS BY THE DRP, THE ASSESSEE IS IN APPEAL BEFORE THE ITAT. BEFORE US, THE AR REITERATED TH E SUBMISSIONS MADE BEFORE THE REVENUE AUTHORITIES AND THE DRP AND MADE FURTHER SUBMISSIONS THAT THE WORKING ARRIVED AT BY THE ASSESSEE WAS A CORRECT AND THEREFORE, THE COMPUTATION OF ADJUSTMENT MADE BY THE REVENUE AUTHORITIES WERE INFIRM. 11. THE AR SUBMITTED THAT THE BASIS OF ARRIVING AT THE M EAN PLI INDICATOR, THE ASSESSEE HAD MADE THE FOLLOWING ANALYSIS: DESCRIPTION AMOUNT(RS.) OPERATING REVENUE 36,69,84,790 OPERATING COST (TC) 31,25,25,091 OPERATING PROFIT (OP) 5,44,59,699 OP/TC 17.43 THE ASSESSEE HAS USED TNMM AS MOST APPROPRIATE METHOD TO BENCHMARK THE TRANSACTION, USING OP/TC (OPERATING PROFIT TO OPERATING COST) AS PLI. BASED ON THE FOLLOWING COMPARABLES SR. NO. NAME OF COMPARABLE AVERAGE PLI BASED ON MULTIPLE YEAR DATA 1 CHOKSI LABORATO RIES LTD 32.45% 2 VIMTA LABS LTD 20.09% 3 DOLPHIN MEDICAL SERVICES LTD 10.22% 4 NG INDUSTRIES LTD. 20.04% 5 MAX NEEMAN MEDICAL INTERNATIONAL LTD.(SEG.) - 5.39% 6 PFIZER LTD. (SEG.) 9.57% MEAN 14.50 ASSESSEES PLI 17.43 12. THE TPO AFTER CONSIDERING THE COMPARABLES, OBSERVED, IN RESPONSE, THE ASSESSEE SUBMITTED THAT IT CONSID ERED COMPANIES ENGAGED IN RESEARCH AND TESTING SERVICES AND DIAGNOSTIC AND TESTING SERVICES. THE REASON GIVEN B Y THE ASSESSEE TO BROADEN THE SEARCH IS THAT, AS ADEQUATE COMPANIES COULD NOT BE FOUND WHOSE BUSINESS WAS CLOSELY COMPARABLE TO THAT OF THE ASSESSEES R&D SEGMENT. IN THIS REGARD, IT IS TO BE STATED THAT TH ERE ARE SUFFICIENT NUMBER OF COMPARABLE COMPANIES ARE AVAIL ABLE IN THE R&D SECTOR, AS EVIDENCED BY THE COMPARABLES CONSIDERED BY THE TPO. SECONDLY, EVEN UNDER TNMM, T HE PRIMARY EMPHASIS IS ON TO SEARCH FOR COMPARABLES, A S CLOSE AS POSSIBLE TO THE FUNCTIONS CARRIED BY THE M/S WATSON PHARMA PVT LTD ITA 1423/M/2014 ITA 1565/MUM/2014 5 ASSESSEE. SO, WHEN COMPARABLES ARE AVAILABLE IN THE R&D SECTOR, THERE IS NO REASON WHY THE ASSESSEE HAS TO BROADEN THE SEARCH. IT IS THE QUALIFY OF COMPARABLE S RATHER THAN THE QUANTITY OF COMPARABLES THAT IS IMPORTANT. 6.3 IT IS TO BE NOTED THAT THE COMPANIES PROVIDING MEDICAL DIAGNOSTIC/TESTING SERVICES AND CAN NOT BE COMPARAB LE TO THE ASSESSEES FUNCTION OF PROVIDING R&D SERVICES T O ITS AE IN THE FIELDS OF FORMULATION, DEVELOPMENT, BIO- CHEMICAL RESEARCH ETC. THE FUNCTIONAL PROFILE OF TH E ASSESSEE IS THAT OF A RESEARCH AND DEVELOPMENT SERVICES PROVIDER WHICH INVOLVES REVERSE ENGINEERIN G OF DRUGS AND CREATING NEW DRUGS AS PER SPECIFICATION O F THE AE. ANY COMPANY DOING BROADLY SIMILAR JOB WOULD BE CONSIDERED COMPARABLE TO THE ASSESSEE. THE CORE POI NT HERE IS PROVIDING RESEARCH AND DEVELOPMENT SUPPORT TO AN INDUSTRY. THE ABOVE TWO COMPANIES ARE RUNNING MEDICAL AND DIAGNOSTICS CENTRES FROM WHICH THEY ARE TREATING INBOUND PATIENTS. THEY ARE NOT UNDERTAKING ANY KIND OF MEDICAL SEARCH WITH THE FUNCTION OF PROVIDI NG RESEARCH AND TECHNICAL SERVICES. REJECTED FOUR OF THE COMPARABLES, OBSERVED, SR. NO. COMPANY REASON FOR REJECTION 1 DOLPHIN MEDICAL SERVICES LTD THE COMPANY MAINLY PROVIDES MEDICAL DIAGNOSTIC AND OPHTHALMOLOGIC SERVICES TO PATIENTS. NONE OF THE STEPS FOLLOWED BY ASSESSEE IN ITS RESEARCH ACTIVITIES ARE INVOLVED IN THE FUNCTIONING OF THE COMPANY. 2 N. G. INDUSTRIES LTD THE COMPANY HAS MEDICAL CENTRES, WHICH ARE ENGAGED IN PROVIDING DIAGNOSTIC/PATHOLOGICAL SERVICES. THE COMPANY CARRIES ON NO RESEARCH ACTIVITIES FOR THE FY 2008-09. 3 MAX NEEMAN MEDICAL INTERNATIONAL LTD IT HAS RELATED PARTLY TRA NSACTION EXCEEDING 25% OF THE REVENUE FOR THE FY 2008-09 4 PFIZER LTD FIRSTLY THE COMPANY HAS DIFFERENT ACCOUNTING YEAR ENDING WITH NOVEMBER, 2009. FURTHER, THE SERVICES SEGMENT IS INTO CLINICAL DEVELOPMENT OPERATIONS, WHICH PRIMARILY INCLUDE CONDUCTING CLINICAL TRIALS, NEW PRODUCT DEVELOPMENT AND UNDERTAKING COMPREHENSIVE DATA MANAGEMENT FOR NEW DRUG DEVELOPMENT. THE SEGMENT REVENUE FOR THE FY 2008-09 IS OF RS. 22.09 CRORES AND RS. 21.95 CRORES ARE WITH RELATED PARTIES (SOURCE: ANNUAL REPORT FOR FY 2008-09). THUS, THE SERVICES SEGMENT IS A CAPTIVE CENTRE FOR PFIZER GROUP AND THUS THE SEGMENT FAILS 25% RELATED PARTY TRANSACTIONS FILTER. 13. ON THE FINAL ANALYSIS, THE AO LAY HIS BASIS ON THE FOLLOW ING FINAL COMPARABLES AS A RESULT, AFTER CONSIDERING THE OBJECTIONS OF THE ASSESSEE AND ALSO EXAMINATION OF ADDITIONAL COMPANIES SUBMITTED BY THE ASSESSEE, THE M/S WATSON PHARMA PVT LTD ITA 1423/M/2014 ITA 1565/MUM/2014 6 FOLLOWING ARE THE FINAL COMPARABLES THAT ARE USED FOR BENCHMARKING THE ALP OF THE TRANSACTIONS ENTERED BY IT WITH ITS AE UNDER THE CONTRACT R&D SEGMENT:- SR. NO. NAME OF COMPARABLE OP/TC (%) FY 2008-09 1 CHOKSI LABORATORIES LTD 23.67 2 TCG LIFESCIENCES LTD 41.33 3 VIMTA LABS LTD 13.04 4 ALPHAGEO (INDIA) LTD 20.25 5 JUBILANT CHEMSYS LTD 27.18 6 GVK BIOSCIENCES PVT. LTD 16.61 7 SIRO CLINPHARM PVT LTD 25.59 8 SYNGENE INTL LTD. 28.87 9 RESEARCH SUPPORT INTL PVT LTD 23.30 10 AURIGENE DISCOVERY TECHNOLOGIES LTD. 16.23 MEAN 23.61 ASSESSEES PLI 17.43 AND ARRIVED AT THE FOLLOWING RESULT IN VIEW OF THE ABOVE DISCUSSIONS, THE INTERNATIONA L TRANSACTIONS ON ACCOUNT OF CONTRACT R&D SERVICES PROVIDED BY THE ASSESSEE TO ITS AE ARE PROPOSED TO BE BENCHMARKED TO DETERMINE THE ALP, BY APPLYING THE MEAN MARGIN OF 23.61% OF THE NINE COMPARABLES FINAL LY SELECTED AND RETAINED FROM THE LIST OF THE NINE COMPARABLES FINALLY SELECTED AND RETAINED FROM THE LIST OF COMPARABLES SUGGESTED BY THE ASSESSEE. ACCORDINGLY, THE ALP OF THE TRANSACTIONS IS COMPUTED AS FOLLOWS: OPERATING REVENUE 36,69,84,790 OPERATING COST(TC) 31,25,25,091 OPERATING PROFIT(OP) 5,44,59,699 OP/TC 17.43% 14. SIMILARLY, ON THE PRODUCT DEVELOPMENT, THE TPO WENT O N THE LOCATION SAVING BENCH MARK AND EXTRACTED THE EXCER PTS OF CLINICAL TRIAL MAGNIFIER PAPER WRITTEN BY MR. JOHAN PE KARLBERG , MD, PHD. OF CLINICAL TRIAL CENTRE, LI KA SHING FACULTY OF MEDICINE, THE UNIVERSITY OF HONG KONG, HONG KONG, P R CHINA , WHO GAVE THE FOLLOWING ANALYSIS. M/S WATSON PHARMA PVT LTD ITA 1423/M/2014 ITA 1565/MUM/2014 7 15. THE TPO, THEREFORE, OBSERVED, ON AN ANALYSIS OF THIS ARTICLE FOLLOWING POINTS AR E WORTH CONSIDERING: THERE IS 50% REDUCTION IN INVESTIGATOR FEES IN INDIA AND OTHER EMERGING CONTTRIES. THUS, BASED ON THE ABOVE, THE OVERALL COST OF RESEARCH & DEVELOPMENT, EXCLUDING RAW MATERIAL, IS ESTIMATED TO BE AROUND 50% OF WHAT IS COSTS IN USA. BASED ON THIS REASONABLE ASSUMPTION, WITH BACKING OF A RESEARCH ARTICLE, THE LOCATION SAVINGS ARE COMPUTED AS FOLLOWS: M/S WATSON PHARMA PVT LTD ITA 1423/M/2014 ITA 1565/MUM/2014 8 AMOUNT IN INR CONTRACT R & D FORMULATION R & D MATERIAL COST 2,63,44,433.17 FACILITY OVERHEADS ALLOCATION ON BATCHES 36,88,019.18 ALLOCATED R & D OVERHEADS 5,24,47,957.71 TOTAL FORMULATION R & D EXPENSES 8,24,80,410.06 API R & D MATERIAL COST 5,23,54,759.51 FACILITY OVERHEADS ALLOCATION ON E BATCHES 83,32,958.76 ALLOCATED R & D OVERHEADS 3,69,48,070.88 TOTAL API R & D EXPENSES 9,76,35,789.15 BEC 7,94,51,778.21 GRAND TOTAL (FORMULATION + API + BEC) 25,95,67,977. 42 COST EXCLUDING MATERIALS 18,08,68,785 COST IN US FOR SIMILAR ACTIVITY (COST IN INDIA IS 50% CHEAPER AS COMPARED TO US) 36,17,37,570 COST SAVINGS 18,08,68,785 LESS : COST DIS - SAVINGS 0 LOCATION SAVINGS 18,08,68,785 THUS, IN THE CASE OF ASSESSEE, AND WATSON GROUP, TH E LOCATION SAVINGS ARISING DUE TO R & D FACILITY LOCA TED IN INDIA IS RS. 18,08,68,785/-, AS THE ASSESSEE COULD NOT SUBMIT ANY DETAILS TO SUBSTANTIATE THAT ANY OF SUCH BENEFIT WOULD BE/WILL BE PASSED ON TO THE CUSTOMERS/DISTRIBUTORS IN USA. IT IS TO BE NOTED THAT BASED ON THE BARGAINING POWE R OF THE AES, THE ENTIRE LOCATION SAVINGS CANNOT BE ATTR IBUTED TO INDIA. IN THE INSTANT CASE, AE REQUIRES THE ASSE SSEE WITH ITS FDA APPROVED R&D SITES ALONG WITH TECHNICA L MANPOWER; WHEREAS THE ASSESSEE REQUIRES E FOR INTRODUCING NEW GENERIC PRODUCTS TO BE LAUNCHED IN US MARKET IN GENERIC DRUGS. AS THE ASSOCIATION IS MUTU ALLY BENEFICIAL, THE SPLIT OF LOCATION SAVINGS BETWEEN A SSESSEE AND ITS AE ARE TREATED AS 50%:50% AND ACCORDINGLY, THE LOCATION SAVINGS OF RS. 18,08,68,785/- IS DIVIDED BETWEEN THE ASSESSEE AND THE AE ON A 50 : 50 BASIS. IN LIGHT OF ABOVE, AN ADJUSTMENT OF RS. 9,04,34,392 /- IS PROPOSED TO THE ARMS LENGTH OF THE PRICE OF THE INTERNATIONAL TRANSACTIONS OF ASSESSEE ON ACCOUNT O F LOCATION SAVINGS. 7. SUMMARY THE TRANSFER PRICING ADJUSTMENTS MADE IN THIS ORDER ARE SUMMARIZED AS UNDER: SR. NO. NATURE OF ADJUSTMENT AMOUNT (RS) 1 LOCATION SAVINGS ARISING IN THE MANUFACTURING SEGME NT 25,19,22,871 2 ADJUSTMENT IN P RODUCT DEVELOPMENT R & D SEGMENT UNDER TNMM 1,93,27,475 3 LOCATION SAVINGS ARISING IN THE PRODUCT DEVELOPMENT R&D SEGMENT 9,04,34,392 TOTAL 36,16,84,738 M/S WATSON PHARMA PVT LTD ITA 1423/M/2014 ITA 1565/MUM/2014 9 16. THE TPO, THEREFORE, SUGGESTED THE TP ADJUSTMENT AT RS. 36,16,84,738/-. THE ADJUSTMENT SO MADE HAS BEEN SUSTAINE D BY THE DRP, HENCE, THE INSTANT APPEAL BEFORE THE ITAT. 17. BEFORE US, THE AR SUBMITTED, I N ORDER TO DETERMINE ARM'S LENGTH PRICE OF INTERNATIONAL TRANSACTION RELATING TO PROVISIO N OF CONTRACT RESEARCH AND DEVELOPMENT SERVICES TO AE, ASSE SSEE CONSIDERED TRANSACTIONAL NET MARGIN METHOD ('TNMM') AS M OST APPROPRIATE METHOD AND SELECTED OPERATING PROFIT TO TOTA L COST ('OP/TC') MARGIN AS PROFIT LEVEL INDICATOR. THE ASSESSEE SE LECTED 6 COMPARABLES IN ITS TRANSFER PRICING STUDY REPORT WITH TH REE YEARS AVERAGE OP/TC MARGIN OF 14.50%. AS AGAINST THIS THE ASSESSEE EARNED OP/TC MARGIN OF 17.43% DURING AY 2009-10. HOWEVER, DURING TRANSFER PRICING ASSESSMENT, THE TPO DIRECTED ASSESSEE TO COMPUTE OP/TC MARGIN OF COMPARABLE S USING SINGLE YEAR DATA (I.E. DATA FOR FINANCIAL YEAR 2008-09). FURTHER, OUT OF 6 COMPARABLES SELECTED BY THE ASSESSEE IN ITS TRANSFER PRICING STUDY REPORT, THE TPO REJECTED 4 COMPA RABLES AND ADDED 8 NEW COMPARABLES. BASED ON THIS APPROACH TP O COMPUTED OP/TC MARGINS OF THE COMPARABLES AT 23.61%. THE DRP CONFIRMED THE APPROACH OF TPO/AO, EXCEPT THAT THE D RP DIRECTED TPO/AO TO EXCLUDE ALPHAGEO LTD. FROM THE SET OF COMPARABLES. CONSEQUENTLY, IT RESULTED IN TRANSFER PRICING ADJUSTMENT OF RS. 2,04,84,562/-. 18. WHILE REFERRING TO THE COMPARABLES ADOPTED BY THE ASSESSEE IN ITS TP STUDY, THE REASONS GIVEN ARE INCLUSION OF DOLPHIN MEDICAL SERVICES LTD IN COMPARABLE SET BEFORE TPO AND DRP, ASSESSEE INTER-ALIA CONTENTED T HAT DOLPHIN MEDICAL SERVICES LTD SELECTED AS COMPARABLE COMPANY BY THE ASSESSEE IN ITS TRANSFER PRICING STUDY REPORT SHOULD NOT BE REJECTED FROM THE SET OF COMPARABLES FOR FOLLOWING REASONS: THE COMPANY PROVIDES TESTING AND CLINICAL TRIAL SERVICES. M/S WATSON PHARMA PVT LTD ITA 1423/M/2014 ITA 1565/MUM/2014 10 FUNCTIONAL PROFILE OF DOLPHIN MEDICAL SERVICES LTD. IS BROADLY SIMILAR TO THOSE RENDERED BY THE ASSESSEE (DRP PB - PAGE 20). FUNCTIONALLY SIMILAR COMPANIES CAN BE TREATED AS COMPARABLE. THIS VIEW IS ALSO SUPPORTED BY RULE 1OB(2) OF THE INCOME TAX RULES, 1962 ('THE RULES') AND ALSO IN PARA 2.62 OF OECD GUIDELINES ISSUED IN JULY 2010 19. TO SUPPORT THE ABOVE CONTENTION, THE AR SUBMITTED AND PLACED RELIANCE ON THE FOLLOWING DECISIONS DOLPHIN MEDICAL SERVICES LTD IS ALSO INTO THE BUSI NESS OF CLINICAL TRIAL SERVICES WHICH IS BROADLY COMPARABLE TO THE ACTIVITY OF CONTRACT RESEARCH AND DEVELOPMENT SERVI CES. THIS IS ALSO REFLECTED IN THE ANNUAL REPORT OF THE DOLPHIN MEDICAL SERVICES LTD FOR FINANCIAL YEAR 2008-09. TH E RELEVANT EXTRACTS OF THE REPORT ARE AS FOLLOWS: THE COMPANY WAS ABLE TO ACHIEVE THIS GOAL AND ENSURED THAT NO LOSS WAS INCURRED ON IT. IN ADDITIO N TO THIS DUE TO GLOBAL RECESSION, THE OUTSOURCING OF CL INICAL TRIALS FROM USA AND EUROPE HAS SLOWED DOWN AND THE COMPANY NEEDS TO EXPLORE LOCAL OPPORTUNITIES ALSO T O FULFIL THE BUSINESS REQUIREMENTS OF THE CR0 VENTURE . THE HUGE MONTHLY RENTALS FOR THIS BUILDING WILL ALS O HE A BURDEN TO THE COMPANY IN CASE OF ANY POTENTIAL PROB LEM IN GETTING THE CLINICAL TRAILS/CR() CONTRACTS FROM THE WEST ... (REFER PAGE NO 311 OF THE PAPER BOOK). THE ABOVE EXTRACTS DEMONSTRATE THAT THEY ARE INTO CLINICAL TRIALS AND CONTRACT RESEARCH (CR0) LIKE TH E ASSESSEE. 11. ANOTHER COMPANY ACCEPTED BY TPO NAMELY SIRO CLINPHARM PVT. LTD. IS ALSO ENGAGED IN CLINICAL RES EARCH & DEVELOPMENT SERVICES APART FROM OTHER SERVICES. T HUS, THE TPO HAS ALSO CONSIDERED BROADLY COMPARABLE COMPANIES. THE RELEVANT EXTRACT OF ANNUAL REPORT OF SIRO CLINPHARM PVT. LTD. IS AS FOLLOWS : 'REVENUE FROM CLINICAL TRIAL RESEARCH ACTIVITIES IS ACCOUNTED FOR AS AND WHEN THE SERVICES ARE RENDERED AS PER THE TERMS AND CONDITIONS OF THE RESPECTIVE AGREEMENTS UNDER THE PROPORTIONATE COMPLETION METHO D. REVENUE RELATING TO THE WORK ACCOMPLISHED IS RECOGNIZED WHEN NO SIGNIFICANT UNCERTAINTY AS TO MEASURABILITY OR COLLECTABILITY EXIST. '(REFER PAGE II OF THE ANNUAL REPORT OF SIRO CLINPHARM PVT. LTD). HENCE, DOLPHIN MEDICAL SHOULD ALSO BE ACCEPTED AS A COMPARABLE. IN NUMBER OF RULINGS HONBLE INCOME TAX APPELLATE TRIBUNAL HAS RECOGNIZED THAT TNMM REQUIRES ONLY BRO AD FUNCTIONAL AND PRODUCT/SERVICES SIMILARITY. THESE R ULINGS ARE CITED BELOW: O GE INDIA TECHNOLOGY CENTRE (P.) LTD. VS. DCIT 30TAXMAN.COM249(BANG) O LLOYDS TSB GLOBAL SERVICES P LTD V DCIT 33TAXMAN.COM259(MUM-TRIB) M/S WATSON PHARMA PVT LTD ITA 1423/M/2014 ITA 1565/MUM/2014 11 O ACIT V SCHAFHORST MARKETING CO LTD 13TAXMAN.COM 104(MUM-TRIB) O TECNIMONT ICB P LTD. V ACIT VS ACIT 24TAXMAN.COM28(MUM-TRIB) O WILLIAM HARE INDIA P LTD VS ACIT (ITA 2071/MDS/2012) 20. THE AR, THEREFORE SUBMITTED THAT IN CASE RESULTS OF DOLPHIN MEDICAL SERVICES LTD. IS INCLUDED, AS INCLUDED BY THE ASSESSEE BEFORE THE TPO/DRP, THEN THE MARGIN SHALL COME WITHIN THE +/-5% RANGE AND THEREFORE NO ADJUSTMENT OF RS. 2,04,84,562/- SHALL BE REQUIRED. TO SUBSTANTIATE, THE AR GAV E THE FOLLOWING COMPARISON SR. NO. NAME OF THE COMPARABLE FINAL COMPARABLES MARGIN AS PER DRPS DIRECTION FINAL + DOLPHIN MEDICAL 1 CHOKSI LABORATORIES LTD 23.67% 23.67% 2 TCG LIFESCIENCES LTD 41.33% 41.33% 3 VIMTA LABS LTD 13.04% 13.04% 4 JUBILANT CHEMSYS LTD 27.18% 27.18% 5 GVK BIOSCIENCES PVT. LTD 16.61% 16.61% 6 SIRO CLINPHARM PVT LTD 25.59% 25.59% 7 SYNGENE INTL LTD. 28.87% 28.87% 8 RESEARCH SUPPORT INTL PVT LTD 23.30% 23.30% 9 AURIGENE DISCOVERY TECHNOLOGIES LTD. 16.23% 16.23% 10 DOLPHIN MEDICAL SERVICES LTD - 7.14% AVERAGE MARGINS OF COMPARABLES 23.98% 22.30% MARGIN OF WATSON PHARMA PVT LTD. 17.43% COMPUTING OF +/-5% RANGE PARTICULARS AMOUNT AMOUNT TOTAL COST A 31,25,25,091 31,25,25,091 ARMS LENGTH OPERATING PROFIT MARGIN B 23.98% 22.30% ARMS LENGTH OPERATING PROFIT C=A*B 7,49,43,517 6,96,80,594 ARMS LENGTH OPERATING INCOME D=A+C 38,74,68,608 38,22,05,685 VALUE OF INTERNATIONAL TRANSACTION E 36,69,84,790 36,69,84,790 DIFFERENCE BETWEEN ARMS LENGTH PRICE OF OPERATING INCOME AND VALUE OF INTERNATIONAL TRANSACTION F=D-E 2,04,83,818 1,52,20,895 5% OF VALUE OF INTERNATIONAL TRANSACTION 1,83,49,240 1,83,49,240 TRANSFER PRICING ADJUSTMENT 2,04,83,818 NIL M/S WATSON PHARMA PVT LTD ITA 1423/M/2014 ITA 1565/MUM/2014 12 21. IN THE ABOVE ANALYSIS, WHAT IS SEEN AND TO BE DECID ED IS WHETHER TO INCLUDE THE RESULTS OF M/S DOLPHIN MEDICAL SERVIC ES LTD. OR NOT. FROM THE FINAL ANALYSIS, EXCEPT FOR M/S DOLPHIN, ALL OTHER COMPARABLES AS TAKEN BY THE TPO ARE ACCEPTED B Y THE ASSESSEE. 22. AS PER THE SUBMISSIONS OF THE AR AND DR, WE FIND THAT THE REASONING GIVEN BY TPO TO EXCLUDE DOLPHIN WAS PRIMARILY ON AN ARGUMENT THAT FUNCTIONING OF DOLPHIN MEDICAL SERVICES LTD. IS DIFFERENT. HOW IT IS DIFFERENT, THE REVENUE AUTHORITIES DID NOT MAKE ELABORATE ANALYSIS. ON THE OTHER HAND, THE AR SUBM ITTED DETAILED REASONING BEFORE THE REVENUE AUTHORITIES AND NOW BEFORE US, AS TO WHY THE ASSESSEE HAD INCLUDED THE RESULTS OF DOLPHIN. 23. THE AR SUBMITTED THAT FUNCTIONAL PROFILE OF DOLPHIN WAS BROADLY SIMILAR TO THAT OF THE ASSESSEE. THE AR SUBMITTE D THAT BESIDES THE OECD GUIDELINES ISSUED IN JULY 2010 IN PARA 2.6 2, AND THE RELEVANT INCOME TAX RULES 1962 I.E. RULE 10B(2) ALSO EMPHASIZE THAT FUNCTIONALLY SIMILAR COMPANIES CAN BE TREATE D AS COMPARABLES. THE AR SUBMITTED THAT DOLPHIN IS INTO THE BUSINESS OF CLINICAL TRIAL SERVICES, WHICH IS BROADLY SIMILAR TO T HE FUNCTION OF THE ASSESSEE. THIS FACT, IT IS NOTED IS NOT COUNTERED BY THE DR, WHO SUBMITTED THAT WHEN TPO AND DRP HAVE EXCLU DED THE RESULTS OF DOLPHIN, THEN IT IS NECESSARY THAT THE RESU LTS SHOULD BE KEPT EXCLUDED. THIS BALD REASONING, IN OUR VIEW CANNOT BE REASONABLE GROUND FOR EXCLUSION. THE COORDINATE BENCHES AT THE ITAT AT MUMBAI, CHENNAI AND BANGALORE HA VE CONSISTENTLY CAME TO THE CONCLUSION THAT FUNCTIONALLY SIMILA R COMPARABLES HAVE TO BE TAKEN. IN GE INDIA TECHNOLOGY CENTRE (P) LTD. VS. DCIT 30 TAXMAN.COM 249 (BANG) IN PARA 34, IT HAS BEEN OBSERVED, M/S WATSON PHARMA PVT LTD ITA 1423/M/2014 ITA 1565/MUM/2014 13 IN GENERAL, CLOSELY COMPARABLE PRODUCTS/SERVICES ARE RE QUIRED IF THE COMPARABLE UNCONTROLLED PRICE (CUP) METHOD IS USED FOR AR MS LENGTH PRICING, THE RESALE PRICE, COST-PLUS METHODS GENERALLY RE QUIRE A LESSER DEGREE OF PRODUCTS OR SERVICES COMPARABILITY AND MAY B E APPROPRIATE IF FUNCTIONAL COMPARABLES ARE AVAILABLE. THE TNMM REQUIRES O NLY BROADLY FUNCTIONAL END PRODUCT/SERVICES COMPARABILITY. IN MANY IN STANCES, IT WILL BE POSSIBLE TO USE IMPERFECT COMPARABLES, E.G. COMPA RABLES FROM ANOTHER INDUSTRY SECTOR, POSSIBLY ADJUSTED TO ELIMINATE O R REDUCE THE DIFFERENCES BETWEEN THEM AND THE CONTROLLED TRANSACTIO N. HENCE, CONTENTION THAT COMPARABLES HAVE TO BE OF R&D COMPANIE S FROM THE SAME INDUSTRY IS NOT APPROPRIATE FOR TNMM. THE AR ALSO PLACED RELIANCE ON THE DECISION OF OF THE COOR DINATE BENCH AT MUMBAI, IN THE CASE OF LLOYDS TSB GLOBAL SERVICES P LTD. V DCIT 33.TAXMAN.COM 259 (MUM-TRIB), WHEREIN IT HAS BE EN OBSERVED IN PARA 22 OF THE ORDER, MOREOVER, GOING BY FUNCTIONAL PROFILE SPECIFICALLY THAT I CRA MANAGEMENT CONSULTANT SERVICES, PRIMA FACIE, IT IS SEEN THAT IT IS ALSO ENGAGED IN THE BUSINESS OF SUPPORT SERVCES LIKE STATEGY RISK MANAGEMENT, PROCESS CONSULTING, TRANSACTION ADVISORY PO LICY AND REGULATION AND DEVELOPMENT CONSULTING. THESE FUNCTIONS AR E, BY AND LARGE, SIMILAR TO THE ASSESSEES ACTIVITIES. THEREFORE, T HIS COMPANY ON MERITS ALSO IS INCLUDABLE IN THE SET OF COMPANIES. IN THE CASE OF ACIT V SCHAFHORST MARKETING CO. LTD. 13 TAXMAN.COM 104 (MUM-TRIB), IN PARA 14 OF THE ORDER, IT HAS B EEN HELD, TNMM IS MORE BROAD BASED AND THE VARIATION IN THE TYP E OF SERVICES, AS IN THIS CASE CAN BE ABSORBED IN THIS METHOD. IN THE CASE OF TECNIMONT ICB P LTD. V ACIT VS ACIT 24 TAXMAN.COM 28( MUM-TRIB) IN PARA 10, IT HAS BEEN OBSERVED, THE ASSESSEE HAD SUBMITTED THAT WHILE IT WAS ENGAGED IN MAINLY EXECUTION OF ENGINEERING SERVICES THROUGH SPECILISED SOF TWARE, ICBC WAS ENGAGED IN MAINLY EXECUTION OF ELECTRICAL AND INSTRUMEN TATION PROJECTS, INCLUDING ONSITE ERECTION AND ALLIED ACTIVITIES WH ICH WERE LABOUR INTENSIVE, BUT THE TRANSACTIONAL NET MARGIN METHO D IS MORE TOLERANT TO DIFFERENCES IN FUNCTIONS. IT CANNOT BE OP EN TO HIM TO CONTEND THAT THERE ARE SLIGHT DIFFERENCES AT FUNCTIONAL LEVEL AND , FOR THAT REASON ALONE, COMPARABLES SHOULD BE REJECTED. THE AR ALSO PLACED RELIANCE ON THE DECISION OF WILLIAM HARE INDIA P LTD. VS ACIT (ITA 2071/MDS/2012), AND SUBMITTED THAT THE DEISION WAS MORE ON THE POINT OF VIEW THAT IN TNMM FUNCTIO NAL COMPARABILITY IS IMPORTANT THEN PRODUCT SIMILARITY. 24. IN THE LIGHT OF THE ABOVE, WE ARE OF THE CONSIDERED O PINION THAT RESULTS OF DOLPHIN SHOULD NOT BE EXCLUDED, AS DOLPHIN IS M/S WATSON PHARMA PVT LTD ITA 1423/M/2014 ITA 1565/MUM/2014 14 FUNCTIONALLY ACCEPTABLE COMPARABLE, WHEREBY, THE RESULTANT PLI SHALL FALL WITHIN SAFE HARBOR OF +/-5 AND NO ADJUSTMENT SHAL L BE REQUIRED. 25. WE THEREFORE, DIRECT THE REVENUE AUTHORITIES TO DELET E THE ADDITION MADE ON CONTRACT RESEARCH AND DEVELOPMENT SEG MENT, MADE AT RS. 2,04,84,562/-. 26. ANOTHER ASPECT INTRINSICALLY ATTACHED TO THE ABOVE GROUND IS THE RISK ADJUSTMENT, NOT TAKEN INTO CONSIDERATION BY T HE TPO/DRP. IT HAD BEEN CONTENDED BEFORE HON'BLE DRP, ASSESSEE CONTENDED THAT ECONOMIC ADJUSTMENT FOR DIFFERENCE IN RISK PROFILE OF ASSESSEE VIS--VIS COMPARABLES SHOULD BE ALLOWED FO R FOLLOWING REASONS: RESEARCH AND DEVELOPMENT ACTIVITIES PERTAINING TO PHARMACEUTICAL INDUSTRY (CLINICAL TRIAL, CHEMICAL RESEARCH, FORMULATION DEVELOPMENT ETC) CAN BE BROAD LY CLASSIFIED UNDER TWO MODELS (A) WHERE RISKS ARE BOR NE BY SERVICE PROVIDER AND (B) WHERE RISKS ARE NOT BOR NE BY SERVICE PROVIDER. BY AND LARGE, ALL INDIAN RESEA RCH AND DEVELOPMENT SERVICE PROVIDERS WOULD FALL UNDER CATEGORY (A) WHEREAS RESEARCH AND DEVELOPMENT SERVI CE PROVIDERS SET BY MULTINATIONAL COMPANIES IN INDIA W OULD FALL UNDER CATEGORY (B) CONTRACT RESEARCH AND DEVELOPMENT SERVICE PROVIDERS SET BY MULTINATIONAL COMPANIES OPERATE ON SHARED SERVICE CONCEPT BASIS. REVENUE MODELS ARE GENERALLY COST PLUS. THEY DO NOT TAKE ANY ENTREPRENEURIAL LIABILITY AND ASSOCIATED R ISKS AS PARENT COMPENSATES FOR ALL COSTS. NO MARKETING ELEMENT INVOLVED. ENTIRE RISK OF RESEARCH AND DEVELOPMENT ACTIVITIES UNDERTAKEN BY ASSESSEE RESIDES WITH THE AE. EVEN IF THE ASSESSEES RESEARCH AND DEVELOPMENT FAILS TO MEET T HE OBJECTIVES, STILL IT WOULD RECOVER THE TOTAL COST O F RESEARCH AND DEVELOPMENT PLUS MARK UP. ASSESSEE PERFORMS AS CAPTIVE SERVICE PROVIDER AND THUS ASSUMES LIMITED RISKS. ACCORDINGLY, RISK ADJUSTMENT SHOULD BE ALLOWED FOR DIFFERENCE IN RISK OF ASSESSEE VIS--VIS COMPARABLE COMPANIES IN INDIA. ON THIS POINT ASSESSEE PLACED RELIANCE ON RULE IOB (1)(D)(III) OF THE RULES AND OECD TRANSFER PRICING GUIDELINES PARA 1.23 ALSO RELIANCE WAS PLACED ON THE DECISION OF PUNE IT AT IN THE CASE OF E-GAINS (ITA NO. 1685/ PN/ 2007) REFERE NCE ALSO MADE TO RULE 10B(3) VI. CONTENTION OF TPO/DRP 17. HON'BLE DRP HELD THAT THE ASSESSEE HAS MADE THE CLAIM FOR RISK ADJUSTMENT IN A ROUTINE MANNER AND N O FACTS OR OTHER MATERIAL HAS BEEN BROUGHT ON RECORD TO I, M/S WATSON PHARMA PVT LTD ITA 1423/M/2014 ITA 1565/MUM/2014 15 SPECIFY SUCH RISK ADJUSTMENT COMPUTATION. ACCORDING LY, PLACING RELIANCE ON FOLLOWING RULINGS, DRP DENIED T O GRANT RISK ADJUSTMENT ( PAGE 7 OF DRP ORDER): THE PRIMARY CONTENTION OF REVENUE WAS COMPUTATION N OT PROVIDED. WILLS PROCESSING SERVICES VS. DCIT(2013) MARUBEM INDIA (P) LTD VS. DCIT INTERRA INFORMATION TECHNOLOGIES INDIA PVT. LTD. VS . DCIT (2013) GENERAL ATLANTIC PVT. LTD. VS. ACIT (2013) VII. ARGUMENT OF THE ASSESSEE BEFORE HON'BLE INCOME TAX APPELLATE TRIBUNAL RISK ADJUSTMENT SHOULD BE ALLOWED 17. IN CASE DOLPHIN MEDICAL SERVICES LTD IS ADDED T O THE COMPARABLES SET THEN THE ASSESSEE'S MARGIN FALLS WI THIN +/- 5% RANGE. THEREFORE IN SUCH CASE RISK ADJUSTMEN T WOULD BECOME ACADEMIC. HOWEVER, ASSESSEE'S ARGUMENT FOR RISK ADJUSTMENT ARE AS FOLLOWS: 19. BEFORE YOUR HONOR'S THE ASSESSEE WOULD LIKE TO SUBMIT THAT RISK ADJUSTMENT SHOULD BE ALLOWED FOR FOLLOWING REASONS: 19.1 ASSESSEE VIDE SUBMISSION DATED 17/09/2013 HAS FILED DETAILED WORKING OF RISK ADJUSTMENT USING CAPM (CAPITAL ASSET PRICING MODEL) METHOD BEFORE HON'BLE DRP (REFER PAGE NO. 314 TO 316 OF THE PAPER BOOK FOR SUBMISSION OF RISK ADJUSTMENT MADE TO HON'BLE D RP) 19.2 RESEARCH AND DEVELOPMENT ACTIVITIES PERTAINING TO PHARMACEUTICAL INDUSTRY (CLINICAL TRIAL, CHEMICAL R ESEARCH, FORMULATION DEVELOPMENT ETC) CAN BE BROADLY CLASSIF IED UNDER TWO MODELS (A) WHERE RISKS ARE BORNE BY SERVI CE PROVIDER AND (B) WHERE RISKS ARE NOT BORNE BY SERVI CE PROVIDER 19.3 BY AND LARGE ALL INDIAN RESEARCH AND DEVELOPME NT SERVICE PROVIDERS WOULD FALL UNDER CATEGORY (A) WHE REAS RESEARCH AND DEVELOPMENT SERVICE PROVIDERS SET BY MULTINATIONAL UNITS WOULD FALL UNDER CATEGORY (B) 19.4 CONTRACT RESEARCH AND DEVELOPMENT SERVICE PROVIDERS SET BY MULTINATIONAL COMPANIES OPERATE ON SHARED SERVICE CONCEPT BASIS. REVENUE MODELS ARE GENERALLY COST PLUS. THEY DOES NOT TAKE ANY ENTREPRENEURIAL LIABILITY AND ASSOCIATED RISKS AS P ARENT COMPENSATES FOR ALL COSTS. NO MARKETING ELEMENT INV OLVED 19.5 ASSESSEE PERFORMS AS CAPTIVE SERVICE PROVIDER AND THUS ASSUMES LIMITED RISKS 19.6 ENTIRE RISK OF RESEARCH AND DEVELOPMENT ACTIVI TIES UNDERTAKEN BY ASSESSEE RESIDES WITH THE AE. EVEN IF THE ASSESSEE'S RESEARCH AND DEVELOPMENT FAILS TO MEET T HE OBJECTIVES STILL IT WOULD RECOVER THE TOTAL COST OF RESEARCH AND DEVELOPMENT PLUS MARK UP 19.7 FURTHER ASSESSEE WOULD LIKE TO PLACE RELIANCE ON RULING IN CASE OF MOTOROLA SOLUTIONS INDIA PRIVATE LIMITED VS. ACIT (ITA NO. 5637/DEL/2011) WHEREIN CAPM METHOD OF COMPUTING RISK ADJUSTMENT HAS BEEN UPHELD BY THE HON'BLE DELHI BENCH OF INCOME TAX APPELLATE TRI BUNAL THUS, RISK ADJUSTMENT SHOULD BE ALLOWED IN THE CASE OF ASSESSEE. M/S WATSON PHARMA PVT LTD ITA 1423/M/2014 ITA 1565/MUM/2014 16 27. ON GOING THROUGH THE RIVAL CONTENTIONS, WE ARE OF THE VIEW THAT ON THE ISSUE OF RISK ADJUSTMENT, DETAILED ANALYSIS H AD BEEN PROVIDED. SINCE WE HAVE ALLOWED THE INCLUSION OF PLI RESULTS OF DOLPHIN, THE ADJUSTMENT FELL WITHIN THE +/-5% RANGE. THE AR SUBMITTED THAT THE ASSESSEE BEING A CAPTIVE SERVICE PROVIDER HENCE UNDERTAKES LESSER RISK AS COMPARED TO COMPARA BLE COMPANIES WHICH UNDERTAKES HIGHER RISK. THIS FACT H AS NOT BEEN DISPUTED BY THE REVENUE AUTHORITIES. MUMBAI BENCH OF INCOME TAX APPELLATE TRIBUNAL IN THE CASE OF SYMATEC (SUP RA) CONTEMPLATES THE STANDARD DEDUCTION OF 5% FOR RISK ADJUSTMENT. HOWEVER, IF NOT 5% THEN RISK ADJUSTMENT UPTO 2.25% WHICH IS THE DIFFERENCE BETWEEN BANK FIXED DE POSIT RATE (WHICH UNDERTAKES LITTLE MORE RISK) AND RISK F REE GOVERNMENT BOND (WHICH UNDERTAKES RISKS) SHOULD BE ALLOW ED. THE AR FURTHER SUBMITTED THAT EVEN IF MINIMUM RISK ADJUST MENT AT RATE OF 1% IS ALLOWED, EVEN THEN THE ASSESSEE SHALL FA LL WITHIN THE TOLERANCE RANGE OF +/-5% AS PER SECOND PROVISO TO SECTION 92C(2) OF THE ACT. 28. EVEN WHEN WE CONSIDER THE RISK ADJUSTMENT, THE ASSESSEES CASE WOULD FALL WITHIN THE TOLERANCE RANGE AND THEREFORE, NO TP ADJUSTMENT WOULD BE CALLED FOR. 29. ADJUSTMENT OF LOCATION SAVING ON CONTRACT MANUFACTUR ING OF RS. 25,19,22,871/- AND CONTRACT R & D OF RS. 9,04,34,392/-. 30. THE ASSESSEE IS ENGAGED IN PROVIDING CONTRACT MANUFACTURING AND CONTRACT RESEARCH & DEVELOPMENT SER VICES TO ITS AE(S). IN CONSIDERATION OF THE SAID SERVICES , THE AE(S) COMPENSATE THE ASSESSEE ON A TOTAL OPERATING COST P LUS ARM'S-LENGTH MARK-UP BASIS. IN THE TRANSFER PRICING ST UDY REPORT PREPARED BY THE ASSESSEE, SEARCH WAS PERFORMED TO IDENTIFY COMPARABLE COMPANIES ENGAGED IN PROVIDING M/S WATSON PHARMA PVT LTD ITA 1423/M/2014 ITA 1565/MUM/2014 17 SIMILAR PHARMACEUTICAL CONTRACT MANUFACTURING AND CONTRACT RESEARCH AND DEVELOPMENT SERVICES IN INDIA. 31. DURING THE COURSE OF PROCEEDING BEFORE THE DRP, TPO/ DRP ACCEPTED THE TNMM METHOD AND ALSO THE COMPARABLES SELE CTED BY ASSESSEE FOR BENCHMARKING CONTRACT MANUFACTURING SER VICES PROVIDED BY THE ASSESSEE TO ITS AES. 32. HOWEVER, THE TPO/DRP CONTENDED THAT THE ASSESSE E OUGHT TO HAVE RECEIVED EXTRA COMPENSATION ON ACCOUN T OF LOCATION SAVINGS OVER AND ABOVE THE MARGINS EARNED BY T HE COMPARABLES. THE TPO/DRP THEN PROCEEDED WITH THE COMPUTATION OF LOCATION SAVINGS BY USE OF ARTICLES APPEARING IN JOURNALS AND WEBSITES. 33. THE TPO/DRP, ALLOCATED THE LOCATION SAVINGS ON AD-HOC BASIS BY DIVIDING THE SAVINGS EQUALLY BETWEEN ASSESSEE A ND ITS AE. BASED ON THIS APPROACH TPO/DRP MADE AN ADJUSTMENT OF RS. 34,23,57,263/- ON ACCOUNT OF LOCATION SAV INGS IN RESPECT TO THE CONTRACT MANUFACTURING SEGMENT AND CONTRACT RESEARCH AND DEVELOPMENT SEGMENT. THE BREAK-UP OF T HE ADJUSTMENT IS AS FOLLOWS: SR. NO. PARTICULARS AMOUNT 1 LOCATION SAVINGS ADJUSTMENT IN RESPECT TO CONTRACT MANUFACTURING SEGMENT 25,19,22,871 2 LOCATION SAVINGS ADJUSTMENT IN RESPECT OF CONTRACT R & D SEGMENT 9,04,34,392 TOTAL LOCATION SAVINGS ADJUSTMENT 34,23,57,263 THE CONTENTIONS OF THE TPO FOR MAKING SUCH AN ADJUSTMEN T ON ACCOUNT OF LOCATIONS SAVINGS ARE THAT THE MAIN AIM OF WATS ON GROUP IS TO REDUCE COST BY TRANSFERRING SEVERAL SOLID DO SAGE PRODUCTS FROM ITS FACILITIES IN US TO WATSON INDIA'S FACILITIES IN GOA, INDIA BY REFERRING TO 10K (PUBLIC DOCUMENT) FILED BY WAT SON INDIA. M/S WATSON PHARMA PVT LTD ITA 1423/M/2014 ITA 1565/MUM/2014 18 34. IN THE PROCEEDINGS BEFORE THE TPO, TPO CALLED FOR THE DETAILS OF COST OF MANUFACTURING IN USA AND ULTIMATE SELLING PRICE TO THE DISTRIBUTORS IN RESPECT OF PRODUCTS MAN UFACTURED IN ASSESSEE'S FACILITY IN INDIA. THESE DETAILS WERE N OT FILED BY ASSESSEE, AS THE ASSESSEE WAS NOT PRIVY TO SUCH DETAILS OF ITS AE. SINCE THE ASSESSEE DID NOT PROVIDE THESE DETAILS, B EING NOT AVAILABLE WITH IT, THE TPO ASSUMED THAT THE LOCATIO N SAVINGS DOES ARISES AND THEREFORE RESULTS INTO INCREASED PR OFITS OR LOCATION RENTS. 35. TPO THEREFORE, RELIED ON US TAX COURT'S CASES ON LOCATION SAVINGS NAMELY SUNDSTRAND CORPORATION AND SUBSIDIARIES VS. COMMISS IONER (FISCAL YEAR 1977-78) COMPAQ COMPUTER CORPORATION AND SUBSIDIARIES VS. COMMISSIONER (FISCAL YEAR 1986-92) ELI LILY & CO VS. US (FISCAL YEAR 1971-72) NATIONAL SEMICONDUCTOR CORPORATION VS. COMM (FISCAL YEAR 1976 TO 1981) BAUSCH & LOMB VS. COMM (FISCAL YEAR 1980) 36. TPO ALSO RELIED ON THE POSITION TAKEN BY INDIA TAX ADMINISTRATION IN UN TP MANUAL CHAPTER 10. 37. FURTHER, TPO HELD THAT THE ASSESSEE DID NOT PRO VE WITH PROPER DOCUMENTARY EVIDENCE THAT WATSON'S COMPETITO RS IN USA HAVING MANUFACTURE BASE IN INDIA, SO THAT ALL T HE COMPETITORS ARE IN SYNC, AND THUS MADE THE BASIS TO RED UCE THE PRICES DUE TO COST SAVINGS ARISING IN INDIA 38. IN ORDER TO ALLOCATE LOCATION SAVINGS, TPO RELI ED UPON A RESEARCH ARTICLE ON THE WEBSITE OF FROST AND SULLIV AN, WRITTEN BY AISWARIYA CHIDAMBARAM IN RESPECT OF CONTRACT MANUFACTURING SEGMENT AND AN ARTICLE 'CLINICAL TRIAL MAGNIFIER VOL. 1:6 JUNE 2008' IN RESPECT OF CONTRACT R&D SEGMENT. 39. BASED ON THESE ARTICLES TPO CONCLUDED THAT, IN CASE OF M/S WATSON PHARMA PVT LTD ITA 1423/M/2014 ITA 1565/MUM/2014 19 CONTRACT MANUFACTURING, COST IN INDIA IS AROUND 40% OF C OST IN USA (EXCLUDING RAW MATERIAL COST) AND IN CASE OF CO NTRACT R&D, THE COST OF R&D IN INDIA (EXCLUDING RAW MATERIAL COST ) IS AROUND 50% OF COST IN USA. 40. TPO THUS COMPUTED LOCATION SAVINGS AND APPORTIONED T HE SAME ON BASIS OF 50:50 RATIO BETWEEN THE ASSESSEE AND ITS AE. HE THEREFORE, SUGGESTED AN ADJUSTMENT OF RS. 25,19,22,871 /-. 41. AGGRIEVED BY THIS ADJUSTMENT/ADDITION, THE ASSESS EE APPROACHED THE DRP. 42. BEFORE DRP, THE ASSESSEE CONTENTED THAT ADJUSTMENT IN RESPECT OF LOCATION SAVINGS IS NOT WARRANTED BECAUSE, THE ASSESSEE HAD COMPLIED WITH THE PROVISIONS OF SECTION 92C(1) AND 92C(2) OF THE ACT FOR DETERMINING ARM'S LENGTH PRICE OF INTERNATIONAL TRANSACTIONS WITH AE. THAT THE TPO ER RED IN DISREGARDING THE TRANSFER PRICING ANALYSIS CARRIED OUT BY THE ASSESSEE AND HAS FAILED TO APPRECIATE THAT IN THE CASE OF THE ASSESSEE NONE OF THE CONDITIONS SET OUT IN SECTION 92C (3) OF THE ACT GET SATISFIED. 43. IT WAS ARGUED THAT THE ASSESSEE DOES NOT HAVE EX CLUSIVE ACCESS TO THE FACTORS THAT MAY RESULT IN THE LOCATION SP ECIFIC ADVANTAGES. AS A RESULT, THERE IS NO SUPER PROFIT T HAT ARISES IN THE ENTIRE SUPPLY CHAIN. 44. IT WAS FURTHER POINTED OUT THAT THE COMPARABLES SELE CTED BY THE ASSESSEE ARE LOCAL INDIAN COMPARABLES, OPERATING I N SIMILAR ECONOMIC CIRCUMSTANCES AS THE ASSESSEE, AND ACCORDINGLY, IF AT ALL, THERE IS ANY BENEFIT ON ACC OUNT OF LOCATION SAVINGS, THAT HAS ALREADY GOT EMBEDDED IN THE OPERATING MARGINS OF THE COMPARABLE COMPANIES. ON THIS PO INT ASSESSEE RELIED ON THE DECISION OF THE COORDINATE BENCH O F THE M/S WATSON PHARMA PVT LTD ITA 1423/M/2014 ITA 1565/MUM/2014 20 ITAT AT DELHI, IN THE CASE OF GAP INTERNATIONAL SOU RCING (INDIA) PVT. LTD. VS ACIT, REPORTED IN 149 TTJ 437 (DE L ITAT) WHEREIN IT WAS HELD THAT: THE ARM'S LENGTH PRINCIPLE REQUIRES BENCHMARKING T O HE DONE WITH CORN PARABLES IN THE JURISDICTION OF TESTED PA RTY AND THE LOCATION SAVINGS, IF ANY, WOULD BE REFLECTED IN THE PROFITABILITY EARNED BY CORN PARABLES WHICH ARE USED FOR BENCHMAR KING THE INTERNATIONAL TRANSACTIONS. THUS IN OUR VIEW, NO SE PARATE /ADDITIONAL ALLOCATION IS CALLED FOR ON ACCOUNT OF LOCATION SAVINGS. 45. THE AR SUBMITTED THAT THE ASSESSEE OPERATED IN PER FECTLY COMPETITIVE MARKET AND DOES NOT HAVE ANY MONOPOLY IN THE MARKET IN WHICH THEY OPERATE. IF IN CASE, THERE EXI STS ANY LOCATION SAVINGS BECAUSE OF MARKET FORCES, THEY WOU LD BE PASSED ON TO THE FINAL CUSTOMER OF WATSON US. (DRP FORM 35A, PAGE 40-43) 46. THE ASSESSEE FURTHER SUBMITTED BEFORE THE DRP TH AT THE ARM'S LENGTH ALLOCATION SHOULD BE DETERMINED BASED O N THE BARGAINING POWER OF THE ASSESSEE AS WELL AS THE AE. I N THE INSTANT CASE, THE AE HAS OPERATIONS ACROSS THE GLOBE AND COULD PROCURE THE FINISHED GOODS / SERVICES EITHER FROM THE ASSESSEE OR ANY OTHER GROUP COMPANIES OR EVEN THIRD PARTIES. THUS, THERE ARE VARIOUS ALTERNATIVES AVAILABLE TO AE, WHICH CONFERS BARGAINING POWER IN HANDS OF THE AE. BESIDES THIS, T HERE ARE NUMEROUS THIRD PARTY CONTRACT MANUFACTURING AND R& D SERVICE PROVIDERS IN INDIA, WHICH COULD PROVIDE BAR GAINING POWER TO THE AE. 47. IN ANY CASE, AS PER OECD GUIDELINES, LOCATION S AVINGS IS NOT AN INTANGIBLE ASSET, TILL SUCH TIME, WHERE SPEC IFIC ADVANTAGES ARE CAPABLE OF BEING OWNED OR CONTROLLED BY A N INDIVIDUAL ENTERPRISE. 48. PROFIT SPLIT METHOD WOULD BE APPLICABLE MAINLY IN INTERNATIONAL TRANSACTION INVOLVING TRANSFER OF UNI QUE M/S WATSON PHARMA PVT LTD ITA 1423/M/2014 ITA 1565/MUM/2014 21 INTANGIBLES, OR WHERE INTERNATIONAL TRANSACTIONS AR E SO INTERRELATED THAT THEY CANNOT BE EVALUATED SEPARATE LY. IN THE INSTANT CASE, LOCATION SPECIFIC ADVANTAGES CANNOT BE CA LLED AS INTANGIBLE ASSET. THUS, THE TPO'S APPROACH OF FOLLOWING INDIA CHAPTER IN UN TP MAUNAL (WHICH IS THE OPINION OF TAX ADMINISTRATION AND NOT THE VIEW OF INDIAN GOVERNMENT) WHIC H ADVOCATES USE OF PROFIT SPLIT METHOD FOR ALLOCATION OF LOCATION SAVINGS IS NOT CORRECT. 49. THE ASSESSEE ALSO ARGUED THAT ONCE IT IS REMUNE RATED AT AN ARM'S LENGTH PRICE BY TAKING REGULAR COMPARAB LES UNDER THIS JURISDICTION THEN NO LOCATION SAVING IS TO BE ATTRIBUTED. THIS ARGUMENT OF THE ASSESSEE WAS REJEC TED BY THE DRP STATING THAT IT CANNOT BE SAID THAT THE ASSE SSEE HAS BEEN REMUNERATED AT THE ARM'S LENGTH PRICE. IN SUPPORT OF ITS CONTENTION ASSESSEE HAS SUBMITTED THAT AS ITS MARGI NS ARE BETTER THAN FULL FLEDGED MANUFACTURERS OF PHARMA IN INDIA O R RESEARCH AND DEVELOPMENT SERVICE PROVIDERS, THE PRICE REALIZED BY IT FROM ITS AE IS AT ARM'S LENGTH. HOWEVER IN TH IS REGARD COMPARING PROFITS IS NOT RELIABLE. AS STATED BY THE ASSESSEE, IT IS SELLING GENERIC PHARMA PRODUCTS TO ITS AE FOR WH ICH THERE ARE NUMBER OF COMPETITORS IN THE MARKET. SO, THE MORE RE LIABLE MEASURE OF THE ARM'S LENGTH PRICE WILL BE SALE PRICE OF OTHER MANUFACTURERS IN USA. 50. DRP FURTHER ASKED ASSESSEE TO PROVIDE INFORMATI ON RELATING TO SALE PRICE PREVAILING IN THE US MARKET IN RESPECT OF THE GOODS EXPORTED BY THE ASSESSEE TO ITS AE. ASSESSE E FURNISHED A REPLY DATED DECEMBER 17, 2013 WHEREIN DETAILS OF ONLY 19 STOCK KEEPING UNITS (SKUS) (OUT OF 79 SKUS) WAS AVAILABLE WITH CUSTOMS DATABASE WHICH COMPRISED OF ONLY 23 CRORES OF ASSESSEE'S EXPORTS. EACH UNIT OF PRODUCT EXPORTED I S TERMED AS STOCK KEEPING UNITS. IT WAS OBSERVED THAT ASSESSEE IS NOT M/S WATSON PHARMA PVT LTD ITA 1423/M/2014 ITA 1565/MUM/2014 22 EARNING ARM'S LENGTH PROFIT AS PRICE TO AE IN 5 OUT OF 19 CASES ARE UNFAVORABLE. NO DETAILS OF COMPARABLE PRICES WA S GIVEN WITH RESPECT TO BALANCE 100 CRORES I.E. BALANCE 60 SKUS. IN THE ABSENCE OF DETAILS OF SALES PRICES WITH RESPECT TO SKUS IT CANNOT BE SAID THAT THE ASSESSEE IS DERIVING ARM'S LEN GTH PRICE FOR GOODS SUPPLIED TO ITS AE. ASSESSEE DID NOT SUBMIT ANY EVIDENCE THAT LOCATION SAVINGS HAS BEEN PASSED ON TO TH E END CUSTOMER. 51. DRP, TO STRENGTHEN ITS CASE, REFERRED TO A TABLE SHO WING PRICES AT WHICH ASSESSEE HAS EXPORTED TO AE AND COM PARABLE RETAIL PRICE OF SAME DRUG IN INDIA WHICH ALSO SHOWS THAT THE SALE PRICE IN INDIA IS HIGHER THAN ASSESSEE'S SALE PRICE IN MOST CASES. IT WAS ALSO OBSERVED THAT THE ASSESSEE F AILED TO PRODUCE RELEVANT INFORMATION IN RESPECT OF THE CONT RACT R&D SERVICES AND THEREBY ATTRIBUTION TO INCOME UNDER TH AT SEGMENT REMAINED UNVERIFIABLE. IT ALSO OBSERVED THAT THE ASSESSEE FAILED TO SHOW THAT THERE WAS NO LOCATION SAVINGS BY NOT PRODUCING DETAILS OF COST OF PRODUCTION OF THE PROD UCTS MANUFACTURED BY ASSESSEE, BEFORE AND AFTER THE TRANSFER OF MANUFACTURING SITE TO INDIA. 52. DRP, ON THESE GROUNDS SUSTAINED THE APPROACH O F TPO AND UPHELD THE ADJUSTMENT ON ACCOUNT OF LOCATION SAVING S. ACCORDING TO THE DRP, CONDITIONS OF SECTION 92C(3) HAVE BEEN FULFILLED AS THE INFORMATION ASKED BY TPO WAS NOT P RODUCED BY THE ASSESSEE. THAT THE ASSESSEE FAILED TO SHOW THAT THERE WAS NO LOCATION SAVINGS BY NOT PRODUCING DETAILS OF COS T OF PRODUCTION OF THE PRODUCTS MANUFACTURED BY ASSESSEE , BEFORE AND AFTER THE TRANSFER OF MANUFACTURING SITE TO INDIA. TH AT THE AE'S ANNUAL REPORT CLEARLY REFERS TO RELOCATION OF MANUF ACTURING FACILITY. M/S WATSON PHARMA PVT LTD ITA 1423/M/2014 ITA 1565/MUM/2014 23 53. THE DRP, THEREFORE, SUSTAINED THE ADDITIONS MAD E BY THE AO/TPO. 54. AGAINST THIS ORDER OF DRP, THE ASSESSEE, NOW IS IN APPEAL BEFORE THE ITAT. 55. BEFORE US THE AR REITERATED THE SUBMISSIONS MAD E BEFORE THE REVENUE AUTHORITIES AND SUBMITTED THAT ADJUSTMENT ON ACCOUNT OF LOCATION SAVINGS IS NOT AT ALL WARRANTED, AS LOCATION SAVING ARISES IN NOT PERFECTLY COMPETITIVE MARKET. IN THE CASE OF THE ASSESSEE THE RE IS NO ECONOMIC RATIONALE FOR LOCATION SAVINGS ADJUSTMENT AS WATSON US FACES STIFF COMPETITION IN THE US MARKET WHICH IS EVIDENT FROM THE ANNUAL REPORT OF WATSON PHARMACEUTICAL INC. (PAGE 10 & 32 OF FORM 10K AND DRP FORM 35A PAGE 41 TO 43). THE RELEVANT EXTRACT OF FORM 10K OF WATSON PHARMACEUTICAL INC. IS AS FOLLOWS: 'WE ACTIVELY COMPETE IN THE GENERIC PHARMACEUTICAL INDUSTRY. REVENUES AND GROSS PROFIT DERIVED FROM TH E SALES OF GENERIC PHARMACEUTICAL PRODUCTS TEND TO FOLLOW A PATTERN BASED ON CERTAIN REGULATORY AND COMPETITIVE FACTORS . AS PATENTS AND REGULATORY EXCLUSIVITY FOR BRAND NAME PRODUCTS EXPIRE OR ARE SUCCESSFULLY CHALLENGED, THE FIRST OFF-PATENT MANUFACTURER TO RECEIVE REGULATORY APPRO VAL FOR GENERIC EQUIVALENTS OF SUCH PRODUCTS IS GENERALLY A BLE TO ACHIEVE SIGNIFICANT MARKET PENETRATION. AS COMPETIN G OFF- PATENT MANUFACTURERS RECEIVE REGULATORY APPROVALS O N SIMILAR PRODUCTS, MARKET SHARE, REVENUES AND GROSS PROFIT T YPICALLY DECLINES, IN SOME CASES DRAMATICALLY. ACCORDINGLY, THE LEVEL OF MARKET SHARE, REVENUES AND GROSS PROFIT ATTRIBUTABL E TO A PARTICULAR GENERIC PRODUCT NORMALLY IS RELATED TO T HE NUMBER OF COMPETITORS IN THAT PRODUCT'S MARKET AND THE TIMING OF THAT PRODUCT'S REGULATORY APPROVAL AND LA UNCH, IN RELATION TO COMPETING APPROVALS AND LAUNCHES. CONSEQUENTLY, WE MUST CONTINUE TO DEVELOP AND INTRO DUCE NEW PRODUCTS IN A TIMELY D COST-EFFECTIVE MANNER TO MAINTAIN OUR REVENUES AND GROSS PROFIT. IN ADDITION TO COMPE TITION FROM OTHER GENERIC DRUG MANUFACTURERS, WE FACE COMPETITI ON FROM BRAND NAME COMPANIES IN THE GENERIC MARKET. MANY OF THESE COMPANIES SEEK TO PARTICIPATE IN SALES OF GENERIC P RODUCTS BY, AMONG OTHER THINGS, COLLABORATING WITH OTHER GENERI C PHARMACEUTICAL COMPANIES OR BY MARKETING THEIR OWN GENERIC EQUIVALENT TO THEIR BRAND PRODUCTS AS AUTHO RIZED GENERICS. OUR MAJOR COMPETITORS IN GENERIC PRODUCTS INCLUDE TEVA PHARMACEUTICAL INDUSTRIES, LTD., MYLAN INC., M ALLINCKRODT M/S WATSON PHARMA PVT LTD ITA 1423/M/2014 ITA 1565/MUM/2014 24 PHARMACEUTICALS GENERICS (A SUBSIDIARY OF COVIDIEN AG) AND SANDOZ.' (REFER PAGE 10 OF FORM 10K) 'REVENUES AND GROSS PROFIT DERIVED FROM THE SALES O F GENERIC PHARMACEUTICAL PRODUCTS TEND TO FOLLOW A PA TTERN BASED ON CERTAIN REGULATORY AND COMPETITIVE FACTORS . AS PATENTS FOR BRAND NAME PRODUCTS AND RELATED PRODUCT S EXCLUSIVITY PERIODS EXPIRE. THE FIRST GENERIC MANUF ACTURER TO RECEIVE REGULATORY APPROVAL FOR GENERIC EQUIVALENTS OF SUCH PRODUCTS IS GENERALLY ABLE TO ACHIEVE SIGNIFICANT M ARKET PENETRATION. AS COMPETING OFF-PATENT MANUFACTURERS RECEIVE REGULATORY APPROVALS ON SIMILAR PRODUCTS OR AS BRAND MANUFACTURERS LAUNCH GENERIC VERSIONS OF SUCH PRODUCTS (FOR WHICH NO SEPARATE REGULATORY APPROVAL IS REQUIRED), MARKET SHARE, REVENUES AND GROSS PROFIT TYPICALLY DECLINE, IN SOME CASES DRAMATICALLY. ACCORDINGLY, T HE LEVEL OF MARKET SHARE, REVENUE AND GROSS PROFIT ATTRIBUTABLE TO A PARTICULAR GENERIC PRODUCT NORMALLY IS RELATED TO T HE NUMBER OF COMPETITORS IN THAT PRODUCT'S MARKET AND THE TIM ING OF THAT PRODUCT'S REGULATORY APPROVAL AND LAUNCH. CONSEQUENTLY, WE MUST CONTINUE TO DEVELOP AND INTRODUCE NEW PRODUCTS IN A TIMELY AND COST-EFFECTI VE MANNER TO MAINTAIN OUR REVENUES AND GROSS MARGINS. ADDITIONALLY, AS NEW COMPETITORS ENTER THE MARKET, THIS MAY INCREASE PRICING PRESSURE ON CERTAIN PRODUCTS, WHIC H WOULD RESULT IN LOWER GROSS MARGINS. THIS IS PARTICULARLY TRUE IN THE CASE OF CERTAIN ASIAN AND OTHER OVERSEAS COMPETITOR S, WHO MAY BE ABLE TO PRODUCE PRODUCTS AT COSTS LOWER THAN THE COSTS OF DOMESTIC MANUFACTURERS. IF WE EXPERIENCE SUBSTANTIA L COMPETITION FROM ASIAN OR OTHER OVERSEAS COMPETITOR S WITH LOWER PRODUCTION COSTS, OUR PROFIT MARGINS WILL SUFFER. (PAGE 32 OF FORM 10K) MANY OF THE WATSONS PEER GROUP COMPANIES IN NORTH AMERICA HAVE THEMSELVES OUTSOURCED MANUFACTURING AND/OR RES EARCH FACILITIES IN INDIA OR CHINA. THIS IS EVIDENT FROM THE FORM 10K OF PEER GROUP COMPANIES I.E. MYLAN INC. AND TEVA PHARM ACEUTICAL INDUSTRIES LTD. 56. ACCORDING TO THE AR, NEITHER WATSON US (I.E. AE ) NOR THE ASSESSEE HAVE ANY MONOPOLY IN THE MARKET IN WHIC H THEY OPERATE AND NEITHER THE ASSESSEE HAS GENERAL ACCESS T O ALL THE LOCATION SPECIFIC ADVANTAGES. ACCORDINGLY, IF THERE EXIS TS ANY LOCATION SAVINGS BECAUSE OF MARKET FORCES, THEY WOULD BE PASSED ON TO THE ULTIMATE CUSTOMERS OF WATSON US (I.E. AE). ON THIS POINT THE AR RELIED ON THE DECISION OF HON'BLE DELHI IN COME TAX APPELLATE TRIBUNAL IN THE CASE OF GAP INTERNATI ONAL SOURCING (INDIA) PVT. LTD VS. ACIT (2012) 149 TTJ 437 (DEL ITAT) AT PARA 9.2 (VII) PAGE 43 HELD, THE INTENT OF SOURCING FROM LOW COST COUNTRIES FOR A MANUFACTURER/RETAILER IS TO SURVIVE IN STIFF COMPETITION BY PROVIDING A LOWER COST TO ITS END-CUSTOM ERS. M/S WATSON PHARMA PVT LTD ITA 1423/M/2014 ITA 1565/MUM/2014 25 GENERALLY, THE ADVANTAGE OF LOCATION SAVINGS IS PASSED ONTO THE END-CUSTOMER VIA A COMPETITIVE SALES STRATEGY....'. THE AR TO CLARIFY THAT NO ADDITIONAL EVIDENCE HAD BEEN SUBMITTED, SUBMITTED THAT THE 10K DOCUMENT, AS REFERRED TO IN T HE ARGUMENTS, IS A PUBLIC DOCUMENT AND THEREFORE, IT CANNOT BE TAKEN TO BE ADDITIONAL EVIDENCE. 57. THE AR REITERATED THAT IN ANY CASE, BENEFIT ON ACCOUNT OF LOCATION SAVINGS (IF ANY) IS FACTORED IN THE PROFIT MARGIN OF THE LOCAL COMPARABLES SELECTED FOR BENCHM ARKING THE INTERNATIONAL TRANSACTION. THE AR PLACED RELIANCE ON CASE OF GAP INTERNATIONAL (SUPRA) AND ACTION 8: GUIDANCE O N TRANSFER PRICING ASPECTS OF INTANGIBLES (OECD/G20 BASE EROSION AND PROFIT SHIFTING PROJECT). 58. AFTER HEARING THE DETAILED ARGUMENTS FROM EITHE R SIDE, AND AFTER GOING THROUGH THE EVIDENCE AND THE CASE C ITED BEFORE US, WE ARE OF THE OPINION, THAT THE ASSESSEE AS WELL AS THE AE OPERATES IN A PERFECTLY COMPETITIVE MARKET AND THE ASSESSEE DOES NOT HAVE EXCLUSIVE ACCESS TO THE FACTO RS THAT MAY RESULT IN THE LOCATION SPECIFIC ADVANTAGES. AS A RE SULT, THERE IS NO SUPER PROFIT THAT ARISES IN THE ENTIRE SUPPLY CHA IN. THUS THERE IS NO UNIQUE ADVANTAGE TO THE ASSESSEE OVER COM PETITORS. WE ARE BASING OUR OPINION ON THE FACT THAT THE REVENUE AUTHORITIES WERE NOT ABLE TO SUBSTANTIATE THE ADJUSTMEN TS MADE EITHER FROM THE PRESENT DAY SCENARIO OR ANY AUTHENTICAT ED AND GLOBALLY MATERIAL. 59. THE FACTUM OF NON SUBMISSION OF DETAILS BECAME THE SUBJECT MATTER OF DISPUTE IN THE CASE OF UCB INDIA (P) LT D. VS ACIT, REPORTED IN 124 TTJ 289, WHEREIN THE SPECIAL BENCH HELD, THE ASSESSEES CASE IS THAT IT HAS NEVER PREPARED T HE RECORDS AS LAID DOWN BY RULE 10D(1)(F). WHEN NO SUCH ANALYSIS OR ESTIMATES M/S WATSON PHARMA PVT LTD ITA 1423/M/2014 ITA 1565/MUM/2014 26 OR FORECASTS OR BUDGETS ARE PREPARED BY THE ASSESSE E FOR ITS BUSINESS, NON FURNISHING OF SUCH NON EXISTENT RECORD S CANNOT LEAD TO A CONCLUSION THAT THE ASSESSEE HAS NOT FURNISHED THE INFORMATION AND DOCUMENTS PRESCRIBED UNDER R. 10(D(1)( F). THE MAINTENANCE OF THESE RECORDS IS PROCEDURAL AND NON MAINTENANCE OF THE SAME IS NOT SUCH THAT IT WOULD AFFECT THE DETE RMINATION OF ALP... THE SPECIAL BENCH IN THIS CASE NOTED THAT THE RELEVANT PROVISIONS HAVE USED THE WORDS IF ANY , WHICH MEANS THAT NON SUBMISSION OF RECORDS CANNOT FORM THE BASIS OF MAKING ADJUSTMENTS IN THE ALP ON BALD ASSERTIONS. IN SUCH A CA SE, WE ARE OF THE OPINION THAT ONE OF THE REASONS FOR MAKING ALP ADJUSTMENT IS WITHOUT ANY BASIS. 60. WE FIND THAT THE COMPARABLES SELECTED BY THE ASSESSEE TO DETERMINE ARM'S LENGTH PRICE OF TRANSAC TION RELATING TO CONTRACT MANUFACTURING AND CONTRACT RESEARCH AND DEVELOPMENT ARE LOCAL INDIAN COMPARABL ES OPERATING IN SIMILAR ECONOMIC CIRCUMSTANCES AS THE ASSESSEE. THIS ACCORDING TO US ARE IN LINE WITH THE DECISION OF COORDINATE BENCH OF THE ITAT, DELHI, IN THE CASE OF GAP INTERNATIONAL SOURCING (INDIA) PVT. LTD. (SUPRA) , WHEREIN THE TRIBUNAL HELD, 'THE ARM'S LENGTH PRINCIPLE REQUIRES BENCHMARKING T O BE DONE WITH COMPARABLES IN THE JURISDICTION OF TESTED PART Y AND THE LOCATION SAVINGS, IF ANY, WOULD BE REFLECTED IN THE PROFITABILITY EARNED BY COMPARABLES WHICH ARE USED FOR BENCHMARKI NG THE INTERNATIONAL TRANSACTIONS. THUS IN OUR VIEW, NO SE PARATE/ ADDITIONAL ALLOCATION IS CALLED FOR ON ACCOUNT OF L OCATION SAVINGS. 61. FURTHER, OECD AND G20 IN ACTION 8: GUIDANCE ON TRANSFER PRICING ASPECTS OF INTANGIBLES WHICH IS PART OF BASE EROSION AND PROFIT SHIFTING PROJECT, HAS PROVIDED GUIDANCE ON ISSUE OF LOCATION SAVINGS AND CONCLUDED THAT WHERE LOCAL MARKET COMPARABLES ARE AVAILABLE SPECIFIC ADJUSTMENT FOR LOCATION SAVING IS NOT REQUIRED. ALL THE G20 COUNTRIES HAVE GIVE THEIR CONCURRENCE TO THIS POSITION AND INDIA IS PAR T OF G20 M/S WATSON PHARMA PVT LTD ITA 1423/M/2014 ITA 1565/MUM/2014 27 COUNTRIES. RELEVANT EXTRACTS OF ACTION 8 ARE AS FOLLOWS: '1.83 WHERE THE FUNCTIONAL ANALYSIS SHOWS THAT LOCA TION SAVINGS EXIST THAT ARE NOT PASSED ON TO CUSTOMERS OR SUPPLI ERS, AND WHERE COMPARABLE ENTITIES AND TRANSACTIONS IN THE L OCAL MARKET CAN BE IDENTIFIED, THOSE LOCAL MARKET COMPAR ABLES WILL PROVIDE THE MOST RELIABLE INDICATION REGARDING HOW THE NET LOCATION SAVINGS SHOULD BE ALLOCATED AMONGST TWO OR MORE ASSOCIATED ENTERPRISES. THUS, WHERE RELIABLE LOCAL MARKET COMPARABLES ARE AVAILABLE AND CAN BE USED TO IDENTI FY ARM'S LENGTH PRICES, SPECIFIC COMPARABILITY ADJUSTMENTS FOR LOCATION SAVINGS SHOULD NOT BE REQU IRED. 62. FURTHER, WE ARE OF THE OPINION THAT, THE CALCULATION BA SED ON LOCATION SAVINGS BY TPO IS ALSO INFIRM, AS IT IS BASED ON ASSUMPTIONS AND NOT IN ACCORDANCE WITH THE PROVISIONS O F THE INCOME TAX ACT, 1961, BECAUSE FOR COMPUTING COST SAVING S TPO HAS RELIED ON AN ARTICLE PUBLISHED IN YEAR 2012 WHEREAS ASSESSEE'S CASE IS FOR FINANCIAL YEAR 2008-09. THER EFORE INTERPOLATION CANNOT BE TAKEN INTO CONSIDERATION, U NLESS SPECIFIED. 63. FOR DETERMINING COST OF PRODUCTION (IN CASE OF CONTRACT MANUFACTURING SEGMENT) AND COST OF CONDUCTING RESEARCH A ND DEVELOPMENT ACTIVITIES (IN CASE OF CONTRACT RESEARCH AND DEVELOPMENT SEGMENT) IN DEVELOPED/WESTERN COUNTRIES , TPO RELIED ON FOLLOWING ARTICLES: SR. NO. RELEVANT SEGMENT OF WATSON INDIA ARTICLE RELIED UPON 1 CONTRACT MANUFACTURING SEGMENT INDIAN GENERIC PHARMACEUTICALS MARKET-A SNAPSHOT (SOURCE:- HTTP://WWW.FROST.COM/SUBLIB/DISPLAY- MARKETINSIGHT-TOP.DOID=264038078) 2 CONTRACT R&D SEGMENT CLINICAL TRIAL MAGNIFIER VOL . 1:6 JUN 2008 (SOURCE: WWW.CLINICALTRIAL MAGNIFIER.COM 64. AT THE OUTSET, THE ABOVE RELIANCE COULD NOT BE TREAT ED AS ACCEPTABLE, BECAUSE, THESE WERE WEB ARTICLES AND NOT ACC EPTED BY ANY FORUM. IN ANY CASE, IF AT ALL, THIS ASPECT HAS TO BE CONSIDERED, THEN IT HAS TO BE CONSIDERED IN THE CONTEXT OF THE AE AND NOT THE ASSESSEE, BECAUSE THE TESTED PARTY IS TH E M/S WATSON PHARMA PVT LTD ITA 1423/M/2014 ITA 1565/MUM/2014 28 ASSESSEE AND THE INTERNATIONAL TRANSACTION ENTERED INTO BY THE ASSESSEE HAS TO BE TESTED BY COMPARING THE SAME WITH UNCONTROLLED, UNRELATED COMPARABLE TRANSACTION , AS HELD IN THE CASE OF SYSCOM CORPORATION LTD. VS ACIT , REPORTED IN 35 TAXMANN.COM 600 (MUMBAI - TRIB). 65. THE TESTED PARTY IS THE ASSESSEE AND THE INTERNAT IONAL TRANSACTION ENTERED INTO BY THE ASSESSEE HAS TO BE TE STED BY COMPARING THE SAME WITH UNCONTROLLED, UNRELATED COMPARABL E TRANSACTION ONLY AND NOT IN THE CONTEXT OF AE. THE ISSUE OF COMPARABILITY ANALYSIS, WAS DEALT WITH BY THE COORD INATE BENCH OF THE MUMBAI ITAT, IN THE CASE OF LLOYDS TSB GLOBAL SE RVICES (P) LTD., REPORTED IN 33 TAXMANN.COM 259, WHEREIN THE RA TIO LAID DOWN WAS, FOR CARRYING OUT COMPARABILITY ANALYSIS, IT IS TO B E SEEN AS TO WHETHER COMPARABLE COMPANY IS COMPARABLE HAVI NG REGARD TO CHARACTERISTIC OF PROPERTY AND SERVICES, FUNCTIONS P ERFORMED, ASSETS USED AND RISK ASSUMED . 66. THE CONCEPT OF TRANSFER PRICING IS BASED ON THE PRI NCIPLE THAT INSTEAD OF ENTERING INTO A TRANSACTION WITH RELAT ED PARTY, IF THE ASSESSEE HAD ENTERED INTO A SIMILAR TRANSACTION W ITH UNRELATED PARTY, WHAT WOULD HAVE BEEN THE PRICES OF SAID TRANSACTION BETWEEN THE ASSESSEE AND UNRELATED PARTY. THE COMPARISON IS ALWAYS IN THE CONTEXT OF THE EFFECT OF THE R ELATED PARTY TRANSACTION AND UNRELATED PARTY TRANSACTION IN THE HANDS OF THE ASSESSEE. THEREFORE, THE FINANCIAL RESULTS OF THE A E ARE NOT AT ALL RELEVANT FOR THE PURPOSE OF DETERMINATIO N OF ARM'S LENGTH PRICE IN RELATION TO THE INTERNATIONAL TRANSACTION EN TERED INTO BY THE ASSESSEE. THIS RATIO LAID DOWN BY THE CO-ORDI NATE BENCH AT T MUMBAI IN THE CASE OF SYSCOM CORPORATION LTD. VS. ACIT, REPORTED IN 35 TAXMANN.COM 600 (MUMBAI - TRIB. ). RELEVANT EXTRACT OF THE SYSCOM CORPORATION LTD. (SUP RA) IS AS FOLLOWS: M/S WATSON PHARMA PVT LTD ITA 1423/M/2014 ITA 1565/MUM/2014 29 'IN THE GROUND NO. 14 THE ASSESSEE HAS RAISED THE G ROUND THAT THE AE OF THE ASSESSEE HAS BEEN CONSISTENTLY SUFFERING FROM O PERATIONAL LOSS AND THEREFORE NO ADJUSTMENT CAN BE MADE IN RESPECT OF INTERNATIONAL TRANSACTION. WE HAVE HEARD THE LD. AR AS WELL AS TH E LD. DR AND CONSIDERED THE RELEVANT MATERIAL ON RECORD. UNDER T HE TRANSFER PRICING REGULATION/PROVISIONS THE TESTING PARTY IS THE ASSE SSEE AND THE INTERNATIONAL TRANSACTION ENTERED INTO BY THE ASSES SEE HAS TO BE TESTED BY COMPARING THE SAME WITH UNCONTROLLED, UNRELATED COMPARABLE TRANSACTION, THEREFORE, THE PRICE OF INTERNATIONAL TRANSACTION IN THE HAND OF THE AE OF THE ASSESSEE IS ABSOLUTELY IRRELEVANT. THE CONCEPT OF TRANSFER PRICING BASED ON THE PRINCIPLE THAT INSTEA D OF ENTERING INTO A TRANSACTION WITH RELATED PARTY IF THE ASSESSEE HAD ENTERED INTO A SIMILAR TRANSACTION WITH UNRELATED PARTY WHAT WOULD HAVE BEEN THE PRICES OF SAID TRANSACTION BETWEEN THE ASSESSEE AND UNRELATED PARTY. THE COMPARISON IS ALWAYS IN THE CONTEXT OF THE EFFE CT OF THE RELATED PARTY TRANSACTION AND UNRELATED PARTY TRANSACTION A T THE HAND OF THE ASSESSEE. THEREFORE, THE FINANCIAL RESULTS OF T HE AE ARE NOT AT ALL RELEVANT FOR THE PURPOSE OF DETERMINATION OF ARM'S LENGTH PRICE IN RELATION TO THE INTERNATIONAL TRANSACTION ENTERED INTO BY THE ASSESSEE. ACCORDINGLY, WE DO NOT FIND ANY MERIT IN THE GROUND RAISED BY THE ASSESSEE. THE SAME IS DISMISSED. 67. THUS, ONCE THE TNMM METHOD IS ACCEPTED AS METHOD O F CONSIDERING ASSESSEE AS A TESTED PARTY THEN ANY BENEFIT/ADVANTAGE ACCRUING TO AE IS IRRELEVANT IF THE PLI IS WITHIN THE RANGE OF COMPARABLES. 68. THE FACTS IN THE DECISION RELIED UPON BY THE TP O, ARE COMPLETELY DIFFERENT AS COMPARED TO ASSESSEE'S CASE AS THESE CASE LAWS WERE RELATED TO THE FISCAL YEARS (1 970'S AND 1980'S) IN WHICH ECONOMIC SCENARIO WAS COMPLETELY DIFFERENT BUT IN SO FAR AS PRESENT SCENARIO IS CONCERNED, PRIMITIVE. FURTH ER IN ABOVE MENTIONED CASE, TAXPAYERS WERE NOT OPERATING IN PERFECTLY COMPETITIVE MARKET UNLIKE IN THE CASE OF THE ASSESSEE. SUMMARY BRINGING OUT DIFFERENCE IN FACTS IS PROVIDED BELOW: M/S WATSON PHARMA PVT LTD ITA 1423/M/2014 ITA 1565/MUM/2014 30 M/S WATSON PHARMA PVT LTD ITA 1423/M/2014 ITA 1565/MUM/2014 31 M/S WATSON PHARMA PVT LTD ITA 1423/M/2014 ITA 1565/MUM/2014 32 69. WE ALSO TAKE INTO CONSIDERATION THE RELIANCE PLACED ON UN TP MANUAL BY THE TPO, ABOUT WHICH WE ARE CONVINCED WAS INCORRECT RELIANCE, BECAUSE UN MANUAL, IS BASICALLY VIEW OF INDIAN TAX ADMINISTRATION AND IS NOT BINDING ON APPELLATE AUTHORITIES, THE RELEVANT EXTRACT OF WHICH IS GIVEN BELOW: 'CONSENSUS HAS BEEN SOUGHT AS FAR AS POSSIBLE, IT W AS CONSIDERED MOST IN ACCORD WITH A PRACTICAL MANUAL T O INCLUDE SOME ELEMENTS WHERE CONSENSUS COULD NOT HE REACHED, AND IT FOLLOWS THAT SPECIFIC VIEWS EXPRESSED IN THIS MANUA L SHOULD NOT HE ASCRIBED TO ANY PARTICULAR PERSONS INVOLVED IN I TS DRAFTING. CHAPTER 10 IS DIFFERENT FROM OTHER CHAPTERS IN ITS CONCEPTION, HOWEVER. IT REPRESENTS AN OUTLINE OF PARTICULAR COU NTRY ADMINISTRATIVE PRACTICES AS DESCRIBED IN SOME DETAI L BY REPRESENTATIVES FROM THOSE COUNTRIES, AND IT WAS NO T CONSIDERED FEASIBLE OR APPROPRIATE TO SEEK A CONSENSUS ON HOW SUCH COUNTRY PRACTICES WERE DESCRIBED. CHAPTER 10 SHOULD BE READ WIT/I THAT DIFFERENCE IN MIND. 70. IN FACT IN ACTION 8: GUIDANCE ON TRANSFER PRICING ASPECTS OF INTANGIBLES ISSUED BY OECD AND G20 STATES THAT WHERE LOCAL MARKET COMPARABLES ARE AVAILABLE SPECIF IC ADJUSTMENT FOR LOCATION SAVING IS NOT REQUIRED. G20 COUNTRIES HAVE ALSO GIVE THEIR CONCURRENCE TO THIS P OSITION AND INDIA IS PART OF G20 COUNTRIES. 71. THIS, IN ANY CASE IS INCONSISTENT WITH TPO'S OWN APPR OACH FOR ASSESSMENT YEAR 2008-09. 72. IN ASSESSMENT YEAR NO ADJUSTMENT HAS BEEN MADE BY THE TPO ON ACCOUNT OF ALLEGED LOCATION SAVINGS ON CONTR ACT MANUFACTURING AND CONTRACT RESEARCH AND DEVELOPMENT SEGMENT OF THE ASSESSEE. AS THE FACTS IN ASSESSMENT YE AR 2009- 10 ARE SAME AS IN THE CURRENT YEAR, I.E. 2008-09, NO LO CATION SAVING ADJUSTMENT SHOULD BE ALLOWED TO BE MADE. ON T HIS POINT ASSESSEE WOULD LIKE TO PLACE RELIANCE ON THE FOLLOWING DECISIO NS WHEREIN IT HAS BEEN HELD THAT IN THE ABSENCE OF ANY MATE RIAL CHANGE IN THE CIRCUMSTANCES NO DIFFERENT VIEW CAN TAKEN B Y ASSESSING OFFICER THEN TAKEN IN EARLIER YEAR. M/S WATSON PHARMA PVT LTD ITA 1423/M/2014 ITA 1565/MUM/2014 33 MCCANN ERICKSON INDIA PVT LTD (ITA NO. 5871/DEL/201 1) BRINTONS CARPETS ASIA P LTD. VS DCIT (ITA NO. 1296/ PUNE/2008) 73. THE ISSUE GETS STRENGTH FROM THE DECISION OF THE COOR DINATE BENCH AT MUMBAI IN THE CASE OF TECNIMONT ICB (P) LTD. VS ADD. CIT, REPORTED IN 24 TAXMANN.COM 28, WHEREIN THE THIRD MEMBER DECISION HELD, NET PROFIT MARGIN REALIZED FROM A TRANSACTION WITH AN AE CANNOT BE TAKEN AS A COMPARABLE BEING INTERNAL COMPARABLE FOR COMPUTATION OF ALP OF AN INTERNATIONA L TRANSACTION WITH ANOTHER AE EVEN THOUGH SAID NET MARGIN FROM A TRANSACTION WITH AE IS FOUND AND ACCEPTED AS ALP. 74. LAST BUT NOT THE LEAST, THE TPO HAS BASED HIS COMP UTATION ON A METHOD, WHICH IS NOT ASCRIBED BY THE PROVISIONS OF TH E ACT. NO DOUBT, CLAUSE (F) OF SECTION 92C(1) SAYS, SUCH OTHER METHOD AS MAY BE PRESCRIBED BY THE BOARD . FOR ADOPTION OF THIS METHOD, THE TPO HAS TO TAKE CARE THAT THE METHOD HAS TO BE PRESCRIBED BY THE BOARD, WHICH CAN DO SO THROUGH RELEVANT RULES. EV EN RELEVANT RULES DO NOT TALK ABOUT THE METHOD ADOPTED BY THE REVENUE AUTHORITIES. THIS, IN UNISON WITH THE DECISION OF THE COORDINATE BENCH ON INCORRECT METHOD OF COMPUTATION, WE ARE OF THE VIEW THAT THE TPO/AO AND DRP ERRED IN MAKING THE ADJUSTMENT ON ACCOUNT OF LOCATION SAVINGS. 75. WE, THEREFORE, SET ASIDE THE ORDER OF THE DRP AND DIRE CT THE AO TO DELETE THE ADDITION. 76. GROUND NO. 6 PERTAIN TO DIRECTING THE REVENUE AUTH ORITIES TO MAKE ADJUSTMENTS, TAKING INTO ACCOUNT THE SAFE HARBO R RANGE OF +/- 5%. SINCE THE SAFE HARBOR RANGE HAS BEEN ALLOWED B Y THE LEGISLATURE ITSELF, THE REVENUE AUTHORITIES ARE BOUND TO FOLLOW THE SAME. 77. SINCE WE HAVE SET ASIDE THE ORDER OF THE DRP, WE, DIRE CT THE AO TO CONSIDER THE SAFE HARBOR ZONE AND COMPUTE TH E INCOME M/S WATSON PHARMA PVT LTD ITA 1423/M/2014 ITA 1565/MUM/2014 34 ACCORDINGLY. 78. GROUND NO. 6, IS THEREFORE, TREATED AS ALLOWED. 79. GROUNDS NO. 4 & 5 PERTAIN TO DISALLOWING INTEREST INCOME OF RS. 2,10,65,566/- FOR THE PURPOSES OF COMPUTING DEDUCTION U/S 10B. 80. THE AO FOUND THAT THE ASSESSEE HAD TAKEN INTO CONSIDERATION THE INCOME GENERATED AS INTEREST AND SALE OF SCRAP , FOR THE PURPOSES OF COMPUTATION OF DEDUCTION U/S 10B. HE TREATED THE SAME AS INCOME FROM OTHER SOURCES, BEING N OT DERIVED FROM THE OPERATIONS OF BUSINESS. HE RELIED ON VARIO US DECISIONS, WHICH WERE COUNTERED BY THE ASSESSEE, BUT THE AO EXCLUDED THE INCOME FROM INTEREST AND SALE OF SCRAP FROM T HE COMPUTATION. 81. AGAINST THIS, THE ASSESSEE ALONG WITH TP ISSUES APPROACHED THE DRP, WHO SUSTAINED THE DISALLOWANCE MADE BY THE AO. 82. AGAINST THESE DISALLOWANCES, THE ASSESSEE IS NOW BEFOR E THE ITAT. 83. BEFORE US, THE AR SUBMITTED THAT THE INSTANT ISSUE IS COVERED BY THE DECISION IN THE CASE OF MARAL OVERSEAS LT D. VS ADD. CIT, REPORTED IN 16 ITR 565 (TRIB-INDORE) AND ALSO BY THE BANGALORE BENCH OF THE ITAT IN THE CASE OF GE INDIA TECH NOLOGY CENTER (P) LTD. VS DDIT, REPORTED IN 30 TAXMANN.COM 249 (B ANG) AND IS NOW COVERED BY THE HONBLE KARNATAKA HIGH COUR T IN THE CASE OF CIT VS MOTORORALA INDIA ELECTRONICS (P) LTD. REPORT ED IN 265 CTR 94, WHEREIN IT HAS BEEN OBSERVED, FOR THE PURPOSES OF SUB-SECTION (1), THE PROFITS DERIVED FROM EXPORT OF ARTICLES OR THINGS OR COMPUTER SOFTWARE S HALL HE THE AMOUNT WHICH BEARS TO THE PROFITS OF THE BUSINESS O F THE UNDERTAKING, THE SAME PROPORTION AS THE EXPORT TURN OVER IN RESPECT OF SUCH ARTICLES OR THINGS OR COMPUTER SOFT WARE BEARS M/S WATSON PHARMA PVT LTD ITA 1423/M/2014 ITA 1565/MUM/2014 35 TO THE TOTAL TURNOVER OF THE BUSINESS CARRIED ON BY THE UNDERTAKING. BY FINANCE ACT, 2001, WITH EFFECT FROM 01.04.2001, THE PRESENT SUBSECTION (4) IS SUBSTITUTED IN THE PLACE OF OLD SUBSECTION (4). NO DOUBT SUBSECTION 10(B) SPEAKS AB OUT DEDUCTION OF SUCH PROFITS AND GAINS AS DERIVED FROM 100% EOU FROM THE EXPORT OF ARTICLES OR THINGS OR COMPUT ER SOFTWARE. THEREFORE, IT EXCLUDES PROFIT AND GAINS FROM EXPORT OF ARTICLES. BUT SUBSECTION (4) EXPLAINS WHAT IS THE PROFIT DERI VED FROM EXPORT OF ARTICLES AS MENTIONED IN SUBSECTION (1). THE SUBSTITUTED SUB-SECTION (4) SAYS THAT PROFITS DERIV ED FROM EXPORT OF ARTICLES OR THINGS OR COMPUTER SOFTWARE S HALL BE THE ACCOUNT WHICH HARES TO THE PROFITS OF THE BUSINESS OF THE UNDERTAKING AND NOT THE PROFITS AND GAINS FROM EXPO RT OF ARTICLES. THEREFORE, PROFITS AND GAINS DERIVED FROM EXPORT OF ARTICLES IS DIFFERENT FROM THE INCOME DERIVED FROM THE PROFITS OF THE BUSINESS OF THE UNDERTAKING. THE PROFITS OF THE BUSINESS OF THE UNDERTAKING INCLUDES THE PROFITS AND GAINS FROM EXPORT OF THE ARTICLES AS WELL AS ALL OTHER INCIDENTAL INCOME S DERIVED FROM THE BUSINESS OF THE UNDERTAKING. IT IS INTERES TING TO NOTE THAT SIMILAR PROVISIONS ARE NOT THERE WHILE DEALING WITH COMPUTATION OF INCOME UNDER SECTION 80HHC. ON THE C ONTRARY THERE IS SPECIFIC PROVISIONS LIKE SECTION 80HHB WHI CH EXPRESSLY EXCLUDES THIS TYPE OF INCOMES. THEREFORE, IN VIEW OF THE AFORESAID PROVISIONS, IT IS CLEAR THAT, WHAT IS EXEMPTED IS NOT MERELY THE PROFITS AND GAINS FROM THE EXPORT OF ARTICLES HUT ALSO THE INCOME FROM THE BUSINESS OF THE UNDERTAKIN G. 8. IN THE INSTANT CASE, THE ASSESSEE IS A 100% EOU, WHICH HAS EXPORTED SOFTWARE AND EARNED THE INCOME. A PORTION OF THAT INCOME IS INCLUDED IN EEFC ACCOUNT. YET ANOTHER POR TION OF THE AMOUNT IS INVESTED WITHIN THE COUNTRY BY WAY OF FIX ED DEPOSITS, ANOTHER PORTION OF THE AMOUNT IS INVESTED BY WAY OF LOAN TO THE SISTER CONCERN WHICH IS DERIVING INTERE ST OR THE CONSIDERATION RECEIVED FROM SALE OF THE IMPORT ENTI TLEMENT, WHICH IS PERMISSIBLE IN LAW. NOW THE QUESTION IS WH ETHER THE INTEREST RECEIVED AND THE CONSIDERATION RECEIVED BY SALE OF IMPORT ENTITLEMENT IS TO BE CONSTRUED AS INCOME OF THE BUSINESS OF THE UNDERTAKING. THERE IS A DIRECT NEXU S BETWEEN THIS INCOME AND THE INCOME OF THE BUSINESS OF THE UNDERTAKING. THOUGH IT DOES NOT PAR TAKE THE CHARAC TER OF A PROFIT AND GAINS FROM THE SALE OF AN ARTICLE, IT IS THE INCOME WHICH IS DERIVED FROM THE CONSIDERATION REALIZED BY EXPORT OF ARTICLES. IN VIEW OF THE DEFINITION OF 'INCOME FROM PROFITS AND GAINS' INCORPORATED IN SUBSECTION (4), THE ASSESSEE IS ENTITLED TO THE BENEFIT OF EXEMPTION OF THE SAID AMOUNT AS CONTEMPLATED UNDER SECTION 10B OF THE ACT. THEREFOR E, THE TRIBUNAL WAS JUSTIFIED IN EXTENDING LE BENEFIT TO T HE AFORESAID AMOUNTS ALSO. WE DO NOT FIND ANY MERIT IN THESE APP EALS. 84. SIMILAR VIEW WAS TAKEN IN THE DECISION RENDERED EARLIER B Y HONBLE BOMBAY HIGH COURT IN THE CASE OF CIT VS LOK HO LDINGS, REPORTED IN 308 ITR 356 (BOM), WHEREIN IT WAS HELD, INTEREST EARNED BY THE ASSESSEE, A PROPERTY DEVELO PERS, BY MAKING TEMPORARY DEPOSITS OF SURPLUS MONEY OUT OF A DVANCES RECEIVED BY IT FROM INTENDING PURCHASER IS BUSINESS INCOME AND M/S WATSON PHARMA PVT LTD ITA 1423/M/2014 ITA 1565/MUM/2014 36 CANNOT BE ASSESSED AS INCOME FROM OTHER SOURCES . 85. IN SUCH A SITUATION WHERE THE INCOMES SOUGHT TO BE TAXED ARE INTRINSICALLY CONNECTED TO THE BUSINESS OF THE ASSESS EE AND ALSO THAT PROVISIONS FALLING UNDER SECTION 10A & 10B FORM A CODE WITHIN THE CODE, WE ARE OF THE OPINION THAT NO DISALLOWANCE IS CALLED FOR. 86. WE THEREFORE, SET ASIDE THE ORDER OF THE DRP AND DIR ECT THE AO TO COMPUTE THE DEDUCTION, TAKING INTO ACCOUNT THE INT EREST INCOME AS WELL AS SALE SCRAP AS BUSINESS INCOME. 87. GROUND NO. 7 PERTAINS TO ASSESSEES OBJECTION WITH REGARD TO INITIATION OF PENALTY U/S 271(1)(C). 88. THIS ISSUE IS PREMATURE AND, THEREFORE, WE REFRAIN OURSELVES TO GO INTO THE MERITS OF THIS STAGE. HENCE THE GROUND IS REJECTED. 89. TO COME TO THE ABOVE OPINION, WE HAVE TAKEN INTO CONSIDERATION ALL THE CASE LAWS CITED BEFORE US, OUT OF WHICH WE HAVE EXTRACTED THE CASE LAWS AND EVIDENCE, WHICH ACCORD ING TO US WERE IMPORTANT AND RELEVANT TO THE ISSUES INVOLVED. 90. IN THE RESULT, THE APPEAL AS FILED BY THE ASSESSEE IS TREATED AS PARTLY ALLOWED. ITA NO. : 1565/MUM/2014 : DEPARTMENT APPEAL : 91. THE DEPARTMENT HAS RAISED THE FOLLOWING GROUNDS: (I) WHETHER ON THE FACTS AND CIRCUMSTANCES OF THE CASE AND IN LAW, THE HONBLE DRP ERRED IN DIRECTING THE AO TO A LLOW DEDUCTION U/S 10B OF THE ACT IN RESPECT OF ITS GOA UNIT WITHOUT SETTING OFF UNABSORBED DEPRECIATION OF ANOTHER ELIG IBLE UNIT SITUATED IN AMBERNATH RELYING ON THE DECISION OF HO NBLE BOMBAY HIGH COURT IN THE CASE OF BLACK & VEATCH CON SULTANCY (I) LIMITED [334 ITR 72]. (II) WHETHER ON THE FACTS AND CIRCUMSTANCES OF THE CASE AND IN LAW, THE HONBLE DRP ERRED IN DIRECTING THE AO TO A LLOW DEDUCTION U/S 10B OF THE ACT IN RESPECT OF ITS GOA UNIT WITHOUT SETTING OFF UNABSORBED DEPRECIATION OF ANOTHER ELIG IBLE UNIT M/S WATSON PHARMA PVT LTD ITA 1423/M/2014 ITA 1565/MUM/2014 37 SITUATED IN AMBERNATH WITHOUT TAKING COGNIZANCE OF CBDT CIRCULAR F NO. 279/MISC/M-116/2012-IT DTD. 16.07.20 13 2. THE APPELLANT PRAYS THAT THE ORDER OF THE DRP ON THE ABOVE GROUNDS BE SET ASIDE AND THAT OF THE AO BE RESTORED . 3. THE APPELLANT CRAVES LEAVE TO AMEND OR ALTER ANY GROUNDS OR ADD A NEW GROUND WHICH MAY BE NECESSARY. 92. BOTH THE GROUNDS ARE CONNECTED, WE, THEREFORE, TAKE UP THE TWO GROUNDS. 93. AT THE TIME OF HEARING, THE AR SUBMITTED THAT THE ISSU E, AS RAISED BY THE DEPARTMENT IS COVERED BY THE DECISION OF H ONBLE BOMBAY HIGH COURT IN THE CASE OF CIT VS BLACK & VEATCH CONSULTING PVT LTD. REPORTED IN 348 ITR 72 (BOM), WHEREIN IT HAS BEEN HELD, DEDUCTION UNDER S. 10A, HAS TO BE GIVEN EFFECT T O AT THE STAGE OF COMPUTING THE PROFITS AND GAINS OF BUS INESS. THIS IS ANTERIOR TO THE APPLICATION OF THE PROVISIO NS OF S. 72 WHICH DEALS WITH THE CARRY FORWARD AND SET OFF O F BUSINESS LOSSES. A DISTINCTION HAS BEEN MADE BY THE LEGISLATURE WHILE INCORPORATING THE PROVISIONS OF C HAPTER VI-A. SECTION 80A(1) STIPULATES THAT IN COMPUTING T HE TOTAL INCOME OF AN ASSESSEE, THERE SHALL BE ALLOWED FROM HIS GROSS TOTAL INCOME, IN ACCORDANCE WITH AND SUBJECT TO THE PROVISIONS OF THE CHAPTER, THE DEDUCTIONS SPECIFIED IN SS. 80C TO 80U. S. 80B(5) DEFINES FOR THE PURPOSES OF CHAPTER VI-A 'GROSS TOTAL INCOME' TO MEAN THE TOTAL INCOME COMPUTED IN ACCORDANCE WITH THE PROVISIONS O F THE ACT, BEFORE MAKING ANY DEDUCTION UNDER THE CHAP TER. WHAT THE REVENUE IN ESSENCE SEEKS TO ATTAIN IS TO TELESCOPE THE PROVISIONS OF CHAPTER VI-A IN THE CON TEXT OF THE DEDUCTION WHICH IS ALLOWABLE UNDER S. 10A, WHIC H WOULD NOT BE PERMISSIBLE UNLESS A SPECIFIC STATUTOR Y PROVISION TO THAT EFFECT WERE TO BE MADE. IN THE AB SENCE THEREOF, SUCH AN APPROACH CANNOT BE ACCEPTED. THUS ITAT WAS CORRECT IN HOLDING THAT THE BROUGHT FORWAR D UNABSORBED DEPRECIATION AND LOSSES OF THE UNIT THE INCOME WHICH IS NOT ELIGIBLE FOR DEDUCTION UNDER S. 10A OF THE ACT CANNOT BE SET OFF AGAINST THE CURRENT PROFI T OF THE ELIGIBLE UNIT FOR COMPUTING THE DEDUCTION UNDER S. 10A OF THE IT ACT. BROUGHT FORWARD UNABSORBED DEPRECIATION AND LOSSES OF UNIT THE INCOME WHICH IS NOT ELIGIBLE FOR DEDUCTION UNDER S. 10A CANNOT BE T OFF AGAINST CURR ENT PROFIT OF THE ELIGIBLE UNIT FOR COMPUTING THE DEDUC TION UNDER S. 10A. 94. THE DR ACCEPTED THE FACT THAT THE ISSUE IS IN FAVOUR OF THE ASSESSEE IN THE LIGHT OF THE REFERRED CASE LAW. 95. IN THE CIRCUMSTANCE, WE REJECT THE GROUNDS TAKEN B Y THE DEPARTMENT. M/S WATSON PHARMA PVT LTD ITA 1423/M/2014 ITA 1565/MUM/2014 38 96. AS A RESULT, THE APPEAL, AS FILED BY THE DEPARTMENT IS DISMISSED. TO SUM UP: ASSESSEES APPEAL IN ITA NO. 1423/MUM/2014 IS TREATED AS PARTLY ALLOWED; DEPARTMENT APPEAL IN ITA NO. 1565/MUM/2014 STANDS DISMISSED. ORDER PRONOUNCED IN THE OPEN COURT ON 9 TH JANUARY, 2015. SD/- SD/- ( ) ( ) (R C SHARMA) ( VIVEK VARMA ) ACCOUNTANT MEMBER J UDICIAL MEMBER MUMBAI, DATE: 9 TH JANUARY, 2015 $/ COPY TO:- 1) / THE APPELLANT. 2) / THE RESPONDENT. 3) THE DRP-II, MUMBAI. 4) THE CIT- CONCERNED ________, MUMBAI. 5) ,'-. $! , , / THE D.R. K BENCH, MUMBAI. 6) ./0 1 COPY TO GUARD FILE. 2 3! / BY ORDER / / TRUE COPY / / 4 / 5 6 , DY. / ASSTT. REGISTRAR I.T.A.T., MUMBAI *895! '.!. *CHAVAN, SR.PS