Transfer Pricing and the SEZ Conundrum: The Aurobindo Pharma Case and Its Far-Reaching Implications

Introduction: A High-Stakes Battle in Transfer Pricing

The intersection of transfer pricing regulations and Special Economic Zone (SEZ) benefits has long been a contentious space, with businesses navigating a fine line between compliance and optimization. Aurobindo Pharma Ltd. v. ACIT (Hyderabad ITAT, 2025) brings this issue into sharp focus, revealing the complexities of inter-unit transactions, pricing methodologies, and regulatory scrutiny.

At the heart of the dispute lies the transfer of Active Pharmaceutical Ingredients (APIs) and other raw materials between Aurobindo’s non-SEZ units and its SEZ units. The Indian tax authorities challenged the company's benchmarking methods, rejecting its transfer pricing (TP) study and making substantial adjustments to its income. The company countered, arguing that the authorities misapplied economic principles and ignored alternative benchmarking methods that were valid under Indian tax law.

This case is more than just a dispute over numbers—it reflects a broader challenge faced by companies operating in SEZs, balancing tax benefits with transfer pricing compliance. The ruling has significant implications for pharmaceutical, manufacturing, and export-driven businesses operating in similar frameworks.

Understanding the Core Dispute: Transfer Pricing Adjustments in SEZ Transactions

The Context

Aurobindo Pharma, a major player in the pharmaceutical sector, operates multiple manufacturing facilities, including SEZ and non-SEZ units. The company transferred raw materials from non-SEZ units to SEZ units and benchmarked these transactions using the Cost Plus Method (CPM)—a widely accepted transfer pricing methodology that compares internal transactions with third-party sales.

However, the Transfer Pricing Officer (TPO) rejected this approach, arguing that Aurobindo's methodology was flawed, as it excluded a significant portion of products while calculating the median price. Instead, the TPO cherry-picked six product families (out of 11) that had lower prices, leading to a substantial transfer pricing adjustment.

The key issues in the case:

• Selective benchmarking: The TPO picked only certain products, ignoring the overall pricing of Aurobindo’s product families.
• Rejection of the company’s TP study: Despite following an industry-accepted method, the company's analysis was dismissed.
• Non-recognition of alternative methods: The TPO refused to acknowledge an alternative Transactional Net Margin Method (TNMM) analysis submitted by Aurobindo, even though it was accepted in subsequent years.

This arbitrary selection of transactions resulted in a significant tax liability for Aurobindo Pharma, prompting it to appeal to the Dispute Resolution Panel (DRP) and later the Income Tax Appellate Tribunal (ITAT).

The ITAT’s Analysis and Ruling: A Lesson in Economic Rationality

1. The Problem with Cherry-Picking Transactions

The ITAT found that both Aurobindo and the tax authorities had taken extreme positions. On one hand, Aurobindo’s methodology excluded 70% of its product families, leading to a distorted outcome. On the other, the TPO’s approach focused only on lower-priced products, completely disregarding higher-priced transactions that could have balanced the pricing equation.

The ITAT ruled that when a company sells a group of products as a "basket," the correct approach is to evaluate the entire basket of transactions, rather than isolating only those that favor a tax adjustment. This principle is crucial for pharmaceutical companies, FMCG businesses, and others dealing with diverse product lines.

2. Acceptance of TNMM as an Alternative Benchmarking Method

Aurobindo Pharma had submitted a supplementary TP study using TNMM, demonstrating that its transactions were within the acceptable Arm’s Length Price (ALP) range. However, the DRP ignored this study.

The ITAT found this inconsistent, noting that the same tax authorities had accepted TNMM for the subsequent assessment year (2020-21). It ruled that if TNMM was deemed acceptable for future years, it should have been considered for the year under dispute as well.

3. Remanding the Case for Reassessment

Recognizing the flaws in both Aurobindo’s and the TPO’s methodologies, the ITAT remanded the case back to the tax authorities. It directed them to:

• Consider the entire product basket rather than selectively choosing low-priced transactions.
• Adopt TNMM as the most appropriate method, given its acceptance in later years.
• Reassess the ALP determination with external comparables, ensuring a fairer benchmarking process.

Implications for Businesses: Lessons from the Aurobindo Pharma Case

1. The Growing Scrutiny of SEZ Transactions

The Indian tax authorities are increasingly scrutinizing inter-unit transactions between SEZ and non-SEZ units, particularly where tax benefits under Section 10AA of the Income-tax Act are involved. Companies operating in SEZs must:

• Ensure their transfer pricing documentation is robust and defensible.
• Consider multiple benchmarking methods to preempt challenges from tax authorities.
• Maintain consistency in methodology across years to avoid retrospective adjustments.

2. The Danger of Arbitrary Adjustments by Tax Authorities

The case highlights the risks of selective benchmarking by tax officers. Businesses must be prepared to challenge:

• Cherry-picking of transactions that distort actual pricing trends.
• Rejection of valid benchmarking studies without due consideration.
• Inconsistent tax treatment across years, leading to unpredictability in compliance.

3. The Importance of Alternative Benchmarking Approaches

Companies facing TP disputes should:

• Preemptively conduct alternative TP analyses, such as TNMM, to strengthen their position.
• Use external comparables to validate pricing, reducing the risk of arbitrary adjustments.
• Engage proactively with tax authorities to address potential concerns before they escalate into litigation.

Beyond Transfer Pricing: The Case’s Wider Impact

Apart from transfer pricing, the case also addressed two critical tax deductions:

1. Weighted Deduction under Section 35(2AB) for R&D ExpensesThe tax authorities disallowed weighted deductions on certain clinical trial expenses.The ITAT ruled in favor of Aurobindo, affirming that clinical trials outside in-house R&D facilities still qualify for deductions.
2. Additional Depreciation ClaimsThe tax authorities denied additional depreciation on plant & machinery used for R&D.The ITAT ruled that the disallowance was unwarranted, reinforcing the importance of following established precedents.

Conclusion: A Call for Rational Transfer Pricing Practices

The Aurobindo Pharma Ltd. v. ACIT ruling is a landmark case that underscores the challenges of transfer pricing in SEZ transactions. It highlights:

• The risks of arbitrary selection of transactions by tax authorities.
• The importance of consistency in transfer pricing methodologies.
• The need for businesses to proactively defend their pricing mechanisms.

With India tightening its transfer pricing regulations and intensifying scrutiny of SEZ tax benefits, businesses must adopt a proactive, well-documented approach to compliance.

This case is not just about a pharmaceutical giant—it’s a wake-up call for all companies engaged in inter-unit transactions within tax-advantaged zones. The lessons here will shape future litigation, tax planning, and corporate finance strategies for years to come.