PHARMACEUTICAL INDUSTRY CASE STUDY

1. PHARMACEUTICAL INDUSTRY CASE STUDY Presentation by Alpana Saksena CIT(A) International Tax MUMBAI

2. 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

3. Method of Computing ALP • ABC India aggregated all transactions • Applied the TNMM method • Used a set of external comparables • to benchmark profits

4. Commission transaction

5. Commission transaction Assessee's Contention ABC AE Marketing & Canvasser services for exports as per agreement Payment of Commission @12.5% of Sales ABC India

6. 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 • Export of formulations • Commission • Sundry Reimbursements

7. Comparisons of Operating Profit margins So, ABC India stated that its transactions are at arms length

8. Justification for commissionpayment 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.

9. 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

10. 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

11. Documentation Rules The Rule 10D(3) states that information in sub-rule (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.

12. 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

13. As no such documents were produced Commission payment was not authenticated In the opinion of revenue

14. 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 similar independent comparables Separate set of required for benchmarking

15. 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 • Advertisement • Commission • Sales promotion As a percentage of sales

16. Which means We needed to look at the Foreign expense to sales ratio

17. 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

18. Taxpayer took another plea Domestic sales 480 Crores Domestic Selling expenses ratio 16.14% 103.08 Crores Export sales Foreign Selling expenses (Commission) ratio 12%

19. 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

20. 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).

21. Analysis given by assessee

22. 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

23. Department rejects assessee’s contentions Dept carried out analysis on the same set of comparablesoriginally used for TNMM analysis by the taxpayer, for benchmarking its profits instead of the new 5 companies selected by ABC India

24. 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

25. Analysis of forex outflow / export sales of Independent comparables

26. 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%)

27. Thank you