Randox Laboratories India Private Limited Vs ACIT (ITAT Bangalore)
The core issue arising for consideration is, whether the international transaction relating to purchase of reagents, spares, consumables from the AE is a simple trading activity, hence, can be benchmarked under RPM. Before we advert to the core issue, it is necessary to understand the activities of the assessee with its AE. As stated earlier in the order, assessee’s AE is manufacturing medical diagnostic reagents, analyzers and consumables. Assessee imports these reagents form the AE and sells them to diagnostic units / laboratories in India for use in various chemical analysis. These reagents are analyzed in machines / equipments known as analyzers. For the purpose of sale of reagents, the assessee enters into specific agreements with third party customers. As per the terms of the agreement, a sample copy of which is placed in the paper book, the customer in India is required to purchase reagents from the assessee and in the event of such purchase, the assessee provides them the analyzer for carrying out the chemical analysis with the reagents. As per the terms of the agreement, the analyzer is made available to the customer for a period of five years without any extra cost. Further, as per the terms of agreement, the assessee is required to provide spares for the analyzer and also provide services including repairs. The analyzers were kept with the third party customers since the assessee was undertaking a research regarding its products as per Indian norms for clinical tests and to provide feedback to the Head Office. Thus, as could be seen from the facts on record, the analyzers were never sold to the third party customers who buy the reagents from the assessee, but, were only installed in their premises for chemical analysis and research work for a period of five years. After expiry of five year period, the WDV of the analyzers get reduced to zero and accounting entries to that effect are passed in the books. These facts are evident from the materials available on record. Thus, it is clear, the assessee is merely purchasing reagents from its AE and reselling them to third party customers in India without making any value addition. In fact, the analyzer / spares of the machines are never sold to the third party customers but always remain the property of the assessee.
It is very much clear that in the year under consideration, assessee has not undertaken any manufacturing activity as the manufacturing unit was still in the process of being set-up. On the contrary, the facts on record clearly reveal that the assessee had purchased reagents and chemicals from its AE and sold to the third party customers without any value addition. Further, the analyzers, spares and consumables, though, were imported, however, they were not sold but were provided in the laboratories / diagnostics units of the third party customers for testing and research activity. Keeping in perspective the aforesaid factual position, it has to be examined which is the appropriate method to benchmark the arm’s length price of the transaction. On-going through the provisions of rule 10B and more particularly sub-rule-1(b) of the aforesaid rule, it is evident that RPM is applicable to a case where the price at which property purchased or service obtained by a enterprise from the AE is resold or provided to an unrelated enterprise. The gross profit margin of such a transaction is thereafter compared to the gross profit margin of similar comparable uncontrolled transactions after making necessary adjustment with regard to the expenditure incurred, functional and other differences, the arm’s length price is determined. Thus, in the facts of the present case, since the assessee has resold the goods imported from the AE without any value addition, the most appropriate method which can be applied for determining the arm’s length price is RPM and TNMM cannot be the most appropriate method in such type of transaction.
If assessee resold goods imported from AE without any value addition, than most appropriate method for determining ALP is RPM
FULL TEXT OF THE ORDER OF ITAT BANGALORE
This is an appeal by the Assessee against the order dated 23.10.2019 of the Asst.CIT, Circle 5(1)(1), Bangalore passed u/s.143(3) read with Sec.144C of the Income Tax Act, 1961 (the Act) in relation to assessment year 2015-16.
2. We shall first take up for consideration Grounds No. 3 & 4 raised by the Assessee which are with regard to the adoption of the Most Appropriate Method (MAM) for determination of Arm’s Length Price (ALP) in respect of an international transaction of sale of reagents by the Assessee to its Associated Enterprise (AE).
3. The Assessee is a wholly owned Indian subsidiary of Randox Laboratories Ltd., a company based in United Kingdom (hereinafter referred to as AE). The parent company is primarily engaged in the business of manufacturing medical diagnostic reagents and analyzers. Diagnostic reagents are used to diagnose a range of health issues by screening for pathogens, antigens, co-infections, genetic diseases, and a host of other physical diseases. Analyzer is a medical laboratory instrument designed to measure different chemicals and other characteristics in a number of biological samples quickly, with minimal human assistance. These measured properties of blood and other fluids may be useful in the diagnosis of disease.
4. The Assessee imports reagents and diagnostic equipments (analyzers) from the parent Randox Laboratories (India) P. Ltd. and sells them to independent third parties in India. The question before the AO was, whether the price paid by the Assessee to its AE for purchase of reagents was at Arm’s length because as per the provisions of Sec.92 of the Act, income arising from an international transaction (transaction with a related party) has to be determined having regard to Arm’s Length Price (ALP). Section 92F define Arm’s Length Price is the price applied (or proposed to be applied) when two unrelated persons enter into a transaction in uncontrolled conditions. Unrelated Persons; Section 92A, the persons said to be unrelated if they are not associated or deemed to be associated enterprise. Uncontrolled Conditions; are that conditions which are not controlled or suppressed or moulded for achievement of a predetermined results.
5. The AO referred to the Transfer Pricing Officer (TPO) the question of determination of ALP of the aforesaid transaction of purchase of reagents, as per provisions of Sec.92CA of the Act. The main dispute between the Assessee and the Revenue is with regard to which is the most appropriate method (MAM) for determination of ALP, whether it is Transaction Net Margin Method (TNMM) as contended by the revenue or the Resale Price Method (RPM) as contended by the Assessee.
6. It was the plea of the Assessee that it purchases reagents, analyzers and spares from its Associated Enterprises (AEs) and sells them as it is in India. No further addition to these products are done once they are imported into India. From 2013, Assessee also started purchasing the reagents in bulk and packing them in smaller quantities for sale in India for certain non-standard quantities, which are purely based on customer requests in India. However, it does not carry out any manufacturing activity but for the purpose of excise duty, the activity of packing reagents in smaller quantities is considered as deemed manufacture. It does not carry out any further activities on the reagents that are purchased form its AEs and sells the same as it is in smaller quantities.
7. In order to facilitate the sale of its reagents, Assessee devised a selling model. Under this model, Assessee under an agreement titled ‘Placement agreement’ places an analyzer in the premise of its customer at free of cost for a period of upto 5 years. This placement of the analyzer is to facilitate the sale of its reagents and also to ensure that in case the customer gets accustomed to use the analyzer that is placed by Assessee in the customer’s premises, they might eventually buy the same from the Assessee. The conditions for placing this analyzer is after taking a commitment from the customer that the reagents totaling certain minimum committed value is mandatorily to be purchased from Assessee.
8. The TPO concluded that the Assessee is not a mere distributor and rejected the usage of RPM which the Assessee had considered as the Most Appropriate Method (MAM) and instead chose Transactional Net Margin Method (TNMM) as the MAM. Further, the TPO also rejected the TP study conducted by the Assessee and passed the order u/s 92CA of the Act on 29.10.2018 making an addition of Rs. 3,01,91,170 as TP adjustment.
9. The Assessee in its objection to the draft assessment order in which the addition proposed by the TPO was added to the total income, before the Dispute Resolution Panel (DR) contended that the Assessee is merely a distributor and the activity conducted by the Assessee is that of buying and reselling reagents and analysers without any change in the product. It was reiterated that in order to better the sale of the reagents, it has adopted a model for Indian market, which the Assessee calls it as ‘Reagent Rental Contract (RRC)’, where the analyser machine in which such reagents are used are placed in the premises of the customer and a certain commitment for sales is taken from them. This is a mode to increase the sale of reagents, to cater to the customer requirement of ensuring that the capital investment that they will have to do in buying expensive analysers is reduced and also a business strategy to cater to price sensitive and fragmented Indian market. It was also highlighted that the labs in India are to a large extent run by persons who might not have the capacity to invest in purchasing the machines, which are technologically advanced and thereby monetarily expensive. There is no change in the fact that the Assessee is merely an entity that is re-selling the reagents. For those customers who are interested in buying the machines, Assessee sells the same to them as well.
10. With regard to the accounting treatment, the Assessee pointed out that when Assessee places an analyzer in the place of its customer, the cost of such analyzer is capitalized in the books of the Assessee and depreciation is claimed on such analysers which is a business expenditure and charged to the Profit & Loss account. This has been categorized under Plant & Machinery in the Fixed Assets schedule in the audited financial statements. Majority of the assets in Plant and Machinery are the analyzers itself. If a company has to carry out its activities, it will require various fixed assets to aid its core business activities. In the case of a trading company like Assessee, assets that aid the sale of its products are its key assets.
11. It was contended that merely because a certain mode of selling/distribution has been adopted by the Assessee does not in any way mean that they don’t remain a reseller of the product. The product remains the same with no value addition. It is only that the selling mode adopted has been made conducive to ensure that the sales in India increases for the Randox reagents. A pictorial summary of the business model of the Assessee’s business is provided in page 309 of the paperbook. As a distributor, the activity of the Assessee is to ensure that the maximum number of products are sold and any method for that can be adopted.
12. With regard to the conclusions of the TPO that since there is a huge cost of depreciation in the Profit & Loss account and hence the Assessee is not a simple distributor, the Assessee pointed out that during the previous year the Assessee earned a gross margin of 31.16% which is generally higher as compared to the other distributors. As mentioned in the OECD TP guidelines, this is one of such situations where the gross margin is higher because, there are activities conducted in selling, which entails such a higher margin. The TPO has gone by presumptions that as a distributor, the gap between Gross Profit and Net Profit cannot be higher. It is the plea of the Assessee that merely, because the selling model that the Assessee has adopted is unique and not ordinary, this presumption does not hold good.
13. It was the plea of the Assessee that the TPO presumed that distributors do not do any activities other than distribution. It was the plea of the Assessee that it is very clearly mentioned in the risk analysis of the Assessee in the Transfer Pricing Documentation that the Assessee bears the risk of marketing and creating demand for the product. It is responsible for ensuring that the product sales increase. In order to do that, the Assessee has adopted such methods and functions which will create more demand and products can be sold. The TPO’s assumption that distributor will not carry out such functions in baseless. Further, by the TPO’s admission itself, the Gross margin earned by the Assessee is huge. This is a clear indication that because of the additional activities in selling the product that the Assessee is adopting, it is naturally earning higher margins.
14. The DRP however confirmed the order of the TPO and held that, the Assessee has unique business model and during the year, the functions performed are not of a simple distributor.
15. Aggrieved by the order of the DRP on the MAM for determining ALP, the Assessee is in appeal before the Tribunal. It is the plea of the Assessee before the Tribunal that there is neither any reasoning that has been provided for such a presumption nor any factual modification that has been done by the DRP in arriving at such conclusion. It has been the contention of the Assessee that the conclusions arrived by the TPO as confirmed by the DRP are only based on surmise and needs to be reversed. It is also the plea of the Assessee that the DRP failed to follow the rulings of Hon’ble Mumbai ITAT in the case of the Assessee in IT(TP)A No.507/Mum/2015 and IT(TP)A No. 1568/Mum/2015 relating to AY 201011 and in IT(TP)A No. 433/Bang/2016 and IT(TP)A No. 800/Bang/2016 relating to AY 2011-12 wherein the business activity of the Assessee were the same. It has also been contended that the DRP erroneously gave a finding that the facts of the Assessee are different for AY 2010-11 and 2011-12 as against the facts for the relevant year being AY 2015-16. It has also been contended that the DRP has failed to understand the nature of manufacturing activity carried out by the Assessee. It was reiterated that from 2013, Assessee had started purchasing the reagents in bulk and packing them in smaller quantities for sale in India for certain non-standard quantities, which are purely based on customer requests in India and it does not carry out any actual manufacturing activity of the product. However, for the purpose of excise duty, the activity of packing reagents in smaller quantities is considered as deemed manufacture. So, if one actually analyses the manufacturing activity, it does not carry out any further activities on the reagents that are purchased form its AEs and sells the same reagents as it is in smaller quantities.
16. It was submitted that the sale from manufacturing segment reproduced as under is insignificant as compared to the distribution/ traded segment.
