Granules India Limited, Hyderabad vs Assessee

This appeal by Assessee is directed against the Order of the Assessing Officer (AO) passed u/s. 143(3) r.w.s. 92CA(3) consequent to the directions of the Dispute Resolution Panel (DRP) u/s. 144C(5) of the Income Tax Act, 1961 (Act).

2. Briefly stated, assessee M/s. Granules India Limited is engaged in the business of manufacture of bulk drug (API) Formulations/Granules (PFI) and tablets. Assessee is having a wholly owned subsidiary in USA named Granules USA (Inc.) to market the products manufactured by assessee. For the AY. 2009-10, assessee filed :- 2 -: I.T.A. No. 775/Hyd/2014 Granules India Ltd.,

its return of income on 30-09-2009 declaring total income of Rs. 1,04,02,901/- after claiming deduction under section 10B of the Act.

3. The AO ultimately determined the total income at Rs. 12,71,70,274/- vide Draft Order dated 31-01-2014 by making the following adjustments :

i. Transfer pricing adjustment u/s.92CA Rs. 8,86,12,580 ii. Belated payment of Provident Fund Rs. 1,81,191 iii. Belated payment of Employees State Rs. 4,58,162 Insurance iv. Disallowance of GDR expenses u/s.35D Rs. 17,60,140 v. Disallowance of deduction u/s.10B Rs. 3,33,94,883

4. The assessee raised various objections before the DRP and the DRP considered the objections and passed the order dt. 27-11-2013, whereby the addition under TP adjustment was confirmed and on the other additions, the matter was restored to the file of the AO for verification/fresh examination. Now the assessee has filed the present appeal challenging the order of Hon'ble DRP confirming the TP adjustment raising the following Grounds of Appeal:

"1. The TPO erred in rejecting the economic analysis undertaken by the assessee in accordance with the provisions of the Act read with the Income Tax Rules 1962 and consequently making adjustments to the transfer pricing of its international transaction with AE.

2. The TPO erred in selection of the tested party for determination of ALP.

3. The TPO erred in rejecting Resale Price Method (RPM) which was selected by the assessee as the most appropriate method to determine arm's length price for transactions entered with its AE.

4. The DRP in para 6.2 of their order erred in rejecting the submissions made with respect to grounds 1, 2 & 3 above, which consequently led to no relief being granted by the Assessing Officer in Final assessment order u/s. 143(3) dated 31.01.2014.

:- 3 -: I.T.A. No. 775/Hyd/2014 Granules India Ltd.,

5. The TPO erred in rejecting the alternative analysis undertaken by the assessee under TNMM to determine the arm's length prince for transaction entered by the assessee with its AE by giving the following reasons:

a. Turnover filter applied by assessee is not appropriate b. Selection of comparable with forex revenue more than 60% is not appropriate and no rationale c. Comparables selected by the assessee are functionally different.

The TPO erred in conducting a fresh search to identify suitable comparables for comparison under TNMM.

6. The DRP in paras 7.2, 7.3 & 7.4 of their order erred in rejecting the submissions made with respect to ground 5 above, which consequently led to no relief being granted by the Assessing Officer in Final Assessment order u/s.

143(3) dated 31.01.2014.

7. Without prejudice to Ground.5, the TPO erred in applying the following filters in selecting comparable to determine ALP under TNMM

a. Turnover Filter - this filter resulted in reducing the no. of comparables b. Functionally different - selected comparable companies which are functionally different that of the assessee

The TPO erred in making adjustment of Rs. 8,86,12,580/- in respect to sales made to its AE.

8. The DRP in para 8.0 of their order erred in rejecting the submissions made with respect to ground No. 7 above, which consequently led to no relief being granted by the Assessing Officer in Final Assessment u/s. 143(3) dated 31.01.2014.

9. The Assessing Officer erred in initiating penalty proceedings u/s. 271(1)(c) at the time of finalization of order of Assessment.

10. For the above and / or any other additional grounds that may be submitted at the time of hearing of the appeal, the appellant prays before the Hon'ble Tribunal that the above addition be deleted and necessary order be passed".

5. The assessee has raised 10 grounds in its appeal. Ground No. 1 and 10 are general in nature. Hence, does not require any adjudication. Ground No. 2 to 8 pertains to TP adjustments made under section 92C.

:- 4 -: I.T.A. No. 775/Hyd/2014 Granules India Ltd.,

6. Transfer Pricing adjustments : Ground No. 2 is with reference to issue of selection of tested party in determination of Arm's Length Price (ALP). Briefly stated, during the financial year assessee entered into various international transactions with its Associated Enterprise (AE) for a total sum of Rs. 1,03,86,76,126/- as under :

S.N. Class of Paid/ A.E. Amount Method transactions Received (in INR) applied 1. Export of Received Granules 83,06,28,503 RPM finished USA Inc. goods 2. Purchase of Paid Hubei 20,76,29,307 CUP raw Granules materials Biocause Pharmaceu ticals Co. Ltd., China 3. Interest Received Granules 4,18,316 CUP received on USA Inc. loan 1,03,86,76,126

7. In the T.P. study assessee had furnished profitability analysis in respect of domestic sales and sales to AE and non-AE under export segment for FY. 2008-09. Assessee has allocated direct and indirect expenses to these segments in proportion to their sales and not of their actual basis. In the T.P. study of assessee, the tested party was the AE in USA. Assessee exported finished goods to AE in USA for a sum of Rs. 83,06,28,503/- and assessee submitted before the AO that the AE has least complex transactions and the ALP can be determined actually by adopting Re-sale Price Method (RPM). Assessee sourced the data from the website www.sesc.gov and the international transactions with the AE were compared by searching the data based in the website and six comparables were picked from the business of marketing and distribution using the multiple year data. Assessee arrived at weighted :- 5 -: I.T.A. No. 775/Hyd/2014 Granules India Ltd.,

average gross profit margin of these companies computed at ranges from 3.07% to 29.23%. The gross profit margin of AE was worked out to 5.13% and concluded that international transaction with the AE were at arm's length.

8. The TPO held that transfer pricing study of the assessee by making the AE as tested party was defective and rejected the same by giving the following reasons :

i. FAR analysis of the companies selected as comparables not properly carried out;

ii. Search process and matrix not provided;

iii. Filters applied not revealed;

iv. Multiple year data used;

v. Foreign comparables selected are cherry picked and found to be

functionally dissimilar. The activities in which they are engaged are different from that of the taxpayer.

9. In addition to the RPM, the assessee carried out an independent analysis by applying Transactional Net Margin Method (TNMM) as the most appropriate method for analyzing the sale transactions. This TP study was rejected by the TPO. The TPO had used only the current year data on Prowess and Capitaline Plus databases for searching the comparables and selected 8 comparables, the arithmetic mean PLI (OP/OC) of which comes to 21.01% as against the PLI of the taxpayer at 9.35% which is outside the arm's length range of [x/-] 5%. Therefore, the TPO made adjustment u/s. 92CA(3) of Rs. 8,86,12,580/-. Being aggrieved, the assessee had filed objections before the Hon'ble DRP.

:- 6 -: I.T.A. No. 775/Hyd/2014 Granules India Ltd.,

10. Before the DRP, it was contended that rejection of TP study, rejection of AE as the tested party and rejection of RPM was not justified. The assessee submitted before DRP that it is engaged in the manufacture of API, PFI and FD and is the parent company and assumes the responsibility to manufacture the pharmaceutical products, undertakes to maintain the quality standards and specifications as per the requirements of the AE. In the TP study, the tested party was the associated enterprise in USA. The assessee exported the finished goods to AE in USA for a sum of Rs. 83.06 Crores and for the TP study purpose, the entity in USA was selected and the taxpayer submitted before the AO and DRP that it had the least complex transactions and ALP can be determined accurately by adopting the RPM and selected 6 comparables from the business of marketing and distribution and concluded that the international transactions with the AE were at arm's length.

11. However, the DRP following its order for earlier years i.e., AY. 2007-08 and 2008-09, rejected the submission of the assessee.

12. The assessee in the TP study report, in addition to the analysis of international transactions under RPM, also made an alternative analysis under TNMM and conducted search in the Capitaline plus database and identified 4 comparables after applying certain filters i.e., companies having net foreign exchange revenue over 60% and turnover filter between Rs. 190 Crore to Rs. 440 Crores and companies having related party transactions less than 25% and selectged 2 companies (Nueland Labs and Vinathi Organics) as comparables. The TPO found the search process conducted by the assessee defective and carried out an independent analysis by applying TNMM as the MAM for analyzing the sale transactions by using Powess :- 7 -: I.T.A. No. 775/Hyd/2014 Granules India Ltd.,

and Capitaline plus databases. The final filters applied by the TPO are as under:

i. Companies whose data is not available for the FY. 2008-09 were excluded;

ii. Companies whose revenue manufacturing of pharmaceuticals is less than 75% of the total operating revenues were excluded;

iii. Companies whose revenues from operations are between Rs. 250 to Rs. 380 crores are selected;

iv. Companies which have more than 25% related party transactions (income as well as expenditure combined);

v. Companies having different financial year ending (i.e., not March 31, 2009) or data of the company does not fall within 12 month period i.e., 1-4-08 to 31-3-2009 after rejected;

vi. Companies that are functionally different from that of taxpayer, after giving valid reasons, were excluded;

13. With regard to TNMM method, to determine the ALP for transaction entered by assessee with its AE, it was submitted before Hon'ble DRP that the TPO was not justified in rejecting the comparables selected by the assessee on the ground viz (1) turnover filter applied by assessee is not appropriate (2) selection of comparable with forex revenue more than 60% is not appropriate and no rationale and (3) comparable selected by the assessee are functionally different.

14. The DRP held that the assessee had been selected as the tested party and applied the turnover filer of Rs. 250 Crores to Rs. 380 Crores. The TPO in principle agreed with the assessee that there should be a turnover filter in manufacturing sector and the dispute is in respect of the quantum. It was noted that the assessee adopted the sales range of Rs. 190 Crores to Rs. 440 Crore whereas the TPO adopted Rs. 250 :- 8 -: I.T.A. No. 775/Hyd/2014 Granules India Ltd.,

Crores to Rs. 380 Crores. Since the assessee's turnover is Rs. 315.93 Crores and the assessee had not given any reasons as to why it had adopted such wide range of turnover, the TPO's selection of companies which have similar scale of operation is nearer to the turnover of the assessee and more accurate. Therefore, the turnover filter applied by the TPO was held to be justified and accordingly, the objection was rejected.

15. On the next issue regarding the export revenue filter, the assessee's submission before DRP was that, revenues from exports in a comparable should be in excess of 60% of the total turnover. Since the assessee had not substantiated this ground with any facts and figures neither before the TPO nor before the panel, the objection was rejected.

16. As regard to the assessee's argument that some of the comparables selected by the TPO were functionally dissimilar had been considered. The panel noted that the TPO had given the profile of the comparables selected and also noted that the companies Natco Pharma Ltd., Venus Remedies Ltd., Hitkal Ltd., had been held to be functionally similar to the assessee-company in the AY. 2008-09 and the DRP had endorsed/considered the view of the TPO. Accordingly, the panel upheld the selection of these three companies as comparables. Regarding Indoco Remedies Ltd., the TPO had noted at para 7.3 that there was no functional dissimilarity and for the reasons given therein, the panel agreed with the view of the TPO. In the case of Aarti Drugs Ltd., the TPO had rejected the assessee's objection that the said company fails the turnover filter applied by the TPO, by clearly stating that as per the audited financials of the said company, its operating revenue was Rs. 376.6 Crores and thereby passes the turnover filter applied. Therefore, the panel rejected the objection. Aggrieved with the order of DRP, the assessee had come up with the present appeal.

:- 9 -: I.T.A. No. 775/Hyd/2014 Granules India Ltd.,

17. It was submitted before us by the Ld. AR that the issue may be restored to the file of AO for fresh determination of ALP by following the RPM, since, for earlier years, it was held by this Hon'ble Tribunal that RPM is the most appropriate method for determining the ALP and the issue was restored to the file of AO. Ld CIT-DR had no serious objection for remitting the matter back to the file of AO following the orders of this Hon'ble Tribunal for earlier years.

18. We heard the rival parties and perused the orders of this Hon'ble Tribunal for the earlier years as well as the orders of the lower authorities. We concur with the submission of the Ld. AR that issue should be sent back to the file of AO/TPO with a direction that ALP may be determined by adopting RPM as most appropriate method in line with the earlier assessment years. The co-ordinate bench of this Hon'ble Tribunal held in ITA No. 1793/Hyd/2012 (AY. 2008-09) in para 11 of its order held as under:

"10.......................

11. We have considered the rival contentions and examined the issue. Since we have already considered above that A.E. should be selected as tested party, it is nothing but natural that the T.P. study should be undertaken by Resale Price Method only, as A.E. is only undertaking the distribution of assessee's products in the local market. Profitability of the selected Comparable companies in domestic market may vary with the profit margins available abroad, particularly in the USA market. DRP also rejected the method solely on the reason that AE was not selected as tested party. Therefore, keeping in mind the submissions made by the Ld. Counsel, the issue of selection of method of resale price method or of TNMM or any other method suitable to the international transactions is also restored to the file of A.O. to examine the suitability of various methods and consider accordingly".

19. Respectfully following the order of the co-ordinate bench, we also restore the issue of selection of most appropriate method as well as selection of the tested party to the file of AO/TPO to examine afresh, :- 10 -: I.T.A. No. 775/Hyd/2014 Granules India Ltd.,

whether AE can be selected as tested party and RPM can be selected as most appropriate method.

20. The issue of determining ALP by TNMM becomes academic in the light of our above finding. However, the assessee is given liberty to raise any contentions as and when needed in case RPM method is rejected by the TPO. Therefore, there is no need to adjudicate the grounds relating to the filters, comparables relating to TNMM raised in the appeal.

21. As far as the ground of penalty proceedings u/s. 271(1)(c), since it is only consequential in nature and does not arise out of the order of DRP. Hence this ground is not maintainable.

22. In the result, the appeal is partly allowed for statistical purposes.

Order pronounced in the open Court on 27th May, 2015

Sd/- Sd/-

(SAKTIJIT DEY) (INTURI RAMA RAO) JUDICIAL MEMBER ACCOUNTANT MEMBER

Hyderabad, Dated 27th May, 2015

TNMM :- 11 -: I.T.A. No. 775/Hyd/2014 Granules India Ltd.,

Copy to :

1. Granules India Limited, 2nd Floor, 3rd Block, My Home Hub, Hitec City, Madhapur, Hyderabad.

2. The Deputy Commissioner of Income Tax, Circle-2(3), Range-2, Hyderabad.

3. Dispute Resolution Panel (DRP), Hyderabad.

4. The Director of Income Tax, International Taxation, Income Tax Towers, 10-2-3, A.C.Guards, Hyderabad.

5. Addl. Commissioner of Income Tax (Transfer Pricing), Hyderabad.

6. D.R. ITAT, Hyderabad.