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APA ANNUAL REPORT

APA - Annual Report (2016-17)

CASE LAWS

2017-TII-157-ITAT-HYD-TP

DR REDDYS LABORATORIES LTD Vs ADDL CIT: HYDERABAD ITAT (Dated: April 28, 2017)

Income Tax - Sections 92B & 92CA

Keywords - Corporate guarantee - generic drug - inter corporate loans - interest - tax deducted at source - tax holiday unit - profit sharing ratio

The Assessee is engaged in the manufacture and sale of bulk drugs, APIs, Formulations and other pharmaceutical products. The return was processed u/s 143(1) and was subsequently revised. The case was selected for scrutiny. The case was referred to TPO for determining the ALP of the international transactions entered into by assessee-company. While passing the order u/s 92CA, the TPO observed that assessee had a full-fledged in-house research and development division, engaged in research on new products and on process development of existing products. The TPO noticed that assessee-company entered into loan transactions with it's AEs and charged interest. The loan transactions with Falcon Mexico and Lacock Holdings are subject matter of dispute for A.Y. 2009-2010. The TPO noted that the assessee did not file any submission regarding the corporate guarantees which were outstanding as on 31st March, 2009. The TPO also noted that the guarantees are given to subsidiaries. The TPO noticed that the AE had derived benefit in the form of lower interest rate by 1.3%. With regard to expenditure referable to ESOPs, AO observed that it is incurred in connection with the issue of fresh lot of shares to increase share capital and hence it is capital in nature, not allowable as deduction. During the course of draft assessment proceedings, assessee submitted that it should be allowed tax credit amounting to Rs.14.88 crores being 10% of the interest income earned by the Company from its subsidiary i.e., M/s. Lacock Holdings Ltd., Cyprus. This credit was not claimed in the return. However, similar claim was accepted by the DRP in the proceedings for the A.Y. 2008-09. Having regard to the circumstances, the AO allowed the claim of the assessee. With regard to the issue of loans given to Lacock Holdings and Falcon D. Mexico the Panel observed that the RBI examined the matter from the perspective of FEMA Regulations and not from arms length perspective. With regard to corporate guarantees, the Panel observed that in assessee's own case for the A.Y. 2008-09 AO was directed to adopt 0.7% of the loan amount as ALP and therefore, similar direction was given for this year also. As regards disallowance on account of ESOPs the Panel followed the decision of ITAT, Special Bench, Bangalore in the case of Biocom Ltd., and directed the AO to work-out the deduction accordingly. DRP followed the decision of ITAT, Bangalore Special Bench in the case of Biocon Ltd., vs. DCIT to hold that expenditure incurred towards ESOPs is an ascertained liability and thus, the allowance is revenue expenditure. As regards the disallowance of claim of depreciation on goodwill, the DRP followed the order passed by them in the assessee's own case for the A.Y. 2008-09 and rejected the contention of the assessee.

During the DRP proceedings, the AO intimated to the Panel that there has been remittance to Switzerland by the assessee without deduction of tax at source and requested the Panel to consider the information suitably to issue necessary directions to remedy the escapement of the income of assessee. The ACIT (TP) reported that assessee i.e., Dr. Reddy Laboratories, along with it's AEs (DRL, USA) developed a generic drug for the patented drug (Sumatripton) of Glaxo Smithkline USA (GSK). A suit was filed by the GSK against DRL disputing the rights of DRL to sell the generic drug in the USA territory. Through an out of Court settlement in 2006, before the US District Court, DRL and GSK agreed that Sumatripton will be manufactured by GSK but marketed by DRL USA with all the support from DRL (India). In lieu of its contribution, it was agreed that the profit shall be shared between the DRL USA and DRL India equally. Another A.E. i.e., DRL, Switzerland agreed to bear certain risks like post-sales liabilities of DRL USA, as per MOU with DRL India, in May, 2008 and in consideration thereon, the assessee agreed to part 50% of its share of profit to DRL, Switzerland. With regard to the sharing of profit between the DRL India and its Swiss A.E. the DRP considered the matter in extenso to hold that the sharing of 50% of profits received from DRL, USA is not on account of any commercial expediency but shifting of profits to lower tax regime. The Panel concluded that by virtue of share of 25% of profit with Switzerland A.E. the profit which was taxable in India was diverted to Switzerland. In otherwords, the amount diverted to Switzerland is assessable to tax in India. The Panel directed the AO to treat only 50% of the share as profit of the assessee-company instead of 60% sought to be adopted by the AO. Aggrieved by the order of the DRP, Revenue preferred an appeal contending that the DRP erred in law in holding that the profit sharing ratio between DRL India, DRL USA is 50% – 50% overlooking the fact that TPO has made detailed analysis in arriving at the conclusion that the assessee had a major role in development of generic drug and therefore, it is entitled to 60% share of profit. The Revenue also contended that the DRP is not correct in holding that expenditure towards ESOPs is Revenue in nature. Assessee also preferred appeals for both the years by raising various grounds.

Having heard the parties, the Tribunal held that,

Whether ALP adjustment on account of provision for coporate guarantee is warranted if the costs incurred by the assessee in providing such guarantee does not fall within the meaning of 'international transaction' u/s 92B - NO: ITAT

+ the first issue is with regard to the bank guarantee extended by the assessee for a loan availed by Lacock Holdings. The main contention of the assessee is that the case law relied upon by Revenue did not make any analysis on the issue as to whether corporate guarantee falls under the definition of "International Transaction" or not. No doubt the assessee has not appealed against the DRPs order before ITAT for the A.Y. 2008-09 but it cannot be considered as a covered issue in favour of the Revenue since a legal issue can be raised at any stage, each year being distinct and separate and right of appeal is provided to the assessee for each year independently. In this reard it was observed that the ITAT, Delhi Bench in the case of Bharati Airtel Ltd., has considered an identical issue which was re-affirmed in the case of Siro Clinpharma Pvt. Ltd., vs. DCIT ( 2016-TII-192-ITAT-MUM-TP). The Bench observed that transfer pricing is an anti abuse legislation which tells you as to what is the acceptable behaviour but it does not trigger levy of tax in a retrospective manner because no party can be asked to do an impossibility. Analysing further the Bench observed that though Explanation to Section 92B is stated to be clarificatory, it has to be necessarily treated as effective from the A.Y. 2013-2014. We have also analysed the case law relied upon by the Revenue and also the provisions of the Act. In our considered opinion, the view taken by the Delhi Bench of ITAT in the case of Bharati Airtel Ltd., is one of the possible views on the matter and so long as there is no binding decision of any other Higher Forum taking a contrary view, the one which is favourable to the assessee has to be adopted even though other Benches have taken a different view. We, therefore, hold that the Explanation to Section 92B cannot be applied retrospectively and for the years under consideration the assessee having not incurred any costs in providing corporate guarantee it would not constitute "International Transaction" within the meaning of Section 92B of the Act and consequently, ALP adjustment is not warranted on this aspect. Since we are of the opinion that it falls outside the ambit of "International Transaction" the alternative contention urged before us need not be taken into consideration. Suffice to say, that each year being independent, merely because the assessee has accepted in the earlier year it would not come in the way of the assessee to urge the same issue in a subsequent year;

Whether benchmarking of ALP of inter-corporate loans made to the AE should be determined on the basis of LIBOR + 200 basis points and the market rate prevailing in the respective countries should not be taken into account for the same - YES: ITAT

+ The next issue is with regard to the attribution of additional interest on loans given to A.Es. In so far as AY 2009-2010 is concerned, ALP adjustments are only with reference to inter-corporate loans to it's AE namely Lacock Holdings, Cyprus and Falcon Mexico wherein the interest was charged by the assessee at 5% and 9.5% respectively. The TPO benchmarked interest rates at 6.5% and 12% by taking into account Euribor rate + 2.5% and Mexican rates respectively. We have carefully considered the rival submissions and perused the material on record. The principle that emerges from the decisions cited by the assessee particularly in assessee's own case for the earlier years, show that benchmarking of ALP should be LIBOR + 200 basis points and TPO should not determine the ALP by taking into consideration the market rate prevailing in the respective countries. Even for A.Y. 2008-2009, the Hyderabad Bench accepted in principle that LIBOR + 200 basis points can be adopted as ALP. Under these circumstances, we set aside the matter to the file of the A.O. who is directed to adopt the LIBOR rate applicable for the years under consideration + 200 basis points to arrive at the ALP.

+ The next issue is with regard to allowability of claim of depreciation on goodwill. American Remedies Ltd., got merged with the assessee & upon merger the difference between the consideration and the net worth was considered as goodwill and depreciation was claimed on such goodwill. AO disallowed the claim on the ground that it is not an intangible asset. This view was confirmed by the DRP. An identical issue has come-up before the ITAT in assessee's own case for the A.Y. 2008-09 wherein the Bench set aside the issue to the file of the AO. The facts and circumstances being identical, we hereby direct the AO to verify the nature of the expenditure and disallow only such expenditure which was not incurred for the purpose of business of the assessee.

Whether with regard to allocation of corporate overhead expenses to tax holiday units, net expenditure of the corporate entity should be allocated amongst all units on the basis of turnover - YES: ITAT

+ The next issue is with regard to the allocation of corporate overheads expenses to tax holiday units. Assessee claimed certain amount of exemption u/s 10B on the eligible undertaking. A.O. allocated the corporate overheads on adhoc basis to undertaking claiming exemption under section 10B and thereby, reduced the amount of exemption available. According to the assessee section 10B unit is independently functional with separate/identified set of employees and hence the expenditure which is not directly related to the undertaking should not be allocated to such undertaking on adhoc basis. In assessee's own case for the A.Ys. 2007-08 and 2008-09, the Tribunal set aside the matter with the observations : "....to direct the A.O. to allocate the only net expenditure of the corporate entity amongst all the units on the basis of the turnover." Facts being identical in this year also, we direct the A.O. to allocate net expenditure of the corporate entity amongst all the units on the basis of turnover. This ground is disposed of accordingly.

Whether equal division of profits by an Indian entity with its AE can be doubted when there is an agreement between the two providing for sharing of profits in such an equal ratio - NO: ITAT

+ The next ground relates to the issue of profit sharing between DRL Swiss and DRL India. Having regard to the overall circumstances of the case, we are of the firm view that the sharing of profits between DRL, India and DRL SA is for bonafide business purposes and therefore, assessee is entitled to claim deduction on this count. It may not be out of place to mention that the AO was of the view that the assessee has a major role in product development and therefore, in the process of sharing profits between DRL US and DRL, India, assessee is entitled to larger share i.e., 60%. It is not in dispute that the DRL, US has undertaken the responsibility of warehousing and marketing the product in US territory which is the main role that requires to be played in selling a drug during the exclusivity period. Despite that assessee having initially done the Research and filed an abbreviated new drug application for the drug namely "Sumatripton" and got approval to manufacture and develop the product in India and to sell the same in USA, there was an agreement between DRL, US and DRL, India to share the profits equally. Under these circumstances, we are of the view that the DRP was justified in holding that the sharing of profits between India and US at 50%-50% cannot be questioned. As already stated herein above, out of 50% share that the assessee earned it had to part with a portion of the profit with the DRL SA for the detailed reasons set-out in the above paras. Having regard to the circumstances of the case and in the backdrop of the principles laid down by the Supreme Court in the case of S.A. Builders, we are of the firm view that the agreement between DRL, India and DRL SA cannot be doubted.

Assessee's appeal partly allowed

 

2017-TII-18-SC-INTL

DIT Vs AP MOLLER MAERSK AS: SUPREME COURT OF INDIA (Dated: April 28, 2017)

Income tax - India-Denmark DTAA - Article 9

Keywords - attribution of income - operation in international traffic & shipping business

The Revenue preferred the present SLP challenging the judgment, whereby the High Court had held that the receipts attributed to operation of ships by a Denmark resident entity in international traffic, could not be denied the benefit of Article 9 of Indo Denmark DTAA, if the income was on account of use of containers from the operations of feeder vessels having nexus with shipping business.

On appeal, the Supreme Court condones the delay and dismisses the SLP following the the judgment delivered in Civil Appeal No.8040 of 2015 in Director of Income Tax (IT)- I v. A.P. Moller Maersk A/S.

Revenue's SLP dismissed