Serdia Pharmaceutical verdict crucial for companies hit by transfer pricing issues

 MUMBAI: The outcome on an appeal filed by Serdia Pharmaceutical, the Indian arm of French pharmaceutical major Servier, before the Bombay High Court is crucial for companies battling transfer pricing issues arising out of the cost of importing raw materials.

Transfer price is the price at which subsidiaries and divisions of a company transact with each other. Several MNCs are grappling with tax demand in India as the tax office believe that the transactions did not happen at the arm's length price - the price between persons other than associated enterprises.

Serdia imported active pharmaceutical ingredients (API) from its associated enterprise and manufactured the final product in India.

The pharma company filed an appeal against an
Income-Tax Appellate Tribunal order (ITAT) by Pramod Kumar, an ITAT member and an expert in international taxation.

The hearing on the verdict, which is likely early next month, is critical for the transfer pricing authorities as a major chunk of the revenue from transfer pricing comes form adjustments made on cross-border deals of pharma companies which are often accused of manipulating import prices of generic drugs to siphon off profits abroad. (In other words, the I-T department will pull up the Indian arm of an MNC if it believes that it has deflated profits - and therefore, paid less tax - by either importing certain products at a higher rate or selling cheap to the parent).

Some of the biggest corporate litigations relate to transfer pricing dispute. In the US, Glaxo alone had to make a settlement of $3.4 billion in an out-of-court deal with the
US Treasury and is currently facing similar litigation in Canada.

The Serdia order will also clear the cloud over the transfer pricing adjustments made when MNC pharma companies claim higher import price for API and declare less margin and less taxes.

The high court will rule on another important issue: whether the company has the right to decide on the most appropriate method for arriving at Arms Length Price (ALP).

The ITAT order in the case of Serdia states that companies are bound to adopt a simple method and that the
transfer pricing officer has the right to challenge the company if he thinks some other method is better suited for the purpose. The ITAT member has analysed relevant provisions in the Indian transfer pricing rules and compared them with similar laws in developed countries and concluded that the transfer pricing officer has the powers to challenge the method adopted by the company to arrive at ALP.

The officer found that
Serdia India had imported the API at 4.5 times the price than its competitor Torrent PharmaceuticalsBSE 0.00 %. Its plea before the officer was that since it has declared profits, it should be accepted. The company also pleaded that since its drug is superior than the original innovator's, its profit report should be accepted.

The transfer pricing officer, however, did not accept Serdia's method for the ALP calculation, and said instead of the Transaction Net Margin (TNM) method that compares the profits of the industry, it should have adopted the Comparable Uncontrolled Price (CUP) process which focuses on comparing prices of the products in the industry.

ITAT also did not accept Serdia's justification of higher import prices, and found holes in Serdia's argument that
APIsBSE 0.00 % were manufactured on equipment standards set by the World Health Organisation, the British Good Manufacturing Practices (GMP) and the guidelines of health, safety and environment (HSE) standards.

ITAT also observed that "APIs imported by Serdia are not unique items as claimed by it, and that such business models, being adopted by pharmaceutical companies, leave ample scope for them to manipulate API prices so as to regulate profitability of their controlled entities".