Pharma and Manufacturing Industry - Analysis & … · Methodology for Benchmarking and Documentation ... entails challenges • Distribution ... Sourcing, Product Bundling
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Pharmaceutical Industry - International Transactions
Import of Active Pharmaceutical Ingredients
Issue
DocumentationSuggestions
• Comparability with generic API’s;• Secret Comparables using power u/s 133(6);• CUP analysis for import of actives / formulations. (using
CIMS data) – geographic differences ignored
• Selection of right comparables;• Carry out analysis on IMPEX / Customs database;• Exclusion of companies from different geographies;• Difference in Selling Price, Pharmacopeia;• Re-iteration of high profits under TNMM, if applicable;• Analysis of the customs data / relevant industry
• Evaluation of commission transaction separately required as the same is not closely connected to other transactions;
• If no direct documentary evidence to demonstrate services rendered could be disallowed;
• Commission percentage more than 3-5% scrutinized;
• Documentary evidences like copy of agreement, marketing material, letters from overseas AE, CA Certificate / Bank Realization Certificates, etc. should be maintained;
• Demonstrate tangible benefits;• Demonstrate that marketing in India is routine and not non-
routine
Documentary evidence very crucial
Pharmaceutical Industry - International Transactions
• High mark up comparables selected by TPO without carrying out appropriate FAR as to whether Indian AE does actual clinical trials or only acts as coordinator;
• Difficulties arise in identifying appropriate comparable companies
• Charges mark-up even on pass through cost
• Role may vary from mere facilitation/co-ordination v/s responsibility for the completion of the trials;
• Risk associated with failure of product development primarily assumed by AE;
• Service being procured from a third party – pass through cost;
• Demonstrate pass through cost is pure reimbursement
Demonstrate the functional dissimilarity of comparables
Pharmaceutical Industry - International Transactions
• Contract research vs. co-developing drugs with foreign partners based on revenue sharing models
• Relatively high mark-ups insisted by the revenue – with adjustment for location savings
• Difficulty in identifying appropriate comparable companies;
• Publicly available information databases do not provide results of companies purely engaged in contract research activities
• Difficult to ascertain whether potential comparables are engaged in contract research, or are co-developing drugs with foreign partners based on revenue sharing models.
Pharmaceutical Industry - International Transactions
Other Issues• Product Analysis vis-à-vis basket of products approach
• Drugs Prices Control Order (DPCO).
- Price control under the DPCO may cause product margins of pharmaceutical companies to come under pressure
- Where the pricing of raw material inputs procured from associated enterprises is sought to be reviewed by the application of profit based transfer pricing methods, the identification of comparable companies entails challenges
• Distribution
- Start-up losses
- Use of profit level indicator (Gross margin vs net margin)
Rational judgment needs to be adopted for CUP method. Rejection of TNMM based on entity level margins.
Hierarchy of methods citing CUP as the most preferred methods. Also in OECD hierarchy taken into consideration.
Transactional methods to be preferred over profit based methods
Issue
Priority of Methods
Final Decision
Importance of Agreement
NA License and royalty agreement are separate. Need to be considered for ALP calculation
Hidden Technical fees needs to be supported by agreement.
Fresh adjudication with rejection of TNMM and CUP method. New TP documentation study to be undertaken.
Extra amount above ALP treated as dividend. Additional evidence required and referred back for fresh adjudication to take into account the licensing agreement
Challenges for Contract Manufacturers• Functional profile of Contract Manufacturers - Risk-free operations• Remuneration model - remunerated with a Cost Plus Mark-up with reference to
third party manufacturers
Challenge• Third parties available as benchmarks are Entrepreneurial manufacturers
Undertake full gamut of risks Not remunerated on “Cost Plus” basis
Solutions• Adjustments for better comparability
Possible adjustments for working capital and Risk differential• Alternate PLIs
Use of Return on Assets (ROA) as PLI Use of Return on Capital Employed (ROCE) as PLI
Typical forms of payouts - Royalty, Technical fee, Management fee, Guarantee fee
Primary challenge – Payouts through having economic substance are challenged in the start up phase due to existing losses
Benchmarking - Is a challenge due to inadequate comparable data in public domain
Documentation - Under the transaction specific approach it is necessary to analyze potential “cost-benefit” and maintain appropriate documentation to substantiate arm’s length nature of payouts
Cost- Benchmarking payouts of comparable companies, Basis of arriving at the value of payouts ( Direct / Indirect Method) by the Group
Potential Benefits - Need for obtaining service from the Group, Analysis of potential benefit obtained by the Company and value attributable to the service
Other Regulatory Considerations - The recent relaxation of the statutory RBI / FEMA limits on royalty and technical fee payouts increases the challenge of defending the arm’s length nature of such transactions.
• Then, it was mere reporting of transactions in Form 3CD and Form 10CCB, - Now, reporting of justification of a price charged along with arm's length price in
Form 3CEB (this form would undergo change to accommodate domestic TP)
• Then, generic justification or comparison was still sufficient, - Now, scientific justification based on prescribed methods is to be maintained
• Then, normal documentary evidences were sufficient, - Now, TP documentation supported by robust supportings required
• Then, related party transactions used to be scrutinized at the assessment stage by the Assessing Officer, - Now, the assessee is duty bound to maintain justification and file mandatory
Chartered Accountant's report at the threshold
• Then, related party transactions not so closely scrutinized by the AO, - Now, there will be aggressive monitoring by the TPO/AO
Free of cost services or benefits to tax holiday units to be valued at arm’s length
Overlap of SDT compliance with good corporate governance objectives…
Companies falling under Presumptive taxation whether SDT applicable?
Although TP compliance is a 'specific anti-avoidance regulation – SAAR' it can be superseded by the proposed GAAR rules, if there is an exceptional case of abusive behavior on the part of the taxpayer…
Penal consequences are very onerous in case of non-compliance
No corresponding adjustment allowed for other party for adjustments made, if any, by the TPO for transactions falling under SDT
Specific Action steps / Supporting documents tocollate on a real time basis
• Close tracking of covered transactions - clear communication to the management of each company to track covered transaction and maintain supporting documents, illustrated (not exhaustive) as under:
- Supporting invoices (including third party invoices for similar transaction, if any)- Relevant agreements, contracts, written/documented understanding- Cost allocation calculations along with justification of allocation keys wherever cost is
being shared- Valuation reports- Rationale for any mark up and price charged- Documentation to support benefits derived- Deliverables obtained- Qualification and experience for KMP, where transacted with- Comparative details of third party, where transacted with for similar situation or where
evaluated for a particular transaction- Quotes received from third parties- Competitor/ industry data as available in public domain- Computation of transactional / segmental / company level margin
Karishma R. PhatarphekarPartner & Practice Leader, Transfer Pricing ServicesGrant Thornton India LLPM +91 98202 38577 D +91 22 6626 2625E [email protected]
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