SMT. P. MADHAVI DEVI, JUDICIAL MEMBER 
AND B. RAMAKOTAIAH, ACCOUNTANT MEMBER

Girish Dave, CIT-DR for the Appellant. 
S. Moharana for the Respondent.

ORDER

Smt. P. Madhavi Devi, Judicial Member - In this appeal, the assessee is aggrieved by the assessment order passed under S. 143(3) read with S. 144C of the Income Tax Act, 1961. The assessee company which is engaged in the business of manufacturing and exporting pharmaceutical products, i.e. drug intermediates and Active Pharmaceutical Ingredients (API) entered into transactions of purchase of lab materials and sale of intermediates and APIs to its AE in Canada. The determination of the Arm's Length Price (ALP) was referred to the Transfer Pricing Officer (TPO in short) U/S 92CA Act. The TPO determined the Arm's Length Price of the international transaction relating to sale of finished goods at Rs. 89.58 crores as against Rs. 73.28 crores received by the assessee and the adjustment of Rs. 16.30 crores was proposed. The AO passed the draft assessment order in accordance thereto against which the assessee preferred objections before the Dispute Resolution Panel (DRP in short) which approved the draft assessment order and in compliance thereto the assessing officer passed the final assessment order dt. 22-10-2012 against which the assessee is in appeal before us.

2. In the grounds of appeal, the assessee has raised five grounds out of which grounds No.1 and 5 are general in nature and need no adjudication. As regards grounds No.2, we find that there are sub-grounds therein which are all against the transfer pricing adjustment. We find that grounds 2.1.1 to 2.1.3 are general grounds against the TP adjustment and hence need no adjudication.

3. As regards grounds 2.2.1 to 2.2.2 against non-consideration of the Cost Accountants allocation of costs between AE and NON AE segments as correct, brief facts relating to this issue are as under:

The assessee is a company which is engaged in the business of manufacturing and exporting pharmaceutical products, i.e., drug intermediates and Active Pharmaceutical Ingredients(API). It was incorporated as a limited company on 24.2.95 and commenced its commercial production during the financial year 1998-99 and the factory of the assessee is located in Nalgonda District of erstwhile united Andhra Pradesh State. During the relevant previous year, the assessee has sold drug intermediates and APIs for a sum of Rs. 72.10 crores out of which sales to its AE constituted 33.61% of the APIs and 66.39% of drug intermediates. Since the transaction was with its AE, the Assessing Officer referred the issue of determination of Arm's Length Price to the Transfer Pricing Officer under S. 92CA of the Act. The TPO during the course of proceedings under S. 92CA of the Act observed that the AE of the assessee, i.e. Apotex Pharmachem Inc. was founded in 1974 as a distributor of pharmaceutical ingredients and in the late 80s with the advent of research and manufacturing of API, started its growth and that Apotex Pharmachem Inc is a member of Apotex Group of companies and is Canada's largest manufacturer and provider of high quality generic pharmaceuticals to the Canadian Health-care system. He further observed that the said company is the holder of commercially important patents that will protect its inventions in process chemistry in the important markets for years to come and a total of over 200 Drug Master Files, formatted to North American and European requirements have been prepared and filed by Apotex Pharmachem Inc. in all the world's advanced regulatory jurisdictions. It was further observed that the AE also has R&D facility in Toronto to invent new products and to discover the new processes, with which they are having international patents for their products. It was observed that the assessee company since 1998 has been supplying its products to its AE and therefore the AE has shown interest to have a joint venture with the assessee company. Therefore in August 2002, 50% of the share holding of the assessee company were acquired by the Apotex Pharmachem Inc. Canada and became a joint venture with the company. These shares were subsequently transferred to their parent company, Apotex Pharmaceutical Holdings Inc. in the year 2005.

3.1 The TPO observed that during the relevant previous year, the assessee has entered into the following international transactions-

He observed that the assessee has chosen TNMM as the most appropriate method for determination of the Arm's Length Price for its international transactions with its AE and the margin of the assessee for the financial year 2007-08 was worked out at 13.10%, whereas the margin of the five companies selected by the assessee as comparable reflected margin of 5.11% and since the assessee's margin was higher, the international transactions were treated to be at Arm's Length Price. The Transfer Pricing Officer, however, did not agree with the TP study of the assessee and therefore conducted a fresh search on the available databases and selected eight companies as comparables to the assessee and determined the Arithmetic Mean PLI of the comparables at 17.53%. Accordingly, he determined the adjustment under S. 92CA of the Act at a sum of Rs19.36 crores.

4. The comparables selected by the assessee for its Transfer Pricing Documentation and their Arithmetic Mean PLI are as under-

The comparables selected by the TPO for the Transfer Pricing Study and their Arithmetic mean PLI are as under-

5. During the proceedings before the TPO, the assessee had filed the details of the cost allocation between the AE and non-AE in exports market and sales made in domestic market, but the TPO did not accept the same observing that the same was not audited. Further it was observed that the assessee has considered other income in the AE segment which is not correct. He therefore did not accept the segmental information furnished by the assessee. The assessee objected to the same before the DRP stating that during the F.Y 07-08, it had maintained cost records product wise and accordingly it has prepared the segmental details between AE and NON-AE which are verified and certified by the cost accountant and further that the statutory auditor in the CARO report has mentioned that the assessee maintained cost records as required which were broadly reviewed by the auditor. It was also submitted that the assessee, while carrying out the exercise of cost allocation, allocated the fixed costs to the AE and NON-AE segments based on the products manufactured and capacity utilized by both the segments and further that the costs pertaining to the unutilized capacity were not allocated to any of the segments as it was shown separately as unallocated costs and that the same was certified by the cost accountant. With regard to the observation of the TPO that other income which is not operating income is included in the income from AE, the assessee submitted that except for interest income all the other items of income are operating in nature. The Dispute Resolution Panel after going through the report of the assessee observed that the cost allocation was certified by a Cost Accountant under the Companies Act, and that statutory auditor under the Companies Act referred to the report of the Cost Accountant in his statutory report and observed that the company had maintained cost records under S. 209(1)(d) of the Companies Act and therefore, the observations of the TPO that segmental details are not audited is not correct. Having held so, Dispute Resolution Panel perused the allocation made by the Cost Accountant and did not agree with the allocation of indirect cost of production and the allocation of Administrative Overheads. It observed that the Cost Accountant did not allocate the following expenditure either to AE or to non-AE or to domestic transactions.

The Panel further observed that the administrative overheads of a sum of Rs. 303.72 lakhs were not allocated to any segment, though the assessee during the previous year had sales to AE, non-AE and also to independent persons in India. The panel also observed that the cost Accountant of the assessee did not allocate the above indirect cost of production and administrative overheads aggregating to Rs. 1373.52 lakhs, though they were incurred by the assessee for the purpose of business and they form part of the Profit & Loss Account. Therefore, the Panel worked out the allocation of expenses to the segments in the ratio of sales of each segment. Further, with regard to the other income included in the operating income, the DRP agreed with the assessee that other than interest income, all other items of income are operating income and are to be allocated in proportion to the sales of the respective segments. Thereafter the DRP also agreed with the contention of the assessee that the adjustment in TNMM should be restricted to the international transactions and held that the PLI determined by the TPO should be restricted to the operating cost attributable to the international transactions. The DRP, thus reduced the TP adjustment from Rs. 19.36 crores to Rs. 16.97 crores. Against the allocation of unallocated expenses of Rs. 1373.52 lakhs only to AEs and non-AE transactions by the DRP, assessee is in appeal before us.

6. The learned counsel for the assessee, while reiterating the submissions made before the authorities below, submitted that though the DRP has accepted that the cost allocation has been audited, has erroneously observed that the unallocated expenditure relating to unutilized capacity has to be allocated to the AE and non-AE transactions including domestic transactions. He submitted that Dispute Resolution Panel has itself observed that the cost allocation has been audited by Cost Accountant and that the statutory auditor has also referred to the report of the Cost Accountant in his statutory report, and therefore the contents of such report should have been considered and applied without any adjustment. Thus, according to him, the PLI has not been computed correctly. In support of the contention that the audited report ought to have been accepted, the ld. Counsel for the assessee relied upon the decision of the Tribunal at Chennai in the case of 3i Infotech Ltd. v. ITO [2013] 35 taxmann.com 582.

7. The Learned Departmental Representative, on the other hand, supported the orders of the authorities below.

8. Having regard to the rival submissions and the material on record, we find that the cost allocation between AE and Non-AE segments by the Cost Accountant has been audited and the same has also been reported by the statutory auditor. The segmental details furnished by the assessee are reproduced at para 4.10 of the DRP's order. A perusal of the same shows that a sum of Rs. 1069.80 lakhs has been shown as unallocated costs. According to the assessee, this pertains to the unutilized capacity. The assessee has specifically stated so before the DRP. But DRP proceeded to allocate the unallocated expenditure between the AE and Non-AE without specifically dealing with the contention of the assessee. Correct allocation of expenditure amongst various segments of the assessee's transactions has to be done to arrive at the correct PLI. It is the contention of the assessee that the assessee has unutilised capacity, to which the unallocated cost pertains to and that the audited books of account ought not to have been interfered with. For this purpose, the learned counsel for the assessee had relied on the decision of the Madras Bench of the Tribunal in the case of 3i Infotech Ltd. (supra) wherein it was held that it is not open to the revenue to reject the working prepared by the assessee without pointing out any error therein. However, in the case before us, the revenue is seeking to interfere with the cost accountants report as the adjustment towards under utilization of the capacity has not been allowed both by the TPO as well as the DRP. Therefore, this issue would depend on the decision taken on whether the adjustment for under utilization of the capacity is allowable or not.

9. The assessee's grounds of appeal No. 2.3 and 2.4 are against the denial of Capacity Utilization adjustment and depreciation adjustment respectively. As regards these adjustments to be made while taking the comparables, the Learned counsel for the assessee submitted that the capacity utilisation of the assessee was just 21% as compared to 64.51% of the comparables. It was also submitted that various benches of the Tribunal have held that capacity utilisation is a factor to be considered and adjustment is to be made before determination of Arm's Length Price. Similarly, with regard to depreciation adjustment, it was submitted that the assessee follows depreciation rate as per the written down value method under the Companies Act, whereas some of the comparables selected by the TPO followed straight-line method and applied depreciation rate prescribed under the Companies Act. It was submitted that the rate of depreciation under written down value method is higher than the straight-line method and hence, the depreciation cost for assessee is higher than its comparables. Therefore, he submitted that while determining the Arm's Length Price, adjustment with regard to the difference in depreciation has to be allowed. In support of his contention that adjustment for the differences in the depreciation rates is concerned, the ld. Counsel for the assessee has placed reliance upon the decision of the coordinate bench of this Tribunal in the case of Market Tools Research (P.) Ltd. v. Asstt. CIT [2014] 150 ITD 296/[2013] 32 taxmann.com 358. As regards adjustment for capacity utilisataion, he placed reliance upon the decision of the Pune Bench of the Tribunal in the case of Tasty Bite Eatables Ltd. v. Asstt. CIT [2015] 59 taxmann.com 437. The ld. DR, on the other hand, relied upon the orders of the authorities below.

10. Having regard to the rival contentions and the material on record, we find that the TPO and the DRP have disallowed these adjustments on the ground that the assessee was a contract manufacturer and therefore the prices at which the goods were supplied to AE cannot go below the agreed price as stipulated in the agreement with its AE. The TPO and the DRP observed that there was a share purchase agreement between the parties wherein it is stipulated that the assessee shall supply the drug intermediate at cost+ a 20% mark up and in the case of API, if a Drug Master file is not required for sale of API, the purchase price shall be the lesser of cost of such goods+ a 30% mark up on the prevailing price of such goods of similar quality exported from India, but in no case, the company is required to sell the purchaser, the goods at less than the cost + 20% markup. Further it was also observed that if a Drug Master file is required, the purchase price of the product by the AE shall be 75% of the lowest price available to the purchase for goods of similar quality in the market in which the material is intended to be used or the taxpayer's cost in producing such product + a 50% A markup, whichever is lower and if no comparable product is available, the purchaser's price shall be the taxpayer's cost + a 50% markup. Therefore, they held that the assessee has an assured return of 20% on cost and hence the under utilization of capacity has no impact on the PLI of the assessee. Further, with regard to the depreciation adjustment , it was held by the DRP that the depreciation debited to the P&L account of the assessee is not abnormal as compared to the depreciation debited to P&L account in earlier years and further that in TNMM method, a broad comparison at entity level is made and each and every expenditure cannot be compared with the companies in the basket of comparables and the depreciation being a fixed cost which the assessee has to recover from the AE as a contract manufacturer, it becomes a part of the cost of the assessee and a separate adjustment is not required as a contract manufacturer. Thus, it seen that the adjustments have been denied on the ground that the assessee is a contract manufacturer and hence the price charged to the purchaser includes the said costs and does not affect the profit margin of the assessee. We find that sub-rule (2) to Rule 10B of I T Rules provide for determination of Arm's Length Price after making FAR (Functions, Assets and Risks) Analysis. The Rule prescribes that necessary adjustments are to be made before comparing the assessee with any other comparable performing similar functions, applying similar assets with same or similar risks involved. For this purpose, the TPO has to necessarily make the FAR Analysis and make suitable adjustments wherever necessary to bring a comparable on par with the assessee, as far as the financial results are concerned. We also agree with the contention of the assessee that where suitable adjustments are not possible, such company cannot be taken as a comparable to the assessee. However, it is pertinent to note that no company is exactly similar to the other company and there are always some differences between the companies. Therefore, it has been held that the comparability has to be among the most comparable companies and the adjustments are to be carried out to the possible extent. In the case before us, we find that the Assessing Officer as well as the DRP have refused to make adjustment on account of low capacity utilization and also on account of difference in the method and rate of depreciation claimed by the assessee as against the comparables. The decisions on which the learned counsel for the assessee has placed reliance upon, held that necessary adjustments have to be made before comparing such companies with the assessee. The decisions of the Tribunal citedsupra on which the assessee has placed reliance upon, we are of the opinion that the adjustments of under utilization of the capacity and the difference in the depreciation are the factors which are likely to materially affect the price or cost charged or paid, or the profit arising from, such transactions in the open market. Therefore, we direct the AO/TPO to allow the adjustments on account of under-utilisation of capacity and also difference in depreciation method adopted by the assessee and the comparable companies. Since we have held that the adjustment for the under utilization of capacity is allowed, the issue of apportionment of unallocated expenses also needs to be allowed. How much of the un-allocated costs do really pertain to under utilization and nature of such costs unallocated were not examined either by the TPO or the DRP and neither are the details filed before us. Consequently, TPO has to examine and consider to what extent the claim can be allowed. The AO/TPO are accordingly directed to re-compute the ALP after allowing the above adjustments after due verification. Therefore, Grounds No.2 and sub-grounds there under are treated as allowed and the issue of recomputation of the ALP only in accordance with the above directions is remitted to the file of the AO/TPO.

11. As regards Ground No.3 relating to disallowance of loss on account of the directions passed by the DRP, brief facts are that the assessee while exporting the Bulk Drugs, lodged rebate claim with the excise authorities and credited the CENVAT Receivable Account. During the relevant financial year, claim was made to the extent of Rs. 3,17,00,903. The Assessing Officer considered the same as income of the assessee under S. 41(1) of the Act. Against it, the assessee raised objection before the DRP. The DRP relying on the Tribunal's order in assessee's own case for the assessment year 2002-03 directed the Assessing Officer to verify the Revised Profit & Loss Account prepared after merging the Central Excise Duty Account and adopt the resultant profit for the purpose of computation of tax. Pursuant to the directions of the DRP, the Assessing Officer considered the Revised Profit & Loss Account filed before the Assessing Officer debiting Rs. 3,44,61,286 on account of CENVAT availed on various items and crediting Rs. 3,29,71,595 being Central Excise Rebate receivable, and arrived at resultant loss of Rs. 5,49,17,427 as against Rs. 5,34,27,736 as per the financial statements. This has resulted in an additional loss of Rs. 14,89,691. However, the Assessing Officer has not allowed the same on the ground that the assessee has not claimed this additional loss in the return of income filed. Against this finding of the Assessing Officer, assessee is in appeal before us.

12. While the learned counsel for the assessee relied upon the above submissions, the Learned Departmental Representative supported the order of the Assessing Officer.

13. Having regard to the rival contentions and the material on record, we find that Article 265 of the Constitution of India allows the Revenue to levy taxes but only in accordance with law. If during the course of assessment proceedings, it is found that the assessee is eligible for deduction in excess of the sum claimed by it in the return of income, it does not amount to a fresh claim. In our opinion, the Assessing Officer has erred in holding it to be a fresh claim. Therefore we direct the AO to verify and allow the claim of the assessee in accordance with law. Ground No.3 is accordingly set aside to the file of the Assessing Officer and treated as allowed for statistical purposes.

14. As regards ground No.4 against short deduction of TDS of Rs. 1,37,864, we remand this issue also to the file of the Assessing Officer with a direction to verify the claim of the assessee on this aspect and allow the same in accordance with law.

15. To sum up, on all the issues involved in this appeal, the matter is remitted to the file of the Assessing Officer for redetermination of the ALP afresh in the light of our observations herein above and in accordance with law, after giving reasonable opportunity of hearing to the assessee.

16. In the result, assessee's appeal is treated as allowed for statistical purposes.