ACIT (LTU-1) Vs Glenmark Pharmaceuticals Ltd (ITAT Mumbai)
ITAT Mumbai held that assessee selecting Associated Enterprise (AE) as “tested party” justifiable. Accordingly, transfer pricing study conducted by the assessee is duly acceptable.
Facts- The assessee had entered international transactions in the nature of export of goods (formulations) to its Associated Enterprises located in 12 Countries. Besides it had exported R & D services to Switzerland, imported formulations from Argentina. In the Transfer pricing study, the assessee had selected AEs as ‘Tested party” and TNM method as most appropriate method. After examining the transfer pricing study of the assessee, the TPO took the view that the transfer pricing study of the assessee is not proper and accordingly, he did not accept the same.
Accordingly, the AO held that the AEs cannot be treated as tested parties. TPO held that ALP of margin should be taken as the rate of 10.86% earned on sale to non-AEs both in domestic and Export market. Accordingly, he made transfer pricing adjustment of Rs.1,37,66,503/- and Rs.63,09,494/- respectively for the exports made to South Africa and Mexico.
Conclusion- Held that the profitability of the assessee in exporting products to these two AEs is increasing year after year. Under these set of facts and in the facts and circumstances of the case, we are of the view that there is no reason to ignore transfer pricing study conducted by the assessee should be accepted. Accordingly, we set aside the order passed by Ld CIT(A) and direct the AO to delete the transfer pricing adjustment made in respect of exports made to M/s Glenmark, South Africa and M/s Glenmark, Mexico.
FULL TEXT OF THE ORDER OF ITAT MUMBAI
The assessee has filed appeal for AY 2014-15. The revenue has filed appeal and cross objection for the very same year. All of them are directed against the order passed by Ld CIT(A)-56, Mumbai and they are being disposed of by this common order, for the sake of convenience.
2. At the time of hearing, the Ld A.R did not press Ground no. 1(b) relating to transfer pricing adjustment made in respect of export to Glenmark Thailand due to smallness of amount. The assessee also did not press ground no.3 pertaining to the addition of Rs.5.70 crores, which relate to allocation of R & D expenses to units eligible u/s 80IC/80IE of the Act. Accordingly, the grounds relating to the above said issues are dismissed as not pressed.
3. The remaining grounds urged by the assessee give rise to the following issues:-
(a) Addition on account of Transfer pricing adjustment
(i) in respect of export to Glenmark South Africa
(ii) in respect of export to Mexico
(b) Disallowance of weighted deduction claimed u/s 35(2AB) of the Act.
(c) Allocation of interest expenses of Rs.7.37 crores to units eligible u/s 80IC/80IE of the Act.
(d) Disallowance of sales promotion expenses of Rs.30.37 crores u/s 37(1) of the Act.
(e) Disallowance of Investment Allowance of Rs.16.51 crores u/s 32AC of the Act.
4. The revenue is in appeal on the following issues:-
(a) Relief granted in respect of transfer pricing adjustment made in respect of Corporate Guarantee.
(b) Relief granted in respect of deduction claimed u/s 35(2AB) of the Act.
(c) Relief granted in respect of allocation of R & D Expenditure.
(d) Partial relief granted in respect of allocation of interest expenditure.
(e) Relief granted in respect of addition made u/s 14A of the Act.
5. The Cross objection filed by the revenue is objecting to the observation made by Ld CIT(A) that the reason for disallowance u/s 37(1) based on MCI guidelines and CBDT Circular 5 of 2012 does not subsist for the disallowance of sales promotion expenses.
6. It can be noticed that certain issues are common in the appeals of both the parties. Accordingly, they are disposed of together.
7. The facts relating to the case are stated in brief. The activities of the assessee are described as under by the Transfer pricing officer (TPO):-
“The assessee is the ultimate holding company of the Glenmark Group. It is a Research led Global, fully integrated pharma company head quartered in Mumbai, incorporated in 1977, and engaged in the business of manufacturing and marketing of formulations in India. Globally it enjoys diversified presence in regulated and developing international market. Post Restructuring in 2008, the company now focuses on manufacturing and marketing FDF. The specialty business comprising branded generics and R & D is part of the assessee.”
Since the assessee had entered into international transactions, the AO referred the matter of determination of Arms Length Price of the same to the TPO, who proposed additions by way of transfer pricing adjustment. Hence the AO passed the draft assessment order making additions on account of transfer pricing adjustments and also various other additions. Since the assessee did not prefer to object the draft assessment order before Ld Dispute Resolution Panel, the AO passed the final assessment order. The appeal filed by the assessee before Ld CIT(A) was partly allowed. Hence both the parties have filed appeal on the issues stated above.
8. We shall first take up the appeal of the assessee, in which the common issues shall be adjudicated together. The first issue urged by the assessee relates to the transfer pricing adjustment made in respect of goods Exported to the Associated Enterprises (AE) located in South Africa and Mexico.
8.1 The assessee had entered international transactions in the nature of export of goods (formulations) to its Associated Enterprises located in 12 Countries. Besides it had exported R & D services to Switzerland, imported formulations from Argentina. In the Transfer pricing study, the assessee had selected AEs as ‘Tested party” and TNM method as most appropriate method. After examining the transfer pricing study of the assessee, the TPO took the view that the transfer pricing study of the assessee is not proper and accordingly, he did not accept the same. Hence, he asked the assessee to benchmark the international transactions by taking the “assessee” itself as tested party and adopting internal TNM method as most appropriate method.
8.2 The OP/OC of Formulations, both domestic and Export sales made to non-AEs was 10.86% and the same was adopted as ALP margin by TPO. The TPO accepted ALP of all transactions of exports to various Countries except the exports made to South Africa, Thailand and Mexico. In this appeal, we are concerned with the exports made to South Africa and Mexico. The OP/OC of exports made to South Africa and Mexico was 3.85% and (-) 3.02% respectively, which was below the ALP rate of 10.86%. The assessee offered certain explanations with regard to low profit/loss earned/incurred in the above two countries. It was also submitted that the TPO had accepted ‘Associated Enterprises’ as tested party in the preceding two assessment years and hence, under the principles of consistency, the said methodology should not be disturbed. The assessee also relied upon the decision rendered by Hon’ble Supreme Court in the case of Radhasoami Satsang (1992 AIR 377) in support of the Principle of Consistency.
8.3 But the TPO did not accept the same. The TPO expressed the view that the companies have different financial year ending cannot be considered to be comparable. He further expressed the view that the companies having different format and non-availability of Balance Sheet, not having proper figure of RPT and unclear description of function are not reliable. Accordingly, the AO held that the AEs cannot be treated as tested parties. Accordingly, the TPO held that ALP of margin should be taken as the rate of 10.86% earned on sale to non-AEs both in domestic and Export market. Accordingly, he made transfer pricing adjustment of Rs.1,37,66,503/- and Rs.63,09,494/- respectively for the exports made to South Africa and Mexico.
8.4 The Ld CIT(A) agreed with the views expressed by TPO. With regard to the Principle of Consistency, the Ld CIT(A) held that the decision of TPO is based on facts applicable to the year. He also pointed out that the fact that the AEs are different accounting years is a significant defect. Accordingly, he confirmed the transfer pricing adjustment made by the TPO.
8.5 We heard the parties on this issue and perused the record. There is no dispute that the foreign AEs were accepted as tested parties by the TPO in the preceding two years. During the year under consideration, the TPO did not accept associated enterprises as tested party for the following reasons:-
(a) The financial year of the companies having foreign jurisdiction did not match with the financial year of the assessee herein.
(b) Due to use of database which have their own format and non-availability of Balance Sheet, financials containing proper figure of RPT and description of function, data base are not reliable.
8.6 It is the submission of Ld A.R that the foreign AEs of the assessee are engaged in the business of distribution of assessee’s formulation products. It is quite usual for any enterprise that the new branches will incur losses in the initial years, when new markets are explored. Once inroads are made into the local market, then the new branch will start making profits. He submitted that the AEs located in 9 Countries are making good profits. The Glenmark, Mexico has started operation during the year under consideration only. The Glenmark, South Africa is in its initial stages and making efforts to penetrate the local market. Since both these AEs are new in their respective Geographical jurisdictions, they have to incur huge expenditure to make inroads into the local market. Further, it is known to everyone that the turnover will be low during the initial years and it would take some years to break-even. Till that time, they are bound to incur huge losses in their initial years of operation. The Ld A.R submitted that, because of this peculiar situation, the assessee has selected both the foreign AEs as tested parties and compared their profitability with the profitability of foreign comparable companies. Since the AEs are buying products from the assessee company, their profitability would increase, if the assessee sells products to them at lower rates. If the assessee sells at higher prices, then their profitability will fall. Hence, for the purpose of transfer pricing provisions qua the assessee, the AEs should earn profit less than the profitability of comparable companies, which would mean that the assessee has not under invoiced its products, i.e., the sale to AEs is at arms length. It is the submission of Ld A.R, this methodology was adopted by the assessee to determine the ALP of various AEs in the earlier years and the same has been accepted in the preceding years.
8.7 The ld A.R submitted that, if the issue is approached in this way, what is required to be seen is whether the assessee has made profits from export of goods to its AEs and whether the profitability of AEs was less than that of the comparable companies. The Ld A.R submitted that the data relating to the above said two AEs corresponds to the above said approach. The relevant details are tabulated as under:-
(A) Glenmark, South Africa:- (Rs. In lacs)
