Mumbai Bench of Income Tax Appellate Tribunal (Mumbai ITAT, in short) in its recent ruling dated December 31, 2010 in case of Serdia Pharmaceuticals (India) Limited vs. Asst. Commissioner of Income-tax (ITA Nos: 2469/Mum/06, 3032/Mum/07 and 2531/Mum/08) has ruled on several issues relating to transfer pricing including the rejection of Transactional Net Margin method considered by the taxpayer over Comparable Uncontrolled Price method proposed by the transfer pricing officer. The judgment is quite big, however synopsis of the judgment is given below:
Facts of the Case
The taxpayer, i.e. Serdia Pharmaceuticals India Private Limited (Serdia or the taxpayer, in short), is a company incorporated in India and 74% of its share capital is held by Servier International BV, a company incorporated in the Netherlands, and the remaining 26% of its share capital is held by a Mauritius based company by the name of Serdia (Mauritius) Limited. Servier BV, in turn, is a subsidiary of Les Laboratoires Servier France (Servier France, in short), a well-known pharmaceutical company which is said to have its presence in more than 140 countries worldwide, including in Egypt by way of a subsidiary in the name of Servier Egypt Industries Ltd Egypt (Servier Egypt, in short).
The taxpayer is engaged in secondary manufacturing process in the sense it does import the active pharmaceutical ingredients (API, in short), puts them in a delivery mechanism by combining them with excipients, and thus produce the FDF, i.e. finished dosage form, for consumption by the end user. The FDF is produced and marketed by Serdia, while the API is imported from its Associated Enterprises (AEs, in short).
For the purpose of computation of arm’s length price and compliance of Indian transfer pricing regulations, the transfer pricing report was carried out by one of the Big4 Accounting firm and Transactional Net Margin Method (TNMM, in short), was used as the most appropriate method. As the operating margin of the taxpayer was more than the mean operating margin of comparable companies, the transactions with the AEs were considered to be at arm’s length.
During the course of related assessment proceedings, the Assessing Officer made references to the Transfer Pricing Officer (TPO, in short) for determination of arm’s- length price for the transactions that the taxpayer entered into with its AEs.
During the course of the transfer pricing assessment, the TPO collected information on the prices at which these APIs are purchased by other producers of the competing FDFs. And it was observed by the TPO that the prices at which other producers are purchasing these APIs is much lower than the price paid by the taxpayer to its AEs for purchase of same APIs. After doing certain adjustment for difference in quality, the TPO considered the prices at which other producers are purchasing as Comparable Uncontrolled Price (CUP, in short) and suggested an equal to the difference in prices.
The taxpayer filed an appeal before the Commissioner of Income-tax (Appeal), however no relief was given by the Commissioner of Income-tax (Appeal) to the taxpayer. Aggrieved by the stand so taken by the Commissioner (Appeals), the taxpayer filed an appeal before Mumbai ITAT.
Issues addressed by Mumbai ITAT
Mumbai ITAT addressed on couple of more issues than given below, however we are of the view that the issues given below are more important from the perspective of knowledge sharing:
Issue No.1: Whether it is open to the transfer pricing officer to reject the most appropriate method adopted by the taxpayer, wherein, the results arrived at by determination of arm’s length price computed by the taxpayer is not contrary to the transfer pricing regulations in India
Mumbai ITAT: It is within the powers of the transfer pricing officer to go into the question as to whether the method of determining the arm’s length price adopted by the taxpayer is indeed most appropriate method of determining the arm’s length price on the facts of taxpayer’s case, and, on being satisfied that it is not the most appropriate method of determining the arm’s length price, the TPO is also justified in determining the arm’s length price on the basis of, what he found to be, the most appropriate method on the facts of the case.
Issue No.2: Since Indian transfer pricing regulations does not provide for any order of preference in selection of the most appropriate method, no such order of preference – direct or implied, can be exercised.
Mumbai ITAT: While there is no particular order or priority of methods which the taxpayer must follow, and no method can invariability be considered to be more reliable than others, on a conceptual note, transactional profit methods (i.e., Transactional Net Margin Method and Profit Split Method) are treated as methods of last resort which are pressed into service only when the standard methods, which are also termed as ‘traditional methods’ (i.e., Comparable Uncontrolled Price Method, Resale Price Method and Cost Plus Method) cannot be reasonably applied”. The traditional transaction method have an inherent edge over the traditional profit methods in most of the situations, and, therefore, wherever both the methods can be applied in an equally reliable manner, traditional transaction methods are to be preferred over traditional profit methods.
Issue No.3: Applicability of CUP method, as the most appropriate method, for import of APIs/ generic drug from AEs.
ITAT: As long as appropriate comparables can be found, CUP method will indeed be the most appropriate method in respect of purchases of generic drug, even when such a generic drug is manufactured by its original patent holder. The high quality standards employed in manufacturing process do confer a certain degree of comfort in the sense that the API has minimal impurities and has been manufactured in a responsible manner, but this degree of comfort does not affect its comparability with the same API manufactured by generic drug companies.
Issue No.4: When import price is approved by one wing of the Government (for e.g. Custom Authorities), can such prices being treated as excessive or unreasonable having regard to legitimate business?
ITAT: the Income-tax Act provides a specific mechanism for computation arm’s length price, and it is only when determination of arm’s length price is made in accordance with the scheme of the Act that the onus of the taxpayer is discharged. Merely because another arm of the Government considers this price at an arm’s length price, even though for the purposes of customs duty, the taxpayer can not be relieved of the burden of establishing that it is an arm’s length, for the purposes of transfer pricing requirements, in terms of the provisions of the Income tax Act.
Conclusion
As Mumbai ITAT has upheld the order of the Commissioner of Income-tax (Appeal), it is expected that the taxpayer would go to Hon’ble High Court. For the taxpayer and transfer pricing professionals in India
· The data which is considered as CUP by the TPO was not available with the taxpayer at the time of filing of return. Further, such data is regarded as hidden comparable as same such kind of price information is not available in public domain and accordingly some tax authorities restrict its usage. This case allows the usage of hidden comparables. Further, I am not sure why the taxpayer has not taken appealed again the usage of the same.
· This case highlights the importance of traditional methods over transactional profit methods, thus it may not be the cake walk for the tax authorities or the taxpayer to simply apply TNMM and close the case.
· In this case useful reference was made to decision pronounced by the tax court of foreign jurisdiction, thus it is important for the transfer pricing professionals in India to not only track the judgments of Indian Appellate Authorities and Courts but also to keep eye on development happening in foreign land. [Glaxo Smithkiline Inc Vs Her Majesty the Queen (2008 TCC 324 ) – Tax Court of Canada].
· The decision of Mumbai ITAT, in light of Glaxo Smithkiline Inc Vs Her Majesty the Queen (2008 TCC 324 ) – Tax Court of Canada, may have far reaching consequence on multinational pharmaceutical companies operating in India
· As this case will move to Hon’ble High Court, it would be interesting to watch a battle - CUP vs. TNMM.
Trust the above will find you useful.
Your’s
Gaurav Garg
Transfer Pricing Consultant
(M): +91 9899994934
(E): gaurav@jgarg.com
JGarg Economic Advisors
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