Eli Lilly & Company (India) Pvt. Ltd., New Delhi V. ACIT, New Delhi

ITA 5265/DEL/2011

• Counselvise Citation: [2012] 140 COUNSELVISE.COM (IT) 65851 (ITAT-DELHI)
• Duration Of Justice: 11 month(s) 23 day(s)
• Appeal Type: Income Tax Appeal
• Pronouncement Date: 21-11-2012
• Appeal Filed By: Assessee
• Order Result: Allowed
• Bench Allotted: B
• Next Hearing Date: 02-07-2012
• Assessment Year: 2007-2008
• Appeal Filed On: 28-11-2011
• Result in Favour of: Assessee
• Court: TRIBUNAL
• Department Lawyers: PEEYUSH JAIN
• Keywords: Gross profit estimation; Business income; Transfer pricing; International transaction; Rule of consistency; Wholly owned subsidiary
• Section: 92F; 142(1); 234B; 10B; 92

Judgement Text

I.T.A. NO. 5265/DEL/2011 1 IN THE INCOME TAX APPELLATE TRIBUNAL (DELHI BENCH B: NEW DELHI) BEFORE SHRI U.B.S. BEDI, JUDICIAL MEMBER AND SHRI SHAMIM YAHYA, ACCOUNTANT MEMBER ITA NO.5265/DEL/ 2011 (ASSESSMENT YEAR: 2007-2008) ELI LILLY & COMPANY (INDIA) PVT. LTD. VS. ACIT PLOT NO.92, SECTOR-32, CIRCLE -1(1), INSTITUTIONAL AREA, I.P ESTATE NEW DELHI NEW DELHI. PAN: AAACE9801F (APPELLANT) (RESPONDENT) ASSESSEE BY :SHRI AJAY VOHRA & SHRI NEERAJ JAIN, AD V. SHRI ABHISHEK AGRAWAL, CA REVENUE BY :SHRI PEEYUSH JAIN, CIT.DR. ORDER PER U. B. S. BEDI, JM: THIS APPEAL OF THE ASSESSEE IS DIRECTED AGAINST TH E ORDER PASSED U/S 143 (3) READ WITH 144C OF THE INCOME TAX ACT, FOR THE ASSESSMENT YEAR-2007-08 DATED 20.04.2011,WHEREBY, DIFFERENCE IN ALP AS DETERMINED BY THE TPO AND CONFIRMED BY DISPU TE RESOLUTION PANEL-1, NEW DELHI HAS BEEN CHALLENGED AS PER GROUND NO.2 TO 2.6, WHEREAS, GROU ND NO.1 IS GENERAL AND GROUND NO.3 IS WITH REGARD TO LEVYING INTEREST U/S 234 B AND SECTION 23 4 C OF THE ACT WHICH IS CONSEQUENTIAL AND GROUND NO.4 IS NOT PRESSED. 2. FACTS INDICATE THAT ASSESSEE FILED ITS RETURN DE CLARING RS.138,476,801/- AS INCOME ON 31.10.2007. THE CASE WAS TAKEN UP FOR SCRUTINY AND NOTICE U/S 143 (2) WAS ISSUED AND SERVED UPON THE ASSESSEE. FURTHER NOTICE U/S 143(2), 142(1) ALO NG WITH QUESTIONNAIRE WERE ISSUED, WHICH WERE DULY SERVED UPON THE ASSESSEE. AUTHORIZED REPRESENT ATIVE ATTENDED AND FILED THE REQUIRED I.T.A. NO. 5265/DEL/2011 2 PARTICULARS, AS PER QUESTIONNAIRE AND ORDER SHEET, WHICH WERE VERIFIED ON TEST- CHECK BASIS IN PARA 2 TO 5 OF THE ASSESSMENT ORDER WHICH IS REPRODUCED AS UNDER: 2. THE COMPANY WAS INCORPORATED ON MARCH 18, 1993 AS A PRIVATE LTD. COMPANY WITH ITS HEADQUARTERS IN NEW DELHI WITH NINE BRANCH OFFICES BY VIRTUE OF 50:50 JOINT VENTURE AMONG TWO PARTNERS, NAMELY ELI LILLY AND CO MPANY, INDIANAPOLIS, USA, THROUGH ITS WHOLLY OWNED SUBSIDIARY, ELI LILLY NETH ERLAND BV AND RANBAXY LABORATORIES LTD., NEW DELHI. ELI LILLY AND COMPANY , INDIANAPOLIS, USA (HEREINAFTER CALLED LILLY US) IS ENGAGED IN THE B USINESS OF RESEARCH, MANUFACTURING, MARKETING AND SALE OF FORMULATIONS T HAT FIND USAGE IN THE TREATMENT OF SEVERAL; DISEASE SEGMENTS RANGING FROM ONCOLOGY, CNS, CARDIOVASCULAR, INFECTIOUS DISEASES, ENDOCRINE ETC. THE COMPANY REC EIVED FOREIGN COLLABORATION PERMISSION IN APRIL 1993 TO MANUFACTURE AND MARKET PRODUCTS OF ELI LILLY AND COMPANY UNDER ITS BRAND NAME. THE COMPANY LAUNCHED ITS PRODUCTS IN OCTOBER, 1993 WITH 3 PRODUCTS NAMELY DOBUTREX, TOBRANG AND D ISTACLOR. IN THE F.Y 1993-94, COMPANY ACHIEVED SALES TURNOVER OF RS.177 CRORES WI TH AN ASSESSED LOSS OF RS.4.91 CRORES. DURING THE F. Y.2006-07, LILLY INDIA WAS ENGAGED IN THE BUSINESS OF TRADING OF FORMULATIONS AND PROVIDING SERVICES VIZ. CLINICAL T RIALS AND ANSWERING MEDICAL QUERIES AND OTHER SUPPORT SERVICES TO OTHER ASSOCIA TED ENTERPRISES. 3) A REFERENCE WAS MADE TO THE TFI-I(2) TO DETERMIN E THE ARMS LENGTH PRICE U/S 92CA(3) IN RESPECT TO INTERNATIONAL TRANSACTIONS EN TERED INTO BY THE ASSESSEE DURING THE F. Y. 2006-07. THE ORDER OF THE TPO-I (2) DATED 08.10.2010 PASSED U/S 92CA (3) OF THE ACT HAS BEEN RECEIVED. TRANSFER PRICING OFFICER VIDE HIS ORDER HAS DETERMINED THE ADJUSTMENT/ DIFFERENCE ON ACCOUNT OF ALP IN RESPECT OF INTERNATIONAL TRANSACTIONS WITH ASSOCIATED ENTERPRISES AT RS.135,950,375/- AS FOLLO W. 8. BASED ON THE DISCUSSIONS IN THE PRECEDING PARAS, THE GROSS MARGIN OF THE ASSESSEE IS CALCULATED AS BELOW. OPENING STOCK : 414,965,282 SALES : 1,823,107,281 PURCHASES : 1,758,133,119 FREE SAMPLES : 23,276,950 CUSTOMS DUTY : 65,074,378 CLOSING STOCK: 566 ,033,645 GROSS PROFIT: 174,245,097 2,412,417,876 2,4 12,417,876 SUBVENTION INCOME CANNOT BE TAKEN AS PART OF THIS C ALCULATION BECAUSE OF ITS CHARACTER AS OTHER INCOME. I.T.A. NO. 5265/DEL/2011 3 TOTAL SALES : RS.1,823,107,281/- GROSS MARGIN @47.21% : RS.860,688,947/- GROSS MARGIN SHOWN : RS.174,245,097/- ARMS LENGTH VALUE OF PURCHASE : RS.1,071,689,269/- PURCHASE VALUE SHOWN : RS.1,758,133,119/- DIFFERENCE : RS.686,443,850/- LESS: SUBVENTION INCOME : RS.550,493,475/- ADJUSTMENT U/S 92CA : RS.135,950,375/- THE ARMS LENGTH VALUE OF THE INTERNATIONAL TRANSAC TION RELATED TO PURCHASE OF GOODS IS DETERMINED AT RS.1,071,689,269/- AS AGAINS T RS.1,758,133,119/- DETERMINED BY THE ASSESSEE. THE DOWNWARD ADJUSTMENT OF RS.135, 050,375/- IS REQUIRED TO BRING IT TO ARMS LENGTH. THE ASSESSING OFFICER SHALL ENHA NCE THE INCOME OF THE ASSESSEE BY RS.135,950,375/-. THE ASSESSEE SHALL NOT GET THE BE NEFIT OF THE PROVISO OF SECTION 92C(2) AS THE DIFFERENCE OF RS.686,443,850/- IS MOR E THAN 5% OF THE VALUE OF INTERNATIONAL TRANSACTION. FOLLOWING THE ORDER OF THE TRANSFER PRICING OFFICE R THE ADJUSTMENT/ DIFFERENCE ON ACCOUNT OF ALP AMOUNTING TO RS.135,950,375/- IS PROPOSED TO BE ADDED TO THE RETURNED INCOME. ACCORDINGLY, DRAFT ASSESSMENT ORDER U/S 144C DATED 14.12.2010 WAS PASSED BY THE UNDERSIGNED. (4) THE ASSESSEE FILED THE OBJECTIONS AGAINST THE D RAFT ASSESSMENT ORDER WITH THE DISPUTE RESOLUTION PANEL (DRP), DELHI ON 28.01.2011 . HONBLE DRP-I, NEW DELHI HAS ISSUED ORDER U/S 144C (5) OF THE INCOME TAX ACT , 1961 DATED 08.08.2011, RECEIVED IN THE OFFICE OF THE UNDERSIGNED ON 30.09. 2011. THE DRP VIDE HIS ORDER DATED 08.08.2011 HAS UPHELD THE ORDERS OF THE TPO/A O (COPY OF THE ORDERS OF DRP DATED 08.08.2011 ENCLOSED). (5) IN VIEW OF ABOVE, I AM SATISFIED THAT THE ASSES SEE HAS CONCEALED THE PARTICULARS OF INCOME TO THE TUNE OF RS.135,950,375/- WITHIN TH E MEANING OF SECTION 271(1)(C) OF THE ACT. THEREFORE, THE ASSESSEE IS LIABLE TO LEVY OF PENALTY U/S 271(1) (C) OF THE ACT. PROCEEDINGS U/S 271(1)(C) OF THE ACT ARE BEING INIT IATED SEPARATELY. WITH THESE REMARKS, THE TOTAL INCOME OF THE ASSESSE E IS BEING RECOMPUTED AS UNDER: NET TAXABLE INCOME AS PER THE RETURN OF INCOME -RS. 138,476,801 ADD: DIFFERENCE IN ALP AS DETERMINED BY TPO -RS.135 ,950,375 ---------------------- I.T.A. NO. 5265/DEL/2011 4 ASSESSED INCOME RS.274,427,176 ASSESSED. CHARGED INTEREST U/S 234 A, B,& C I F ANY. ALLOW CREDIT FOR PREPAID TAXES IF ANY. ISSUE REQUISITE DOCUMENTS. 3. AGGRIEVED BY THE ORDER OF THE AO, THE ASSESSEE H AS COME UP IN APPEAL AND CHALLENGED THE ACTION OF ASSESSING OFFICER, RAISING GROUND NO. 2 T O 2.6 AS UNDER: 2. THAT THE AO ERRED ON FACTS AND IN LAW IN MAKING ADJUSTMENT OF RS.135,590,375/- TO THE INCOME OF THE APPELLANT ON ACCOUNT OF THE DIFFERENCE IN THE ARMS LENGTH PRICE OF THE INTERNATIONAL TRANSACTION S OF PURCHASE OF FORMULATIONS UNDERTAKEN DURING THE PREVIOUS YEAR. 2.1 THAT THE AO/DRP ERRED ON FACTS AND LAW IN REJEC TING THE TRANSFER PRICING ANALYSIS UNDERTAKEN BY THE APPELLANT FOR BENCHMARKI NG THE TRANSACTION OF PURCHASE OF FORMULATIONS APPLYING TNMM AND INSTEAD APPLIED R PM AS THE MOST APPROPRIATE METHOD. 2.2 THAT THE AO ERRED ON FACTS AND IN LAW IN NOT AP PRECIATING THAT BECAUSE OF RESTRICTIONS IMPOSED BY THE DRUG CONTROL AUTHORITIE S OF INDIA ON FIXATION OF PRICE OF MEDICINES, RPM COULD NOT BE CONSIDERED AS MOST APPR OPRIATE METHOD. 2.3 THAT THE AO ERRED ON FACTS AND IN LAW IN NOT AP PRECIATING THAT DUE TO LACK OF APPROPRIATE PATENT LAWS IN INDIA, GENERIC DRUGS PUT ADDITIONAL PRESSURE ON PRICE OF MEDICINES TRADED BY THE APPELLANT. 2.4 WITHOUT PREJUDICE, THE AO ERRED ON FACTS AND IN LAW IN DISREGARDING THE INTERNAL BENCHMARKING UNDERTAKEN BY THE APPELLANT F OR DETERMINING THE ARMS LENGTH PRICE OF THE INTERNATIONAL TRANSACTION OF PURCHASE OF FORMULATIONS APPLYING RPM ON THE GROUND THAT (I) THE INTERNAL BENCHMARKING WAS N EITHER AVAILABLE IN AUDITED ACCOUNTS NOR IN THE TP STUDY REPORT (II) THE PURCHA SES MADE FROM UNRELATED PARTIES CONSTITUTES ONLY 31% OF THE TOTAL PURCHASES. 2.4 WITHOUT PREJUDICE, THE AO ERRED ON FACTS AND IN LAW IN CONSIDERING FOLLOWING COMPANIES AS COMPARABLES EVEN WHEN THEY WERE INTO M ANUFACTURING ACTIVITIES AS AGAINST THE APPELLANT WHICH IS SOLELY INTO TRADING OF FORMULATIONS: I. MANKIND PHARMA LIMITED II. NOVARTIS INDIA LIMITED I.T.A. NO. 5265/DEL/2011 5 III. TTK HEALTHCARE LIMITED 2.5 THE AO ERRED ON FACTS AND IN LAW IN CONSIDERING SALES OF FORMULATIONS OF RS.1,823,107,281/- REPRESENTING TOTAL VALUE OF PURC HASE OF FORMULATIONS AS AGAINST THE SPECIFIC FINDING OF DRP TO CONSIDER RS.1,164,30 3,000/- AS SALES MADE FROM FORMULATIONS PURCHASED ONLY FROM ASSOCIATED ENTERPR ISE. 2.6 THE AO ERRED ON FACTS AND IN LAW IN NOT REDUCIN G SUBVENTION INCOME OF RS.550,493,475/- RECEIVED FROM THE ASSOCIATED ENTER PRISE IN THE NATURE OF SUBSIDY, FROM THE VALUE OF PURCHASE OF FORMULATIONS OF THE G ROUND THAT SAME REPRESENTS OTHER INCOME EARNED BY THE APPELLANT. 4. THE LD. AR WHILE ARGUING THE APPEAL ON GROUND NO .2 TO 2.3 HAS SUBMITTED THAT TNMM METHOD WAS NOT ACCEPTED BY THE TPO WHEREAS, IT IS T HE MOST APPROPRIATE METHOD. SO AS TO THE BUSINESS OF THE ASSESSEE IS CONCERNED, ASSESSEE HAS FILED BROAD PROPOSITION (B.P) AND SUBMITTED THAT ASSESSEE DEALS IN DRUGS AND PRICE LEASED TO BE DIRE CTED DRUGS PRICE CONTROL AUTHORITY. ONLY SALE PRICES TO BE REGULATED WHILE MAKING REFERENCE TO PA GE 3 OF THE B.P. REFERENCE WAS MADE TO DRUG PRICE CONTROL ORDER 1995 AND IT WAS SUBMITTED THAT DRP HAS APPLIED RE-SALE PRICE METHOD AND WHILE RELYING UPON B.P PAGE 456 PARA 2, IT WAS SUBMITTED THAT OECD GUIDELINES 2009 ARE APPLICABLE IN SUCCEEDING YEAR. DEPARTMENT HAS DRAFTED TNMM METHOD . TPO CANNOT TAKE METHODS IN TWO DIFFERENT YEARS AND RELYING UPON AT PAGES 510 TO 52 4 OF PAPER BOOK AND GIVING ITS SPECIFIC REFERENCE MAKING AT PAGE 518, PARA 11 OF PAPER BOOK. 4.1 IN ORDER TO ARGUE THE APPEAL OF THE ASSESSEE, LD. A .R. OF THE ASSESSEE FILED FOLLOWING BROAD PROPOSITION IN SHORT REFERRED TO AS (BP) ON THE IS SUE RAISED IN THE APPEAL: ELI LILLY & CO. (INDIA) PVT. LTD. ('THE APPELLANT') IS ENGAGED IN THE BUSINESS OF TRADING OF LIFE SAVING DRUGS FORMULATIO NS SOURCED ITS ASSOCIATED ENTERPRISES ('AES') AS WEL L AS FROM THIRD PARTIES. DURING THE FINANCIAL YEAR 2006-07, THE APPELLANT EN TERED INTO THE INTERNATIONAL TRANSACTION, INTER ALIA, OF PURCHASE OF FORMULATIONS FROM THE ASSOCIATED ENTERPRISE, OF RS. 1,24,28,99,954 FO R RESELLING/TRADING IN INDIA. IN THE TRANSFER PRICING DOCUMENTATION, THE APPELLAN T DETERMINED ARM'S I.T.A. NO. 5265/DEL/2011 6 LENGTH PRICE OF THE 'INTERNATIONAL TRANSACTION' OF PURCHASE OF FORMULATIONS APPLYING TRANSACTIONAL NET MARGIN METHOD ('TNMM'), BY COMPARING OPERATING PROFIT MARGIN WITH THAT OF F IVE COMPARABLE AVERAGE OP/ SALES % OF 5 COMPARABLE COMPANIES 2.80% OP/ SALES % OF THE APPELLANT 5.06% THE TRANSFER PRICING OFFICER ('TPO') IN HIS ORDER DATED 08.1 0.20 1 0, HOWEVER, REJECTED TNMM A PPLIED BY THE APPELLANT AND INSTEAD APPLIED RESALE PRICE METHOD ('RPM') AS THE MOST APPROPRIATE METHOD, HOLDING THAT (I) THE APPEL LANT DOES NOT ADD ANY SIGNIFICANT VALUE TO THE GOODS IMPORTED; AND ( II) RELIABLE GROSS MARGIN DETAILS ARE AVAILABLE FOR COMPARABLE COMPANI ES. THE APPELLANT ALSO CONTENDED BEFORE THE TPO THAT CONSID ERING THAT THE APPELLANT HAS PURCHASED SIMILAR FORMULATION FROM RE LATED PARTIES AS WELL AS UNRELATED PARTIES, RPM COULD BE APPLIED CON SIDERING SUCH INTERNAL COMPARABLES. ACCORDINGLY, THE APPELLANT HA D SUBMITTED SEGMENTED DETAILS OF PROFITABILITY IN RESPECT OF TH E TRANSACTIONS OF SALES OF FORMULATIONS PURCHASED FROM RELATED VIS-A- VIS UNRELATED PARTIES. THE GROSS PROFIT MARGIN (GP/SALES) EARNED BY THE APPELLANT ON TRANSACTIONS WITH THE ASSOCIATED ENTERPRISE WAS WORKED OUT AT 50.06%, WHICH WAS HIGHER THAN THE AVERAGE GROSS PROFIT MARG IN EARNED ON SIMILAR TRANSACTIONS WITH UNRELATED THIRD PARTIES A T 21.54%. ACCORDINGLY, THE INTERNATIONAL TRANSACTION OF PURCH ASE OF FORMULATIONS WAS CONSIDERED TO BE AT ARM'S LENGTH PRICE. THE TPO, HOWEVER, ALSO REJECTED INTERNAL BENCHMARKI NG SUBMITTED BY THE APPELLANT, AND \HIMSELF CARRIED OUT A FRESH SEA RCH FOR COMPARABLE COMPANIES AND ACCORDINGLY CONSIDERED \FOLLOWING COM PANIES WITH AVERAGES GROSS PROFIT/SALES RATIO OF 47.21 %, AS UN DER: NAME OF THE COMPANY GROSS PROFIT ON SALES FOR FY 2006-07( %) 1 COSME FARMA LABORATORIES LTD. 64.46 2 MANKIND PHARMA LIMITED 42.97 3 MARKSONS PHARMA LIMITED 31.70 4 NOVARTIS INDIA LIMITED 55.76 5 TYTK HEALTHCARE LIMITED 41.16 ARITHMETIC MEAN 47.21 THE TPO FURTHER, INSTEAD OF REDUCING SUBVENTION INC OME FROM THE COST OF GOODS SOLD', CONSIDERED IT AS OTHER INCOME AND R EDUCED IT FROM THE DIFFERENCE BETWEEN ARM'S LENGTH PRICE AND VALUE OF INTERNATIONAL I.T.A. NO. 5265/DEL/2011 7 TRANSACTIONS. ACCORDINGLY, THE TPO COMPUTED AN ADJU STMENT OF RS. 135,9550,375 TO THE TOTAL INCOME OF THE APPELLANT A S UNDER: TOTAL SALES RS.1,823,107,281 GROSS MARGIN @ 47.21% RS.860,688,947 GROSS MARGIN SHOWN RS.174,245,097 DIFFERENCE RS.686,443,850 LESS: SUBVENTION INCOME RS.550,493.475 ADJUSTMENT U/S 92CA RS.135,950,375 THE ADJUSTMENT MADE BY THE TPO IS UNLAWFUL AND IS N OT SUSTAINABLE FOR THE REASONS SUBMITTED AS UNDER: INCORRECT APPLICATION OF RPM: THE TPO HAS ERRED IN APPLYING RPM AS THE MOST APPRO PRIATE METHOD DUE TO FOLLOWING REASONS: (I) PRICE CONTROL REGULATIONS IN INDIA: THE APPELLANT TRADES IN MEDICAL FORMULATIONS AND MA JORITY OF ITS PRODUCTS ARE SUBJECT TO PRICE CONTROL REGULATIONS ISSUED BY NATIONAL PHARMACEUTICAL PRICING AUTHORITY (N PPA'),GOVERNMENT OF INDIA. UNDER THE DRUG PRICE CONTROL ORDER, 1995. AN ENTITY ENGAGED IN TRADING OF FORMULATIONS IS ALLOWED A MUCH LOWER GRO SS MA RGIN ON IMPORTED FORMULATIONS VIS- A-VIS PURCHASE OF INDIGE NOUS FORMULAT IONS. FURTHER, IN CASE OF NON SCHEDULED DRUGS, NO UPPER CEILING HAS BEEN PRESCRIBED ON THE PROFIT MARGIN S FROM SALE OF SUCH PRODUCTS AND A COMPANY CAN DETERMINE THE PRICE OF SUCH PRODUCTS AS PER THE MARKET FORCES. HENCE, GROSS MARGIN EARNED BY AN INDIA COM PANY IN TRADING OF FORMULATIONS MAY VARY SIGNIFICANTLY DEPENDING ON WHETHER THE COMPANY IS IN THE BUSINESS OF TRADING OF SCHEDULED DRUGS OR NON SCHEDULED DRUGS AND WHETHER SUCH SCHED ULED DRUGS ARE IMPORTED OR MANUFACTURED IN INDIA. I.T.A. NO. 5265/DEL/2011 8 (II) PATENT LAWS APPLICABLE IN INDIA: THE APPELLANT ALSO TRADES IN DRUGS WHICH ARE REGIST ERED UNDER PATENT LAWS OF OTHER COUNTRY BUT NOT IN INDIA. IF PATENT LAWS OF INDIA ARE NOT APPLICABLE ON A SPECIFIC FORMULATION, THEN OTHER DO MESTIC INDIAN COMPANIES CAN ALSO MANUFACTURE SIMILAR GENERIC FORM ULATIONS AT A LESSER PRICE, WHICH ULTIMATELY PUTS A SEVERE PRESSU RE ON PRICING POLICY OF THE APPELLANT. FOR EXAMPLE. GEMCITE, A KEY PATENTED PRODUCT TRADED BY LILLY INDIA HAS AROUND 150 GENERIC PLAYERS IN INDIA, WHO CAN MANUFACTURE THESE DRUGS AT A LESSER PRICE AND HENCE PRICE OF A DRUG MAY VARY SUBSTANTIALLY FROM COMPANY TO COMPANY. RULE 10B(2) OF THE INCOME TAX RULES, 1962 ('RULES') PROVIDES THAT WHILE EVALUATING COMPARABILITY OF AN UNCONTROLLED T RANSACTION WITH CONTROLLED TRANSACTION, DUE CONSIDERATION SHOULD BE GIVEN TO THE MARKET CONDITIONS AND LAWS AND GOVERNMENT ORDERS IN FORCE. REFERENCE IN THIS REGARD, CAN ALSO BE PLACED ON THE FOLLOWING EXTRACT OF TRANSFER GUIDELINES ISSUED BY ORGANIZATION FOR E CONOMIC CO- OPERATION AND DEVELOPMENT ('OECD') UNDER 'REVISION OF CHAPTERS I-III OF THE TRANSFER PRICING GUIDELINES' ISSUED ON 22 ND JULY, 2010 WHICH STATES THAT DUE CONSIDERATION SHO ULD BE GIVEN TO THE GOVERNMENT RESTRICTIONS WHILE EVALUATING UNC NTROLLED TRANSACTION WITH CONTROLLED TRANSACTIONS: 'THE EFFECT OF GOVERNMENT POLICIES 1.73 THERE ARE SOME CIRCUMSTANCES IN WHICH A TAXPAY ER WILL CONSIDER THAT AN ARM'S LENGTH PRICE MUST BE ADJUSTED TO ACCO UNT FOR GOVERNMENT INTERVENTIONS SUCH AS PRICE CONTROLS (EVEN PRICE CUTS), INTEREST RATE CONTROLS, CONTROL OVER PAYMENTS FOR SERVICES OR .. MANAGEMENT FEES, CONTROLS OVER THE PAYMENT OF ROYALTIES, SUBSIDES TO PARTICULAR. SECTORS, EXCHANGE CONTROL, ANTIDUMPING DUTIES, OR E XCHANGE RATE POLICY. AS A GENERAL RULE, THESE GOVERNMENT INTERVE NTIONS SHOULD BE TREATED AS CONDITIONS OF THE MARKET IN THE PARTICULAR COUNT RY, AND IN THE ORDINARY COURSE THEY SHOULD BE TAKEN INTO ACCOU NT IN EVALUATING THE TAXPAYER'S TRANSFER PRICE IN THAT MARKET ACCORDINGLY, IN VIEW OF THE GOVERNMENT RESTRICTIONS IMPOSED BY WAY OF PRICE CONTROL AND PREVAILING PATENT LAWS, A GROSS M ARGIN COMPARISON WOULD GIVE AN ABSURD RESULT. IN THE ABSENCE OF SUCH INFORMATION IN I.T.A. NO. 5265/DEL/2011 9 PUBLIC DOMAIN, A NET MARGIN ANALYSIS USING TRANSACT IONAL NET MARGIN METHOD WOULD BE THE MOST APPROPRIATE METHOD. FURTHER, UNDER THE TRANSFER PRICING REGULATIONS, FO R THE PURPOSE OF BENCHMARKING ANALYSIS APPLYING TNMM, IT WOULD SUFFI CE IF THE TESTED PARTY AND THE COMPARABLE COMPANY BROADLY FALL INTO SIMILAR BUSINESS SEGMENT, BUT WHAT IS NECESSARY IS THAT THEY SHOULD BE PERFORMING SIMILAR FUNCTIONS, ASSUMING SIMILAR RISKS AND EMPLO YING SIMILAR ASSETS. ATTENTION IS INVITED IN THIS REGARD TO THE PARAGRAP H 3.34 OF THE OECD GUIDELINES, 2009 WHICH IN THE CONTEXT OF APPLICATI ON OF TNMM, CLEARLY PROVIDES AS UNDER: '3.34 PRICES ARE LIKELY TO BE AFFECTED BY DIFFERENC ES IN PRODUCTS, AND GROSS MARGINS ARE LIKELY TO BE AFFECTED BY DIFFERE NCES IN FUNCTIONS, BUT OPERATING PROFITS ARE LESS ADVERSELY AFFECTED BY SU CH DIFFERENCES. AS WITH THE RESALE PRICE AND COST PLUS METHODS THAT TH E TRANSACTIONAL NET MARGIN METHOD RESEMBLES, THIS, HOWEVER, DOES NOT ME AN THAT A MERE SIMILARITY OF FUNCTIONS BETWEEN TWO ENTERPRISES WIL L NECESSARILY LEAD TO RELIABLE COMPARISONS. ' IT IS ALSO A SETTLED POSITION UNDER THE TRANSFER PR ICING REGULATIONS THAT FOR THE PURPOSE OF. BENCHMARKING ANALYSIS APPLYING TNMM, THE FUNCTIONAL COMPARABILITY, I.E., FUNCTIONS PERFORMED , ASSETS UTILIZED AND RISKS ASSUMED, IS RELEVANT AND THE BENCHMARKING ANA LYSIS IS LESS AFFECTED BY THE PRODUCT DIFFERENCES. IT IS FURTHER RESPECTFULLY SUBMITTED THAT TNMM EXAM INES NET PROFIT MARGIN RELATIVE TO AN APPROPRIATE BASE, (E.G. COST, SALES, ASSETS) THAT THE TESTED PARTY REALIZES IN A CONTROLLED SITUATION WITH THAT OF THE UNCONTROLLED COMPARABLES. THE OECD GUIDELINES, 2009 EXPLAIN THE TNMM METHOD AND ITS STRENGTHS IN THE FOLLOWING PARA S: 3.27 ONE STRENGTH OF THE TRANSACTIONAL NET MARGIN M ETHOD IS THAT NET MARGINS (E.G., RETURN ON ASSETS OPERATING INCOME TO SALES, AND POSSIBLY OTHER MEASURES OF NET PROFIT) ARE LESS AFFECTED BY TRANSACTIONAL DIFFERENCES THAN IS THE CASE WITH PRICE, AS USED IN THE CUP METHOD. THE NET MARGINS ALSO MAY BE MORE TOLERANT TO SOME FUNCT IONAL DIFFERENCES BETWEEN THE CONTROLLED AND UNCONTROLLED TRANSACTIO NS THAN GROSS PROFIT MARGINS. I.T.A. NO. 5265/DEL/2011 10 DIFFERENCES IN THE /FUNCTIONS. PERFORMED BETWEEN EN TERPRISES ARE OFTEN REFLECTED IN VARIATIONS IN OPERATING EXPENSES. CONS EQUENTLY, ENTERPRISES MAY HAVE A WIDE RANGE OF GROSS PROFIT M ARGINS BUT STILL EARN BROADLY SIMILAR LEVELS OF NET PROFITS. 3.28 ANOTHER PRACTICAL STRENGTH IS THAT IT IS NOT N ECESSARY TO DETERMINE THE FUNCTIONS PERFORMED AND RESPONSIBILITIES ASSUME D BY MORE THAN ONE OF THE ASSOCIATED ENTERPRISES. SIMILARLY, IT IS OFTEN NOT NECESSARY TO STATE THE BOOKS AND RECORDS OF ALL PARTICIPANTS IN THE BUSINESS ACTIVITY ON A COMMON BASIS OR TO ALLOCATE COSTS FOR ALL PART ICIPANTS. THIS CAN BE PRACTICALLY ADVANTAGEOUS WHEN ONE OF THE PARTIES TO THE TRANSACTION IS COMPLEX AND HAS MANY INTERRELATED ACTIVITIES OR WHEN IT IS DIFFICULT TO OBTAIN RELIABLE INFORMATION ABOUT ONE OF THE PAR TIES ..... ' IN VIEW OF THE ABOVE, IT IS RESPECTFULLY SUBMITTED THAT TNMM BEING MORE TOLERANT AND LESS SUSCEPTIBLE OF MINOR FUNCTIONAL DIFFERENCE OUGHT TO HAVE BEEN APPLIED AS THE MOST APPROP RIATE METHOD FOR DETERMINING THE ARM'S LENGTH PRICE OF PURCHASE OF F ORMULATIONS UNDERTAKEN BY THE APPELLANT MADE BY THE ASSESSING OFFICER ON ACCOUNT OF DIFFERENCE IN ARMS LENGTH PRICE OF INTERNATIONAL TRANSACTION OF PURCHASE OF FORMULATIONS IS NOT SUSTAINABLE AND LIA BLE TO BE DELETED.; 2. RES-JUDICATA - BENCHMARKING OF TRANSACTION OF PU RCHASE OF FORMULATIONS WAS UNDERTAKEN BY APPLYING TNMM DURING A Y 2008-09 THE TPO HAS HIMSELF BENCHMARKED THE TRANSACTION OF PURCHASE OF FORMULATIONS BY APPLYING TNMM IN THE AS SESSMENT YEAR 2008-09. THERE IS NO CHANGE IN FACTS OF THE CURRENT YEAR WITH RESPECT TO THE TRANSACTION OF PURCHASE OF FORMULATIONS VIS- A-VIS THE FACTS OF ASSESSMENT YEAR 2008-09. IN VIEW OF THE AFORESAID, IT IS RESPECTFULLY SUBMITTED THAT THE TRANSACTION OF PURCHASE OF FORMU LATIONS OUGHT TO HAVE BEEN ACCEPTED TO BE AT ARM'S LENGTH, APPLYING TNMM IN THE YEAR UNDER CONSIDERATION, TOO. RELIANCE IN THIS REGARD I S PLACED ON THE DECISION OF THE HON'BLE PUNE BENCH OF THE TRIBUNAL IN THE CASE OF BRINTONS CARPETS ASIA PVT. LTD VS DCIT (ITA NO 1296/PN/2010), WHEREIN IT IS HELD AS UNDER: 'WE HAVE CONSIDERED THIS ARGUMENT AND IN OUR OPINIO N, IT IS A SETTLED LAW THAT THE PRINCIPLE OF RES JUDICATE IS INAPPLICA BLE TO INCOME TAX MATTERS. HOWEVER, THE SAME IS TRUE AS LONG AS THE F ACTS ARE DIFFERENT IN DIFFERENT AYS. OTHERWISE, THE RULE OF CONSISTENCY I S RELEVANT TO INCOME TAX MATTERS AND AO CANNOT BE IGNORE THE SAME. THERE OUGHT TO BE I.T.A. NO. 5265/DEL/2011 11 UNIFORMITY IN TREATMENT AND CONSISTENCY WHEN THE FA CTS AND CIRCUMSTANCES ARE IDENTICAL' SINCE INTERNATIONAL TRANSACTION OF PURCHASE OF FORM ULATIONS HAS .. BEEN. BENCHMARKED APPLYING TNMM IN THE SUBSEQUENT YEAR, T HEREFORE, THERE IS NO REASON TO DISPUTE THE APPLICATION OF TNMM AS THE MOST APPROPRIATE METHOD IN THE RELEVANT PREVIOUS YEAR. 3. INCORRECT REJECTION OF COMPARABLE COMPANIES: DURING THE COURSE OF ASSESSMENT PROCEEDINGS, THE AP PELLANT SUBMITTED PROFIT MARGINS OF THE FOLLOWING COMPARABLE COMPANIE S, SUBSTANTIAL INCOME FROM TRADIN G ACTIVITIES FORMULATIONS: NAME OF THE COMPANY GROSS PROFIT ON SALES FOR F.Y. 2006-07 ADITYA MEDISALES LIMITED 3.70 % B A & B BROTHERS (EASTERN) LTD. 9.40 PERCENT COSME FARMA LABORATORIES LIMITED 64.46 PERCENT SHARON BIO-MEDICINES LTD 18.86 PERCENT SOLUMIKS HERBACEUTICALS LTD. 50.90 PERCENT SERUM INTERNATIONAL LTD. 50.53 PERCENT ARITHMETIC MEAN 32.98 PERCENT THE TPO SUMMARILY REJECTED THE AFORESAID COMPANIES HOLDING THAT THESE COMPANIES HAVE A HIGH LEVEL OF MANUFACTURING EXPENDITURE OR THE LEVEL OF PERSONNEL EXPENSES IS VERY HIGH. THE T PO, FURTHER FAILED TO APPRECIATE THE FACT THAT THE AFORESAID COMPANIES AR E FUNCTIONALLY COMPARABLE TO THE APPELLANT, AND HENCE, FOR THE PUR POSE OF BENCHMARKING THE INTERNATIONAL TRANSACTION OF 'PURC HASE OF FORMULATIONS' UNDERTAKEN BY THE APPELLANT, APPLYING RPM, THE ABOVE MENTIONED COMPANIES OUGHT TO BE CONSIDERED FOR THE PURPOSE OF THE COMPUTATION OF ARM'S LENGTH PRICE. CONSIDERING THE AFORESAID COMPANIES CONSIDERED BY T HE APPELLANT WITH AVERAGE GROSS PROFIT MARGIN OVER SALES OF 32.98%, N O ADJUSTMENT ON ACCOUNT OF DIFFERENCE IN INTERNATIONAL TRANSACTION OF PURCHASE OF FORMULATIONS IS WARRANTED, AS UNDER: PARTICULARS ANLOUNT(RS. ) TOTAL SALES RS.L,823,107,281 I.T.A. NO. 5265/DEL/2011 12 GROSS MARGIN @ 32.98% RS. 601,260,781 GROSS MARGIN SHOWN RS. 174,245,097 DIFFERENCE RS.427,015,684 LESS: SUBVENTION INCOME RS. 550,493,475 ADJUSTMENT U/ S 92CA NIL IN VIEW OF THE AFORESAID, THE ADJUSTMENT MADE BY TH E TPO ON ACCOUNT OF DIFFERENCE IN ARMS LENGTH PRICE OF INTERNATIONAL TRANSACTION OF PURCHASE OF FORMULATIONS IS NOT SUSTAINABLE AND LIA BLE TO BE DELETED. 4.THE TPO ERRED IN CONSIDERING COMPANIES AS COMPARA BLE TO THE APPELLANT HAVING SUBSTANTIAL MANUFACTURING ACTIVITI ES: IT IS RESPECTFULLY SUBMITTED THAT RPM METHOD IS APP LICABLE IN A SITUATION WHERE PROPERTY PURCHASED FROM RELATED PAR TY IS SOLD TO UNRELATED ENTITY WITHOUT ADDING ANY SIGNIFICANT VAL UE ADDITION. ACCORDINGLY, IN COMPUTING ARM'S LENGTH MARGIN, GROS S MARGIN EARNED BY COMPANIES FROM ONLY TRADING ACTIVITIES SHOULD BE CONSIDERED COMPARABLE. PARA 2.22 OF THE OECD GUIDELINES PROVIDES, IN THIS REGARD, AS UNDER: '2.22 AN APPROPRIATE RESALE PRICE MARGIN IS EASIEST TO DETERMINE WHERE THE RESELLER DOES NOT ADD SUBSTANTIALLY TO TH E VALUE OF THE PRODUCT. IN CONTRAST, IT MAY BE MORE DIFFICULT TO U SE THE RESALE PRICE METHOD TO ARRIVE AT AN ARM'S LENGTH PRICE WHERE, BE FORE RESALE, THE GOODS ARE FURTHER PROCESSED OR INCORPORATED INTO A MORE COMPLICATED PRODUCT SO THAT THEIR IDENTITY IS LOST OR TRANSFORM ED (E.G. WHERE COMPONENTS ARE JOINED TOGETHER IN FINISHED OR SEMI- FINISHED GOODS). ' THE TPO, IN HIS ORDER HAS CONSIDERED FOLLOWING COMP ANIES FOR THE PURPOSE OF BENCHMARKING THE INTERNATIONAL TRANSACTI ON OF PURCHASE OF DRUG FORMULATION WITH AVERAGE GROSS PROFIT/SALES RA TIO OF 47.21 %, AS UNDER: I.T.A. NO. 5265/DEL/2011 13 NAME OF THE COMPANY GROSS PROFIT ON SALES FOR FY 2006-07( %) 1 COSME FARMA LABORATORIES LTD. 64.46 2 MANKIND PHARMA LIMITED 42.97 3 MARKSONS PHARMA LIMITED 31.70 4 NOVARTIS INDIA LIMITED 55.76 5 TYTK HEALTHCARE LIMITED 41.16 ARITHMETIC MEAN 47.21 HOWEVER, WHILE CONSIDERING THE AFORESAID COMPANIES, THE TPO HAS ERRONEOUSLY SELECTED FOLLOWING COMPANIES ENGAGED IN MANUFACTURING ACTIVI TIES, AS COMPARABLE COMPANIES: (I) NOVARTIS INDIA LTD. (II) TTK HEALTHCARE LTD. (III) MANKIND PHARMA LTD. IT IS ALSO SUBMITTED THAT, FOR THE PURPOSE OF APPLI CATION OF RPM, THE FOLLOWING COMPARABLE COMPANIES PLACED ON RECORD BY THE APPELLANT DURING THE ASSESSMENT PROCEEDINGS, WHICH ARE SOLELY ENGAGED IN TRADING ACTIVITIES SHALL ALSO BE CONSIDERED IN THE FINAL SET OF COMPARABLE COMPANIES: (I)ADITYA MEDIASALES LIMITED (II) B A & B BROTHERS (EASTERN) LIMITED (III) COSME PHARMA LABORATORIES LIMITED (IV) SOLUMIKS HERBACEUTICALS LTD. (V) SERUM INTERNATIONAL LTD. ACCORDINGLY, AFTER CONSIDERING ONLY THOSE COMPANIES WHICH ARE MAJORITY ENGAGED IN THE BUSINESS OF TRADING OF DRUG FORMULATIONS, I.T.A. NO. 5265/DEL/2011 14 FROM THE FINAL SET OF COMPARABLE COMPANIES CONSIDER ED BY THE TPO AS WELL AS THE APPELLANT, THE AVERAGE GROSS PROFIT OVE R SALES WORK OUT TO 35.11 %, AS UNDER: NAME OF THE COMPANY ONLY TRADING GP/SALES % PAGE NO.(PB-1) COMPANIES CONSIDERED BY THE APPELLANT ADITYA MEDISALES LIMITED YES 3.70 137 BA & B BROTHERS (EASTERN) LIMITED YES 9.40 138 COSME FARMA LABORATORIES LIMITED YES 64.46 139 SHARON BIO-MEDICINES LIMITED NO MANUFACT URING PROFIT CLUBBED WITH TRADING PROFIT. 140 SOLUMIKS HERBACEUTICALS LIMITED YES 50.90 141 SERUM INTERNATIONAL LTD. YES 50.53 142 COMPANIES CONSIDERED BY THE TPO COSME FARMA LABORATORIS LTD (COMMON) YES - MARKSONS PHARMA LTD YES 31.70 312-341 NOVARTIS INDIA LTD. NO. MANUFAC TURING PROFIT CLUBBED WITH TRADING PROFIT. 250/263 TTK HEALTHCARE LTD. NO. MANUFAC 290/295 I.T.A. NO. 5265/DEL/2011 15 TURING PROFIT CLUBBED WITH TRADING PROFIT MANKIND PHARMA LTD. NO. MANUFAC TURING PROFIT CLUBBED WITH TRADING PROFIT 208 AVERAGE 35.11 ACCORDINGLY, IT IS RESPECTFULLY SUBMITTED THAT AFTE R CONSIDERING THE AFORESAID COMPANIES HAVING ONLY TRADING INCOME AND FUNCTIONALLY COMPARABLE TO THE APPELLANT WITH AVERAGE GROSS PROF IT MARGIN OVER SALES OF 35.11 %, NO ADJUSTMENT ON ACCOUNT OF DIFFE RENCE IN INTERNATIONAL TRANSACTION OF PURCHASE OF FORMULATIO NS IS WARRANTED, AS UNDER; I.T.A. NO. 5265/DEL/2011 16 PARTICULARS AMOUNT RS. TOTAL SALES RS.L,823,107,281 GROSS MARGIN @ 35.11 % RS. 640,092,966 GROSS MARGIN SHOWN RS. 174,245,097 DIFFERENCE RS.465,847,869 LESS: SUBVENTION INCOME RS. 550,493,475 ADJUSTMENT U/S 92CA NIL THE ADJUSTMENT MADE BY THE TPO ON ACCOUNT OF DIFFER ENCE IN ARMS LENGTH PRICE OF INTERNATIONAL TRANSACTION OF PURCHA SE OF FORMULATIONS IS NOT SUSTAINABLE AND LIABLE TO BE DELETED. 5. WITHOUT PREJUDICE, THE TRANSACTION OF PURCHASE O F FORMULATIONS WAS AT ARM'S LENGTH EVEN AFTER APPLYIN G RPM WITH INTERNAL COMPARABLE: IT IS RESPECTFULLY SUBMITTED THAT THE APPELLANT, DU RING THE YEAR PURCHASED FOR RESALE, SIMILAR FORMULATION FROM THE AE AS WELL AS UNRELATED PARTIES. THE GROSS PROFIT MARGIN (GP/SALE S) EARNED BY THE APPELLANT ON TRANSACTIONS WITH THE ASSOCIATED ENTER PRISE WAS WORKED OUT AT 50.06%, WHICH WAS HIGHER THAN THE AVERAGE GR OSS PROFIT MARGIN EARNED ON SIMILAR TRANSACTIONS WITH UNRELATED THIRD PARTIES AT 21.54%. ACCORDINGLY, THE INTERNATIONAL TRANSACTION OF PURCH ASE OF FORMULATIONS WAS CONSIDERED TO BE AT ARM'S LENGTH PRICE. THE TPO/DRP, HOWEVER, DISREGARDED THE INTERNAL BENC HMARKING UNDERTAKEN BY THE APPELLANT FOR DETERMINING THE ARM 'S LENGTH PRICE OF THE INTERNATIONAL TRANSACTION OF PURCHASE OF FORMUL ATIONS APPLYING RPM ON THE GROUND THAT (I) THE INTERNAL BENCHMARKIN G WAS NEITHER AVAILABLE IN AUDITED ACCOUNTS NOR IN THE TP STUDY R EPORT AND (II) THE PURCHASES MADE FROM UNRELATED PARTIES CONSTITUTES O NLY 31 % OF THE TOTAL PURCHASES AND (III) THE PURCHASES MADE FROM UNRELATED THIRD PARTY IS AN ESTIMATED FIGURE. THE CONTENTIONS OF THE TPOIDRP IN DISREGARDING INTE RNAL COMPARISON CARRIED OUT BY THE APPELLANT FOR BENCHMARKING INTER NATIONAL TRANSACTIONS OF PURCHASE OF FORMULATIONS ARE UNLAWF UL AND NOT SUSTAINABLE FOR THE REASONS SUBMITTED HEREUNDER: RULE 10B( 1 )(B) OF THE INCOME-TAX RULES ('THE RULE S') PROVIDES THAT I.T.A. NO. 5265/DEL/2011 17 FOR APPLICATION OF RPM, THE PROFIT MARGIN REALIZED BY AN ENTERPRISE OR BY AN UNRELATED ENTERPRISE FROM COMPARABLE UNCON TROLLED TRANSACTION OR A NUMBER OF SUCH TRANSACTIONS ARE TO BE COMPARED WITH NET PROFIT MARGIN REALIZED BY THE ENTERPRISE (TESTE D PARTY) FROM THE INTERNATIONAL TRANSACTIONS ENTERED INTO WITH AN ASS OCIATED ENTERPRISE. RULE 1OB(1)(B) OF THE RULES READS AS FOLLOWS: '10B. DETERMINATION OF ARM'S LENGTH PRICE UNDER SEC TION 92C. (1) FOR THE PURPOSES OF SUB-SECTION (2) OF SECTION 92C, THE ARM'S LENGTH PRICE IN RELATION TO AN INTERNATIONAL TRANSA CTION SHALL BE DETERMINED BY ANY OF THE FOLLOWING METHODS, BEING T HE MOST APPROPRIATE METHOD, IN THE FOLLOWING MANNER, NAMELY :- XXX XXX XXX (B) RESALE PRICE METHOD, BY WHICH, (I) THE ..PRICE AT WHICH PROPERTY PURCHASED OR SERVICES OBTAINED BY THE ENTERPRISE FROM AN ASSOCIATED ENTERPRISE IS RES OLD OR ARE PROVIDED TO AN UNRELATED ENTERPRISE, IS IDENTIFIED; -- (II) (II) SUCH RESALE PRICE IS REDUCED BY THE AMOUNT OF A NOR MAL GROSS PROFIT MARGIN ACCRUING TO THE ENTERPRISE OR T O AN UNRELATED ENTERPRISE FROM THE PURCHASE AND RESALE O F THE SAME OR SIMILAR PROPERTY OR FROM OBTAINING. AND PROVIDING THE SAME OR SIMILAR SERVICES, IN A COMPARABLE UNCONTROLLED T RANSACTION, OR .A NUMBER OF SUCH TRANSACTIONS; (III) THE PRICE SO ARRIVED AT IS FURTHER REDUCED BY THE E XPENSES INCURRED BY THE ENTERPRISE IN CONNECTION WITH THE P URCHASE OF PROPERTY OR OBTAINING OF SERVICES; (IV) THE PRICE SO ARRIVED AT IS ADJUSTED TO TAKE IN TO ACCOUNT THE FUNCTIONAL AND OTHER DIFFERENCES, INCLUDING DIFFERE NCES IN ACCOUNTING PRACTICES, IF ANY, BETWEEN THE INTERNATIONAL TRANSA CTION AND THE COMPARABLE UNCONTROLLED TRANSACTIONS, OR BETWEEN -, THE ENTERPRISES ENTERING INTO SUCH TRANSACTIONS, WHICH COULD MATERI ALLY AFFECT THE AMOUNT OF GROSS PROFIT MARGIN IN THE OPEN MARKET; (V) THE ADJUSTED PRICE ARRIVED AT UNDER SUB-CLAUSE (IV) IS TAKEN TO BE AN ARM'S LENGTH PRICE IN RESPECT OF THE PURCHASE OF THE PROPERTY OR OBTAINING OF THE SERVICES BY THE ENTERPRISE FROM TH E ASSOCIATED ENTERPRISE. ' IT IS SUBMITTED THAT IN THE CASE OF THE APPELLANT, RPM COULD APPROPRIATELY BE APPLIED CONSIDERING INTERNAL COMPA RABLE UNCONTROLLED TRANSACTIONS ENTERED INTO BY THE APPEL LANT WITH UNRELATED PARTIES. SUCH INTERNAL COM PARABLES, IT IS SUBMITTE D, PROVIDE THE BEST GUIDE AND IDEAL BENCHMARK FOR INTERNATIONAL TRANSAC TIONS. IN FACT, I.T.A. NO. 5265/DEL/2011 18 INTERNAL COMPARABLES AVAILABLE IN CASE OF AN ASSESS EE ARE TO BE PREFERRED FOR THE PURPOSE OF BENCHMARKING OF INTERN ATIONAL TRANSACTIONS APPLYING RPM, INSTEAD OF RELYING ON EX TERNAL COMPARABLES, AS PROVIDED IN PARAGRAPH 3.26 OF THE GECD GUIDELINES WHICH READS AS UNDER: '3.26. THE TRANSACTIONAL NET MARGIN METHOD EXAMINES THE NET PROFIT MARGIN RELATIVE TO AN APPROPRIATE BASE (E.G. COSTS, SALES, ASSETS) THAT A TAXPAYER REALIZES FROM A CONTROLLED TRANSACTION OR TRANSACTIONS THAT ARE APPROPRIATE TO AGGREGATE UNDER THE PRINCIPLES O F CHAPTER 1). THUS, A TRANSACTIONAL NET MARGIN METHOD OPERATES IN A MAN NER SIMILAR TO THE COST PLUS AND RESALE PRICE METHODS. THIS SIMILARITY MEANS THAT IN ORDER TO BE APPLIED RELIABLY, THE TRANSACTIONAL NET MARGI N METHOD MUST BE APPLIED IN A MANNER CONSISTENT WITH THE MANNER IN W HICH THE RESALE PRICE OR COST PLUS METHOD IS APPLIED. THIS MEANS IN PARTICULAR THAT THE NET MARGIN OF THE TAXPAYER FROM THE CONTROLLED TRAN SACTION (OR TRANSACTIONS THAT ARE APPROPRIATE TO AGGREGATE UNDE R THE PRINCIPLES OF CHAPTER 1) SHOULD IDEALLY BE ESTABLISHED BY REFERENCE TO THE N ET MARGIN THAT THE SAME TAXPAYER EARNS IN COMPARABLE U NCONTROLLED TRANSACTIONS. WHERE THIS IS NOT POSSIBLE. THE NET M ARGIN THAT WOULD HAVE BEEN EARNED IN COMPARABLE TRANSACTIONS BY AN I NDEPENDENT ENTERPRISE MAY SERVE AS A GUIDE. A FUNCTIONAL ANALYSIS OF THE ASSOCIATED ENTERPRISE AND, IN THE LATTER CASE, THE' INDEPENDENT ENTERPRISE IS REQUIRED TO DETERMINE WHETHER THE TRA NSACTIONS ARE COMPARABLE AND WHAT ADJUSTMENTS MAY BE NECESSARY TO OBTAIN RELIABLE RESULTS'. (EMPHASIS SUPPLIED) AS PER THE OECD GUIDELINES, THE NET MARGIN OF THE TAXPAYER FROM THE CONTROLLED TRANSACTION SHOULD IDEALLY BE ESTABLISHE D BY REFERENCE TO THE NET MARGIN THAT THE SAME TAXPAYER EARNS IN COMP ARABLE UNCONTROLLED TRANSACTIONS. WHERE THIS IS NOT POSSIB LE, THE NET MARGIN THAT WOULD HAVE BEEN EARNED IN COMPARABLE TRANSACTI ONS BY AN INDEPENDENT ENTERPRISE MAY SERVE AS A GUIDE. IT IS RESPECTFULLY SUBMITTED THAT THE OECD GUIDELINES ON TRANSFER PRICING RECOGNIZES THE FACT THAT INTERNAL COMPARABLES, IF AVAILABLE, A RE TO BE ADOPTED IN THE FIRST INSTANCE, AS THE PREFERRED BENCHMARK. ONL Y WHERE SUCH INTERNAL COMPARABLES ARE NOT AVAILABLE, RESORT CAN BE HAD TO EXTERNAL COMPARABLES, WHICH MAY EVEN OTHERWISE BE DIFFICULT TO OBTAIN AND INFORMATION IN RESPECT OF WHICH MAY BE INCOMPLETE A ND DIFFICULT TO INTERPRET. 'THE OECD UNDER 'REVISION OF CHAPTERS I-III OF THE TRANSFER PRICING GUIDELINES' ISSUED ON 22 ND JULY, 2010, TOO, RECOMMENDED THE USE OF INTERNAL COMPARABLE DATA FOR BENCHMARKING ANALYSIS, AS UNDER: C.3.4.4 RELIANCE ON DATA FROM THE TAXPAYER'S OWN OP ERATIONS ('INTERNAL DATA'): ] I.T.A. NO. 5265/DEL/2011 19 2.141 'WHERE COMPARABLE UNCONTROLLED TRANSACTIONS 0 / SUFFICIENT RELIABILITY ARE LACKING TO SUPPORT THE DIVISION 0/ THE COMBINED PROFITS, CONSIDERATION SHOULD BE GIVEN TO INTERNAL DATA, WHI CH MAY PROVIDE A RELIABLE MEANS OF ESTABLISHING OR TESTING THE ARM'S LENGTH NATURE OF THE DIVISION OF PROFITS ' ***** ***** A.4.2 INTERNAL COM PARABLES: 3.27 'STEP 4 OF THE TYPICAL PROCESS DESCRIBED AT PA RAGRAPH 3.4 IS A REVIEW OF EXISTING INTERNAL COMPARABLES, IF ANY. IN TERNAL COMPARABLES MAY HAVE A MORE DIRECT AND CLOSER RELATIONSHIP TO T HE TRANSACTION UNDER REVIEW THAN EXTERNAL COM PARABLES. THE FINANC IAL ANALYSIS MAY BE EASIER AND MORE RELIABLE AS IT WILL PRESUMABLY R ELY ON IDENTICAL ACCOUNTING STANDARDS AND 'PRACTICES FOR THE INTERNA L COMPARABLE AND FOR THE CONTROLLED TRANSACTION. IN ADDITION, ACCESS TO INFORMATION ON INTERNAL COMPARABLES MAY BE BOTH MORE COMPLETE AND LESS COSTLY. ' ***** ***** A.4.3 EXTERNAL COMPARABLES AND SOURCES 0/ INFORMATI ON: PARA 3.29 -.'THERE ARE VARIOUS SOURCES OF INFORMATION THAT CA N BE USED TO IDENTIFY POTENTIAL EXTERNAL COMPARABLES. THIS SUB-SECTION DISCUSSES PARTICULAR ISSUES THAT ARISE WITH RESPECT TO COMMERCIAL DATABASES, FOREIGN COMPARABLES AND INFORMATION UNDI SCLOSED TO TAXPAYERS. ADDITIONALLY, WHENEVER RELIABLE INTERNAL COMPARABLES EXIST, IT MAY BE UNNECESSARY TO SEARCH FOR EXTERNAL ONES, SEE PARAGRAPHS 3.27-3.28. ' ***** ***** 3.32 'IT WILL BE UNNECESSARY TO USE A COMMERCIAL DA TABASE IF RELIABLE INFORMATION IS AVAILABLE FROM OTHER SOURCES, E.G. I NTERNAL COMPARABLES, RELIANCE IS ALSO PLACED ON THE DECISIO N OF HON'BLE MUMBAI BENCH OF THE TRIBUNAL IN THE CASE OF UCB INDIA (P) LTD. V CIT.,30 SOT 95 (MUMBAI). WHEREIN, THE TPO SOUGHT TO UNDERTAKE THE BENCHMARKING ANALYSIS APPLY ING TNMM BY CONSIDERING SEGI?3NTED RESULTS BY COMPARING OPERATI NG PROFIT MARGIN EARNED FROM TRANSACTIONS OF ASSOCIATED ENTERPRISES AND UNRELATED PARTIES. THE TPO REQUIRED THE ASSESSEE TO SUBMIT SU CH SEGMENTED PROFITABILITY OF TRANSACTIONS WITH ASSOCIATED ENTER PRISES AND UNRELATED PARTIES. THE APPELLANT CONTENDED BEFORE THE TRIBUNA L THAT SEGMENTAL REPORTING REQUIREMENTS WERE NOT ATTRACTED AND THE A SSESSEE IN TERMS OF I.T.A. NO. 5265/DEL/2011 20 THE ACCOUNTING STANDARD WAS NOT REQUIRED TO MAINTAI N SEPARATE SEGMENTAL PROFITABILITY IN RESPECT OF TRANSACTIONS WITH ASSOCIATED ENTERPRISES AND UNRELATED PARTIES. THE ASSESSEE, ON THAT BASIS, INSISTED THAT THE BENCHMARKING ANALYSIS APPLYING TNMM BE UND ERTAKEN AT ENTITY LEVEL BY COMPARING OPERATING PROFIT MARGIN EARNED BY THE ASSESSEE WITH OPERATING PROFIT MARGIN OF COMPARABLE UNCONTROLLED ENTERPRISES. THE TRIBUNAL IN THE AFORESAID BACKGROUND HELD THAT NOTWITHSTANDING THAT THERE WAS NO REQUIREMENT FOR THE ASSESSEE TO R EPORT SEGMENTED RESULTS IN THE AUDITED ACCOUNTS, THE ASSESSEE WAS R EQUIRED TO PROVIDE WORKING FOR OPERATING PROFIT MARGINFROM TRANSACTION S UNDERTAKEN WITH ASSOCIATED ENTERPRISES AND UNRELATED PARTIES. SUCH COMPARISON OF PROFITABILITY ON TRANSACTION TO TRANSACTION BASIS W AS, ACCORDING TO THE TRIBUNAL,TO BE PREFERRED OVER ENTITY LEVEL COMPARIS ON FOR APPLICATION OF TNMM UNDER THE TRANSFER PRICING REGULATIONS. FUR THER, IN THE CASE OF GHARDA CHEMICALS LIMITED VS DCIT, 130 TTJ 556, THE HON'BLE INCOME TAX APPELLATE TRIBUNAL ('IT AT'), TOO, HELD THAT INTERNAL COMPARABLE SHOULD BE PREFERRED OVER EXTERNAL COMPAR ABLES. THE RELEVANT EXTRACT OF THE JUDGMENT IS REPRODUCED BELOW: INTERNAL CUP METHOD ENVISAGES COMPARING THE UNCONTROLL ED TRANSACTIONS OF THE APPELLANT ITSELF WITH OTHER UNRELATED PARTIES SO AS TO DETERMINE THE ALP WITH THE AE. HOWEVER THE E~E.RNAL.CJ1P-'L1JHO.D DISREGARDS THE PRICE CHARGED OR PAID BY THE APPELLANT TO OR FROM I TS UNRELATED PARTIES AND CONTEMPLATES THE COMPARISON OF THE PRICE SO CHA RGED FROM OR PAID TO ITS AE WITH SOME EXTERNAL INDEPENDENT RELIABLE PRICE DATA UNDER SIMILAR CIRCUMSTANCES OF TRANSACTIONS WITH AE. ORDINARILY THE INTERNAL CUP METHOD SHOULD BE PREFERRED OVER THE EXTERNAL CU P METHOD AS IT NE UTRALIZES SEVERAL DISTINGUISHING FACTORS, SUCH AS THE LOCAL F ACTORS AND THE ECONOMIES AVAILABLE OR UNAVAILABLE TO THE A PPELLANT IN PARTICULAR, HAVING BEARING OVER THE COMPARISON OF P RICE CHARGED FROM UNRELATED PARTIES AND AE. THE HON'BLE TRIBUNAL IN THE CASE OF BIRLASOFT (INDI A) LTD. VS. ACIT- .1.3.6TIJ 505, TOO, UPHELD THE INTERNAL BENCHMARKIN G ANALYSIS UNDERTAKEN BY THE APPELLANT WHILE JUSTIFYING THE IN TERNATIONAL TRANSACTIONS OF PROVISION FOR SOFTWARE DEVELOPMENT SERVICES AS AT ARM'S LENGTH APPLYING TNMM AS AGAINST. E XTERNAL BENCHMARKING REFERRED BY THE TPO FURTHER, THE REVENUE IS NOT BEF ORE THE HIGH COURT ON THE ISSUE OF INTERNAL COMPARABILITY. ON THE SAME LINES, THE CO-ORDINATE BENCH OF DELHI T RIBUNAL IN THE CASE OF DESTINATION OF THE WORLD VS. DCIT [ITA NO 5534/P E1L20101TOO, HELD THAT TRANSFER PRICING ANALYSIS SHOULD BE DONE BY TAKING RECOURSE TO INTERNAL UNCONTROLLED TRANSACTIONS. I.T.A. NO. 5265/DEL/2011 21 IN VIEW OF THE ABOVE, WITHOUT PREJUDICE TO THE SUBM ISSION THAT TNMM IS TO BE APPLIED AS THE MOST APPROPRIATE METHOD IN THE PRESENT CASE, RPM ANALYSIS IS TO BE CARRIED OUT CONSIDERING INTER NAL DATA, AS AFORESAID, AND SHOULD BE PREFERRED OVER EXTERNAL CO MPARABLE DATA. FURTHER, IT IS SUBMITTED THAT, IN THE TRANSFER PRIC ING STUDY, THE APPELLANT BENCHMARKED DISTRIBUTION BUSINESS APPLYIN G TNMM WITH OPERATING PROFIT ON OPERATING REVENUE AS THE PROFIT LEVEL INDICATOR. IT IS RESPECTFULLY SUBMITTED THAT THE APPELLANT HAS TH E SAME DISTRIBUTION NETWORK AND MARKETING FORCE AND ADMINISTRATIVE STAF F ETC. FOR BOTH PRODUCTS PURCHASED FROM BOTH RELATED AND UNRELATED PARTIES. HENCE, SEPARATE COST LEVEL DETAILS FROM RELATED AND UNRELA TED SEGMENT BEYOND GROSS MARGIN LEVEL WERE NOT AVAILABLE. ALLOCATION O F COST INTO RELATED AND UNRELATED PARTY SEGMENT WOULD HAVE RESULTED IN SIGNIFICANT ASSUMPTIONS. FURTHER, AS-17 REQUIRES REPORTING OF F INANCIAL INFORMATION ABOUT THE DIFFERENT TYPES OF PRODUCTS A ND SERVICES THAT THE BUSINESS SEGMENT PRODUCES WHICH INCLUDES DIFFERENT GEOGRAPHICAL AREAS IN WHICH IT OPERATES. IT IS NOT THE CASE THAT THE APPELLANT IS NOT SELLING SIMILAR PRODUCTS TO AES AND NON AES AND HEN CE, THERE WERE NO REQUIREMENT OF PROVIDING THE SEGMENTAL IN THE AUDIT REPORT OF THE APPELLANT ACCORDINGLY, THE CONTENTION OF THE TPO FO R REJECTING THE SEGMENTED PROFITABILITY SUBMITTED BY THE APPELLANT ON THE GROUND THAT SEGMENTAL PROFITABILITY WERE AVAILABLE NEITHER IN A UDITED ACCOUNTS OF THE ASSESSEE NOR IN ITS TP STUDY IS ERRONEOUS, PALP ABLE AND OVERRIDING ERRORS OF FACT AND PROCEDURAL UNFAIRNESS. IT IS FURTHER RESPECTFULLY SUBMITTED THAT THE APPEL LANT DID NOT UNDERTAKE BENCHMARKING ANALYSIS CONSIDERING INTERNAL COMPARAB LES IN THE TRANSFER PRICING STUDY, WOULD NOT ESTOPPEL THE APPE LLANT FROM MAKING SUCH A CLAIM IN THE COURSE OF PROCEEDINGS BEFORE TH E TPO. IN ANY CASE, THE APPELLANT HAS SUBMITTED THE AFORESAID BEN CHMARKING ANALYSIS PURSUANT TO THE PROPOSAL OF THE TPO TO UND ERTAKE THE BENCHMARKING ANALYSIS APPLYING RPM. THE CONTENTION OF THE TPO, THEREFORE, IN THIS REGARD, IS NOT SUSTAINABLE. FURTHER, IN TERMS OF CLAUSE (B) OF RULE 1 OB(1) OF THE INCOME-TAX RULES, RPM COULD BE APPLIED CONSIDERING A COMPARABL E UNCONTROLLED TRANSACTION. IN ANY TRANSACTION IN THE APPELLANT'S CASE CONSTITUTE A SIZABLE VOLUME OF 31 % OF THE TOTAL PURCHASES. THE TPO HAS DISREGARDED THE INTERNAL BENCHMARKING PROPOSED BY T HE APPELLANT ON FLIMSY AND UNLAWFUL GROUNDS. FURTHER, THE CONTENTION OF THE TPO THAT THE APPELLA NT HAS DERIVED THE FIGURES OF PURCHASES MADE FROM UNRELATED THIRD PART IES ON AN ESTIMATED BASIS IS ALSO INCORRECT, IN VIEW OF THE F ACT THAT THE APPELLANT HAS SUBMITTED THE SEGMENTED ACCOUNT DULY AUDITED AN D CERTIFIED BY AN I.T.A. NO. 5265/DEL/2011 22 INDEPENDENT CHARTERED ACCOUNTANT, WHEREIN, THE PROC EDURES RELATED TO PURCHASES AND SALES MADE BY THE APPELLANT HAS BE EN MENTIONED AS UNDER; 2. WE OBTAINED THE LIST OF PRODUCTS BEING PURCHASED BY THE COMPANY. IN RESPECT FOR EACH OF THE PRODUCTS, FOLLOWING INFO RMATION WAS INCLUDED IN THE LIST: A)UNIQUE ITEM CODE OF THE PRODUCT B)WHETHER PURCHASED FROM AE OR OTHER ENTERPRISE OR BOTH. 3. FOR PRODUCTS PURCHASED FROM BOTH ASSOCIATED ENT ERPRISE AND OTHER ENTERPRISE, WE OBTAINED BATCH NUMBERS AGAINST EACH PURCHASES MADE DURING THE YEAR. 4. WE OBTAINED LISTING OF PURCHASES DURING THE YEAR ENDED MARCH 31, 2007 CONTAINING: A.UNIQUE ITEM CODE OF THE PRODUCT B.NAME OF THE SUPPLIER C.BASE VALUE OF PURCHASES D.OTHER EXPENDITURES. WE FURNISH OUR FINDINGS BELOW: 4. WITH RESPECT TO POINT NO. 6, WE FOND THAT THE PURCHASES WAS CORRECTLY CATEGORIZED BETWEEN ASSOCIATED ENTERPRISE AND OTHER ENTERPRISES. IT WOULD BE APPRECIATED FROM THE ABOVE THAT THE AMO UNT OF PURCHASES MADE FROM ASSOCIATED ENTERPRISES AND UNRELATED THIR D PARTIES WERE DERIVED ON ACTUAL BASIS AND THE SEGMENTED ACCOUNTS PLACED ON RECORD WERE DULY AUDITED AND CERTIFIED, THE ALLEGATIONS OF THE TPO FINDS NO PLACE. IN VIEW OF THE AFORESAID, IT IS RESPECTFULLY SUBMIT TED THAT SINCE THE GROSS PROFIT MARGIN (GP/SALES) EARNED BY THE APPELL ANT ON TRANSACTIONS WITH THE ASSOCIATED ENTERPRISE WAS WOR KED OUT AT 50.06%, WHICH WAS HIGHER THAN THE AVERAGE GROSS PRO FIT MARGIN EARNED ON SIMILAR TRANSACTIONS WITH UNRELATED THIRD PARTIES AT 21.54%. ACCORDINGLY, THE INTERNATIONAL TRANSACTION OF PURC HASE OF FORMULATIONS WAS CONSIDERED TO BE AT ARM'S LENGTH P RICE. 6. ARMS LENGTH PRINCIPLE TO BE APPLIED ON INTERNATIONAL TRA NSACTION WITH ASSOCIATED ENTERPRISE: THE APPELLANT DURING THE PROCEEDINGS BEFORE THE TPO AS WELL AS DRP I.T.A. NO. 5265/DEL/2011 23 SUBMITTED THE AUDITED SEGMENTAL PROFITABILITY ON TH E BASIS OF PURCHASE MADE FROM RELATED ENTERPRISES VIS-A-VIS UNRELATED T HIRD PARTIES. IT IS RESPECTFULLY SUBMITTED THAT THE TPO WHILE COMPUTING GROSS PROFIT MARGIN OF THE APPELLANT FOR THE PURPOSE OF BENCHMAR KING THE INTERNATIONAL TRANSACTION OF 'PURCHASE OF FORMULATI ONS' CONSIDERED THE ENTIRE SALES OF THE APPELLANT OF RS. 1,82,31,07,281 (COMPRISING OF SALE OF PRODUCTS SOURCED FROM AE OF RS. ,16,43,03,000 AN D FROM UNRELATED PARTIES OF RS.65,88,04,000). WITHOUT PREJUDICE, IT IS RESPECTFULLY SUBMITTED THA T, EVEN IF RPM HAS TO BE APPLIED, ARMS LENGTH PRINCIPLE SHOULD BE RESTRIC TED TO INTERNATIONAL TRANSACTIONS UNDERTAKEN BY THE APPELLANT WITH ITS A SSOCIATED ENTERPRISE. RELIANCE IN THIS REGARD WAS PLACED ON THE DECISION OF MUMBAI BENCH OF TRIBUNAL IN THE CASE OF IL JIN ELECTRONICS (I) P LTD. VS. ACIT (ITA 438/D/2004), WHEREIN, THE HON'BLE TRIBUNAL HAS DIRE CTED TO RESTRICT THE ADJUSTMENT TO THE EXTENT OF TRANSACTIONS UNDERT AKEN BY THE ASSESSEE WITH ITS ASSOCIATED ENTERPRISE, AS UNDER: 'THE APPELLANT HAS ALSO TAKEN ONE ALTERNATIVE GROUN D OUT OF THE TOTAL RAW MATERIALS CONSUMED BY THE APPELLANT FOR MANUFAC TURING PRINT CIRCUIT BOARDS, ONLY 45.51 PERCENT OF THE TOTAL RAW MATERIALS WERE IMPORTED THROUGH APPELLANT'S ASSOCIATE CONCERNS, AN D, THEREFORE, ANY ADJUSTMENT, IF ANY CALLED FOR, CAN ONLY BE MADE TO THE 45.51 PERCENT OF THE TOTAL TURNOVER, AND NOT TO THE TOTAL TURNOVER O F THE APPELLANT. AFTER CONSIDERING THE FACTS OF THE CASE, WE DO NOT FIND A NY DIFFICULTY IN ACCEPTING THIS CONTENTION OF THE APPELLANT THAT AT BEST ONLY 45.51 PER CENT OF THE OPERATING PROFIT CAN BE ATTRIBUTED TO I MPORTED RAW MATERIAL ACQUIRED FORM APPELLANT'S ASSOCIATE CONCERNS. IN TH E PRESENT CASE, THE ASSESSING OFFICER HAS CALCULATED THE OPERATING PROF IT ON THE ENTIRE SALES OF THE APPELLANT, WHICH IN OUR CONSIDERED OPI NION IS NOT JUSTIFIED WHEN IT IS ADMITTED POSITION THAT ONLY 45.51 PER CE NT OF RAW MATERIAL HAS BEEN ACQUIRED BY THE APPELLANT FORM ITS ASSOCIA TED CONCERNS FOR THE PURPOSE OF MANUFACTURING ITEMS------------ WE THEREFORE DIRECT THE ASSESSING OFFICER TO MODIFY THE ASSESSME NT AND MAKE THE ADJUSTMENT ONLY TO THE EXTENT OF DIFFERENCE IN THE ARMS LENGTH OPERATION PROFIT WITH ADJUSTED PROFIT WITH REFERENCE TO THE 45.51 PER CENT OF THE TURNOVER, AND NOT TO THE TOTAL TURNOVER OF THE APPELLANT. THEREFO RE TO THIS EXTENT, THE ADDITION MADE BY THE ASSESSING OFFICER AND FURTHER CONFIRMED BY THE CIT (A) IS REDUCED, WE ORDER ACCORDINGLY. ' [EMPHASIS SUPPLIED} ATTENTION IS ALSO INVITED TO THE DECISION OF HYDERA BAD BENCH OF TRIBUNAL IN THE CASE OF FOUR SOFT LTD. VS. DCIT [IT A NO. 1495/HYD/201O], WHEREIN THE HON'BLE TRIBUNAL HELD T HAT FOR I.T.A. NO. 5265/DEL/2011 24 COMPUTING THE NET MARGIN OF THE ASSESSEE FOR THE PU RPOSES OF TRANSFER PRICING, ONLY THE COST @ 460PB-I I RELATED TO THE TRANSACTION WITH THE ASSOCIATED ENTERPRISES HAS TO BE CONSIDERED, AS UND ER: 'IN OUR CONSIDERED VIEW, FOR COMPUTING THE NET MARG IN OF THE ASSESSEE FOR THE PURPOSES OF TRANSFER PRICING, ONLY THE COST RELATED TO THE TRANSACTION WITH THE ASSOCIATED ENTERPRISES HAS TO BE CONSIDERED AND ACCORDINGLY, WE APPROVE THAT SEGMENTAL FINANCIALS I S TO BE CONSIDERED FOR THE PURPOSE OF ARRIVING AT THE NET MARGIN ON TH E INTERNATIONAL TRANSACTION WITH THE ASSESSEE'S ENTERPRISE IN RESPE CT OF SOFTWARE DEVELOPMENT SERVICES. ' ON THE SIMILAR LINES, THE MUMBAI BENCH OF TRIBUNAL IN THE CASE OF TECHNIMOUNT ICB INDIA P. LTD. VS. ACIT [ITA NO. 709 8/MURNL2010], HELD AS UNDER: 'COMING TO THE MAIN ISSUE AS TO WHETHER THE SEGMENT AL RESULTS ARE TO BE TAKEN INTO CONSIDERATION OR PROFIT MARGIN AT ENT ITY LEVEL IS TO BE CONSIDERED, IT IS SEEN THAT CHAPTER-X INCORPORATES SPECIAL PROVISIONS RELATING TO AVOIDING OF TAX IN REGARD TO INTERNATIO NAL TRANSACTIONS AND INCOME FROM INTERNATIONAL TRANSACTIONS HAS TO BE DE TERMINED AT ARM'S LENGTH PRICE. THEREFORE. AS PER THE PROVISIONS CONT AINED UNDER SECTIONS 92 TO 94. INTERNATIONAL TRANSACTIONS ARE T O BE TAKEN INTO CONSIDERATION. THEREFORE, SEGMENTAL RESULTS ARE TO BE CONSIDERED A ND NOT THE PROFIT AT ENTITY LEVEL' RELIANCE MAY ALSO B E PLACED IN THIS REGARD ON THE FOLLOWING DECISIONS: - ACIT VS. TWINKLE DIAMOND: ITA NO. 5033/MUM/07 - ACIT VS. T TWO INTERNATIONAL PVT. LTD. : ITA NO. 5644/MUM/2008 - ADDL, CIT VS. TEJ DIAM : 130 TTJ 570 (MUM) - ABHISHEK AUTO INDUSTRIES LTD. VS. DCIT: ITA NO. 1 433/DEL/2009 - STARLITE VS. DCIT: ITA NO. 925/MUM/2006 - SMCC CONSTRUCTION INDIA LTD V. ADDL, CIT: 44 SOT 63 (DELHI) (URO) - GENISYS INTEGRATING SYSTEMS (INDIA) PVT. LTD. VS. DCIT [ITA NO. 1231/BANG/2010] IN VIEW OF THE AFORESAID DECISIONS, NO ADJUSTMENT O N ACCOUNT OF DIFFERENCE IN ARMS LENGTH PRICE OF INTERNATIONAL TR ANSACTION OF PURCHASE OF FORMULATIONS WOULD SURVIVE AFTER CONSID ERING THE SEGMENTAL PROFITABILITY OF THE APPELLANT, AS UNDER: I.T.A. NO. 5265/DEL/2011 25 PARTICULARS COMPUTATION OF GROSS PROFIT MARGIN BY THE TPO COMPUTATION OF GROSS PROFIT MARGIN SALES 1,82,31,07,281 1,16,43,03,000 COST OF GOODS SOLD 1,64,88,62,184 1,10,07,93,000 GROSS MARGIN SHOWN 17,42,45,097 6,35,10,000 GROSS MARGIN 9.56% 5.45% ARMS LENGTH GROSS MARGIN AS COMPUTED BY SHE TPO @ 47.21% 86,06,88,947 54,96,67,446 SHORTFALL IN PROFITS 68,64,43,850 48,61,57,46 LESS SUBVENTION INCOME 55,04,93,475 55,04,93,475 BALANCE ADJUSTMENT 13,59,50,375 NIL FURTHER, THE DRP HAS CONSIDERED THE SEGMENTAL PROFI TABILITY OF THE APPELLANT AND ACCORDINGLY GIVEN A SPECIFIC FINDING THAT FOR THE PURPOSE OF COMPUTING THE GROSS PROFIT MARGIN OF THE APPELLA NT, TRANSACTIONS WHICH WERE UNDERTAKEN WITH ASSOCIATED ENTERPRISE ON LY SHALL BE CONSIDERED, AS UNDER: 'THE CORRECT CALCULATION OF THE GROSS PROFIT AS PER THE SEGMENTATION GIVEN BY THE ASSESSEE NOW WOULD BE NET SALES RS.1,16,43,03,000 ~. COST OF GOODS SOLD RS. 1, 10,07,93,000 GROSS PROFIT RS. 6,35,10,000'/ GP/SALES 5.45% HOWEVER, THE ASSESSING OFFICER, WHILE PASSING THE F INAL ORDER DATED 24- 12-2011 FAILED TO TAKE NOTE OF THE SPECIFIC DIRECTI ON OF THE DRP AND PROCEEDED WITH THE ADJUSTMENT PROPOSED BY THE TPO. THE APPELLANT HAD FILED A RECTIFICATION APPLICATION BEFORE THE RP , WHICH IS PENDING DISPOSAL. ACCORDINGLY, THE ADJUSTMENT MADE BY THE T PO WOULD BE DELETED AFTER CONSIDERING THE DIRECTION OF THE DRP. 4.2 LD. COUNSEL FOR THE ASSESSEE WHILE REITERATING SUCH BROAD PROPOSITION IN THE LIGHT OF CASE LAW, HAS PLEADED FOR DELETION OF THE DIFFERENCE IN ALP AS DETERMINED BY THE TPO AND AS CONFIRMED BY DISPUTE RESOLUTION P ENAL-1, NEW DELHI. I.T.A. NO. 5265/DEL/2011 26 5.LD. D.R. FILED HIS WRITTEN SUBMISSIONS TO SUPPORT THE ORDER OF THE A.O. BASED ON THE DIFFERENCE IN ALP AS DETERMINED BY THE TPO AND CONFIRMED BY LD. DISPUTE RESOLUTION PANEL -1(DRP), NEW DELHI AS UNDER: I PLACE RELIANCE ON THE DIRECTION OF THE HONBLE DRP, THE TPO AND THE A.O. AS RELEVANT. I HAVE PLACED THESE ARGUMENT S TO BOLSTER THE DIRECTIONS/ORDERS OF THE AUTHORITIES BELOW. THESE SUBMISSIONS ARE MERELY A BRIEF NOTE ON THE LINE OF ARGUMENTS, AS DI RECTED BY THE HONBLE BENCH. THE DETAILED AND COMPREHENSIVE ARGU MENTS HAVE ALREADY BEEN MADE. A. GROUNDS 2.1 TILL 2.4 RELATING TO USE OF RPM OVER TNMM CLAIM OF THE ASSESSEE THAT THERE ARE DRUG CONTROL RESTRIC TIONS AND LACK OF PATENT LAWS IN INDIA, AND REJECTION OF INTERNAL BEN CHMARKING AND THE THREE ENTITIES BEING IN MANUFACTURING ACTIVITIES AL SO. IT HAS BEEN NOTED IN THE ORDER OF DRP, PARAGRAPH 4. 1 AND 4.2, THAT EVEN THE COMPARABLES WERE AFFECTED BY GOVT. POLICIE S SUCH AS DRUG CONTROL REGULATIONS, AND PATENT LAWS IN INDIA. IT IS THE TPOS CASE THAT THE ASSESSEE DID NOT DEMONSTRATE THAT THE COMP ARABLES WERE UNAFFECTED BY THIS WHILE THE ASSESSEE ONLY WAS AFFE CTED. ALL THE ENTITIES CHOSEN IN THE ANALYSIS WERE SUBJEC T TO INDIA LEGISLATION/LAWS/BUSINESS ENVIRONMENT. IT IS A FACT THAT THE ASSESSEE DID 11IIT MAKE SUFFI CIENT PROFITS IN ITS PURCHASES FROM THE AES. THE TESTED PARTY BEING THE INDIAN ENTITY. THE ASSESSEE NEEDED TO HAVE BEEN CONCERNED ONLY WITH THE BENCH MARK MARGINS REQUIRED TO BE EARNED ILL INDIA. THE ASSESSEE IS THE TESTED PARTY AS CHOSEN BY THE ASSESSEE HIMSELF. THERE IS N O JUSTIFICATION FOR THE ASSESSEE TO BEND BACKWARDS TO ACCOMMODATE ITS A F. WHAT EFFECTIVELY THE ASSESSEE, WISHES TO CONVEY IS THAT THE US ENTITY WILL NOT COMPROMISE ON ITS PROFITS OR PRICES, THOUGH IN THIS PROCESS THE INDIA N ASSESSEE MAY EARN LESS THAN BENCH MARK PROFITS IN I NDIA. THE ASSESSEE DID NOT SPECIFY AS TO HOW WERE THE PRICES FIXED BY THE AE. WITH REGARD TO ASSESSEE'S CLAIM THAT TNMM IS A BETT ER METHOD OVER RPM, IT IS POINTED OUT THAT THE ASSESSEE IS IN A RESELL SIT UATION. IT HAS BEEN SPECIFIED BY THE ASSESSEE IN ITS OWN TP STUDY REPORT THAT RPM WOULD HAVE BEE I! THE IDEAL METHOD FOR BENCH MARKING IN A SITUATION SIMILAR TO THE ASSESSEE. YET THE ASSESSEE CHOSE IN. IGNORE RPM. ON A PLEA THAT THE DATA WAS NOT AVAILABLE (PLEASE SEE PA RAGRAPH 2. ON PAGES 2 AND OF THE TPOS ORDER). RELIANCE IS PLACED UPON ORDER OF MIS SCRDIA PHARMACEUTICALS, 136 IT1 129. MUMBAI, WHICH PRESCRIBES A PRIMACY OF METHODS (PLEASE SEE PARAGRAPHS 54 TILL 66 OF THIS ORDER). IN PARAGRAPH 66 OF THIS ORDER IT HAS BEEN SPECIFICALLY NOTED THAT A TRADITIONAL METH OD SUCH AS RPM IS PREFERRED OVER PM LIT METHOD, I.C. A METHOD SUCH AS RPM IS PREFERRED I.T.A. NO. 5265/DEL/2011 27 OVER TNMM. FURTHER, IT HAS BEEN NOTED IN THIS ORDER THAT IT IS THE DUTY OF THE A.O./TPO TO CHOOSE MOST APPROPRIATE METHOD FURTHER, IN THE CASE OF M/S STAR DIAMOND GROUP VS DDIT MUMBAI, IN ITA NO. 39231MUMBAI/2008, A Y 04-05 28.01.2011, IT HAS BEEN NOTED THAT RPM IS THE MOST SUITED METHOD IN CASE OF A RESELL SITUATION, SUCH THAT OF THE ASSESSEE IT IS NOTED THAT THE THREE COMPARABLES SPECIFICALLY POINTED OUT BY THE ASSESSEE IN ITS GROUNDS OF APPEAL VIZ. M/S MANKIND PHARMA LTD. M/S NOVARTIS INDIA LID AND M/S.TTK HEALTHCARE LTD. HAVE VERY LESS MANUFACTURING EVEN THE ASSESSEE' SOWN COMPARABLE, M /S SHARON BIO- MEDICINES LTD. IS INTO MANUFACTURING. THE ASSESSE'S PLEA THAT WHEREAS IT IS INTO TRADING AND THESE ENTITIES ARE INTO MANU FACTURING, ALSO DOES NOT HOLD GOOD AS THE PERCENTAGE OF MANUFACTURING IS VERY LESS VIZ. A VIZ. THE OVER ALL SALE OF THESE ENTITIES. THE TPO HAS COVE RED THIS ISSUE ON PAGE 9. I (J .URD II OF HIS ORDER. MOREOVER, EVEN THE ASSESSEE'S OWN COMPARABLE M/S SHARON BIO MEDICINES LTD. IS ALSO IN TO MANUFACTURING. IT IS ALSO POINTED OUT THAT THE SUBMISSIONS MADE BY THE ASSESSEE SUPPOSEDLY AS BROAD PROPOSITIONS BEFORE THE HONBLE ITA T IN THE FORM OF A 20 PAGE WRITE UP IS AT VARIANCE WITH THE SUBMISSIONS DETAILED IN TP STUDY REPORT. THESE VARIATIONS ARE POINTED OUT IN THE FORM OF TABLE BELOW :- S.NO. NAME OF THE ENTITY BUSINESS DESCRIPTION AS PER PAGE 159/160 OF THE PAPER BOOK AND FORMING ANNEXURE 3A TO THE TP STUDY REPORT BEING PAGE 110/111 OF TP STUDY REPORT BUSINESS DESCRIPTION AS PER ASSESSEES BROAD PROPOSITIONS, PAGE 9 THEREOF 1 SHARON BIOMEDICINES LTD. THE COMPANY IS ENGAGED IN TRADING OF MEDICINES/BULK DRUGS/FORMULATIONS, ONLY THE COMPANY IS ALSO INTO MANUFACTURING 2 SERUM INTERNATIONAL LTD. ON PAGE 160 OF THE PAPER BOOK, THE ASSESSEE CLAIMS THAT THIS ENTITY IS INTO TRADING AND ALSO HAS REVENUE FROM WINDMILL POWER. THE ASSESSEE HAS CLAIMED THAT THIS ENTITY IS ONLY INTO TRADING. NO MENTION OF REVENUE FROM WIND POWER 3 SOLUMIKS HERBACEUTICALS LTD. ON PAGE 160, THE ASSESSEE CLAIMS THAT MORE THAN 75% OF THE REVENUE ONLY WAS DERIVED FROM TRADING OF DRUGS AND FORMULATIONS THE ASSESSEE HAS CLAIMED THAT THIS ENTITY IS ONLY INTO TRADING. I.T.A. NO. 5265/DEL/2011 28 B. THE ASSCSSEE'S CLAIM, MADE IN GROUND NO. 2.6 THA T SUBVENTION INCOME OF RS.55,04,93,475/- IS NEEDED TO BE REDUCED FROM THE VALUE OF PURCHASES FROM THE AE. THE ASSESSEE HAS WRONGFULLY REPORTED THE FIGURE OF RS 1,04.93,475/- AS 'SUBVENTION INCOME. AS PER ASSESSEE'S O' V N ANNUAL AUDITED ACCOUNTS. ILL TRANSACTIONS WITH RELATED PARTIES, PAGE 20 I OF PAP ER HOOK. THE ASSESSEE HAS SHOWN SUBVENTION INCOME AT R S. 53.21 CRORES ONLY. THERE IS MARKET RESEARCH INCOME SHOWN AT RS. 1.83 CRORES. BOTH THESE TRANSACTIONS NEEDED TO BE SEPARATELY BEN CHMARKED. THE ASSESSEE HAS WRONGLY DUBBED THESE TWO TRANSACTIONS AND HAS NOT CARRIED OUT BENCH MARKING OF THESE ITEMS SEPARATELY. IN FACT, THE ASSESSEE OUGHT TO HAVE CHARGED A MARK UP UPON MARKET RESEARCH INCOME WHICH IT HAS FAILED. IN FACT MARKET RESEARCH AND SUBVENTION INCOME ARE O THER INCOMES. WHICH ARE DISTINCT AND CLEARLY DISTINGUISHABLE DIFF ERENT INTERNATIONAL TRANSACTIONS. WHICH NEEDED SEPARATE BENCH MARKING. THE ASSESSEE HAS NOT CARRIED OUT ANY SEPARATE BENCH MARKING FOR THES E ACTIVITIES. (PLEASE REFER TO PAGES 35,36, 37 AND 38 OF PAPER BO OK). THE TPO HAS DISCUSSED IN DETAIL THAT SUBVENTION INCOME WAS OTHER INCOME REPO RTED BY THE ASSESSEE IN ITS OWN AUDITED ANNUAL ACCOUNTS. FURTHERMORE, CROSS SUBSIDISATION IS NOT ALLOWED. TH E SUBVENTION INCOME AND THE MARKET RESEARCH INCOME WERE RECEIVED FOR SEPARATE PURPOSES, AND CANNOT BE REDUCED FROM PURCHASE PRICE OF THE FORMULATIONS. THERE WAS NO SPECIFIC AGREEMENT THAT THESE AMOUNTS WERE GIVEN FOR REDUCTION FROM PURCHASE PRICE. [HEY WERE FOR A SEPARATE PURPOSE AND NEED TO BE GOT BENCH MARKED SE PARATELY. THE ASSESSEE FAILED TO DO SO. THAT EVERY TRANSACTION NE EDS TO BE SEPARATELY BENCHRNARKED IS SUPPORTED BY THE FOLLOWING ORDERS: 1.UCB INDIA (P) LTD. VS. ACIT (200S)) 30 SOT 95/121 N O : 3 1124 TT J 2X9 2.ADDL. ERR VS. TEJ DIAMOND (2010) 37 SOT 341/130 T TJ 570 3.DY. ERR VS. STARLITE (2010) 40 SOT 4211133 N-J 425 4.GLOBAL VANTEDGE (P) LTD. VS. DY.CIT (2010)}7 SOT (DELHI TRIB.) CIT(A) 5.DY CIT VS S NARENDRA (2010) 41 SOT 1 6.DY: CIT VS. STERLITE (2010) 40 SOT .421 (MUM.) 6.ASSTT CIT VS. TWINKLE DIAMOND (~()II, 45 SOT 115 (MUM) (URO) 7.BCUCUON INDIA (P) LTD. VS. ITO (2012) 134 ITD 229 DELHI TRIBUNAL I.T.A. NO. 5265/DEL/2011 29 THE ASSESSEES ARGUMENTS THAT THE ENTITIES CHOSEN B Y THE TPU WERE FUNCTIONALLY NOT COMPARABLE. DOES NOT HOLD WATER. I N FACT, AS NOTED, EVEN THE ASSESSEE'S COMPARABLES ARE NOT EXACTLY COM PARABLE FUNCTIONALLY. IT IS NOTED IN THE CASE OF M/S SYMANTEC, 46 SOT 48, PARA 16 THEREOF, THAT EXACT FUNCTIONAL COMPARABILITY IS NEVER ESTABLISHED. IT HAS BEEN FURTHER NOTED IN THIS ORDER THAT THIS IS T HE REASON WHY THE PLUS MINUS 5% BENEFIT IS ALLOWED TO THE ASSESSEE. WITH REGARD TO THE SEGMENTATION DONE BY THE ASSESSE E, RELIANCE IS PLACED ON THE CASE OF M/S CELL. PARAGRAPH 71B, 3 17 ITR 292 THAT THE ASSESSEE NEEDED TO EVALUATE? TRANSACTION ON A STAND ALONE BASIS, EVEN THOUGH THERE WAS NO STATUTORY REQUIREMENT TO MAINTAIN SEGMENTAL DATA, THE ASSESSEE HAS PROVIDED A REPORT BY M'S SR BATLIB OI & CO. TO SUPPOSEDLY BOLSTER ITS CASE. THIS REPORT IS DATED AUGUST R, 2011, AND PAGES 366 TILL 370 OF PAPER BOOK. THIS REPORT DOES NOT INSPIR E CONFIDENCE, AS NOTED FROM THE CONCLUDING PARAGRAPHS OF THIS REPORT, VIZ, 'BECAUSE THE ABOVE PROCEDURES DO NOT C011STI!UFC EITHER AN AUDIT OR (I REVIEW MAD' IN ACCORDANCE WITH GENERALLY ACCEPTED AUDITING STANDARDS IN INDIA, WE DO NOT EXPRESS ANY ASSURANCE 011 THE MARGIN FOR THE FINANCIAL YEAR 2006 07. HAD WE PERFORMED ADDITIONAL PROCEDURES OR HAD WE PE RFORMED AN AUDIT OR REVIEW OF THE FINANCIAL STATEMENTS IN ACCORDANCE WITH GENERALLY ACCEPTED DUD/RING STANDARDS IN INDIA. OTHER MATTERS MIGHT HAVE COME TO OUR ATTENTION THAT WOULD HAVE BEEN REP ORTED TO YOU. OUR REPORT IS SOLELY FOR THE PURPOSE AS SE T FORTH IN THE FIRST PARAGRAPH OF THIS REPORT AND FOR YOUR INFORMATION AND IS NOT TO BE USED FUR ANY OTHER PURPOSE OR TO BE DISTRIBUTED TO ANY OTHER PARTIES. THIS REPORT RELATES ONLY TO THE ACCOUNTS A ND ITEMS SPECIFIED ABOVE AND DO NOT EXTEND TO ANY FINANCIAL STATEMENTS OF ELI LILLY AND CO. (INDIA) (P) LTD. TAKEN AS A WHOLE. IT IS ALSO POINTED OUT THAT IN THE CASE OF M/S ACIT VS. GENOME BIOTECH (P) LTD., ITA NO. 5272/MUMBAI/2007 DATED 16-05-2012. (P ARA 10.8 THEREOF )THAT MERE FACT THAT THE EXPENSES WERE AUDI TED IS NOT A GROUND ON WHICH A TP ADJUSTMENT COULD BE DELETED BY AN APPEAL AUTHORI TY. C. THE ASSESSEES PLEA REGARDING CONSISTENCY / RES JUDICATA THE ASSESSEE HAS, IN ITS BROAD PROPOSITIONS, BEING WRITTEN SUBMISSIONS HAS NOTED THAT THE DEPARTMENT HAS IN THE SUBSEQUENT YEARS ACCEPTED I.T.A. NO. 5265/DEL/2011 30 ASSESSEE'S BENCH MARKING USING TNMM AND THEREFORE I N THIS PRIOR YEAR ALSO IT SHOULD HAVE ACCEPTED THE SAME, IS NOT ACCEPTABLE. RELIANCE IS PLACED UPON THE ORDERS OF HON'BLE TRIB UNAL IN THE CASES OF M/S JOHN MATHEY OF HON'BLE DELHI TRIBUNAL-DELIVE RED BY HON'HLE SH. U.B.S BEDI AND SH. B.C. MEENA, DATED 29-03-2012 , ITA 344/DE1L2010, PARA 9 THEREOF, AND M/S LI & FUNG INDIA (P) LTD. VS. DCIT DATED 30-09-2011, 2012-143 IT.T 20 I, PARA 8 THEREOF. FURTHER IN THE CASE OF M/S FULFORD VS. DEIT - 140 ITJ 183 IT HAS BEEN HELD THAT THE TPO NEEDS TO APPLY HIS MIND AFRESH EVERY Y EAR. RELIANCE IS ALSO PLACED ON THE: ORDER OF M/S CARRARO INDIA LTD. VS. DCIT - 2008- TIOL-519-IT A T-DEL, AS NOTED IN THE CASE OF M/S JOHN MATHEY, COPY ALREADY SUBMITTED. D. MISCELLANEOUS THE ASSESSEE HAS PUT FORWARD A PROPOSITION THAT INT ERNAL COMPARABLES NEEDED TO BE PREFERRED OVER EXTERNAL COMPARABLES, I N.THIS MATTER THE ASSESSEE HAS RELIED UPON CERTAIN CASES, WHICH HOWEV ER DO NOT HELP THE ASSESSEE. THE CASE OF M/S BIRLA SOFT RELATES TO SERVICES, WHEREAS THE ASSESSEE'S PRODUCTS ARC PHARMACEUTICALS. IN THIS CASE THE METH OD CHOSEN WAS TNMM HOWEVER IN THE CASE OF THE ASSESSEE THE METHOD CHOSEN H) THE TPO IS RPM. IN THE CASE OF GHARDA CHEMICALS THE CHOICE WAS BETWEEN INTERNAL CUP VS. EXTERNAL CUP IN THE ASSESSEE'S CASE THE DISPUTE IS RPM OVER TNMM. SIMILARLY, THE CASE OF DE STINATION OF THE WORLD ALSO INVOLVED TNMM. THEREFORE, ALL THESE CASES HAVE FACTS, DIFFERENT FROM THE ASSESSEE. THE ASSESSEE WHILE CARRYING OUT THE INTERNAL BENCH MARKING HAS CONVENIENTLY NOT PROVIDED FOR THE BULK DISCOUNT/FAVOURABLE CREDI T TERMS THAT WOULD HAVE BEEN AVAILABLE TO IT, WHEN BUYING FROM THE AE. THE ASSESSEE ITSELF HAS CLAIMED THAT BUYING IN INDIA AND SELLING IN INDIA CANNOT BE COMPARED TO AN AT: SITUATION. RELIANCE UPON CASE OR M/S GHARDA CHEMICALS (1 :1() '1'1.1 )50) IS COUNTERED BY POINTING OUT, FROM ASSESSEE'S OWN SUBMISSION. ( PAGE 14 MIDDLE PART) THE LOCAL FACTORS AND ECONOMIES NEED TO HE ACCOUNTED FOR. E. WITH REGARD TO GROUND RELATING TO SECTION 234B AND 234C, IL IS NOTED THAT THESE ARE COMPENSATORY IN NATURE AND FULL COMPENSATION OUGHT TO HAVE BEEN PROVIDED TO REVENUE, WHICH MEANS FULL COMPENSATION VIS. A VIS. FINALLY ASSESSED INCOME. I.T.A. NO. 5265/DEL/2011 31 5.1 WHILE NOTING THE ORDER OF THE A.O. AND REITERAT ING THE WRITTEN SUBMISSIONS FILED BY LD. D.R. PLEADED FOR CONFIRMATION OF THE IMPUGNED ORDER. 6. LD. COUNSEL FOR THE ASSESSEE FILED REJOINED TO T HE ARGUMENTS OF THE LD. D.R. AS UNDER: 1. RESALE PRICE METHOD IS TO BE APPLIED AS THE MOS T APPROPRIATE METHOD. DR'S CONTENTIONS : (I) THE LD. DEPARTMENTAL REPRESENTATIVE (DR), REJEC TING THE APPELLANT'S CONTENTIONS, CONTENDED THAT SINCE THE A PPELLANT WAS ENGAGED ONLY IN TRADING, I.E., PURCHASE AND RESALE OF DRUG FORMULATIONS WITHOUT ANY VALUE ADDITION AT ITS END, FOR BENCHMARKING OF INTERNATIONAL TRANSACTIONS OF PURCHASE OF DRUG FORMULATIONS FROM THE ASSOCIATED ENTERPRISE, RESALE PRICE METHOD WAS TO B E APPLIED AS THE OST APPROPRIATE METHOD. THE LD. DR PLACED RELIANCE IN THIS REGARD ON DECISIONS OF THE BENCHES OF THE TRIBUNAL IN THE CAS E OF GHARDA CHEMICALS LTD. VS. DCIT (130'1'TJ 556) AND SERDIA P HARMACEUTICALS INDIA P. LTD. VS. ACIT (44 SOT 391). (II) THE LD. DR, REFERRING TO PAGE 42 OF THE TRANSF ER PRICING STUDY CONTENDED THAT THE APPELLANT HAD ITSELF, IN THE TRANSFER PRICING STUDY , STATED THAT RPM WAS THE IDEAL METHOD FOR DETERMININ G THE ARM'S LENGTH PRICE, BUT DISREGARDED THE SAME ON FRIVOLOUS GROUNDS. (III) THE APPELLANT HAD APPLIED TRANSACTIONAL NET M ARGIN METHOD ('TNMM') AS THE MOST APPROPRIATE METHOD FOR BENCHMA RKING THE INTERNATIONAL TRANSACTIONS OF IMPORT OF DRUG FORMUL ATIONS, IN ORDER TO TAKE INTO ACCOUNT SUBVENTION INCOME AS PART OF THE OPERATING PROFIT MARGIN. IN THE SUBMISSION OF THE LD. DR, TNMM IN TH E PRESENT CASE WAS NOT THE MOST APPROPRIATE METHOD, BUT THE MOST C ONVENIENT METHOD. APPELLANT'S REJOINDER : THERE IS NO DISPUTE WITH THE CONTENTION OF THE TPO THAT, IDEALLY, IN CASE OF TRANSACTIONS OF RESALE, IT WOULD BE APPROPR IATE TO APPLY RPM. HOWEVER, RPM HAS NOT BEEN CONSIDERED AS THE MOST AP PROPRIATE METHOD SINCE GROSS PROFIT ARGIN OF THE COMPARABLE C OMPANIES CANNOT BE RELIABLY DETERMINED FOR THE REASONS STATED AT PA GE 42 OF THE TRANSFER PRICING STUDY; AS UNDER: ABSENCE OF RELIABLE DATA ON FUNCTIONAL COMPARABILITY (SAME OR SIMILAR SERVICES) OF COMPARABLE COMPANIES, I.E., TH E DEGREE OF COMPARABILITY EXISTING BETWEEN THE INTERNATIONAL TR ANSACTION AND THE UNCONTROLLED TRANSACTIONS AND BETWEEN THE ENTERPRIS ES ENTERING INTO SUCH TRANSACTIONS; AND ABSENCE OF RELIABLE GROSS MA RGIN DATA OF COMPARABLE COMPANIES NECESSARY FOR APPLICATION OF T HE METHOD. ' I.T.A. NO. 5265/DEL/2011 32 IT IS SUBMITTED THAT, CONSIDERING THE FOLLOWING SPE CIAL CIRCUMSTANCES, THE GROSS PROFIT MARGIN EARNED BY THE APPELLANT FRO M INTERNATIONAL TRANSACTIONS OF IMPORT OF DRUG FORMULATIONS CANNOT BE COMPARED WITH GROSS MARGIN EARNED BY UNRELATED PARTIES ENGAGED IN MANUFACTURING OR FROM TRADING IN INDIGEN OUSLY MANUFACTURED PHARMACEUTICALS: (A) COMPETITION WITH SMALLER PLAYERS NOT SUBJECT T O PATENT LAWS : IT IS RESPECTFULLY SUBMITTED THAT THE PATENT LAW IN INDIA. DOES NOT ALLOW PRODUCT SPECIFIC PATENTS, WHICH ESSENTIALLY MEANS T HAT COMPANIES CAN MANUFACTURE CHEAPER GENERIC DRUGS. THE SAME PUTS SE VERE PRICE PRESSURE ON THE PATENTED PRODUCTS SOLD BY THE APPEL LANT IN INDIA, WHICH HAVE TO COMPETE WITH CHEAPER LOCALLY MANUFACT URED DRUGS. WITH STRONGER PATENT LAWS, THE PRODUCTS SOLD BY THE APPE LLANT IN INDIA COULD HAVE FETCHED MUCH HIGHER PRICES .THE COMPETITIVE SC ENARIO REGARDING APPELLANT'S PRODUCTS IS SUMMARIZED AS FOLLOWS: S.NO. LILLY INDIAS PRODUCT NO. OF GENERIC PLAYERS NAME OF GENERIC PRODUCT 1 HUMINSULIN TOTAL (VIAL + CARTS) 7 WOSULIN (WOC), RECONSULIN (SHREYA), INSUCARE (RBX) 2 DISTACLOR 453 PHEXIN (GSK), CEFTUM (GSK), ZIFI (FDC) 3 GEMCITE 149 FAMORUBICIN (PIRAMAL), DAXOTEL (DBF), GEFTINAT (NATCO) 4 HUMATROPE 2 LG EUTROPIN (LG LIFE), SAIZEN (SERRI, & INST.) 5 REOPRO 7 AGGRAMED (GERMAN REM), AGGRIBLOC (PIRAMAL), AGGRITOR (TORRENT), TEROFIB (INTAS), G) 2 BAN (GLAND PHARMA), COROMAX (USV) TO REITERATE, THE APPELLANT, IT WOULD BE APPRECIATED, HAS BEEN FACING STRONG COMPETITION FROM GENERIC DRUG MANUFAC TURERS WHICH HAS PUT SIGNIFICANT PRESSURES ON PRICING OF ITS PRODUCT S RESULTING IN LOWER GROSS PROFIT MARGIN EARNED BY THE APPELLANT . /(B) (B) PRICE CONTROL REGULATIONS : 55% TO 60% OF THE SALES VALUES OF THE DUGS TRADED B Y THE APPELLANT ARE I.T.A. NO. 5265/DEL/2011 33 FROM TRADING OF SCHEDULED DRUGS, WHICH ARE SUBJECT TO PRICE CONTROL REGULATIONS BY THE NATIONAL PHARMACEUTICAL PRICING AUTHORITY (NP AA) CONSTITUTED UNDER THE DRUGS (PRICE CONTROL) ORD ER 1995. HOWEVER, IN CASE OF COMPARABLE COMPANIES. THE PROPO RTION OF SALE OF SCHEDULE DRUGS WOULD BE SIGNIFICANTLY LOWER, WHICH MAKE THEM EARN MORE PRO TITS AS THE PRICE CONTROL REGULATION OF NP PA DO NOT APPLY TO NON-SCHEDULED DRUGS. THE RELEVANT PORTION OF THE DR UG (PRICE CONTROL) ORDER, 1995 PROVIDING FOR CALCULATIUN OF R ETAIL PRICE OF DRUG FORMULATIONS, READ AS FOLLOWS: 7. CALCULATION OF RETAIL PRIC~ ULATION ,: THE RETAIL PRICE OF A FORMULATION SHALL BE CALCULAT ED BY THE GOVERNMENT IN ACCORDANCE WITH THE FOLIO W ING FORMULA NAMELY: R.P.=(M.C.+C.C.+P.M.+P.C.)X(1+, THE PROVISION OF TECHNICAL AND ADMINISTRATIVE SERVICES, AND THE L EASE OF PRODUCTION FACILITIES. THIS TYPE OF ARRANGEMENT IS OFTEN REFERRED TO AS A PACKAGE DEAL. SUCH COMPREHENSIVE PACKAGES WOULD BE UNLIKELY TO INCLUDE SALES OF GOODS, HOWEVER, ALTHOUGH THE PRICE CHARGED FOR SALES OF GOODS MAY C OVER SOME ACCOMPANYING SERVICES. IN SOME CASES, IT MAY NOT BE FEASIBLE TO EVALUATE THE PACKAGE AS A WHOLE SO THAT THE ELEMENTS OF THE PACKAGE MUST BE S EGREGATED. IN SUCH CASES, AFTER DETERMINING SEPARATE TRANSFER PRICING FOR THE SEPARATE ELEMENTS, THE TAX ADMINISTRATION SHOULD NONETHELESS CONSIDER WHETHER IN TOTAL THE TRANSFER PRICING FOR THE ENTIRE PACKAGE IS ARM'S LENGTH.' RELIANCE MAY ALSO BE PLACED ON THE GUIDANCE GIVEN B Y THE US AND AUSTRALIAN TP REGULATIONS ON THIS ISSUE. US REGULATIONS 4.482-1 ( F)(2)(I) ALSO PROVIDE IN THIS REGARD AS UNDER: 'THE COMBINED EFFECT OF TWO OR MORE SEPARATE TRANSA CTIONS (WHETHER BEFORE, DURING, OR AFTER THE TAXABLE YEAR UNDE R REVIEW) MAY BE CONSIDERED. IF SUCH TRANSACTIONS, TAKEN AS A WHOLE, ARE SO INTERRELATED THAT CONSIDERATION OF I.T.A. NO. 5265/DEL/2011 58 MULTIPLE TRANSACTIONS IS THE MOST RELIABLE MEANS OF ' DETERMINING THE ARM'S LENGTH CONSIDERATION FOR THE CONTROLLED TRANSACTION S. GENERALLY, TRANSACTIONS WILL BE AGGREGATED ONLY WHEN THEY INVOLVE RELATED PRODUCTS OR SERVICES. SIMILARLY, THE AUSTRALIAN TRANSFER PRICING REGULATI ONS IN TP. 97/20 PROVIDE IN THIS REGARD ' IDEALLY, DEALINGS BETWE EN ASSOCIATED ENTERPRISES SHOULD BE PRICED ON A TRANSACTION BY TRANSACTION BASIS. HOWEVER, IT IS AL SO RECOGNIZED THAT IF IT IS IMPRA CTICAL TO ASSESS INDIVIDUAL TRANSACTIONS (E.G., IF SUCH AN APPROACH WOULD NOT ADDRESS ALL THE RELEVANT ASPECTS OF THE DEALINGS BETWEEN THE PARTIE S THAT AFFECT COMPARABILITY), IT MAY BE MORE APPROPRIATE TO CONSIDER A COMBINATION OF TR ANSACTIONS. GROUPING MAY BE APPROPRIATE IN THE FOLLOWING SITUATIONS: (1) TRANSACTIONS / COMPONENTS OF TRANSACTIONS: DEALINGS BETWEEN ASSOCIATED ENTERPRISES IN A PARTIC ULAR PRODUCT MAY INVOLVE SEPARATE TRANSACTIONS FOR THE PRODUCT, THE INTANGIBLES ASSOCIATED WITH THE PRODUCT, TECHNICAL ADVICE, MANA GEMENT SERVICES AND ANY OTHER RELATED MATTERS. IN DEALINGS WITH INDEPENDENT PARTIES, THE VARIOUS A SPECTS MAY BE ROLLED INTO A PACKAGE DEAL WITH ALL THE ASSOCIATED COSTS B EING INCLUDED IN THE TRANSFER PRICE OF THE PRODUCT. THE VARIOUS ASPECTS MAY NEED TO BE CONSIDERED TOGET HER TO ACCOUNT PROPERLY FOR THE COST AND TO PREVENT DOUBLE COUNTIN G. IF THE INDEPENDENT DEALINGS BEING CONSIDERED AS POS SIBLE COMPARABLE CANNOT BE DESEGREGATED, IT WOULD GENERAL LY BE APPROPRIATE TO GROUP ALL THE RELEVANT TRANSACTIONS BETWEEN ASSOCIATED ENTERPRISES SO COMPARABILITY TO THE UNCO NTROLLED PARTY PACKAGE DEAL TRANSACTION CAN BE PROPERLY DETERMINED . CARE IS NEED TO IDENTIFY THE VALUE OF ANY COMPONENT OF THE PACKAGE I.T.A. NO. 5265/DEL/2011 59 THAT IS SUBJECT TO DIFFERENT DOMESTICS TAX TREATMEN T, E.G., ITEMS SUBJECT TO INTEREST OR ROYALTY WITHHOLDING TAX. (2) INTEGRATED OPERATIONS: IF IT IS DECIDED TO ROUTE THE TRANSACTION THROUGH AN ASSOCIATED ENTERPRISE, IT MAY BE MORE APPROPRIATE TO CONSIDER THE DEALING IN ITS ENTIRELY RATHER THAN CONSIDER THE COMPONENT TRA NSACTIONS ON A SEPARATE BASIS. THERE COULD BE PRACTICAL DIFFICULT IES IN DETERMINING THE TRUE VALUE ADDED BY ANY INTERMEDIATE COMPANY IF IT IS CONSIDERED IN ISOLATION. FOR EXAMPLE, A COMPANY MAY BE LICENSING INTANGIBLE AND SUPPLYING VITAL COMPONENTS TO AN ASSOCIATED AS PART OF A HIGHLY INTEGRATED GLOBAL MANUFACTURING PROCESS. FURTHER, IT IS NECESSARY TO CONSIDER INCREMENTAL DE ALINGS THAT MAY HAVE THE EFFECT OF GRADUALLY ERODING PROFITABILITY. THE MOST APPROPRIATE APPROACH IN SUCH CASES MAY BE TO APPLY THE STATUTORY TEST OF WHETHER INDEPENDENT ENTERPRISES WOULD HAVE ENTERED INTO THE PACKAGE OF TRANSACTIONS, RATHER THAN ANALYZING EACH INDIVIDUAL TRANSACTION SEPARATELY. IF IT CANNOT BE DEMONSTRATED IN A PARTICULAR CASE T HAT THE INTERMEDIATE COMPANY BEARS A REAL RISK OR PERFORMS A FUNCTION ADDING ECONOMIC VALUE IN THE CHAIN THAT HAS PRODUCE D THE VALUE OF THE GOODS OR SERVICES, IT MIGHT BE APPROPRIATE TO A TTRIBUTE ANY PROFIT ELEMENT, CLAIMED TO BE ATTRIBUTABLE TO THE A CTIVITIES OF THE INTERMEDIATE COMPANY, ELSEWHERE IN THE MNES GROUP. INDEPENDENT ENTERPRISES OPERATING INDEPENDENTLY MIG HT NOT BE EXPECTED TO HAVE ALLOWED SUCH A COMPANY TO SHARE IN THE PROFITS FROM THE DEALING. IN TERMS OF THE OECD GUIDELINE, TOO, IT IS POSSIBLE TO UNDERTAKE BENCHMARKING ANALYSIS OF DIFFERENT CONTROLLED TRANS ACTIONS ON AN AGGREGATE BASIS PROVIDED SUCH TRANSACTIONS ARE CLOS ELY INTER LINKED AND CANNOT BE EVALUATED ADEQUATELY ON A SEPARATE BASIS. IT IS ALSO PROVIDED TO UNDERTAKE COMBINED EVALUATION OF TRANSA CTIONS WHICH INVOLVES IN INTERNATIONAL SET-OFF. THE RELEVANT POR TION OF THE OECD GUIDELINES READ AS UNDER: '(VIII) INTERNATIONAL SET OFF I.T.A. NO. 5265/DEL/2011 60 1.60 AN INTENTIONAL SET-OFF IS ONE THAT ASSOCIATED ENTERPRISES INCORPORATE KNOWIN GLY INTO THE TERMS OF THE CONTROLLED TRANSACLIONS. IT OCCURS WHEN ONE ASSOCIATED ENTERPRISE HAS PROVIDED A BENEFIT TO ANOTHER ASSOCIATED ENTERPRISE WITHIN THE GROUP THAT IS BALANCED TO SOM E DEGREE BY DIFFERENT BENEFITS RECEIVED FROM THAT ENTERPRISE IN RETURN. THESE ENTERPRISES MAY CLAIM THAT THE BENEFIT EACH HAS RECEIVED SHOULD BE SET OFF AGAINST THE BENEFIT EACH HAS PROVIDED AS FULL OR PART PAYMENT F OR THOSE BENEFITS SO THAT ONLY THE NET GAINS 01' LOSS AR ANY) ON THE TRANSACTIONS NEEDS TO BE CONSIDERED FOR PURPOSE OF ASSESSING TAX LIABILITIES. FOR EXAMPLE, AN ENTERPRISE MAY LICENSE ANOTHER ENTERPRISE TO USE A PATENT IN RETURN FOR PROVISION OT' KNOW-HOW IN ANOTHER CONNECTION AND CLAIM THAT THE TRANSACTIONS RESULT IN NO PROFIT OR LOSS TO EITHER PARTY. SUCH ARRANGEMENTS MAY SOMETIMES BE ENCOUNTERED BETWEEN INDEPENDENT EN TERPRISES AND SHOULD BE ASSESSED IN ACCORDANCE WITH THE ARM'S LEN GTH PRINCIPLE IN ORDER TO QUANTIFY THE VALUE OF THE RESPECTIVE BENEF ITS CLAIMED AS SET- OFFS. 1.61 INTERNATIONAL SET-OFFS VARY IN SIZE AND COMPLEXITY. SUCH SET-OFFS MAY RANGE FROM A SIMPLE BALANCE OF TWO TRANSACTIONS (SU CH AS A FAVOURABLE SELLING PRICE FOR MANUFACTURED GOODS IN RETURN FOR A FABURABLE PURCHASE PRICE FOR THE RAW MATERIAL USED IN PRODUCING THE GO ODS) TO AN ARRANGEMENT FOR A GENERAL SETTLEMENT BALANCING ALL BENEFITS ACCRUING TO BOTH PARTIES OVER A PERIOD. INDEPENDENT ENTERPRISES WOULD BE VERY UNLIKELY TO CONSIDER THE FALLER TYPE OF ARRANGEMENT UNLESS THE BENEFITS COULD BE ACCURATELY QUANTIFIED AND THE CONTRACT CRE ATED IN ADVANCE. OTHERWISE, INDEPENDENT ENTERPRISES NORMALLY WOULD P REFER TO ALLOW THEIR RECEIPTS AND DISBURSEMENTS TO FLOW INDEPENDENTLY OF EACH OTHER, TAKING ANY PROFIT OR LOSS RESULTING FROM NORMAL TRADING .. . ' THE INDIAN TRANSFER PRICING REGULATIONS ALSO PROVID E FOR THE EVALUATION OF COMBINED TRANSACTIONS. THE TERM 'TRAN SACTION' HAS BEEN DEFINED IN CLAUSE (V) OF SECTION 92F OF THE ACT TO INCLUDE THE ARRANGEMENT, UNDERSTANDING OR ACTION IN CONCERT WHE THER OR NOT I.T.A. NO. 5265/DEL/2011 61 SUCH ARRANGEMENT, UNDERSTANDING OR ACTION IS FORMAL OR IN WRITING. RULE LOA(D)OF THE RULES, TOO, PROVIDES THAT 'TRANSACTION' INCLUDES A NUMBER OF CLOSELY LINKED TRANSACTIONS. ON AN ANALYSIS OF THE OECD GUIDELINES, TRANSFER PRI CING REGULATIONS/PRACTICES IN OTHER JURISDICTION AS OUTL INED HEREINABOVE, AND CONSIDERING THE MANDATE OF PROVISIONS OF RULE 1 0A(D) OF THE RULES, THE FOLLOWING POSITION EMERGES: (A) IT IS POSSIBLE TO CONDUCT COMBINED EVALUATION OF IN TERLINKED TRANSACTIONS. (B) IT IS POSSIBLE FOR THE ASSOCIATED ENTERPRISE INVOLV ED IN THE CONTROLLED TRANSACTION TO UNDERTAKE/PROVIDE BENEFIT IN ONE CONTROLLED TRANSACTION TO COMPENSATE FOR THE BENEFIT RECEIVED IN THE OTHER CONTROLLED TRANSACTION. IN SUCH SITUATION THE BENE FIT RECEIVED SHOULD BE SET OFF AGAINST THE BENEFIT PROVIDED, I.E., SUCH TRANSACTIONS ARE REQUIRED TO BE EVALUATED TOGETHER. (C) THE COMBINED EFFECT OF TWO OR MORE SEPARATE TRANSAC TIONS MAY BE CONSIDERED IF SUCH TRANSACTIONS TAKEN AS A WHOLE ARE SO INTERRELATED THAT CONSIDERATION OF MULTIPLE TRANSAC TIONS IS THE MOST RELIABLE MEANS FOR DETERMINING THE ARMS LENGTH CON SIDERATION. IT WOULD BE APPRECIATED THAT THE SUBVENTION INCOME RECEIVED BY THE APPELLANT PURSUANT TO THE AGREEMENT WITH THE ASSOCI ATED ENTERPRISE IS FOR COMPENSATING THE APPELLANT FOR LOW PROFIT MARGI N OR LOSS INCURRED PURSUANT TO TRADING IN SUCH DRUG FORMULATIONS PURCH ASED FORM ASSOCIATED ENTERPRISE, CONSIDERING PECULIAR REGULAT ORY, ECONOMIC AND MARKET SCENARIO IN INDIA. THE AMOUNT RECEIVED BY T HE APPELLANT BY WAY OF SUBVENTION INCOME FROM THE ASSOCIATED ENTERP RISE IS, THEREFORE, CLOSELY AND INEXTRICABLY LINKED TO THE TRANSACTION OF IMPORT OF DRUG FORMULATIONS AND, THEREFORE, IS REQUIRED TO BE BENC HMARKED TOGETHER, THE SAME IS NOT AMENABLE TO SEPARATE BENCHMARKING A NALYSIS AS CONTENDED BY L. D.R. THERE IS NO QUARREL WITH THE DECISIONS RELIED UPON BY THE LD. D.R. FOR THE PROPOSITION THAT EACH INTERNATIONAL TRANSACTION IS TO BE BENCHMARKED SEPARATELY. IN THE FACTS OF THE CASE, HOWEVER, THE CONTENTION OF THE LD. D.R. THAT SUBVENTION RECEIVED FROM THE AE IS TO BE BENCHMARKED SEPARATELY, IS NOT TENABLE IN AS MUC H AS SUBVENTION I.T.A. NO. 5265/DEL/2011 62 INCOME IS NOTHING BUT COMPENSATION RECEIVED FROM TH E AE FOR THE LOWER PROFIT EARNED FROM RESALE IN INDIA OF DRUG FO RMULATION PURCHASED FORM THE AE. THE SAID SUBVENTION INCOME HAS, THEREFORE, FIRST DEGREE NEXUS AND IS INEXTRICABLY LINKED TO TH E INTERNATIONAL TRANSACTIONS OF IMPORT OF DRUG FORMULATIONS. THE S AME IS, IN FACT, COMPENSATION FOR THE TRANSFER PRICING ADJUSTMENT AL READY PAID BY THE AE AND IS REGARDED AS SUCH BY THETHE TPO, WHEN THE TPO HIMSELF REDUCES THE SUBVENTION INCOME FROM THE TRANSFER PRI CING ADJUSTMENT AT PAGE 30 OF THE TPO'S ORDER REPRODUCED BELOW: TOTAL SALES RS.1,823,107,281 GROSS MARGIN @ 47.21% RS.860,688,947 GROSS MARGIN SHOWN RS.174,245,097 ARMS LENGTH VALUE OF PURCHASES RS.1,071,689,269 PURCHASE VALUE SHOWN RS.1,758,133,119 DIFFERENCE RS.686,443,850 LESS: SUBVENTION INCOME RS.550,493,475 ADJUSTMENT U/S 92CA RS.135,950,375 WITHOUT PREJUDICE TO THE AFORESAID, IT WOULD BE APP RECIATED THAT EVEN IF RPM IS TO BE APPLIED, THE ADJUSTMENT SHOULD BE R ESTRICTED TO INTERNATIONAL TRANSACTIONS UNDERTAKEN BY THE APPELL ANT WITH ITS ASSOCIATED ENTERPRISE AS ACCEPTED BY THE DRP AT PAR AGRAPH 4.5 OF ITS DECISION. RELIANCE IS ALSO PLACED IN HIS REGARD ON THE FOLLOWING DECISIONS: IL JIN ELECTRONICS (I) P LTD. VS. ACIT (ITA 438/0/2 004) (MUM) FOUR SOFT LTD. VS. DCIT [ITA NO. 14951HYD/2010] (H YD) TECHNIMOUNT RES INDIA P. LTD. VS. ACLT TTA NO. 7098IMUM/2010] (MUM) ACIT VS. TWINKLE DIAMOND: ITA NO. 50331MUM/07 ACIT VS. T TWO INTERNATIONAL PVT. LTD. : ITA NO. 5644IMUMJ2008 ADDL. CIT VS. TEJ DIAM : 130 TTJ 570 (MUM) ABHISHEK AUTO INDUSTRIES LTD. VS. DCIT: ITA NO. 143 3/DEV2009 STARLITE VS. DCIT: ITA NO. 9251MUM/2006 SMCC CONSTRUCTION INDIA LTD V. ADDL. CIT: 44 SOT 63 (DELHI) (URO) GENISYS INTEGRATING SYSTEMS (INDIA) PVT. LTD. VS. D CIT [ITA NO. 1231IBANG/201O] I.T.A. NO. 5265/DEL/2011 63 IT WOULD BE APPRECIATED THAT ADJUSTMENT ON ACCOUNT OF THE ALLEGED DIFFERENCE IN THE ARM'S LENGTH PRICE OF INTERNATION AL TRANSACTIONS FOR PURCHASE OF DRUG FORMULATIONS COMPUTED BY THE TPO, WOULD NOT SURVIVE IF THE BENCHMARKING ANALYSIS IS RESTRICTED ONLY TO INTERNATIONAL TRANSACTIONS OR RELATED PARTY SEGMENT AS FOLLOWS: PARTICULARS COMPUTATION OF GROSS PROFIT MARGIN BY THE TPO (TOTAL TURNOVER) COMPUTATION OF GROSS PROFIT MARGIN (RELATED PARTY SEGMENT ONLY) SALES 1,82,31,07,281 1,16,43,03,000 COST OF GOODS SOLD 1,64,88,62,184 1,10,07,93,000 GROSS MARGIN SHOWN 17,42,45,097 6,35,10,000 GROSS MARGIN 9.56% 5.45% ARMS LENGTH GROSS MARGIN AS COMPUTED BY THE TPO @ 47.21% 86,06,88,947 55,96,67,446 SHORTFALL IN PROFITS 68,64,43,850 48,61,57,446 LESS: SUBVENTION INCOME 55,04,93,475 55,04,93,475 BALANCE ADJUSTMENT 13,59,50,375 NIL FURTHER, REGARDING MARKET RESEARCH INCOME OF RS. 1. 83 CRORES, IT IS STATED IN PARA 6 OF THE NOTES TO FORM 3CEB THAT 'IN RESPECT OF PURCHASE OF FORMULATIONS AND SERVICE KITS FROM THE ASSOCIATED ENTERPRISES (RECEIPT OF PROMOTIONAL GRANTS, VIZ, SU BVENTION INCOME AND MARKET RESEARCH INCOME FROM ELI LI/~V NETHERLAN DS, 13. V. HAVE BEEN TAKEN AS A CLOSELY LINKED TRANSACTION TO THE PURCHASE OF FORMULATIONS AND SERVICE KITS), THE ASSESSEE HAS DE TERMINED THAT THE TRANSACTION NET MARGIN METHOD (FNMM) IS THE MOST AP PROPRIATE METHOD. ACCORDINGLY, THE MARKET RESEARCH INCOME HAS ALSO BEEN CONSIDERED AS GRANT RECEIVED BY THE APPELLANT FROM ITS ASSOCIATED ENTERPRISE AND TREATED SIMILAR TO SUBVENTION INCOME . IT IS FURTHER RESPECTFULLY SUBMITTED THAT, IN TERMS OF THE AGREEMENT, THE SUBVENTION INCOME AS ALSO MARKET RESEARCH INCOME HA S BEEN PAID BY THE ASSOCIATED ENTERPRISE IN RELATION TO SALE OF IT S OWN PRODUCTS BY THE APPELLANT AND IS, THEREFORE, DIRECTLY ATTRIBUTABLE TO THE INTERNATIONAL TRANSACTIONS OF PURCHASE OF DRUG FORMULATIONS FROM THE ASSOCIATED ENTERPRISE. THE ENTIRE SUBVENTION INCOME OF RS.55,04,93,475, IS THEREFORE, IN OUR RESPECTFUL SU BMISSION, REQUIRED TO BE REDUCED FROM THE VALUE OF PURCHASES FROM THE ASSOCIATED I.T.A. NO. 5265/DEL/2011 64 ENTERPRISE AS DIRECTED BY THE DR WP AND ADJUSTMENT WOULD, EVEN . OTHERWISE, ON THE FACTS OF THE CASE. 1. 6.1 WHILE RELYING UPON THE WRITTEN SUBMISSIONS IN T HE SHAPE OF BROAD PROPOSITION, REJOINDER IN RESPONSE TO WRITTEN SUBMISSION OF HT D EPARTMENT, LD. COUNSEL FOR THE ASSESSEE PLEADED FOR DELETION OF IMPUGNED ADDITION MADE ON A CCOUNT OF DIFFERENCE IN ARMS LENGTH PRICE AS DETERMINED BY THE TPO AND CONFIRMED BY DRP -I, NEW DELHI WHICH WAS ADOPTED BY THE A.O. TO MAKE THE IMPUGNED ADDITION. 7. WE HAVE HEARD BOTH THE SIDES, CONSIDERED THE MAT ERIAL ON RECORD AS WELL AS BROAD PROPOSITION AND REJOINDER FILED BY THE LD. A.R. AND SUBMISSION MADE BY LD. D.R. IN THE LIGHT OF CASE LAW CITED BY THE RIVAL SIDES IN SUCH SUBMISSIONS AND FIND THAT ALL THE POINTS AS RAISED BEFORE THE TPO, DRP-I AND THE A.O. HAVE NOT APPROPRIATELY BEEN CONSIDERED BEFORE PASSING THE IMPUGNED ASSESSMENT ORDER. THER EFORE, CONSIDERING THE FACTS, CIRCUMSTANCES AND MATERIAL ON RECORD, IN THE LIGHT OF THE CASE LAW CITED BY THE RIVAL SIDES, WE FIND IT JUST AND APPROPRIATE TO SET ASIDE THE OR DER OF THE A.O. AND RESTORE THE MATTER BACK TO HIS FILE FOR RECONSIDERING THE ISSUE RAISED IN THE APPEAL ASSESSMENT AFRESH AFTER GIVING DUE OPPORTUNITY TO THE ASSESSEE. WE HOLD AN D DIRECT ACCORDINGLY. 8. AS A RESULT, APPEAL OF THE ASSESSEE GETS ACCEPTE D FOR STATISTICAL PURPOSES. 9. ORDER PRONOUNCED IN THE OPEN COURT ON 21 ST NOV., 2013. SD./- SD./- (SHAMIM YAHYA) (U.B.S.BEDI) ACCOUNTANT MEMBER JUDICIAL MEMBER DATE: 21 ST NOV., 2013. SP. COPY FORWARDED TO: 1. APPELLANT 2. RESPONDENT 3. CIT 4. CIT(A)-XXV, NEW DELHI AR, ITAT, 5. CIT(ITAT), NEW DELHI NEW DELHI