Monsanto Holding India Pvt. Ltd. Mumbai

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IN THE INCOME TAX APPELLATE TRIBUNAL, MUMBAI BENCH “L”,
MUMBAI

BEFORE SHRI R.S.SYAL (A.M) & SHRI N.V.VASUDEVAN(J.M)

ITA NO.3423/MUM/2008(A.Y.2003-04)
ITA No.6558/Mum/2008(A.Y.2004-05)

The DCIT 8(2), M/s. Monsanto Holdings Pvt.
Room No.216-A, Aaykar Bhavan, Ltd., Ahura Centre, 5th
Floor,
MK Road, Mumbai – 20. Vs. 96, Mahakali Caves Road,
Andheri (East), Mumbai – 93
(Appellant) PAN:AAACM 5981H
(Respondent)

Appellant by : Smt. Malathi Sridharan
Respondent by : Shri M.P.Lohia

ORDER

PER N.V.VASUDEVAN, J.M.

ITA No.3423/Mum/2008 is an appeal by the revenue is against the

order dated 18/1/08 of CIT(A) 32, Mumbai relating to assessment year

2003-04. ITA No.6558/Mum/2008 is also an appeal by the Revenue against

the order dated 24.7.2008 of CIT(A)-32, Mumbai, relating to AY 04-05. Since

one common issue is involved in both these appeals and pertain to the same

Assessee, we deem it fit to pass this consolidated order.

2. First we shall take up for consideration ITA No.3423/Muim/08, appeal of

the revenue for AY 03-04. The ground of appeal of the revenue reads as

follows:-

“On the facts and in the circumstances of the case and in law, the
learned CIT(A) erred in deleting the addition of Rs.1,11,25,027/- made
by way of upward adjustment to the Arm’s Length Price of the
International Transactions of the assessee company, without
appreciating the facts of the case.”

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ITA No.6558/Mum/2008(A.Y.2004-05)

3. The assessee is a company. It is hereinafter referred to as MHPL or

Assessee. MHPL is a wholly owned subsidiary of Monsonto Company, USA,

(hereinafter referred to as MTC) in India. MTC is stated to be a leading

provider of agricultural products to farmers and offers seeds improved

through biotechnology with one or more traits. It is stated to be renowned

all over the world for its technology-based solutions in the agricultural field.

MHPL acts as a holding company for various downstream investments of the

Monsanto group in India. As a group holding company of Indian ventures,

MHPL provides certain support/steward services to various downstream

ventures in India.

4. MTC entered into a Support Agreement with MHPL dated January 1,

2001. Since the said agreement was valid only for a period of one year, a

fresh agreement was executed by the contracting entities (effective from April

1, 2002) (‘the Support Agreement’). The Support Agreement envisages

provision of following services by MHPL.

Contract Research Services:

– Provide contract research services in certain specific area (viz.

agriculture and agro chemicals) for research projects initiated by MTC;

and

– Undertake (at the request of MTC) special studies and market

research on products launched by MTC, concerning the new need of

the Indian market.

Corporate Support Services:
– Assist MTC in expanding its business presence in India through

subsidiaries / JVs;

– Update MTC with the changing regulatory scenario, which includes

import-export regulations, foreign direct investment policy,

commercial issues, etc.; and
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ITA No.6558/Mum/2008(A.Y.2004-05)

– Identity appropriate business opportunities and communicate the

same to MTC;

MHPL provides contract research and support services to MTC from a

separate facility set-up in Bangalore known as Monsanto Research Center

(‘MRC’). The research project is primarily initiated by MTC. MHPL provides

support services to MTC in the field of crop transformation and crop

protection. The Support Agreement further provides that MHPL should

provide such support services to MTC on an exclusive basis and the risk

and rewards of the research would be exclusively owned by MTC. During

F.Y 2002-03, MHPL has received a service fee from MTC aggregating to Rs.

12,97,50,895 for providing the aforesaid corporate support and contract

research services.

5. It is not in dispute that the transaction between the MHPL and MTC

by which MHPL provided contract research services and corporate support

services was an international transaction between two associated enterprises

and, therefore, any income arising out of the said transaction has to be

computed in accordance with the provisions of section 92 of the Income Tax

Act, 1961 having regard to the Arm’s Length Price (ALP).

6. MHPL had filed a transfer pricing study in which it adopted the TNMM

as the most appropriate method for determining the ALP. Operating Profit

(‘OPM’) on total cost has been considered as the relevant net margin for

conducting the comparability analysis. The OPM has been worked out as:

Net Margin = Operating Profit / Operating Cost *100

(Operating Profit = Profit Before Tax + Non-operating income / expense)

(Operating Cost = Total Cost – Interest – Non-operating expenses)

7. The assessee gave operative profit margin of comparable companies

which is as follows:
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ITA No.6558/Mum/2008(A.Y.2004-05)

Sr. Company Name Year Operating Op Exps. OP OP%
No. income

1. Amtrac 31/3/2003 1,458,960 1,475,680 – 1. 3%
Management (16,720)
Services.
2 Dabur Research 31/3/2003 179,997,656 168,718,427 11,279,229 6.69%
Foundation
3. Hinduja Group 31/3/2003 48,002,686 48,455,982 2,059,326 4.25%
India Ltd.
4. ICI India Research 31/3/2003 46,933,379 46,864,594 68,785 0.15%
& Technology
Centre
5. Manu Consultants 31/3/2003 667,500 659,327 8,173 1.24%
Ltd.
6. Raptakos, Brett 31/3/2003 8,987,642 8,336,961 650,681 7.80%
Test Laboratories
Ltd.
Average 3.17%

The operative margin of the assessee was worked out at 7.09% of the total

cost. According to the Assessee the operative margin was higher than the

average OPM of comparable companies i.e. 3.17% and accordingly, having

regard to the provisions of Section 92(3), the consideration being received by

MHPL for rendering support services to MTC meets with the arm’s length

principle. The assessee thus claimed that the international transaction with

its AE was at Arms Length Price and the same should be accepted as proper.

8. The Transfer Pricing Officer (TPO) however was of the view that the

comparable cases which were referred to by the assesse in its Transfer

pricing were not comparable for the following reasons:

S.No. Name of the company Remarks
1. Amtrac Management This company is a share transfer agency. Its
Services total revenues is Rs. 15 lakhs during the P.Y
as compared to Rs. 14 lakhs in the preceding
year. It appears that the services provided by
this company is of routine nature.
2. Dabur Research Foundation This company is engaged in research activity.
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ITA No.6558/Mum/2008(A.Y.2004-05)

3. Hinduja Group India Ltd. This company is engaged in providing
consultancy and advisory services. However,
the nature of such consultancy is not
indicated anywhere and the information in the
balance sheet is very sketchy.
4. ICICI India Research and This company is engaged in technical research
Technology Services activity. The Director’s report has not been
provided. However, from the Balance Sheet it
is evident that it has entered into related party
transaction. It appears to be in-house
research company providing research to ICICI
India Ltd.
5. Manu Consultants Ltd. This company has total consultancy income of
Rs. 1,40,000/- during the year. No other
information is available such as Director’s
Report etc. from which any information
regarding the nature of activity undertaken by
this company could be ascertained.
6. Raptakos, Brett Tests This company is an industrial test laboratory.
Laboratories Ltd.

According to the TPO from a perusal of above it was evident that the

companies appearing at Sr.No.1, 3 and 5 cannot be regarded as comparable

to the assessee’s contract research activity. The level of activity in the case of

Sr.No.1 and 5 according to the TPO was very low. In the case of company at

Sr.No.4, the entire services are rendered to its group companies. In case of

Sr.No.3, the information available was extremely sketchy and it was not clear

what kinds of consultancy services are provided. According to the AO,

barring cases at Sr.No. 2 & 6 the other comparable entities cannot be

considered to be comparable to the functions performed by the assessee in

its contract research activity. The TPO therefore examined database to

identify whether mere closely comparable cases could be identified. The TPO

therefore examined companies engaged in services such as consultancy,

business consultancy, general services, technical and engineering,

consultancy and contract research were examined in ‘prowess’ and

‘çapitaline’ database and on the basis of the same, identified the following

four companies. The companies alongwith their business activities was as

follows

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ITA No.6558/Mum/2008(A.Y.2004-05)

(i) Alpha Geo India Ltd. : This company was engaged in analysis of data

relating to seismic for oil companies

(ii) Vimta Labs Ltd. : They are engaged in providing inspecting, testing and

analysis services in connection with water, food, drug, chemical, petro

products, mineral & water and contract research

(iii) Chokshi Laboratories Ltd.: The company was a commercial testing

house engaged in testing of various products and offers services in the field

of pollution control.

(iv) Syngene International Pvt. Ltd.: This company was formed for providing

contract research services to overseas customers in the field of synthetic

chemistry and molecular biology.

9. The assessee submitted before the TPO that the comparable cases

identified by the TPO are not engaged in similar activities as that of the

assessee. It was further submitted that the services provided by the

comparable cases identified by the TPO were high end services, whereas the

services performed by the assessee were in the nature of low end services.

It was also submitted that two of the comparable companies identified by the

TPO namely Vimta Labs Ltd. & Syngene International Pvt. Ltd. had engaged

in transactions with related parties and were, therefore, not comparable. It

was further submitted that the assets employed by Vimta Labs Ltd.and

Alpha Geo Ltd. were much more than the assets employed by the assessee.

It was also pointed out that the comparable cases identified by the TPO

performed marketing functions also and they had to be face risk of bad debts

whereas the assessee does not perform marketing functions or assumed risk

for bad debts.

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ITA No.6558/Mum/2008(A.Y.2004-05)

10. The TPO however was of the view that the objections raised by the

assessee cannot be accepted. The TPO however, was of the view that the

nature of activities performed by the comparable cases identified by her was

same as that of the assessee. The TPO also held that some of the companies

identified by the assessee also assumed risk of bad debts. With regard to

companies identified as comparable by the TPO having related party

transactions, the TPO held that such related transactions were not with

group companies but were only on account of Key Management Personnel

being one and the same persons. With regard to the objections regarding

capital employed by the companies identified by the TPO being the same the

TPO held that even the comparable companies identified by the assessee

employed huge capital. Similar finding was given with regard to the

performing of marketing functions by the comparable companies identified

by the TPO. With regard to the objection that the assessee was performing

low end services the TPO held as follows:

(a) The assessee employed 50 employees consisting of persons having
Bachelor and Masters degree and some are Ph.Ds. There are support
staffs.

(b) The assessee used lab equipment and computers to perform these
functions.

(c) The assessee carried out efficacy studies of the seeds under
different climatic and soil condition, fertility analysis etc. to comply
with the requirement of regulatory bodies

(d) Providing support for obtaining approval for commercialization of
hybrid seeds of Monsanto

(e)Analysis of hybrid seeds to ascertain pests resistant. The assessee
also outsourced some of these studies

(f) Discovery of gene and its evaluation

(g) Laboratory Testing of genes, studying gene expression on a crop
and whether seeds of such crop contained gene as per requirement.

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ITA No.6558/Mum/2008(A.Y.2004-05)

(h) Assessee has a 25,000 Sq.ft. lab space and 10,000 sq. ft. of green
house space. Pt has also has a well stocked library of technical journal
and research reports.

For the above reasons, the TPO held that the type of services rendered by the

assessee was more comparable to the type of services rendered by the

comparables identified by her. Thereafter the TPO worked out the arithmetic

mean of the four companies identified by her and also six companies

identified by the assessee and arrived at 18.22%. This was later rectified as

there were apparent mistakes in such calculation to16.28%. An addition on

account of adjustment to ALP was determined by the TPO as follows:

Particulars As per revised
calculation.
Revenue from support services including contract 129,750,895
research services.
Profit from the above activity 8,594,456
Cost of the above activity 121,156,439
Profit markup on cost 7.09%
Arm’s Length profit mark up 16.28%
Arm’s length profit (Rs.) 19,719,483
Arm’s Length price (Rs.) 140,875,922
Difference between transaction value and arms 11,125,027
length price (adjustment value)

The same was adopted by the AO and a sum of Rs.1,11,25,027 was added to

the total income of the Assessee by the AO in the order of assessment.

11. Aggrieved by the order of the AO, the Assessee filed appeal before the

CIT(A). The submissions as were made before the AO were reiterated before

the CIT(A). In particular the following aspects were highlighted:

Assessee performs low end services: A comparative summary of the

functions performed by the Assessee and its AE in relation to the research

activity was provided in the form of a table given below:

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ITA No.6558/Mum/2008(A.Y.2004-05)

Functions The Monsanto
Appellant USA
Determining overall concept, direction, and methodology for No Yes
research

Tracking and screening genetic databases and collating Yes No
information for identifying potential gene traits

Preliminary study of gene configurations for tracking desired Yes No
characteristics

Identifying leads and decision to conduct further investigation No Yes

Field trials and selection of potential products for No Yes
commercialization
Advanced development of the hybrid! variety and demonstrate
efficacy of trait

Development of data / documentation for seeking approval No Yes

Seek local government] regulatory approvals and respond to local Yes No
regulatory procedures

Develop plans for product commercialization / launch No Yes

Marketing / sales function No Yes

It was contended that the Assessee’s activities (research support services)

were confined to low-end routine work, not involving use of any significant

assets or intellectual capital or undertaking of any entrepreneurial risk. It

was highlighted that the Assessee’s research work was negligible in

comparison to the global R&D activity of its AE (viz, its parent company —

Monsanto USA).

Risks Assumed by the Assessee: The Assessee submitted that it is a risk

free service provider. In this regard, the Assessee pointed out the risk

assumed by it in the matter of providing contract market research services in

the form of the following chart:

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ITA No.6558/Mum/2008(A.Y.2004-05)

Risk The appellant Monsanto
USA
Market risk No Yes
Research risk No Yes
Price/ margin risk (due to cost overruns etc.) No Yes
Bad debt risk No Yes
Third party liability risk in relation to research No Yes
results.

In the light of the above description of the risk assumed and functions

performed by the Assessee in respect of the international transaction, the

Assessee gave a description of the nature of functions and risks assumed by

the four companies chosen as comparable by the TPO. A comparative

analysis of the activities of the said additional companies ( based on

information available in the annual accounts and official websites of the

companies) vis-à-vis the activity of the assessee, was given by the Assessee

in the form of the following table:

S.No. Name of company Activity of identified company The assessee’s
activity
1. Alphageo (India) Ltd. – Acquiring and processing Provision of research
seismic data support and
– Provides seismic survey facilitation services.
services to oil companies
and government, in relation
to oil exploration projects.
2. Choksi Laboratories – Analytical testing of building
materials, drugs, food,
water, etc.
3. Syngene – Research in the field of
International Pvt. synthetic chemistry and
Ltd. molecular biology.
– Sale of products arising
from research activity.
4. Vimta Labs Ltd. – Clinical trails
– Environmental Monitoring
and impact assessment.
– Analytical testing of a wide
variety of consumer
products.

It was firstly submitted that the four companies chosen by the TPO as

comparable are not engaged in the same/similar activity as the Assessee, the
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ITA No.6558/Mum/2008(A.Y.2004-05)

Assessee did only support in the field of research without assuming any risk.

It was submitted that the four comparable companies chosen by the TPO

were not risk free service providers but perform marketing function assume

entrepreneurial risks and make substantial investments in assets. The

following chart was filed by the Assessee:

Particulars Alpha Geo Choksi Syngene Vimta Labs The Assessee
Nature of activity Not Not Not Not Research
whether comparable comparable comparable comparable support.
comparable t o the
assessee

Level of activity High-end High-end High-end High-end Low-end
Related party / Yes No Yes No Transaction
controlled under
transactions (Rs. 0.42 cr. (Transactions consideration
Amounting with holding
to 4.27% of company –
sales) Biocon Ltd.)
Relatively higher Yes Yes Yes Yes No
investment in
total assets
0.46
Ratio of costs to 1.02 0.91 2.46
assets

Marketing / sales Yes Yes Yes Yes No
function
Bad debt risk Yes Yes Yes Yes No
Price / margin Yes Yes Yes Yes No
risk
Business risk Yes Yes Yes Yes No

Yes – indicate existence of specified functions/assets/risk
No – indicate absence of specified functions/assets/risk

12. Without prejudice to the Assessee’s contention that the four additional

companies identified by the learned TPO should not be considered as

comparable, it was submitted that the learned TPO should have also

included other similar instances existing in the database at the time of

assessment proceedings, as comparable which are also engaged in the
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ITA No.6558/Mum/2008(A.Y.2004-05)

same/ similar activity as the four additional companies selected by the TPO,

viz., :

1. Clingene International Private Limited

2. Panacea Biotec Limited. (‘Research and development’ segment)

3. I D C (India) Limited

4. CRISIL Limited (‘Information segment’ pertaining to the company’s
research activity)

5. ICRA Limited (‘Information segment’ pertaining to the company’s
research activity)

13. It was brought to the notice of the learned CIT(A) that the Assessee had

submitted before the AO vide letter dated March 24, 2006 requesting the

learned AO to include Clingene International Pvt. Ltd. as a comparable

(along with other companies considered in the TPO’s order) for

benchmarking the Assessee’s international transaction. It was pointed out

that as per the annual report of Clingene International Pvt. Ltd. for FY 2002-

03 the said company was engaged in similar activity as Syngene

International Pvt. Ltd. — one of the companies considered by the learned

TPO as comparable. It was highlighted that the operating profit margin of

Clingene was (-) 33.97% of its operating cost. Thus, it was prayed that if

Syngene is considered as comparable, then even Clingene International Pvt.

Ltd. ought to have been included as a comparable in determining the arm’s

length price. After including Clingene International Pvt. Ltd. as comparable

(alongwith the correct profit margins of the ten companies considered by the

learned TPO in order dated March 20, 2006), the arithmetic mean of the

profit margins of all eleven companies would stand reduced to 11.71%. Since

the profit margin from the Assessee’s contract research and support services

activity was 7.08% on cost, the transaction value the Asssessee’s

international transaction meets with the arm’s length principle by applying
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ITA No.6558/Mum/2008(A.Y.2004-05)

the safe harbor rule enshrined in the second proviso below Section 92C(2) of

the Act which provides that if the variation between the arm’s length price

determined by the TPO and price at which the international transaction has

actually been undertaken by the Assessee does not exceed five per cent of

the latter, the price at which the international transaction has actually been

undertaken shall be deemed to be the arm’s length price. The following

chart would explain the contention put forth by the Assessee:

Sl.No. Company Name Year OP%
1. Amtrac Management Services Ltd. 31.3.2003 -1.13%
2. Dabur Research Foundation 31.3.2003 6.69%
3. Hinduja Group India Ltd. 31.3.2003 4.25%
4. ICI India Research & Technology
Centre 31.3.2003 0.15%
5. Manu Consultants Ltd. 31.3.2003 1.24%
6. Raptakos, Brett Test Laboratories
Ltd. 31.3.2003 7.80%
7. Vimta Labs Ltd. 31.3.2003 26.08%
8. Alphageo (India) Ltd. 31.3.2003 37.28%
9. Syngene International Pvt.Ltd. 31.3.2003 46.51%
10. Choksi Laboratories Ltd. 31.3.2003 33.36%
11. Clingene International Pvt.Ltd. 31.3.2003 -33.97%
————

ARITHMETICAL MEAN 11.71%
————

Calculation of Arm’s Length Price based on the above:

Particulars Rs.

Revenue from Contract Research 12,97,50,895
Profit from Contract Research support 85,94,456
Cost of Contract Research support 12,11,56,439
Profit markup on cost 7.09%

Arm’s Length Profit mark up 11.71%
Arm’s Length Profit 1,41,84,851
Arms’s Length Price 13,53,41,290
Difference between the transaction value and
Arm’s Length Price 55,90,395
95% of Arm’s Length Price 12,85,74,225
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ITA No.6558/Mum/2008(A.Y.2004-05)

Since the Transaction value falls within 5% range, the Assessee’s price

should be accepted as at Arm’s Length.

14. Without prejudice to the above contentions and in the alternative the

Assessee pointed out that in terms of Rule 10B(1)(e)(i) of the rules, the

TNMM can be applied by taking three criteria viz., the net profit margin

realised by the enterprise from an international transaction entered into with

an associated enterprise can be computed in relation to costs incurred or

sales effected or assets employed or to be employed by the enterprise or

having regard to any other relevant base. The Assessee point out that if cost

to Asset ratio is taken in respect of the companies identified by it and that

identified by the TPO, the Assessee’s cost to asset ratio is much higher. The

following charts were given to demonstrate the above proposition:

Chart-1: Ratio of Operating Costs to Assets of the comparable companies

identified by the Assessee:

Name of the Company Operating cost/Assets

Amtrac Management Services Ltd. 0.57

Dabur Research Foundation 1.47

Hinduja Group India Ltd. 1.10

ICI India Research & Technology Centre 1.13

Manu Consultants Ltd. 1.05

Raptakos, Brett Test Laboratories Ltd. 1.16

———————

Arithmetic Mean 1.08

The Assessee’s Operating Cost to Asset 2.46

Chart-2: Ratio of Operating Costs to Assets of the 4 comparable companies

identified by the TPO:

Name of the Company Operating cost/Assets
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Alpha Geo Ltd. 0.46

Vimta Laboratories 0.91

Choksi Laboratories Ltd. 0.35

Syngene International Pvt.Ltd. 1.02

———————

Arithmetic Mean 0.69

The Assessee’s Operating Cost to Asset 2.46

15. Finally it was submitted that even if all contentions of the Assessee are

rejected and it is held that the comparable identified by the TPO are

comparable with that of the Assessee functionally, even then in terms of

Rule 10B(3) of the Rules, adjustments to the profit margin of the

comparables have to be made to eliminate the effects of differences in

functions, asets and risks.

16. The CIT(A) after considering the above submissions on behalf of the

Assessee, held as follows:

a) The Assessee was a low end service provided for it’s AE and it’s role

was limited to providing support services in relation to the research

activities of the Associated enterprises. The Assessee was not taking any

business risk like contract risk, market risk, warranty risk, price risk

etc., which were borne by the Associate enterprise. The Intellectual

Property Right (IPR) was owned by the AE and not the Assessee. The

Assessee only deployed necessary human resources and infrastructure

for research. The above characteristics of the international transaction of

the Assessee were not kept in mind while making functional comparison

with those selected by the TPO.

b) The TP study done by the Assessee was in accordance with the Act

and the Rules and confirmed to the OECD guidelines. Though identical

transaction could not be located even by the Assessee, an attempt was

made to find out comparable transactions as close as possible to the
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controlled transaction. This according to CIT(A) was evident from the fact

that even the TPO did not reject the comparable identified by the

Assessee.

c) The CIT(A) also held that Syngene International Pvt. Ltd. And Clingene

International Pvt. Ltd. Were both subsidiary companies of Biocon Ltd.

Engaged in identical business and the TPO arbitrarily selected Syngene

International Pvt. Ltd. As comparable and ignored Clingene International

Pvt. Ltd. As comparable. The CIT(A) held that had Clingene International

Pvt. Ltd. been considered as comparable then the arithmetic mean would

of all comparables selected by the TPO and the Assessee would be only

11.71% and applying the safe harbour rules in terms of Second Proviso

below Sec.92C(2) of the Act, the difference in price between the one

adopted by the Assessee and the ALP determined by including Clingene

International Pvt. Ltd. Would be within + or – 5% range calling for no

adjustment to the price adopted by the Assessee in respect of the

international transaction.

For the above reasons, the CIT(A) deleted the addition made by the AO.

17. Aggrieved by the order of the CIT(A), the Revenue has preferred the

present appeal before the Tribunal. We have heard the submissions of the

learned D.R. and the learned counsel for the Assessee.

18. The learned D.R. submitted that the findings of the CIT(A) that the TPO

did not take into account the functional dissimilarity between the

comparable cases relied by the Assessee and the comparable cases identified

by the TPO on her own study, is not correct. It was submitted by her that

the further finding of the CIT(A) that the Assessee was performing low end

services is also not correct. In this regard the Assessee pointed out to the

findings of the TPO in her order as to how the functions performed by the

Assessee were high end. It was also submitted by her that the process of
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selection of comparable as adopted by the Assessee as well as the TPO were

identical viz., selection of data from “prowess” and “capitalline”, keeping in

mind the nature of service rendered by the Assessee to its AE viz., contract

research and corporate support services. It was her submission that there

is always an element of subjectivity in the process of selection of comparable

on the basis of functional similarity. It has to be seen to what extent the

comparable functional similarity adopted by the TPO is arbitrary. It was her

submission that the TPO in the present case has given valid reasons for

choosing 4 additional companies as comparable with that of the business of

the Assessee based on functions performed. It was her submission that

neither the CIT(A) nor the Assessee has been able to show to what extent the

action of the TPO is arbitrary.

19. Her further contention was that the findings of the CIT(A) that the TPO

arbitrary did not choose Clingene International Pvt. Ltd., as a comparable

company is not correct. In this regard it was submitted by her that data

relating to Clingene International Pvt. Ltd., was not brought to the notice of

the TPO at all. Our attention was drawn to the fact that the data relating to

Clingene International Pvt. Ltd., was brought to the notice of the AO by

Assessee’s letter dated 24.3.2006. The TPO’s order was passed on

20.3.2006. It was therefore submitted that the TPO had not acted arbitrarily

in not considering Clingene International Pvt. Ltd., as comparable. Without

prejudice to the above contention, it was her submission that though

functionally Clingene International Pvt. Ltd., can be considered as

comparable to the functions performed by the Assessee as it was also

engaged in contract research of drugs, yet the results of Clingene

International Pvt. Ltd., for the Financial Year ending 31.3.2005 cannot be

taken for comparison for the reason that the said company incurred loss due

to the following reasons as stated in the Directors Report:
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18 ITA NO.3423/MUM/2008(A.Y.2003-04)
ITA No.6558/Mum/2008(A.Y.2004-05)

“For the Financial year, the company has incurred a loss of Rs.5.56
million as against a profit of Rs.8.4 million in the previous year. This is
due to the completion of the diabetes study for Surromed Inc. and the
continuation of the self-sponsored diabetic study. This study has
enrolled two research partners viz., Strand Genomics and IISC and the
progress has generated several potentially high value patents for Clingene
International Pvt. Ltd.in the area of new biomarker for Diabetic
Nephrology.

The company is also in the process of setting up a Human
Pharmacology unit to carry out Phast-1 to Phase-3 clinical trial and
BAVBE studies. Necessary application for establishment of the same
have been filed and the facility is expected to be operational by
September, 2003.”

Based on the above remarks of the directors the learned D.R. submitted that

firstly Clingene International Pvt. Ltd. was doing its own research and had

suffered loss during the previous year due to self–sponsored research and

therefore functionally it should not be regarded as comparable or in the

alternative suitable adjustment ought to be made to the result of loss before

benchmarking the same as comparable.

20. It was also submitted by her that the CIT(A) has not considered the

comparability factor of the 4 comparable identified by the TPO on his own

but has only held that the same are not comparable without assigning his

own reasons.

21. The learned counsel for the Assessee reiterated submissions as were

made before the CIT(A). With regard to Clingene International Pvt. Ltd., it

was submitted by him that they were in the business of undertaking

contract research for others and their results were comparable with that of

the Assessee.

22. We have considered the rival submissions. It is not in dispute before us

that the TNMM is the most appropriate method for determining the ALP of

the international transaction. The disputes are with regard to the
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19 ITA NO.3423/MUM/2008(A.Y.2003-04)
ITA No.6558/Mum/2008(A.Y.2004-05)

comparability of the comparable relied upon by the TPO, the nature of

services performed by the Assessee whether it is low end or high end service

and whether the TPO was justified in rejecting one of the comparable

companies identified by the Assessee viz., Clingene International Pvt.Ltd.

and in the event of the same being considered alongwith the other

comparable instances relied by TPO the difference between ALP and the Price

adopted by the Assessee would be less than 5% plus or minus contemplated

by the second Proviso to Sec.92C(2) of the Act and consequently there would

be no need to make any adjustment to the price adopted by the Assessee in

respect of the international transaction entered into with its AE. In this

regard the relevant provisions of the Act have to be noticed.

Computation of arm’s length price .

92C. (1) The arm’s length price in relation to an international transaction
shall be determined by any of the following methods, being the most
appropriate method, having regard to the nature of transaction or class of
transaction or class of associated persons or functions performed by such
persons or such other relevant factors as the Board may prescribe 24
, namely
:—

(a) comparable uncontrolled price method;

(b) resale price method;

(c) cost plus method;

(d) profit split method;

(e) transactional net margin method;

(f) such other method as may be prescribed24
by the Board.

(2) The most appropriate method referred to in sub-section (1) shall be
applied, for determination of arm’s length price, in the manner as may be
prescribed 25
:
26
[Provided that where more than one price is determined by the most
appropriate method, the arm’s length price shall be taken to be the
arithmetical mean of such prices:

Provided further that if the variation between the arm’s length price so
determined and price at which the international transaction has actually
been undertaken does not exceed five per cent of the latter, the price at
which the international transaction has actually been undertaken shall be
deemed to be the arm’s length price.]
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20 ITA NO.3423/MUM/2008(A.Y.2003-04)
ITA No.6558/Mum/2008(A.Y.2004-05)

Determination of arm’s length price under section 92C.

10B. (1) For the purposes of sub-section (2) of section 92C, the arm’s length
price in relation to an international transaction shall be determined by any
of the following methods, being the most appropriate method, in the
following manner, namely :—
(a)…….

to
(d)……..
(e) transactional net margin method, by which,—

(i) the net profit margin realised by the enterprise from an
international transaction entered into with an associated
enterprise is computed in relation to costs incurred or sales
effected or assets employed or to be employed by the enterprise or
having regard to any other relevant base;
(ii ) the net profit margin realised by the enterprise or by an unrelated
enterprise from a comparable uncontrolled transaction or a
number of such transactions is computed having regard to the
same base;

(iii ) the net profit margin referred to in sub-clause (ii ) arising in
comparable uncontrolled transactions is adjusted to take into
account the differences, if any, between the international
transaction and the comparable uncontrolled transactions, or
between the enterprises entering into such transactions, which
could materially affect the amount of net profit margin in the
open market;
(iv ) the net profit margin realised by the enterprise and referred to in
sub-clause ( i) is established to be the same as the net profit
margin referred to in sub-clause ( iii );

(v) the net profit margin thus established is then taken into account
to arrive at an arm’s length price in relation to the international
transaction.
(2) For the purposes of sub-rule (1), the comparability of an international
transaction with an uncontrolled transaction shall be judged with reference
to the following, namely:—
(a) the specific characteristics of the property transferred or services
provided in either transaction;
(b) the functions performed, taking into account assets employed or to
be employed and the risks assumed, by the respective parties to the
transactions;
(c) the contractual terms (whether or not such terms are formal or in
writing) of the transactions which lay down explicitly or implicitly
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21 ITA NO.3423/MUM/2008(A.Y.2003-04)
ITA No.6558/Mum/2008(A.Y.2004-05)

how the responsibilities, risks and benefits are to be divided between
the respective parties to the transactions;

(d) conditions prevailing in the markets in which the respective parties
to the transactions operate, including the geographical location and
size of the markets, the laws and Government orders in force, costs
of labour and capital in the markets, overall economic development
and level of competition and whether the markets are wholesale or
retail.

(3) An uncontrolled transaction shall be comparable to an international
transaction if—

(i) none of the differences, if any, between the transactions being
compared, or between the enterprises entering into such
transactions are likely to materially affect the price or cost charged
or paid in, or the profit arising from, such transactions in the open
market; or

(ii ) reasonably accurate adjustments can be made to eliminate the
material effects of such differences.

(4) The data to be used in analysing the comparability of an uncontrolled
transaction with an international transaction shall be the data relating to the
financial year in which the international transaction has been entered into :

Provided that data relating to a period not being more than two years prior
to such financial year may also be considered if such data reveals facts
which could have an influence on the determination of transfer prices in
relation to the transactions being compared.

23. A reading of the provisions of Rule 10B(2) of the Rules shows that

uncontrolled transaction has to be compared with international transaction

having regard to the factors set out therein. In terms of Rule 10B(3) of the

Rules an uncontrolled transaction shall be considered as comparable if none

of the differences between the controlled and uncontrolled transactions

materially affects the price or cost charged or paid in, or the profit arising

from, such transactions in the open market. If there is scope for variation in

the price or cost charged or paid in, or the profit arising from, such

transactions in the open market, such variation should be capable of being

quantified and suitable adjustment made to eliminate the material effect of

such differences.
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22 ITA NO.3423/MUM/2008(A.Y.2003-04)
ITA No.6558/Mum/2008(A.Y.2004-05)

24. We will first take up for consideration one of the plea of the Assessee

before CIT(A), which was accepted by the CIT(A) to include Clingene as a

comparable (along with other companies considered in the TPO’s order) for

benchmarking the Assessee’s international transaction. It is not in dispute

that as per the annual report of Clingene International Pvt. Ltd. for FY 2002-

03 the said company was engaged in similar activity as Syngene

International Private Limited — one of the companies considered by the

learned TPO as comparable. The operating profit margin of Clingene

International Pvt. Ltd was (-) 33.97% of its operating cost. It was the plea of

the Assessee that if Syngene International Pvt. Ltd is considered as

comparable, then even Clingene International Pvt. Ltd ought to have been

included as a comparable in determining the arm’s length price. After

including Clingene International Pvt. Ltd as comparable (alongwith the

correct profit margins of the ten companies considered by the learned TPO in

order dated March 20, 2006), the arithmetic mean of the profit margins of

all eleven companies would stand reduced to 11.71%. Since the profit

margin from the Assessee’s contract research and support services activity

was 7.08% on cost, the transaction value the Asssessee’s international

transaction meets with the arm’s length principle by applying the safe

harbor rule enshrined in the second proviso below Section 92C(2) of the Act

which provides that if the variation between the arm’s length price

determined by the TPO and price at which the international transaction has

actually been undertaken by the Assessee does not exceed five per cent of

the latter, the price at which the international transaction has actually been

undertaken shall be deemed to be the arm’s length price. The objection of

the learned D.R. was that the results of Clingene International Pvt. Ltd., for

the Financial Year ending 31.3.2005 cannot be taken for comparison for the

reason that the said company incurred loss due to the fact that it was doing

not only contract research but was also doing own research. Operating

Profit (‘OPM’) on total cost considered by the Assessee according to the
———————Page 23———————

23 ITA NO.3423/MUM/2008(A.Y.2003-04)
ITA No.6558/Mum/2008(A.Y.2004-05)

learned D.R. would not be proper as the operating expenses would be

inclusive of own research as well as contract research.

25. To appreciate this contention, we have to have a look at the way

Operating Profit has been arrived at both in the case of Clingene

International Pvt. Ltd and Syngene International Pvt. Ltd, which are as

follows:

Clingene International Pvt. Ltd

Particulars Amount

F.Y.2002-03

Sales/Service Income (as per P & L A/c) 1,10,72,704

Total Operating Income 1,10,72,704

Profit Before Tax (as per P & L A/C.) (60,52,929)

Add: Interest Expenses (as per P & L A/c.) 3,55,460

Operating Profits (56,97,469)

Operating Costs 1,67,70,173

Operating Profit % on cost -33.97%

Syngene International Pvt. Ltd

Particulars Amount

F.Y.2002-03

Total Income (as per P & L A/c) 26,17,97,528

Less: Non operating Income 5,50,695

Total Operating Income 26,12,46,861

Profit Before Tax (as per P & L A/C.) 8,21,85,579

Add: Interest Expenses (as per P & L A/c.) 12,92,903
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24 ITA NO.3423/MUM/2008(A.Y.2003-04)
ITA No.6558/Mum/2008(A.Y.2004-05)

Less: Non-operating income (as per P& L A/c) 5,50,695

Operating Prof

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