TII Instant Update - 2017-TII-INSTANT-ALL-502

2017-TII-424-ITAT-DEL-TP

TEVA API INDIA PVT LTD Vs ADDL CIT: NEW DELHI ITAT (Dated: November 3, 2017)

Income tax - ALP - R&D services - manufacturing segment - seperate benchmarking - exchange loss - operating costs - TNMM

The Assessee company is engaged in manufacturing of APIs, other intermediaries and bulk drugs and is also providing Contract R&D services for in-house use and for group companies. Manufacturing was done on contract basis with cost plus mark up of 8.7% and contract R&D activities were carried out with cost plus mark up of 19.95%. The assessee reported nine international transactions in its report in Form no. 3CEB, accordingly, the AO referred the matter of determination of ALP to the TPO, who observed that assessee used TNMM to benchmark its international transactions pertaining to sale of bulk drugs/bulk drug intermediates; purchase of raw material; sale of raw material; and provision of contract R&D services with PLI of OP/OC. On analysis of the transfer pricing approach of assessee, the TPO observed that there were two segments, namely, manufacturing segment and service segment. The TPO did not approve separate benchmarking of these two major international transactions of Manufacturing and R&D. For the reasons given in the order, the TPO combined these two segments and then proceeded to determine the ALP on an aggregate basis. The TPO determined the assessee's combined OP/OC at 7.10%. In determining such PLI, the TPO reduced Exchange loss of Rs.112.40 million from total expenses for calculating 'Operating costs'. He further carried out a fresh search and, eventually, shortlisted nine companies as comparable, which include two companies from the assessee's lists, namely, Shilpa Medicare Ltd. and Sri Krishna Pharmaceuticals Ltd. Average OP/OC of such nine companies was computed at 13.02%. By applying this PLI as a benchmark, the TPO worked out transfer pricing adjustment of Rs.42,87,51,255/-.

On appeal, the ITAT held that,

Whether foreign exchange gain/loss from trading transactions, should be taken as an item of operating nature - YES: ITAT

Whether exchange loss on account of financing transactions can be considered as non-operating, without linking foreign exchange loss with transaction of borrowing from AEs - NO: ITAT

+ it is seen that the DRP directed the TPO to examine if foreign exchange gain was on account of sales, and if yes, then that should be treated as operating gain. Impliedly, the direction of the DRP was that foreign exchange gain/loss from trading transactions should be taken as an item of operating nature and in other cases it should be considered as non-operating. This view of the DRP accords with the ratio of the judgment of the Supreme Court in CIT VS. Woodward Governor India P. Ltd - 2009-TIOL-50-SC-IT. The counsel for the assessee submitted that the exchange loss of Rs.112.40 million pertains to loan taken by the assessee from Teva Pharmaceuticals Finance, Netherlands B.V., its holding company. Referring to the balance sheet of the assessee for the year under consideration, the AR submitted that the assessee effected long-term borrowings amounting to Rs.992.1 million from its holding company and the exchange loss pertained to such borrowing alone;

+ it can be seen from the balance sheet that there are certain trade receivables as well as trade payables. Admittedly, some of the trade receivables and trade payables are on account of import and export transactions of the trading nature. The AR could not link exchange loss of Rs.112.40 million with the borrowings effected by the assessee from its holding company. It is patent that foreign exchange loss on account of trade receivables and payables has to be taken as an item of operating expenditure and exchange loss on account of financing transactions will be considered as non-operating. Since the ld. AR could not link the amount of foreign exchange loss of Rs.112.40 million with the transaction of borrowing from the assessee's AE, we cannot uphold the argument put forth before us without verification. Under these circumstances, we set aside the impugned order and remit the matter to the file of TPO for ascertaining if exchange loss of Rs.112.40 million pertains to loan transactions from the assessee's AE or trading transactions as well.

Case remanded