Case Law Analysis - Orchid Pharma Limited - Chennai ITAT

Orchid Pharma Limited Vs. DCIT (ITA 771 / CHNY / 2016)

Pramod Kumar AM, G Pavan Kumar JM

Section 92A of the Income Tax Act, 1961 is indeed a very interesting section in itself. The meaning of Associated Enterprise as interpreted by this Judgement is quite an eye-opener. Lets get on to the specific section and the facts of the case.

Section 92A(1) defines Associated Enterprise (AEs) as an enterprise which participates directly / indirectly in the management or control or capital of another enterprise. Further where there exists a common person participating directly / indirectly in management or control or capital of two of such enterprises, such two enterprises can be said to be AEs.

Further Section 92A(2) starts itself as "For the purpose of sub-section (1), two enterprises shall be deemed to be AEs, if;

....

(i) the goods / articles manufactured or processed by one enterprise, are sold to the other enterprise or to persons specified by the other enterprise, and the prices and other conditions relating thereto are influenced by such other enterprise;......

The above extracts from the section 92A are relevant for our analysis of the case law.
The Assessee, in order to establish its business of producing pharma products, in the markets of USA, Canada, Europe and Australia, enters into agreements with the distributors which are established in these markets and can also market the products for the Assessee. The remuneration model followed by the Assessee and the distributors is as follows;

Sales made by the Distributors; (-) Cost of Products sold (-) Marketing cost incurred = Profits earned

These Profits are shared in agreed ratios between the distributor and the Assessee (50:50), (60:40), etc. Further the CEO also had mentioned in his statements, that the selling prices are exclusively determined by the Distributors. Further these Distributors also exercise controls on the sourcing of Raw Materials.
The above facts recorded and compared vis-a-vis sec 92A(2)(i) (supra) was noted and it was concluded that the Distributors were the AEs of the Assessee.

The Assessee had argued that Section 92A(1) should be satisfied too and Sec 92A(2)(i) should not be looked in isolation. (in other words, participation in Management, control and capital needs to exists at entity level and not merely at  transaction level). 

The TPO held that that Sec 92A(2) is a deeming section, and even if sub section (1) is not fulfilled, the Distributors are AEs by virtue of Sec 92A(2)(i). 

Observations by the ITAT:

1. Sub section (1) shall be in principle considered to decide whether an entity is an AE or not. Sub section (2) merely provides illustrations of cases. Further as the management or control or capital in 92A(1) is not defined clearly, one can take recourse to 92A(2). Further the Section 92A(2) starts with "For the purpose of subsection (1)..."; hence Sec 92A(1) and Sec 92A(2) shall be read together.

2. Control as mentioned in 92A(1), need not be on account of participation in capital or management; they can also be due to commercial relationships or personal relationships. Clause (i) of Section 92A(2) does not prescribes any quantum of such influence of other entity. If less than 1% of transaction are influenced by such other entity, it cannot be said to be Controlling Interest in Assessee, and hence it will be beyond the mandate prescribed by Sec 92A(1). Considering a co-ordinate bench judgement of Diageo India, the construction of a taxing statue shall be made preserving the purpose of the provision, must be adopted.

3. The Scale of influence in current case is less than 5% of the total transactions. The scale is so insignificant, that is no participation in control by the distributor over the Assessee.

4. The ITAT observed and distinguised between Narrow concept and broad concept and de jure relationships (Management and Captial) and de facto relationships (Control)

5. In business scenarios and normal day to day negotiations, selling price are influenced by the Buyer. The Customer may offer terms on the basis of "Take it or Leave it" message. This in itself cannot be termed as influence; or else every transactions which are negotiated will have to be termed as transactions with AEs which is clearly absurd and unintended. It is therefore, a more sensible meaning is to be assigned rather than adopting a literal meaning to the term "Influence".

6. Hence in above case, the Distributors cannot be treated as AEs.