Case Law DCIT V Roche DignosticsIndia

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Arm’s length price (“ALP”) is nothing but a benchmark or a standard price meant for comparison with price charged or paid by assessee in international transactions with its associated enterprises. Since this standard price constitutes basis for making addition in hands of assessee on account of its international transactions with associated enterprises, legislature, in order to iron out creases, inserted proviso to section 92C(2); role of this proviso is to make such standard price or ALP, flexible and not rigid. It has been provided that if price actually charged or paid by assessee falls within plus/minus 5% range of such ALP or standard price, then no addition should be made.

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Case Law DCIT V Roche DignosticsIndia

  1. 1. Deputy Commissioner of Income-tax, Circle 8(3) vs. Roche Diagnostics India (P.) Ltd. IT Appeal No. 4127 (Mum.) of 2009Arm’s length price (“ALP”) is nothing but a benchmark or a standard pricemeant for comparison with price charged or paid by assessee ininternational transactions with its associated enterprises. Since thisstandard price constitutes basis for making addition in hands of assessee onaccount of its international transactions with associated enterprises,legislature, in order to iron out creases, inserted proviso to section 92C(2);role of this proviso is to make such standard price or ALP, flexible and notrigid. It has been provided that if price actually charged or paid by assesseefalls within plus/minus 5% range of such ALP or standard price, then noaddition should be made.
  2. 2. Roche Diagnostics India (P.) Ltd.( “the assessee or the Company”)incorporated in the year 1998, was originally a joint venture between AVLMedical Instrumentation AG, Switzerland (AVL Switzerland) and localpromoters. The Diagnostics arm of Roche Group (Roche Diagnostics) acquiredthe medical instruments business of AVL Switzerland in the year 2000.Consequently Roche India became a wholly owned subsidiary of Roche Group.• During the AY 2004-05, the assessee filed its return declaring loss of Rs. 29,65,605 and during the course of assessment proceedings such return was revised declaring loss of Rs. 29,65,610.• The Assessing Officer (“AO”) referred the case to the Transfer Pricing Officer (“TPO”) for computing the ALP in respect of international transactions. The TPO observed that in relevant AY the assessee performed functions of distributor and service provider to its AEs, in respect of biomedical equipments, reagents and spares. The assessees transactions with its Associated Enterprises (AEs) were as under:-
  3. 3. TABLE-1AE Description Amount[Rs. in Crore]Roche Diagnostics, Purchase of Trading 4.28Switzerland GoodsRoche Diagnostic, Purchase of Trading 0.21GermanyRoche Diagnostics Asia Goods Commission 2.59Pacific Pte. Ltd. SingaporeTotal 7.08 • Transaction net margin method (“TNMM”) has been adopted as Most appropriate method (“MAM”) for computing the ALP separately in respect of Distribution activities and Support services rendered to its AEs. The TPO accepted the price declared by assessee as ALP in respect of Support services. • The entire controversy in the present appeal revolves around the determination of ALP in respect of the Distribution segment.
  4. 4. For its distribution division, the assessee depicted operating margin at1.63% as against the arithmetical mean of the operating margin ofcomparable cases as chosen by the assessee at 1.73%. Exercising optionunder proviso to section 92C(2), the assessee declared that its internationaltransactions with AEs were at arms length price.The TPO rejected 5 out of 7 comparables selected by assessee in its TPstudy. Further he considered 5 new comparable cases at his own andworked out mean PBIT at 8.86%.Assessee raised objections to the TPOs inclusion of five new cases and afterconsidering such objections, the TPO finally short listed the comparable caseschosen by him to two. He, thus, worked out PBIT of four comparable cases, thatis, two from the assessees TP study and two as finally selected from the fiveinitially proposed by him- Mean PBIT 8.82%Based on operating margin at 8.82%, TPO made adjustment to the income ofthe assessee for Rs. 11,111,356. Being aggrieved assessee filed appeal to theCIT(A).
  5. 5. Assessee and Department’s contention before CIT (A) The two new comparables chosen by the TPO were functionally different to the assessee’s distribution division. The assessee submitted that the arithmetical mean of the assessees remaining two comparable cases comes at 6.1% and if the option given under proviso to section 92C(2) i.e. plus minus 5% adjustment to the margin was exercised, the assessees declared margin at 1.63% would become comparable to the uncontrolled transactions.. It was also argued that if Comparable uncontrolled price method (“CUP”) was applied for determining ALP, then no adjustment would be required.The submission of applicability of CUP method was raised for the first timebefore the learned CIT(A) apart from adducing certain additional evidence inrespect of two cases chosen by TPO, the learned CIT(A) called for remandreport from the TPO.
  6. 6. The ld CIT(A) got convinced with the assessees contention for the removal oftwo comparable cases, chosen by the TPO for the reasons discussed in theimpugned order.The learned CIT(A) got convinced with the assessees submission and orderedfor the deletion of addition.Being aggrieved department filed appeal to the ITAT.Department’s contention5% adjustment should have been considered of 6.1% being arithmetical meanof OP rate of two comparable cases which were finally selected by him. Since+-5% of 6.1% gives percentage of OP ranging between 6.4% to 5.8%,therefore, assessees declared margin at 1.63% was far below. It was thussummed up that the ld. CIT(A) erred in applying +-5% on the cost instead ofthe OP margin of 6.1%.
  7. 7. Whether the learned CIT(A) was justified in excluding the cases of SpanDiagnostics and Casil Health , selected by TPO as comparables• There is no functional comparability between assessees case and that of comparable, Casil Health and Span Diagnostic as segmental data not available for proper comparability. Therefore hold that the learned CIT(A) was justified in excluding the case of Span Diagnostics and Casil Health from the purview of list of comparable cases. Determination is about the granting of plus minus 5% adjustment.In principle plus minus 5% adjustment is allowable for determining ALP.
  8. 8. The prescription of the proviso to section 92C(2) makes it clear that the plusminus five percent is on the price and not on the profit embedded in suchprice. That plus minus 5% margin has been stipulated on the value of thetransaction and not the income from such transaction. Various methodsprescribed u/s. 92C(1) are ways to compute arms length price in respect ofinternational transactions. These are alternatives having a common objectiveto see as to whether or not the international transaction entered into by theassessee with its AE, is at arms length price.It is relevant to note that the assessee as per its transfer pricing studycomputed operating profit margin at 1.63%. However, the TPO determinedoperating loss at Rs. 14,86,852 discarding the assessees operating profit. It ison the basis of such figure of operating loss of Rs. 14.86 lakh that the additionof Rs. 1.11 crore was made by the A.O but nowhere from the CIT (A) order itcan be ascertained that the learned CIT(A) held such figure of operating lossto be incorrect or correct. He proceeded with profit margin of 1.63% asdeclared by the assessee for coming to the conclusion that it was within therange of 1.405% to 10.597%. When the assessee challenged the adjustment ofRs. 1.11 crore before the ld, CIT(A), it was his duty to adjudicate not only uponthe inclusion or exclusion of the comparable cases and determination ofoperating profit margin percentage but also the most important figure beingoperating profit or operating loss in assessees own case.
  9. 9. Ultimately, under TNMM it is the assessees figure of profit or loss which iscompared with the uncontrolled transactions to determine whether or notthe price charged or paid by the assessee is on ALP. If we accept the TPOscalculation giving loss of Rs. 14.86 lakh as correct, it would mean that suchamount as a percentage of sales value of Rs. 10.91 crore will give percentageof operating loss at 1.36%. In that case, the assessees cost will become Rs.101.36, which will cease to fall between the permissible range of Rs. 89.2050and Rs. 98.595 as worked out by the assessee. In that case the substantial partof the addition (by applying 6.1% instead of 8.82%) so made by the AO wouldbe sustainable.Ultimately, under TNMM it is the assessees figure of profit or loss which iscompared with the uncontrolled transactions to determine whether or notthe price charged or paid by the assessee is on ALP. If we accept the TPOscalculation giving loss of Rs. 14.86 lakh as correct, it would mean that suchamount as a percentage of sales value of Rs. 10.91 crore will givepercentage of operating loss at 1.36%. In that case, the assessees cost willbecome Rs. 101.36, which will cease to fall between the permissible rangeof Rs. 89.2050 and Rs. 98.595 as worked out by the assessee. In that casethe substantial part of the addition (by applying 6.1% instead of 8.82%) somade by the AO would be sustainable.
  10. 10. Since no decision has been rendered by the ld. CIT(A) on this aspect of thematter, we are of the considered opinion that it will be just and fair if theimpugned order is set aside and the matter is restored to his file for givingdecision on it.In the result, the appeal is allowed for statistical purposes.
  11. 11. Bangalore Office 616, Oxford Towers, Bangalore Tel: +91-80-25705494 Telefax: +91-80- 32908917 Email: spnblr@spnagrath.com www.spnagrath.comDelhi OfficeA-380, Defence Colony, New Delhi –24 Prepared By- Rashi Pilaniwala,Tel: +91-11-4980 0000 Nandita Naruka & MeenakshiTelefax: 91-11-4980 0029 GuptaEmail: spn@spnagrath.com

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