IN THE ITAT MUMBAI BENCH ‘L’
RBS Equities (India) Ltd.
Additional Assistant Commissioner of Income-tax
IT APPEAL NOs. 3077 (MUM.) OF 2009, 1236 (MUM.) OF 2010
[Assessment year – 2003-04 & 2005-06]
Date of pronouncement – 14.09.2012
P.M. Jagtap, Accountant Member – These two appeals filed by the assessee against two separate orders of learned CIT(Appeals)-19, Mumbai and learned CIT(Appeals)-15, Mumbai dated 19-02-2009 and 01-12-2009 for assessment years 2003-04 and 2005-06 respectively, involve some common issues and the same, therefore, have been heard together and are being disposed of by this single consolidated order.
2. First we shall take up the appeal of the assessee for assessment year 2003-04 being ITA No. 3077/Mum/2009 which is directed against the order of learned CIT(Appeals)-19, Mumbai dated 19-02-2009.
3. The common issue involved in ground Nos. 1 to 9 of this appeal relates to the addition of Rs.2,13,25,474/- made by the AO and confirmed by the learned CIT(Appeals) to the total income of the assessee by way of transfer pricing adjustment.
4. The assessee in the present case is a company which is engaged in the business of broking and trading in shares as a corporate member of Bombay Stock Exchange and National Stock Exchange. The return of income for the year under consideration was filed by it on 28-10-2003 declaring total income of Rs.5,23,56,068/-. In the said year, the company had provided the stock broking services in respect of clearing house trades to its Associated Enterprise (AE) M/s ABN Ambro Asia (Mauritius) Ltd. and had earned brokerage for the said services amounting to Rs.4,22,84,486/- at the rate of 0.24%. The income so earned from the PE constituted more than 35% of the total income of the assessee from clearing house trades. To determine the arm’s length price of the transactions entered into by the assessee company with its AE, the matter was referred by the AO to the TPO. The TPO after receiving reference u/s 92CA(1) of the Act, proceeded to compute the Arm’s Length Price in respect of this international transaction and directed the assessee to furnish the brokerage rates of top ten clients in terms of volume, which was done on 12-12-2005. A perusal of the list showed that the assessee had transacted with both FIIs and FIs and so it was further required by the TPO to furnish details of the top 10 FIIs clients. The same was furnished by the assessee as reflected at para 3 of the TPO’s order. Based on the details furnished by the assessee, it was observed by the TPO that the average brokerage charged from top 10 FIIs is 0.408% while the average brokerage charged from FIs is 0.22%. Since there was a wide difference between the brokerage rate of .40% charged from FIIs and .22% from FIs and more importantly, the AE of the assessee being a FII, a much lower rate of brokerage of .24% was charged by the assessee. the TPO required the assessee to explain why :
(a) the AE, M/s ABN Amro Asia (Mauritius) Ltd. was charged brokerage at a much lower rate of .24% than the average rate of .40% charged from all the other FIIs and
(b) why the average brokerage rates of .40% charged to the top FIIs should not be applied to the assessee’s transactions amounting to Rs.1,766,94,33,449/- (More than Rs.1,766 crores) with its AE and appropriate addition made to the assessee’s income on account of short charge of brokerage.
5. The assessee submitted its reply dated 20-1-2005 wherein the following points were mainly raised :
(a) the rate does not differ on account of classification of the customers, the rate differs on various other factors such as volume of business, expected future business, marketing efforts, credibility of customer, negotiation power of the customer, to capture market share. Accordingly, the company would commercially be keen to charge a lower rate to a customer having low volume of business in anticipation of future business, build client relationship.
(b) the turnover from the AE constituted 42.7% of the total turnover and its total turnover and the volume of business procured is not comparable with that from third parties.
(c) the AE of the company has snot used the services of any other broker in India and given their entire business to company on an exclusive basis.
(d) even the comparison with third party brokerage rates then due consideration should be given to the volume of business transacted and the fact that company acts as an exclusive brokerage,Online GST Certification Course by TaxGuru & MSME- Click here to Join
(e) It also cited OECD Guidelines to highlight that CUP was not applicable because of differences between AE and third party.
(f) It canvassed its case for application of TNMM as this method has relaxed standard of comparability.
In view of the above submissions and based on its TNMM using Net Profit Margin (NPM), the assessee argued that the weighted average NPM earned by 14 broadly independent companies based on three years data ranges from 1.3% to 25.22% with an arithmetical mean of 11.60% while it has earned the NPM of 24.87% during the financial year which is at arm’s length.
6. The TPO considered/examined the contentions / objections raised by the assessee at length and held as under :
(a) Volume difference : That the volume does have affect on the brokerage rate, but in this trade, as in any other trade, these volumes have to be “committed volumes” and the appellant has not been able to substantiate that its AE had committed any volume of transaction with it. No agreement has been signed between the assessee and its AE and no documentary evidence has been produced. The TPO collected the data of the earlier year and found that the company had in the immediately preceding year had 23.77% of its transactions with its AE and there is nothing to suggest that it would commit large volumes to the assessee. According to the TPO, “it remains act of sheer chance that the AE had a large volume of business with the assessee in the year under consideration”. The TPO further held that given the fact that the assessee had no knowledge that its AE would give its substantial volume of business to it, the lower rate of brokerage of 24 basis points charged from the very beginning of the financial year, from its AE, “irrespective of the volumes”, was a deliberate act on account of the special relationship. As such, the TPO held that providing volume adjustment / discount on the facts of the case without any “committed volumes” cannot be allowed.
(b) Types of Trades : The TPO held that types of trades were FVP and non-DVP, the company had transactions with AE and independent foreign entities in both the segments, therefore, the brokerage earned for both the trades can be compared separately and these two types of trades, in no case reduces the effectiveness of the application of the CUP.
(c) Client Relationship / Client Type : The TPO held that this generalized assertion is not explained in the report as to how the same affects the pricing of the services.
(d) Marketing forces and competition: The TPO held that adjustments would be made as the FIIs were trading through the company and other brokers are ready to pay the higher brokerage than paid by the AEs. The payment of such brokerage of FIIs takes into consideration, the competitive rates offered by the other brokers and the rates paid by them are determined by the market forces. The company is undertaking trades for AEs and foreign FIIs, who are operating from the similar geographical regions, without being present in India, their perception of the Indian Market in terms of risks and rewards would be the same. Considering all these above factors, the TPO was of the view that there was no material difference and so rejected the contention of the appellant that CIP method was not the most appropriate. The TPO further was of the view that, in this case, the internal comparables area available and since the date maintained by the appellant company for such uncontrolled transaction would be more complete and reliable than the data of independent enterprises selected as comparables by the appellant of TNMM is adopted. The TPO in its order has taken .408% as the arm’s length rate being average broking rate in case of foreign clients (FIIs) in respect of CH trades and thereafter, provided adjustments.
(e) Marketing & Sales Function : The TPO has examined the issue in detail in pages 10, 11 and 12 of her order. She has made an adjustment of 0.408% as per the provisions of Section 10B(1)(a)(ii) and came to an arm’s length brokerage rate of 0.36%. Since the appellant had shown .240% as the brokerage rate., therefore, the addition to income proposed by TPO was .120% which in monetary terms came to Rs.2,13,25,474/-/-.
7. The addition as proposed by the TPO above was incorporated by the AO after providing an opportunity of being heard to the appellant. The AO, after taking into account the submissions made, was of the view that no additional facts or figures were brought before it and it was merely a repetition of the submissions made before the TPO, which were duly considered. As such he carried out upward adjustment of Rs.2,13,25,474/- on this issue and made addition to the total income of the assessee to that extent in the assessment completed u/s 143(3) vide an order dated 22-02-2006.
8. Against the order passed by the AO u/s 143(3), an appeal was preferred by the assessee before the learned CIT(Appeals) disputing, inter alia, the addition made by the AO by way of TP adjustment. It was submitted on behalf of the assessee before the learned CIT(Appeals) that TNMM method as applied by it for transfer pricing study was most appropriate method and the TPO was not justified in adopting CUP method for determining the arm’s length brokerage rate of CH rates. Without prejudice to this main argument, it was submitted on behalf of the assessee that even if CUP method was to be considered as the most appropriate method, volume adjustments should have been provided by the TPO. It was submitted that the assessee company provided “execution only” services to its AE while the services rendered to the FIIs were “full brokerage” services. It was submitted that the full brokerage services entailed marketing, research coordinating, management meeting, order execution etc. and that is why the rate charged to the AE was less. It was further submitted that there was an error in the working of the TPO inasmuch as simple average of brokerage rates was taken into consideration by him for determining the arm’s length brokerage rate instead of weighted average. It was also submitted that the brokerage rates charged to Indian Financial Institutions should have taken into account by the TPO as the functions and risk were similar. It was pointed out that if this had been done, the average brokerage rate would have been 0.316% instead of 0.40% as worked out by the TPO. It was contended that the TPO committed a mistake in assuming that market and sales efforts were required also in respect of transactions executed for AEs and thereby granting a lesser adjustment on account of marketing and sales effort at 0.048% as against 0.07% as claimed by the assessee. It was pointed out that the total marketing cost of Rs.2,80,37,910/- considered by the TPO while computing the marketing cost adjustment comprised of the salary and related cost of two employees whose role was restricted only to interacting and maintaining relationship with the third party clients. According to the assessee, the TPO also committed a mistake in not allowing adjustments on account of research function undertaken by the assessee in providing services to third party clients for its CH trades. It claimed that such adjustment should have been allowed at 0.175% as per the working furnished.
9. The above submissions made on behalf of the assessee before him while challenging the TP adjustments were not found acceptable by the learned CIT(Appeals). According to him, CUP method being the traditional method was most direct and reliable for the transfer pricing analysis. He held that even the facts and circumstances of the assessee’s case fully justified adoption of CUP method for TP analysis. As regards the adjustment sought by the assessee on account of volume, the learned CIT(Appeals) held that the volume factor was of no importance keeping in view the nature of assessee’s business and, therefore, the TPO was fully justified in not allowing any volume adjustment in the facts of the assessee’s case. As regards the claim of the assessee for adoption of weighted average arithmetical mean instead of simple average arithmetical mean, the learned CIT(Appeals) held that what is contemplated in the statute is adoption of arithmetic mean only and the concept of weighted average is not recognized by the statute. As regards the contention of the assessee that the brokerage rate charged to Indian FIs should have been taken into account by the TPO for comparability analysis, the learned CIT(Appeals) held that the TPO had maintained high standard of comparability by taking into consideration the top 10 FIs which were similarly placed. As regards the adjustment of 0.67% claimed by the assessee on account of marketing and sales efforts as against 0.48% allowed by the TPO, the learned CIT(Appeals) held that this claim of the assessee was not supported by any evidence or material. He held that in the facts and circumstances of the case, the TPO was very fair and reasonable in allowing such adjustment at 0.48%. Regarding the claim of the assessee for adjustment on account of research function undertaken for providing services to third party clients, the learned CIT(Appeals) held that it was based merely on assumption and estimate and there was no basis to justify the same. He, therefore, overruled all the objections raised by the assessee while challenging the TP adjustment made by the AO/TPO and confirmed the addition made to the total income of the assessee by way of such adjustment.
10. The learned counsel for the assessee, at the outset, strongly objected to the CUP method adopted by the TPO for comparability analysis. He contended that TNMM applied by the assessee for comparability analysis was the most appropriate method in the facts and circumstances of the case and the AO/TPO was not justified in changing the same. Without prejudice to this contention, the learned counsel for the assessee submitted that even if CUP method is to be adopted as most appropriate method for comparability analysis, certain adjustments have to be made as per Rule 10B(1)(a)(ii). He submitted that the AO worked out the arithmetical mean of brokerage rate earned by the assessee from top ten FIIs by taking simple average which is not correct. He contended that arithmetic mean should have been worked out by the AO on the basis of weighted average to make a fair comparison. He submitted that similarly adjustment for marketing function at 0.073%, for research function 0.175% and for volume at 0.042% as claimed by the assessee should have been allowed by the AO/TPO. He submitted that the AO, however, allowed adjustment for marketing function only to the extent of 0.048% and after making the said adjustment to simple average arithmetic mean of 0.408% worked out the arm’s length brokerage rate at 0.36%. He submitted that since the brokerage rate charged by the assessee company to its AE was 0.24%, TP adjustment was made at 0.12% being the difference between arm’s length brokerage rate determined by the TPO and brokerage rate actually charged by the assessee to its AE. He contended that if the weighted average brokerage rate as worked out by the assessee at 0.392% is taken and adjustment for marketing function, research function and difference in volumes as claimed by the assessee are made, the arm’s length brokerage rate would come to 0.102% and the same being lower than the brokerage rate of 0.24% charged by the assessee to its AE, no TP adjustment is actually required to be made.
11. The learned DR, on the other hand, strongly supported the action of the authorities below in adopting CUP method for the purpose of comparability analysis. He submitted that CUP is the most appropriate method to determine the ALP in the facts and circumstances of the assessee’s case especially when internal CUP was available. As regards the various adjustments claimed by the assessee, he submitted that volume of 10 FIIs taken by the TPO for comparability analysis was close to the volume of transactions of assessee company with its AE and, therefore, no adjustment on account of differences in volume need to be allowed. As regards the adjustment claimed by the assessee for marketing and research function, he submitted that such adjustments can be made as per /rule 10B(1)(a)(ii) only if the assessee can support and substantiate its claim for such adjustments by producing relevant evidence and subject to verification by the AO of the said evidence as well as of the working made by the assessee on the basis thereof.
12. We have considered the rival submissions and also perused the relevant material on record. As regards the method to be adopted for comparability analysis, we agree with the contention of the learned DR that CUP is the most appropriate method in the facts and circumstances of the case including especially the fact that internal CUPs are available for the comparability analysis. We, therefore, find no infirmity in the action of the AO/TPO in adopting CUP method for comparability analysis instead of TNMM applied by the assessee.
13. As regards the claim of the assessee for adopting weighted average arithmetic mean of brokerage rate of 10FIIs as against simple average arithmetic mean of such rates taken by the TPO, we find that the first proviso to section 92C speaks about taking arithmetic mean of more than one ALPs determined by the most appropriate method. There is, however, nothing to suggest that volume of the relevant transactions also has to be taken into consideration for the purpose of computing such arithmetic mean. We, therefore, find it difficult to accept the stand of the assessee that weighted average arithmetic mean should be taken and not the simple average arithmetic mean. In our opinion, the learned CIT(Appeals), therefore, has rightly rejected the stand of the assessee on this issue holding that there is no provision in the statute which allows taking weighted average arithmetic mean for determination of arm’s length price.
14. As regards the adjustments claimed by the assessee for marketing function, for research functions and for differences in volumes, it is observed that the relevant details and working have been furnished by the assessee at page No. 161 of the paper book in support of adjustment for marketing function, page No.200 and 211 of the paper book in support of adjustment for research function and paper book page No. 135, 139, 144 and 158 in support of adjustment for difference in volumes. As rightly contended by the learned counsel for the assessee comparable uncontrolled price is required to be adjusted as per Rule 10B(1)(a)(ii) to account for difference, if any, between the international transaction and the comparable uncontrolled transaction which could materially affect the price in the open market. However, as contended by the learned DR, a case has to be made by the assessee for allowing such adjustment duly supported by relevant facts and figures as well as documentary evidence. He has contended that such details and documents, however, need to be verified by the AO/TPO and if the matter is sent back to the AO or the TPO for such verification, he has no objection. Since the learned counsel for the assessee has also agreed with this proposition, we restore this issue to the file of the AO with a direction to consider the claim of the assessee for adjustment for marketing function, research function and differences in volumes afresh on merits after verifying the details and documentary evidence to be furnished by the assessee in support. The claim of the assessee on this issue is accordingly treated as partly allowed for statistical purposes.
15. The issue raised in ground No.10 relates to the disallowance of Rs.2,58,801/-made by the AO and confirmed by the learned CIT(Appeals) on account of assessee’s claim for write off of irrecoverable loan.
16. From the details of other operating expenses debited by the assessee in the profit & loss account, it was noticed by the AO that the assessee has claimed advances written off amounting to Rs.2,58,801/-. While justifying the said claim, the assessee submitted that housing loan was given to one of its employees and since the said employee had become untraceable, the loan given to him was written off as irrecoverable. It is, however, observed by the AO that there was nothing brought on record by the assessee to show any efforts made to recover the loan from the concerned employee or from the security, if any, which was taken while giving the said loan. He, therefore, held that the loss on account of the said loan becoming irrecoverable had not been incurred by the assessee in the year under consideration and the same was disallowed by him. On appeal, the learned CIT(Appeals), confirmed the action of the AO on this issue for the same reasons as given by the AO.
17. We have heard the arguments of both the sides on this issue and also perused the relevant material on record. The learned counsel for the assessee has agreed that the amount in question cannot be allowed as bad debts as the condition stipulated in section 36(1)(vii) read with section 37(2) is not satisfied. He, however, has contended that the same is allowable as business loss. However, as rightly held by the authorities below in this regard, nothing has been brought on record by the assessee to show that the loss as a result of the loan given to the employee becoming irrecoverable was actually incurred in the year under consideration and this being so, we are of the view that the amount in question cannot be allowed even as business loss in the year under consideration. We, therefore, uphold the impugned order of the learned CIT(Appeals) confirming the disallowance made by the AO on this issue and dismiss ground No. 10 of the assessee’s appeal.
18. As regards ground No. 11, it is observed that the issue raised therein relating to charging of interest u/s 234D is squarely covered by Explanation 2 to section 234D inserted by the Finance Act, 2012 with retrospective effect from 01-06-2003 whereby it is clarified that the provisions of section 234D shall also apply to an assessment year commencing before the first day of June, 2003 if the proceedings in respect of such assessment year is completed after the said date. Since the said Explanation is clearly applicable in the case of the assessee, we uphold the levy of interest u/s 234D and dismiss ground No. 11 of the assessee’s appeal.
19. Now we shall take up the appeal of the assessee for assessment year 2005-06 being ITA No. 1236/Mum/2010 which is directed against the order of learned CIT(Appeals)-15, Mumbai dated 01-12-2009.
20. The common issue involved in ground No. 1 to 8 of this appeal relates to the addition of Rs.5,88,62,098/- made by the AO and confirmed by the learned CIT(Appeals) by way of TP adjustment.
21. We have heard the arguments of both the sides and also perused the relevant material on record. As agreed by the learned representatives of both the sides, this issue involved in assessment year 2005-06 is similar to the one involved in the appeal of the assessee for assessment year 2003-04 which has been decided by us in the foregoing portion of this order. As all the material facts relevant to this issue as involved in the year under consideration as well as the arguments of both the sides are similar to that of assessment year 2003-04, we follow our decision rendered in assessment year 2003-04 and restore the issue relating to TP adjustment to the file of the AO with a direction to consider the claim of the assessee for adjustment for marketing function, research function and differences in volumes on merit afresh after verifying the details and documentary evidence to be furnished by the assesse. The claim of the assessee on this issue is accordingly treated as partly allowed for statistical purposes.
22. The issue raised in ground No.9 relates to the disallowance of Rs.72,116/-made by the AO and confirmed by the learned CIT(Appeals) u/s 14A of the Act read with Rule 8D of Income Tax Rules, 1962.
21. According to the AO, the assessee had made investment in shares, the dividend income on which was exempt from tax. He, therefore, held that expenditure incurred by the assessee in relation to the said investment was liable to be disallowed u/s 14A. Accordingly, such expenditure incurred by the assessee was worked out by him at Rs.72,116/- by applying Rule 8D and disallowance to that extent was made by him u/s 14A. On appeal, the learned CIT(Appeals) confirmed the said disallowance.
24. We have heard the arguments of both the sides on this issue and also perused the relevant material on record. As held by the Hon’ble Bombay High Court in the case of Godrej Boyce Mfg. Co. Ltd. v. Dy. CIT  194 Taxman 203. Rule 8D is applicable prospectively from assessment year 2008-09 and for the years prior to 2008-09, the disallowance u/s 14A is required to be made on some reasonable basis. We, therefore, restore this issue to the file of the AO with a direction to recompute the disallowance to be made u/s 14A on some reasonable basis. We also direct the AO to consider the stand of the assessee that no expenditure was actually incurred for the purpose of making investment in shares so as to warrant any disallowance u/s14A. Ground No. 9 of the assessee’s appeal is accordingly treated as allowed for statistical purposes.
25. As regards ground No. 10, the learned counsel for the assessee has agreed that the issue raised therein relating to levy of interest u/s 234D is to be decided against the assessee as the provisions of section 234D are clearly applicable in assessment year 2005-06. Accordingly, we decide this issue against the assessee and dismiss ground No. 10 of the assessee’s appeal.
26. In the result, both the appeals of the assessee are treated as partly allowed for statistical purposes.