Transcript PHARMACEUTICAL INDUSTRY – CASE STUDY (PLEASE …

PHARMACEUTICAL INDUSTRY CASE
STUDY
Presentation by Alpana Saksena
CIT(A) International Tax MUMBAI
Facts of the case
ABC India is engaged in the manufacture
and marketing of formulations
Main transactions were
– Payment of Commission to AE Rs 12.86 crores
– Import of Actives transaction Rs 113.8 crores
Method of Computing ALP
ABC India aggregated all transactions
Applied the TNMM method
Used a set of external comparables
to benchmark profits
Operating Profit Margins of
Comparable companies
7.53%
Operating Profit Margins of ABC India
13.87%
Commission transaction
Commission
transaction
Assessee's Contention
ABC
AE
Payment of
Commission
@12.5% of Sales
Marketing & Canvasser
services for exports as
per agreement
ABC India
Commission
transaction
Taxpayer’s Contention
•ABC India compares its OPM with the
OPM of external comparables
•by aggregating all transactions
•Which were
•Imports of actives
•Commission
•Export of formulations
•Sundry Reimbursements
Comparisons of Operating Profit
margins
Operating Profit Margins of ABC
India
Operating Profit Margins of
Comparable companies
13.87%
7.53%
So, ABC India stated that its transactions
are at arms length
Justification for commission
payment
Taxpayer's contention
 For establishing close contacts with customers
For employing marketing personnel for marketing
these products
 For participating in exhibitions, fairs, buyer/seller
meets, seminar , conferences
To promote products through doctor’s meets, &
conferences
To distribute information material ,leaflets, pattern
cards etc.
Documents produced
To support payments
 Copy of Agreement called “Export
Canvasser agreement”
Some advertisements of overseas AEs
 Letters from overseas AEs to assessee
CA Certificate / Bank Realization
Certificates
Documentation Rules
Prescribed by rule 10D of the I.T. Rules
Lays down 13 different types of information
which should be maintained
They are (broadly speaking)
Enterprise –wise documents
Transaction specific documents
Computation related documents
Documentation Rules
The Rule 10D(3) states that information in subrule (1) shall be supported by
authentic documents
which include
f) letters & other correspondence relating
to terms of contract
(g) documents required to be kept under the
accounting practices followed.
Documents which should have
been produced
 Reports of contacts with customers
List of marketing personnel hired for the purpose
 Details of participation in exhibitions, fairs,
buyer/seller meets, conferences,seminars
List of doctors approached for using product
Copies of information material ,leaflets, pattern
cards distributed
As no such documents were
produced
Commission payment was not
authenticated
In the opinion of revenue
Commission Payment
Revenue's Contention
Objected to aggregation of all transactions for
benchmarking them
Insisted for
separate evaluation of commission
commission was not closely linked to other
transactions if imports, reimbursements
No justification given for rate of 12 % paid
Separate set of similar independent comparables
required for benchmarking
Similar comparables would mean
All such cases
Who had paid commission or any other
expense to any foreign party
To promote their sales
So we needed to look at foreign expenses be it
•marketing
•Sales promotion
•Advertisement
•Commission
As a percentage of sales
Which means
We needed to look at the
Foreign expense to sales
ratio
Commission transaction
Taxpayer’s counter plea
'Result' based Export Canvasser Agreement
not 'effort' based
Results showed 15% increase in sales as
compared to previous year
Hence, transaction is at Arms Length
Taxpayer took another plea
Domestic sales
480 Crores
Domestic Selling
expenses ratio
16.14%
Export sales
103.08 Crores
Foreign Selling expenses
(Commission) ratio
12%
Assessee pleaded that………
costs in India would be lower than the
costs of promoting products in an overseas
market
As the export selling expenses of 12% were
less than the domestic selling expenses of
16.14%
So the commission payment to AE was
at arms length
So dept asked assessee to do the
analysis first
ABC India carried out an analysis of
computing the ‘Foreign exchange expense’
to ‘Sales’ ratio
for the pharma companies (comparable in
size to ABC India).
Analysis given by assessee
Sl
No
Company Total forex
outflow (in
crores)
Total export Forex outflow
sales
as % of
export sales
1
A Co
3.18
66.78
5
2
B Co
2.79
5.42
51
3
C Co
2.00
22.33
9
4
D Co
0.48
1.58
3
5
E Co
7.72
13.03
59%
Average forex outflow on sales
25.40%
Defects in assessee’s analysis
huge variations in the outflow
Some companies have a outflow as high
as 59% and some as low as 3%.
Extraordinary reasons would exist for
such heavy outflows…not explained by
assessee
Most of the companies had paid Royalty
for brand…hence not comparable
Department rejects assessee’s
contentions
Dept carried out analysis on the same set of
comparables originally used for TNMM
analysis by the taxpayer, for benchmarking
its profits
instead of the new 5 companies selected by
ABC India
Basic criteria for selection
Only those independent companies were
short listed who
Matched the Export sales to Gross sales ratio
The taxpayer had a ratio 25% of export
sales / Gross sales
Analysis of forex outflow / export sales
of Independent comparables
Company
Name
F Co
G Co
H Co
I Co
J Co
K Co
Average
Export sales / Gross Forex expense /
sales ratio
Export Sales
ratio
27.28%
2%
27.20%
2%
16.88%
6.8%
13.73%
2%
10.35%
13%
19.70%
4%
4.96%
Commission transaction evaluated separately
Final Outcome:
Adjustment was made to the ALP by taking rate
of 5% instead of 12% as claimed by assessee
F.Y. 2002-03 - 5 % allowed (claimed 12.5%)
F.Y. 2003-04 - 7 % allowed (claimed 12.5%)
Thank you