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:
