Share trading loss cannot be disallowed without reasonable basis

DCIT Vs UBS Securities India Private Limited (ITAT Mumbai)

Conclusion: Loss incurred on account of error trades in respect of dealings of clients and not on own account and the loss incurred in course of carrying on share broking business was in line with accepted market practices, therefore, disallowance of Rs. 35,82,623/- on account of loss on share trading and ad-hoc disallowance of Rs.5,00,000/-, not supported by any reasonable basis had been rightly deleted by CIT(A).

Held: Assessee-company had debited an amount of Rs.35,82,623/- on account of loss on share trading during the year. Accordingly, the proportionate expenses incurred towards incurring speculation loss was to be disallowed. As assessee had not given any expense allocation, AO had rightly disallowed on estimation basis the expenses of Rs.5,00,000/- pertaining to the share trading activity of assessee. During the financial year 2002-03, assessee incurred loss on account of dealing errors such as non-execution of minimum contract quantity/amount, dealing errors by staff etc. In such circumstances, the client disowned shares and assessee was forced to purchase/sell the shares due to such errors and in the process there had been a loss of Rs.35,82,623/-. It was stated by him that CIT(A) in assessee’s own case had held that the share trading loss was allowable as business loss. In the instant case, Explanation to section 73 referred by the AO was not applicable as assessee was not engaged in “business” of purchase/sale of shares of other companies. Further loss was incurred on account of error trades in respect of dealings of clients and not on own account and the loss incurred in course of carrying on share broking business was in line with accepted market practices. Further, dno expenditure had been incurred by assessee in respect of error trades. In such a situation, disallowance of Rs. 35,82,623/- on account of loss on share trading and ad-hoc disallowance of Rs.5,00,000/-, not supported by any reasonable basis ha been rightly deleted by the Ld. CIT(A).

FULL TEXT OF THE ORDER OF ITAT MUMBAI

The appeal filed by the Revenue and cross objection by the assessee are directed against the order of the Commissioner of Income Tax (Appeals)-15, Mumbai [in short ‘CIT(A)’] and arise out of order u/s. 143(3) of the Income Tax Act 1961, (the ‘Act’). Since common issues are involved, we are proceedings to dispose them off through a consolidated order for the sake of convenience.

2. We begin with the grounds of appeal filed by the revenue and the cross objection filed by the assessee in respect of transferpricing adjustments.

2.1     The ground of appeal filed by the revenue reads as under:-

1. On the facts and in the circumstances of the case and in law, the Ld.CIT(A) erred in overlooking the fact that the assessee has not provided any information regarding the level and type of manpower available at the disposal of the associated enterprises and associated enterprises (FIIs) at Mauritius was nothing but a letter box entity having no resources at its disposal to undertake the marketing and research function stated to be performed by it.

2.2 The revenue has further filed an additional ground of appeal, which is produced below:-

1. On the facts and in the circumstances of the case and in law, Ld.CIT(A) erred in allowing the benefit of 5% on arm’s length price (ALP) at the option of the assessee even though Section 92C(2A) clarifies that 5% is not a standard deduction.

2.2.1 Since the additional ground involves pure question of law and do not require any fresh examination of facts, we admit it by following the judgement of the Hon’ble Supreme Court in National Thermal Power Co. Ltd v. CIT (1998) 229 ITR 383.

2.3. The assessee has filed cross objections, which read as under:-

1. While upholding the application of the CUP Method to determine the ALP of the brokerage charged, the CIT(A) has erred in law and facts by:

a. Excluding third party domestic comparables that had a similar FAR profile to third party foreign comparables considered for determining the ALP;

b. Not making any adjustment to take into account the difference in volume of trades executed for the AE vis-a-vis third parties used as comparables; and

c. Disregarding the salary costs of research personnel attributable to clearing trades for third party clients, while calculating the marketing adjustment.

2. The CIT(A) has erred in law and on facts by upholding the rejection of the TNMM and application of CUP Method by the TPO for determining the ALP of the brokerage charged by the appellant to its AE in respect of clearing trades executed on its behalf.

2.3.1 The Ld. counsel has categorically stated that the second ground in the cross-objection is not pressed. Having considered the above submission and facts of the case, the second ground in the cross-objection is dismissed as not pressed.

3. Briefly stated, the facts of the case are that the assessee filed its return of income for the AY 2003-04 on 28/11/2003 declaring total income of Rs.27,54,04,365/-. The assessee is a part of UBS group and is a securities broking company and was incorporated in India on 15/02/1996. The assessee is a leading broking house in India, servicing the needs of FIIs and domestic mutual funds. The assessee is an indirectly owned 100% subsidiary of UBS Switzerland and hence, all its transactions with the other group entities of the UBS fall under the category of international transactions. During the previous year 2002-03 relevant to the AY 2003-04, the assessee has entered into transactions with Swiss Finance Corporation and UBS AG long-term India investment fund. Both these entities are Foreign Institutional Investors (FIIs) based in Mauritius.

The main international transactions entered into by the assessee is on account of the brokerage charged by it on its group entities for the transactions undertaken by it on their behalf in India. For the purpose of benchmarking this transaction, the assessee has applied Transactional Net Margin Method (TNMM). Before the Transfer Pricing Officer (TPO), it was explained by the assessee that the services rendered by it to its group FII could be compared with the services rendered by it to non –group FII for whom it had undertaken similar trades. It was however explained that such rates have not been compared for the only reason that the assessee undertakes marketing function in respect of its transactions with unrelated parties, whereas for the purpose of its transactions with related parties it does not undertake any marketing function. The TPO observed that while applying TNMM, the assessee has compared profits earned by it with the profits earned by other entities operating in India, providing similar broking services. On the basis of the analysis undertaken by the assessee, it has identified 10 comparable companies, who have earned a net operating margin on cost of 15.75%. The assessee further contends that it has earned the margin of 153.76% on its operating costs, which is much higher than the margin earned by the comparable cases. Thus, it was contended before the TPO that the international transactions entered into by it with its group FII are at Arm’s Length Price (ALP). The TPO rejected the TNMM applied by the assessee for the following reasons:-

(i) In the given case, the assessee clearly has not applied the most appropriate method. It is seen that there is a clear market rate prevailing for broking services, which is expressed in terms of a percentage of the trade undertaken. In the presence of a reliable comparable uncontrolled price, the Comparable Uncontrolled Price (CUP) method should have been chosen by the assessee as the most appropriate method. The CUP method is most direct method and hence preferable to all other methods, which determine the ALP in an indirect manner.

(ii) The information or data used by the assessee for the computation of ALP is not reliable or correct. The comparable cases considered by the assessee under the TNMM are not engaged in the functions that are similar to the assessee.

Therefore, the TPO preferred internal comparable uncontrolled transaction to the external comparables selected by the assessee. Before the TPO, the assessee provided certain details of costs incurred on account of marketing in connection with the third party transactions entered into by it. The assessee has mainly considered costs on account of membership and subscription, salary costs, communication costs and travelling costs. The TPO, for the purpose of making adjustments to the brokerage rate considered the costs incurred on account of travelling, communication, membership and subscription. Finally, the TPO increased the total income of the assessee by a sum of Rs.1,93,27,020/-.

The AO, by following the order of the TPO made an adjustment of Rs.1,93,27,020/-.

4. Aggrieved by the order of the AO, assessee filed an appeal before the Ld.CIT(A). We find that vide order dated 05/10/2010, the Ld.CIT(A) upheld the CUP Method adopted by the TPO. Further, the Ld.CIT(A) rejected the contentions of the assessee regarding volume adjustments. Regarding the contentions of the assessee in respect of salary costs of equity sales and equity research personnel, the Ld.CIT(A) held that (i) the salary cost of research personnel incurred towards third party clients for the purpose of carrying out the brokerage adjustment as research is a function which is equally applicable to SFC as well as unrelated/ third party clients and cannot be segregated, is disregarded, (ii) the salary cost of equity sales personnel has been incurred for marketing for unrelated/third party clients and marketing efforts for AE business would be negligible or non-existent, (iii) the assessee has shown various details of equity sales personnel cost to demonstrate that those personnels were involved in marketing function.

Accordingly, the Ld. CIT(A) worked out the brokerage rate charged by the assessee to its AE at 0.28%.

4.1 Also the Ld. CIT(A) held that the assessee is entitled to 5% benefit for the impugned assessment year in respect of adjustment made on clearing house trades. The computation of the adjustment by him, after giving the benefit of 5% to the assessee is reproduced below:

Thus the Ld. CIT(A), considering the adjusted rate of brokerage of 0.31% and allowing the benefit of 5%, worked out the ALP of the related party clearing house trades segment at Rs.85,431,306/- as against Rs.10,31,70,245/- worked out by the TPO. Accordingly, the assessee got relief of Rs.1,76,38,940/-.

5. Before us, the Ld. counsel for the assessee relies on the decision of the order of the Tribunal in the case of Morgan Stanley India Company Pvt. Ltd. (ITA No. 266/Mum/2006) and files the following chart :

Relying on the above chart, the Ld. counsel in response to the clarification sought by the Bench on 08.01.2021, summarizes his contentions stating that :

6. On the other hand, the Ld. Departmental Representative (DR) submits that the TPO has rightly preferred internal comparable uncontrolled transaction to the external comparables selected by the assessee. Further it is explained by him that as the whole business of the assessee is driven by stock market and therefore, ‘volume factors’ are not applicable on the facts of the case. Thus he supports the order of the Ld. CIT(A) on the above.

However, the Ld. DR explains that as the assessee failed to provide any particular of marketing function undertaken by the overseas AE and further failed to provide the details of employees of the AEs in this regard, the TPO has rightly come to a finding that the assessee undertakes the marketing function, if any, in respect of both the related party transactions as well as third party transactions. Therefore, it is pleaded by him that the order of the Ld. CIT(A) in respect of salary costs be set aside and the order passed by the TPO/AO be restored.

The Ld. DR further explains that the Ld. CIT(A) is not correct in allowing the benefit of 5% on ALP at the option of the assessee even though section 92C(2A) clarifies that 5% is not a standard deduction.

7. We have heard the rival submissions and perused the relevant materials on record. The reasons for our decisions are given below.

As mentioned earlier, the assessee has relied on the order of the Tribunal in the case of Morgan Stanley India Company Pvt. Ltd. (supra). In that case, the Tribunal vide order dated 25.02.2020 held as under:

“21. Ground 6 relates to reducing the arm’s length price in respect of brokerage rate charge for Morgan Stanley Dean Witter Mauritius Limited. The Ld.AR of the assessee submits that assessee is a broker / dealer of Bombay Stock Exchange and National Stock Exchange. Assessee is having institutional clients, locally and globally. During the relevant assessment year, the assessee rendered broking services to its AE and to third party clients both, in India and overseas. The assessee benchmarked this transaction by using transaction net margin method (TNMM) in its transfer pricing study report, whereby net margin earned by assessee at entity level was compared with the profit margin earned by comparable companies engaged in similar broking business. The net margin earned by assessee is 35.38% which is higher than the net profit margin earned by comparable companies i.e. 21.63%. Accordingly, the transaction of assessee is within arm’s length price (ALP). During the transfer pricing assessment proceedings, the TPO rejected the appropriate method adopted by assessee and computed the arm’s length price by using comparable uncontrolled price (CUP) method thereby made an adjustment of Rs.1,18,59,779/- with regard to the international transaction. The TPO rejected the contention of assessee while computing the arm’s length price under CUP. Further, on appeal before CIT(A), the contention of assessee was accepted and adjustment was reduced to Rs.658 only. The Ld.AR of the assessee furnished the working of calculation adopted by TPO and the Ld.CIT(A) in the following manner:-

22. The Ld.AR explained that TPO granted an adjustment of marketing cost to the  extent of 0.1076%, which is approximately 30% of weighted average rate charged to third party client. However, Ld. CIT(A) granted adjustment of 40% with respect to marketing cost adjustment for significant volume and research cost and granted relief to the assessee. The Ld.AR further submits that geographical location of market is of no consequence in judging comparability of an uncontrolled transaction for purpose of applying CUP method. The difference in geographical location cannot be reason enough to discard comparables. Geographical location of service recipient to be irrelevant consideration, because the consulting services provided by the assessee would remain the same whether the service receiver is located in ‘X’ country or ‘Y’ country as long as service provider is in India. Reliance is placed on the following judicial precedents to support the said contention:-

• • SI Group-India Ltd v. DCIT (2016) 68 com 158 (Mumbai-Trib)
  • Bharti Airtel Ltd v. ACIT (2014) 43 com 50 (Delhi-Trib)
  • Tower Watson India Pvt Ltd vs DCIT [TS-260-ITAT-2019(DEL)-TP]
  • Inslico Ltd v. DCIT Ts-623-ITAT-2015(DEL)-TP
  • Clear Plus India Pvt Ltd vs DCIT 30 CCH 0652 Del Trib
  • BMW India Pvt Ltd vs ACIT (TS-401-ITAT-2018 (Del Trib)
  • M/s Garware Polyester vs Dy.CIT-8(1), Mumbai ITA No.6169/Mum/2011
  • Circle 1(1), International Taxation, New Delhi vs ABB Lummus Heat Transfer BV [2015] 64 taxmann.com 210 (Delhi-Trib)

23. The Ld.AR accordingly submits that the Ld. CIT(A) was justified in taking the average brokerage rate charged by assessee to its overseas and Indian clients irrespective of geographical location of service recipients. The Ld.AR further submits that volume discount / adjustment should be allowed in computing arm’s length price. It was explained that volume traded / executed by assessee on behalf of Mauritius entity was Rs.1,316 crores for CH trade, which constitute approximately 34% of total CH trade executed by assessee of its clients. And on the other the highest third party client had executed volume of CH trade of Rs. 396.84 Crore which constitute 10% of the total CH trades executed by assessee to all its clients. In support of his submissions the ld AR for the assessee relied on the following case laws;

> Clariant Chemical ( India) Ltd Vs JCIT[ 2014] 44 com 421 (Mumbai-Trib),

> Dresser-Rand India (P) Ltd Vs ACIT [2011] 13 com 82 (Mumbai Trib),

> Livingstones Vs DCIT [2014] 41 com 499(Mumbai-Trib)

24. It was further explained that adjustment of research cost should be allowed for computing the arm’s length price.

25. On the other hand the ld. DR for the revenue supported the order of TPO/ AO.

26. We have considered the submissions of both sides, perused the record. While filing the return of income, the assessee reported transactions with its AE as reported in Form 3CEB. Consequent to that, the AO made reference to the TPO vide reference dated 24.09.2003 for computation of arm’s length price. The TPO vide his order dated 22.02.2005 suggested the adjustment of Rs. 1,18,559,779/- The TPO rejected the TNMM method applied by the assessee for benchmarking its transaction with its AE. The TPO computed the arm’s length price by applying CUP method. And suggested adjustment of RRs.1,18,59,779/- in arm’s length price. On receipt of report of the TPO, the AO made addition of Rs.1,18,59,779/- in respect of arm’s length price while passing the assessment order. The assessee filed appeal before CIT(A). Before CIT(A), the assessee besides other contentions, stated that CUP method cannot be used as it is for determination of ALP of assessee’s transactions with its AE as it is difficult to make accurate adjustments for itself as compared to other trades/transactions and TNMM on the overall basis should have been considered, being more reliable and accurate method in assessee’s case. The Ld. CIT(A), after considering the submissions of assessee concluded that CUP is the most appropriate method which should be applied to the proper adjustment instead of using TNMM which is an indirect method.

27. On the grounds of comparability of comparables, concluded that domestic independent client should be considered for comparability purpose. The assessee further stated that if CUP is to be applied, then appropriate adjustment need to be made for lesser function performed / asset utilised and risk assumed. It was further stated that assessee did not perform any marketing and sales activities while executing trade for AE in Mauritius. Even the levels of other activities like research, trade relationship, etc. are lower as compared to independent client. In addition, Mauritius AE is the trusted client of assessee and provided substantial volume of business. Mauritius AE is dedicated client of the assessee. While fixing the brokerage rate of Mauritius AE, the assessee has to consider all the above factors. Accordingly, the assessee urged that if CUP has to be applied, then discounting factor of 50% should be applied as an adjustment to the brokerage rate charged to all Indian clients.

28. The contention of assessee was accepted by Ld. CIT(A) by taking view that if CUP method has to be applied, then appropriate adjustment need to be made for all differences. The Ld. CIT(A) further noted that TPO has carried out adjustment for marketing function by making adjustment considering part of marketing cost and has not made any adjustment to research activities on the premise that Mauritius AE would be getting research related services from assessee. Thus, the Ld. CIT(A) not agreed with the view of TPO that no adjustments are required to be made for research activities based on assumption and possibility and not on actual facts. The Ld.CIT(A), after considering the high volume of business profit of Mauritius AE to assessee which is 15% of the total business volume of assessee and the other highest client account is only 3.7% of total business volume, the Ld.CIT(A) took his view that it is settled commercial principle that “volume increases, the price decrees”. The Ld.CIT(A), after considering the facts, passed the following order:-

“I agree with the appellant that if CUP method has to be applied then appropriate adjustments need to be made for all differences. The TPO has carried out adjustments for marketing functions by making an adjustment considering part of the marketing cost. The TPO has not made any adjustments for research activities on the premise that MSDW Mauritius would be getting research related services from the appellant. I an unable to agree with the TPO who has formed a view that no adjustments are required to be made for research activities based on certain assumptions and possibilities and not on actual facts.

Further, the TPO has not considered any adjustment for the high volume of business given by MSDW Mauritius to the appellant. The total volume of trades (for purchases and sale) generated by MSDW Mauritius is Rs.1316 crores. As noted by the TPO on page 8 of his order, the business provided by MSDW Mauritius is approximately 15% of the total business volume of total trades. The next highest client accounts for only 3.77% of the total business volume. It is well settled commercial principle that ‘as volume increases, the price decreases’. The TPO has dealt with this issue on para 2 of page 8 in his order. The TPO has picked out certain instances where even though the volume has increased there is no decrease in the brokerage rate and accordingly has not considered any adjustment for volume differences. I am unable to agree with the TPO to the extent that one cannot disregard well-settled commercial principle based on certain stray instances. The fact that ‘as volume increases, the price decreases’ is a well-established commercial principle and accordingly due weightage /adjustment should be given for the huge volume of business given by MSDW Mauritius.

As per the appellant, MSDW Mauritius is a dedicated client i.e. it bought and sold securities only through the appellant for the entire previous year. Accordingly, while fixing the brokerage rate for MSDW Mauritius, the appellant has to consider the fact that MSDW Mauritius has no transactions through any of its competitors. The TPO has not considered any adjustments for the same. I am unable to agree with the TPO as certain amount of adjustment is required to loyalty factor of MSDW Mauritius.

The appellant carries out ‘Clearing House’ and ‘DVP’ trades for MSDW Clearing House’ trades. As stated above, the average brokerage charged to all independent clients for ‘Clearing House’ trades is 0.3511%. The TPO, in his order, has already considered an adjustment of 0.1076% on account of marketing cost. Thus, adjustment granted by the TPO amounts to approx. 30% of average brokerage charged to all independent clients.

As stated above, the appellant has contended that the discounting factor of atleast 50% should be applied as an adjustment to the brokerage rate charged to all independent clients.

Keeping the entire factual matrix in mind, I feel that the ends of justice would be met to both sides by considering a discounting factor of 40%. This discounting factor of 40% would cover the marketing cost adjustment already considered by the TPO.

Conclusion

Based on the above, this sub-ground is partly allowed. For comparability purposes, all the independent entities i.e. domestic as well as overseas should be considered, and a discounting factor of 40% as adjustment should be applied.

The calculation of the arm’s length price is enclosed as Annexure 1.

ANNEXURE-1

Considering the arm’s length price determined on the above factors, the brokerage rate charged by the appellant to MSDW Mauritius for ‘Clearing House’ trades meets with the arm’s length principle. However, the brokerage rate charged by the appellant to MSDW Mauritius for ‘DVP’ trades does not meet with the arm’s length principle and consequently, the addition of Rs.658 is therefore confirmed.”

29. Before us, the Ld. DR for the revenue could not bring out any fact to enable us to take a different view. No contrary law is brought to our notice. Therefore, we do not find any reason to interfere with the finding of Ld. CIT(A). In the result, this ground of appeal also fails.”

7.1 We begin with the contentions of the assessee regarding average of rates charged to third party FIIs and domestic clients. The TNMM applied by the assessee has been rightly rejected by the TPO/AO for the reasons that (i) in the given case the assessee clearly has not applied the most appropriate method as there is a clear market rate prevailing for broking services which is expressed in terms of a percentage of the trade undertaken, (ii) in the presence of a reliable comparable uncontrolled price, the CUP method should have been chosen by the assessee as the most appropriate method, as it is most direct method and hence is preferable to all other methods which determine the ALP in an indirect manner, (iii) the comparable cases considered by the assessee under the TNMM are not engaged in functions that are similar to the assessee.

7.2 Rule 10B(1)(a) of the Income Tax Rules, 1962 (the Rules) delineates Comparable Uncontrolled Price method (CUP), by which,-

(i) the price charged or paid for property transferred or services provided in a comparable uncontrolled transaction, or a number of such transactions, is identified;

(ii) such price is adjusted to account for differences, if any, between the international transaction or the specified domestic transaction and the comparable uncontrolled transactions or between the enterprises entering into such transactions, which could materially affect the price in the open market;

(iii) the adjusted price arrived at under sub-clause (ii) is taken to be an arm’s length price in respect of the property transferred or services provided in the international transaction or the specified domestic transaction.

7.3 Guidance Note on Report u/s 92E (Revised 2019) issued by ‘The Institute of Chartered Accountants of India’ (ICAI) explains in page 88 the following:

Geographical differences, market conditions and size of the markets ;-

The price at which a product is sold in one country cannot be compared with the price at which the same product is sold in another country because of the impact on account of geographical differences i.e. country specific demand/ supply factors, market conditions, regulations and government orders in force, level of competition, availability of substitute products, consumer purchasing power, etc. which could have a bearing on the price.

7.4 Comparable uncontrolled transactions which involve a transaction between one of the enterprises and an uncontrolled party, are referred to as internal comparables. Comparable uncontrolled transactions which involve a transaction between two parties, neither of which is an associated enterprise, are called external comparables.

CUP cannot be applied on basis of comparable uncontrolled transactions- internal or external- that are undertaken in different geographical markets as compared to the market in which the controlled transactions is undertaken.

7.5 For the purposes of sub-rule (1) of rule 10B, the comparability of an international transaction or the specified domestic transaction with an uncontrolled transaction shall be judged, as per sub-rule (2) with reference to the following namely:-

(a) the specific characteristics of the property transferred or services provided in either transaction;

(b) the functions performed, taking into account assets employed or to be employed and the risks assumed, by the respective parties to the transactions;

c) the contractual terms (whether or not such terms are formal or in writing) of the transactions which lay down explicitly or implicitly how the responsibilities, risks and benefits are to be divided between the respective parties to the transactions;

(d) conditions prevailing in the markets in which the respective parties to the transaction operate, including the geographical location and size of the markets, the laws and government orders in force, costs of labour and capital in the markets, overall economic development and level of competition and whether the markets are wholesale or retail.

7.6 It is crystal clear that the assessee’s transactions are with overseas FIIs and hence comparison with other overseas FIIs would alone be appropriate. The fact remains that domestic third party transactions are not comparable with the overseas FIIs on account of geographic differences. Thus the 1(a) of cross-objection is rejected.

8. Then we come to the issue regarding volume adjustments. We observe that though the assessee was specifically requested by the TPO vide office letter dated 17.01.2006 to explain how the brokerage rate was determined for its AE, no specific response was given; nor any evidence furnished to show that the AE was bound to give the assessee a minimum volume of business. A perusal of the documents filed before us clearly indicates that the assessee, while determining the rate charged individually in respect of the various third party FIIs has considered the weighted average rate, which takes into account the volumes. Further, as per the information collected by the TPO, which was also provided to the assessee, ABN Amro Asia Equity (India) Ltd. has charged an average brokerage rate of 0.40% in respect of clearing house trades of Rs.2831 crores with overseas FIIs. DSP Merrill Lynch Ltd. has charged a brokerage rate of 0.44% for clearing house trade of Rs.2103 crores with overseas FIIs. Thus significant volume of transactions were being undertaken at these rates in India between unrelated parties. In view of the above facts, the Ld. CIT(A) has rightly confirmed the negation of volume discount raised by the assessee. Thus the 1(b) of cross-objection is rejected.

9. Then we turn to the issues regarding salary costs. During the course of transfer pricing proceedings, the assessee vide its letter dated 17.02.2006 has considered a sum of Rs.6.53 crores as salary costs on account of marketing for third party business. However, as recorded by the TPO, as per the table provided at annexure 3 of the letter dated 16.01.2006, a sum of Rs.1.94 crores has been considered as being incurred for third party clearing house transactions and a sum of Rs.2.60 crores has been considered as being incurred for related party clearing house transactions. Thus the TPO held that no portion of the salary costs can be considered as being incurred for marketing for third parties on the reasons that (i) though the assessee was specifically requested vide office letter dated 21.02.2006 to provide documentary evidence to show that the said sum of Rs.6.53 crores was incurred on account of marketing activity relating to third party overseas FIIs for comparison, no documentary evidence in this regard could be provided by the assessee, (ii) the assessee itself contends that for its related party transaction no marketing activities were undertaken by it. Even than a salary cost of Rs.2.60 crores has been attributed to its related party clearing house transactions which indicates that salary costs have to be incurred for non-marketing purposes only. The quantum of trade undertaken as clearing house third party transaction and clearing house related party transaction is almost the same. Hence, the entire salary costs of Rs.1.94 crores considered for third party clearing house transaction is on account of non-marketing functions only, (iii) the assessee has failed to provide any particulars of marketing function undertaken by the overseas AE. The assessee has not even provided the details of the employees on role of the AE in this regard. All this clearly indicates that the assessee undertakes the marketing functions, if any, in respect of both related party transactions as well as third party transactions, (iv) costs that have been incurred exclusively for third party transactions have in any case been considered.

With the above observations, the TPO concluded that no portion of the salary costs can be considered as being incurred for marketing for third parties.

10. It was the contentions of the assessee before the Ld. CIT(A) that cost centre-wise-month-wise details of equity sales and research salary cost were filed with the TPO; however, corresponding travel expenses of equity sales and research employees have already been allowed by the TPO as a marketing cost; hence it would be appropriate to align the treatment of equity sales and research salary cost to that of travel cost by also allowing the former. It is further explained that the split financials submitted to the TPO vide submission dated 02.12.2005 were without prejudice basis and on TPO’s request only, hence the treatment of the said salary cost cannot be considered as assessee’s acceptance.

Thus it is submitted that throughout the assessment proceedings, the assessee continued to contend that no marketing effort was involved with respect to trades from AE and that salary cost of equity sales and research personnel is purely driven towards generating third party business only. Therefore it is finally stated that the said salary cost be considered as marketing cost.

In response to the clarification dated 08.01.2021 by the Bench, the Ld. counsel has filed a statement showing adjustment for equity research salary cost, which is reproduced below:

11. As mentioned earlier, the Ld. counsel has relied on the order of the Tribunal in the case of Morgan Stanley India Company Pvt. Ltd. ( supra). A precedent is an authority only for what it actually decides and not for what may remotely or even logically follow from it. Judgments must be read as a whole and observations in judgments should be considered in the context in which they are made and in the light of the questions that were before the court as held in CIT v. Sun Engineering Works Pvt. Ltd., 198 ITR 297 (SC).

In India, the burden of proof in transfer pricing litigation to establish the arm’s length nature of international transaction is generally with the assessee. Once, the assessee discharges this burden, the burden shifts to the tax authorities to establish that the arm’s length price has not been determined in accordance with the provisions of the law or that the information or data used in the computation is not reliable or correct.

12. Keeping in mind the above aspects, we are of the considered view that the salary cost of research personnel need to be re-examined. Therefore, we set aside the order of the Ld. CIT(A) on the above issue and restore the matter to the file of the AO/TPO for making a fresh order after giving reasonable opportunity of being heard to the assessee. We direct the assessee to file the relevant documents/evidence before the AO/TPO. Thus the ground of cross objections raised by the assessee in respect of salary cost of research personnel i.e 1(c) is allowed for statistical purposes. Similarly, the 1^st ground of appeal filed by the revenue is allowed for statistical purposes, on the reasons that the tax authorities have proceeded to examine the actual rate charged by the assessee to its AE in Mauritius and compare the same with the rates charged by it to third parties.

13. The Ld. CIT(A) has held that the applicant will be entitled to 5% benefit for the impugned assessment year in respect of adjustment made on clearing house trades. In this regard, we may refer to the proviso to 92C(2) of the Act, as substituted by the Finance Act, 2002 w.e.f. 01.04.2002, which reads as under:

“Provided that where more than one price is determined by the most appropriate method, the arm’s length price shall be taken to be the arithmetical mean of such prices, or, at the option of the assessee, a price which may vary from the arithmetical mean by an amount not exceeding 5% of such arithmetical mean.”

13.1 Where the variation between ALP as determined with reference to transfer pricing rules and the transaction price is less than 5%, no attempt can be made to substitute ALP for the transaction price in view of section 92C(2). But this rule can have no application, where it exceeds 5%, so as to reduce excess by 5% as claimed by the assessee. In other words, where the difference exceeds 5%, there can be no application of tolerance limit of 5% as decided by the Tribunal in Global Vantage P. Ltd v. DCIT (2010) 1 ITR (Trib.) 326 (Delhi).

Thus for the impugned assessment year, tolerance limit of 5% u/s 92C is not a standard deduction to be reduced from the additions made on account of ALP. After the insertion of sub section 2A to section 92C, with retrospective effect from 1.4.2002, +/- 5 % will not be a standard deduction.

In view of the above provisions in the Act, the additional ground filed by the revenue is allowed.

14. Finally we turn to the 2^nd and 3^rd grounds of appeal filed by the revenue which read as under :

2. On the facts and in the circumstances of the case and in law, the Ld.CIT(A) erred in overlooking the fact that the explanatory notes to the Finance Act, 2005 clearly stated that transactions in derivatives shall cease to be speculative only from the day the Stock Exchanges fulfill the conditions to be prescribed by the Central Government and it was only w.e.f 25t^h January, 2006, that the notification to that effect was issued.

3. On the facts and in the circumstances of the case and in law, the ld.CIT(A) failed to consider that the proviso to 43(5) was mainly a safeguard to cover the losses that may arise by way of holding the stocks and not to cover cases of simultaneous purchase and sale of shares /derivatives with a view to earning profits out of price differentials in different segments.

15. The AO in his order has stated that the trading of shares by the assessee-company comes within the ambit of the Explanation to section 73 and accordingly disallowed the trading loss of Rs.40,82,623/-.

In appeal, the Ld. CIT(A), allowed the grounds of appeal filed by the assessee on the above disallowance with following reasons :

“I have examined the issue and the facts on record. The Appellant is a share broker and has purchased and sold the shares on behalf of its clients. From the evidence gathered during the course of the hearing, the loss has occurred on account of dealing errors or some mistake in carrying out the instructions of the client such as specific limit instructions of the client are overlooked, orders cancelled by client are not entered into the system or overlooked by dealer etc. The Appellant itself is not engaged in the business of share trading. The loss suffered by the appellant on account of errors in the scripts traded by the appellant on behalf of the clients, which comes to approx 0.79% of the turnover of the appellant cannot be termed as excessive. Thus, the loss is incidental to the share broking business and the provisions of Explanation to section 73 of the Act are not applicable in the present case. In any case, this issue has been decided in appellant’s favour by the ITAT for the immediately preceding year (A.Y. 2002­03).”

16. Before us, the Ld. DR submits that the assessee-company has debited an amount of Rs.35,82,623/- on account of loss on share trading during the year. Accordingly, the proportionate expenses incurred towards incurring speculation loss is to be disallowed. It is stated by him that as the assessee has not given any expense allocation, the AO has rightly disallowed on estimate the expenses of Rs.5,00,000/- pertaining to the share trading activity of the assessee. Thus it is argued by the Ld. DR that the order passed by the AO be affirmed.

17. On the other hand, the Ld. counsel submits that during the financial year 2002-03, the assessee incurred loss on account of dealing errors such as non-execution of minimum contract quantity/amount, dealing errors by staff etc. In such circumstances, the client disowns shares and the assessee is forced to purchase/sell the shares due to such errors and in the process there has been a loss of Rs.35,82,623/-. It is stated by him that the Ld. CIT(A) in assessee’s own case for AY 2001-02 and AY 2002-03 has held that the share trading loss is allowable as business loss. Thus the Ld. counsel relies on the order of the Ld. CIT(A).

18. We have heard the rival submissions and perused the relevant materials on record. In the instant case, Explanation to section 73 referred by the AO is not applicable as the assessee is not engaged in “business” of purchase/sale of shares of other companies. Further loss was incurred on account of error trades in respect of dealings of clients and not on own account and the loss incurred in course of carrying on share broking business is in line with accepted market practices. Further, we find that no expenditure has been incurred by the assessee in respect of error trades. In such a situation, disallowance of Rs. 35,82,623/- on account of loss on share trading and ad-hoc disallowance of Rs.5,00,000/-, not supported by any reasonable basis has been rightly deleted by the Ld. CIT(A). Thus the 2^nd and 3rd ground of appeal filed by the revenue are dismissed.

19.  In the result, the appeal by the Revenue is partly allowed and the cross objections by the assessee are partly allowed for statistical purpose.

Order pronounced in the open Court on 16/03/2021.