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aBC ANALYSIS OF A PHARMA COMPANY
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PHARMACEUTICAL INDUSTRY PHARMACEUTICAL INDUSTRY CASE STUDYCASE STUDY
Presentation by Alpana SaksenaCIT(A) International Tax MUMBAI
Facts of the caseFacts of the case
ABC India is engaged in the manufacture and marketing of formulations
Main transactions were
– Payment of Commission to AE Rs Payment of Commission to AE Rs 12.86 crores12.86 crores
– Import of Actives transaction Rs Import of Actives transaction Rs 113.8 crores113.8 crores
Method of Computing Method of Computing ALPALP
Operating Profit Margins of Operating Profit Margins of ABC IndiaABC India
13.8713.87%%
ABC India aggregated all transactions
Applied the TNMM methodUsed a set of external comparables to benchmark profitsOperating Profit Margins of Operating Profit Margins of Comparable companiesComparable companies
7.537.53%%
Commission transaction
CommissioCommission n transaction transaction
Payment of Commission @12.5% of Sales
Marketing & Canvasser services for exports as per agreement
ABC India
ABC AE
Assessee'sAssessee's ContentionContention
•ABC India compares its OPM with the OPM of external comparables•by aggregating all transactions
CommissioCommission n transaction transaction
Taxpayer’s Taxpayer’s ContentionContention
•Which were•Imports of
actives •Commission
•Sundry Reimbursements
•Export of formulations
Comparisons of Operating Profit margins
Operating Profit Margins of Operating Profit Margins of ABC IndiaABC India
13.8713.87% %
So, So, ABC India stated that its transactions
Operating Profit Margins of Operating Profit Margins of Comparable companiesComparable companies
7.537.53%%
are at arms length
Justification for Justification for commissioncommissionpaymentpayment
For establishing close contacts with customers
For employing marketing personnel for marketing these products
For participating in exhibitions, fairs, buyer/seller meets, seminar , conferencesTo promote products through doctor’s
meets, & conferences
Taxpayer's Taxpayer's
contentioncontention
To distribute information material ,leaflets, pattern cards etc.
Copy of Agreement called “Export Canvasser agreement”Some advertisements of
overseas AEs Letters from overseas AEs to
assesseeCA Certificate / Bank Realization Certificates
To support To support paymentspayments
Documents Documents producedproduced
Documentation RulesDocumentation RulesPrescribed by rule 10D of the I.T. Rules
Lays down 13 different types of information which should be
maintained
Enterprise –wise documentsTransaction specific documents Computation related documents
They are (broadly speaking)
Documentation RulesDocumentation RulesThe Rule 10D(3) states that information in sub-rule (1) shall be supported by
f) letters & other correspondence relating to terms of contract(g) documents required to be kept under the accounting practices followed.
authentic documents which include
Documents which should Documents which should have been producedhave 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,seminarsList of doctors approached for using
product Copies of information material ,leaflets, pattern cards distributed
As no such documents were As no such documents were producedproduced
Commission payment was not Commission payment was not authenticatedauthenticated
In the opinion of revenueIn the opinion of revenue
Objected to aggregation of all transactions for benchmarking them
Insisted forcommission was not closely linked
to other transactions if imports, reimbursementsNo justification given for rate of 12 %
paid
Revenue's Revenue's ContentionContention
Separate set of required for benchmarking
Commission Commission PaymentPayment
similar independent comparables
separate evaluation of commission
Similar comparables Similar comparables would mean would mean
Who had paid commission or Who had paid commission or any any other expenseother expense to any foreign party to any foreign party
All such casesAll such cases
To promote their salesTo promote their sales
So we needed to look at So we needed to look at foreign expensesforeign expenses be it be it
•marketinmarketingg
•AdvertiseAdvertisementment•Sales Sales
promotionpromotionAs a percentage of salesAs a percentage of sales
•Commission
Which meansWhich means
Foreign expense to Foreign expense to sales ratiosales ratio
We needed to look We needed to look at the at the
'Result' based Export Canvasser Agreement not 'effort' based
Results showed 15% increase in sales as compared to previous year
Taxpayer’s counter Taxpayer’s counter pleaplea
Commission Commission transactiontransaction
Hence, transaction is at Arms Length
Taxpayer took another Taxpayer took another pleaplea
Domestic salesDomestic Selling expenses ratio Export salesForeign Selling expenses (Commission) ratio
480 Crores
16.14%
103.08 Crores
12%
Assessee pleaded that………
costs in India would be lower than the costs of promoting products in an overseas marketAs 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 So dept asked assessee to do the analysis firstto 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).
Sl Sl NoNo
CompaCompanyny
Total forex Total forex outflow (in outflow (in crores)crores)
Total Total export export salessales
Forex Forex outflow as outflow as % of % of export export salessales
11 A CoA Co 3.18 3.18 66.78 66.78 5522 B CoB Co 2.792.79 5.42 5.42 5151
33 C CoC Co 2.002.00 22.33 22.33 99
44 D CoD Co 0.480.48 1.58 1.58 33
55 E CoE Co 7.727.72 13.03 13.03 59%59%
Average forex outflow Average forex outflow on saleson sales
25.40%25.40%
Analysis given by assesseeAnalysis given by assessee
Defects in assessee’s Defects in assessee’s analysisanalysis
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 Department rejects assessee’s contentionsassessee’s contentions
Dept carried out analysis on the same set of comparables originally used for TNMM analysis by the taxpayer, for benchmarking its profitsinstead of the new 5 companies selected by ABC India
Basic criteria for Basic criteria for selectionselection
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 / Analysis of forex outflow / export sales of Independent export sales of Independent
comparablescomparablesCompany
NameExport sales /
Gross sales ratio
Forex expense /
Export Sales ratio
F Co 27.28% 2%G Co 27.20% 2%H Co 16.88% 6.8%I Co 13.73% 2%J Co 10.35% 13%K Co 19.70% 4%
Average 4.96%
F.Y. 2002-03 - 5 % allowed (claimed 12.5%)
F.Y. 2003-04 - 7 % allowed (claimed 12.5%)
Adjustment was made to the ALP by taking rate of 5% instead of 12% as claimed by assessee
Commission transaction evaluated separatelyFinal Outcome:
Thank youThank you