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The Mumbai Tribunal upholds use of internal CUP with appropriate adjustments for broking transactions
 

The Mumbai Tribunal upholds use of internal CUP with appropriate adjustments for broking transactions

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Recently, the Mumbai Bench of the Income-tax Appellate Tribunal in the case of J.P. Morgan India Private Limited (the Company or the taxpayer) has confirmed the Commissioner of Income-tax (Appeals) ...

Recently, the Mumbai Bench of the Income-tax Appellate Tribunal in the case of J.P. Morgan India Private Limited (the Company or the taxpayer) has confirmed the Commissioner of Income-tax (Appeals) [CIT(A)] order, in upholding the use of Comparable Uncontrolled Price as the most appropriate method for benchmarking the taxpayer’s broking services, after allowing appropriate adjustments for differences in functions performed, assets employed and risks assumed in dealing with related and unrelated parties.

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    The Mumbai Tribunal upholds use of internal CUP with appropriate adjustments for broking transactions The Mumbai Tribunal upholds use of internal CUP with appropriate adjustments for broking transactions Document Transcript

    • KPMG FLASH NEWS KPMG IN INDIA The Mumbai Tribunal upholds use of internal CUP with appropriate adjustments for broking transactions 5 March 2014 Background Recently, the Mumbai Bench of the Income-tax Appellate Tribunal (the Tribunal) in the case of J.P. Morgan India 1 Private Limited (the Company or the taxpayer) has confirmed the Commissioner of Income-tax (Appeals) [CIT(A)] order, in upholding the use of Comparable Uncontrolled Price (CUP) as the most appropriate method for benchmarking the taxpayer’s broking services, after allowing appropriate adjustments for differences in functions performed, assets employed and risks assumed (FAR) in dealing with related and unrelated parties.  During the Assessment year (AY) 2002-03, the taxpayer has provided DVP and DCS services to its associated enterprises (AEs) and unrelated parties. The average brokerage rate charged for these transactions are as follows: Particulars Brokerage rates Unrelated AEs parties Facts of the case DVP trades 0.35% 0.56%  DCS trades 0.36% 0.40% The taxpayer is engaged in the provision of broking services. Its broking activities are of two types 2 Delivery Verses Payment (DVP) and Direct 3 Custodian Settlement (DCS). _________________ 1 J P Morgan India Private Limited v. ACIT [ITA No. 670/MUM/2006) for AY 200203] 2 Delivery versus payment is a settlement system that stipulates that cash payment must be made prior to or simultaneously with the delivery of the security. 3 In a Direct custodian settlement, assets are held by a custodian in the client’s name and deals are cleared and settled by the custodian on the client’s demand.  The taxpayer in its Transfer Pricing (TP) study, aggregated the activities (i.e. DVP and DCS) and concluded that its international transactions in respect of broking services were at arm’s length, by adopting the transactional net margin method (TNMM) as the most appropriate method for determining the arm’s length price. © 2014 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
    •  During the course of TP assessment proceedings, the Transfer Pricing Officer (TPO) sought to reject the use of TNMM as the most appropriate method and applied CUP since internal comparables were available. While applying CUP for each activity separately, the TPO concluded that the pricing of the DCS activity was at arm’s length.  The taxpayer contended that the brokerage rates charged to AEs for DVP activities could not be compared with that charged to unrelated parties, on account of the following significant differences in the functions performed (such as building client relationship, marketing and order origination, preparation and circulation of research reports and order execution), assets employed and risks assumed (such as funding risk, risk of non delivery and operational risk):  Research - functions towards research were significantly lower with respect to the transactions with AEs;   Counterparty credit risk – none towards international transactions as the same are undertaken with AEs. The TPO did not accept the above contentions. Based thereon, the taxpayer further contended that it has incurred lower costs in providing broking services to AEs and the same was considered while pricing the respective transactions. The difference in costs were on account of various factors such as given below, which would have to be reduced from the costs incurred on unrelated transactions to arrive at the adjusted comparable brokerage rate:  Efforts of research personnel based on time spent was 20 per cent lower in case of AEs;  Sales trading efforts for AEs were only 20 per cent of the efforts required on transactions with unrelated parties, as in case of AEs there were no dedicated sales personnel for building and fostering the client’s relationship. The taxpayer further demonstrated that for the DVP activities, the cost incurred was higher by 0.29 per cent (as a ratio of turnover), in case of transactions with unrelated parties as compared to transactions with AEs. After adjusting this additional cost difference, its transactions with AEs were at arm’s length even under CUP method as follows: Brokerage rate to unrelated parties 0.56% Less: Additional Cost difference Adjusted brokerage rate to unrelated parties 0.29% Brokerage rate to AEs 0.35% 0.26%  The TPO observed that the only adjustment for differences to be considered was the difference in the brokerage rates for DCS transactions with AEs and unrelated parties, i.e. 0.36 per cent and 0.40 per cent respectively. Accordingly, the TPO concluded that the brokerage rate to be charged on DVP transactions should be 0.50697 per cent [i.e. 0.5633% x (0.36/0.40%)].  Adopting the above adjusted rate, the TPO computed an adjustment amounting to INR 74.79 lakh to the DVP transactions with AEs.  Against the aforesaid addition, the taxpayer preferred an appeal before the CIT(A). Marketing efforts - the taxpayer’s AE clients did not transact with other Indian brokers, accordingly minimal marketing efforts were required in case of transactions with AEs;   Taxpayers CIT(A) contentions before the Before the CIT(A), the taxpayer raised the following contentions in respect of the arm’s length price determined for its DVP activities:  TNMM should be considered as the most appropriate method for benchmarking the broking transactions.  In case CUP is applied, then adjustment for differences in FAR should be granted.  Also, the contentions put forth before the TPO were reiterated. CIT(A)’s ruling  The CIT(A) upheld the use of CUP as the most appropriate method for benchmarking the taxpayer’s transactions. © 2014 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
    •  However, the CIT(A) allowed the adjustments for differences on account of services rendered to AEs and unrelated parties as contended by the taxpayer; and accordingly deleted the addition made by the TPO.  Aggrieved by the CIT(A) order, both the taxpayer and the Revenue filed appeals before the Tribunal on the following grounds:  By taxpayer  TNMM should be considered as the most appropriate method for the purpose of determining the arm’s length price for the broking transactions; By revenue  Adjustment made by the TPO was wrongly deleted by the CIT(A); 4  Other grounds in relation to (a) disallowance of expenditure incurred for earning dividend, (b) disallowance of club membership fees, and (c) disallowance of expenditure considered as capital in nature in respect of software, support services and repairs and maintenance. Taxpayer’s contentions  TNMM is the most appropriate method for benchmarking the taxpayer’s broking transactions;  Alternatively, acknowledging that the CIT(A) has rightly held that taxpayer was entitled to get relief on account of difference in the activities performed in relation to services rendered to AEs and unrelated parties. Tax department’s contentions  The taxpayer should be allowed the relief on account of differences in activities performed in case of transactions with AEs and unrelated parties. Accordingly, the adjustment for additional cost of 0.29 per cent incurred by the taxpayer in provision of services to unrelated parties has been rightly allowed by the CIT(A). Moreover, the TPO had not pointed out any defect in the computation of the additional costs (i.e. 0.29 per cent) submitted by the taxpayer during the TP assessment proceedings. In view of the above, the Tribunal confirmed the CIT(A) order in upholding the use of CUP as the most appropriate method with appropriate adjustments, and thereby deleting the TP adjustment on provision of broking services to AEs. Our comments This decision of the Mumbai Tribunal endorses CUP as the most appropriate method to determine the arm’s length price for broking transactions. Similar 5 view has been upheld in the cases of RBS Equities (which was one of the first rulings for the broking 6 industry) and Goldman Sachs . In the present case, the Tribunal while considering CUP as the most appropriate method has allowed appropriate adjustments on account of differences like marketing, research efforts, etc. in respect of the FAR for transactions with unrelated parties and AEs for comparability purpose. However, no specific guidance has been detailed/discussed on the methodology for determining the adjustments. Accordingly, in order to determine appropriate adjustments, inferences have to be drawn having regard to the taxpayer’s FAR and the specific fact pattern of each case. Objection on the deletion made by the CIT(A) of the addition made by the TPO. Tribunal’s ruling The Tribunal dismissed the plea of the taxpayer as well as the Revenue on the following grounds: ______________________  TNMM should not be applied when internal CUPs are available. _______________ 4 These grounds were dismissed by the Tribunal, placing reliance on favourable decisions in the taxpayer’s own case for AY 2001-02 and other judicial precedents 5 RBS Equities (India) Ltd. (Formerly known as ABN AMRO Asia Equities (India) Ltd.) v ACIT [ITA No. 3077/Mum/2009 for AY 2003-04 and (ITA No. 1236/Mum/2010) for AY 2005-06]. However, the said ruling was recalled and restored for fresh hearing and disposal vide MAs 732/Mum/2012 and 733/Mum/2012 for the AYs 2003-04 and 2005-06 respectively. 6 Goldman Sachs (I) Securities Private Limited v ACIT [ITA 7724/Mum/2011) for AY 2007-08] © 2014 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
    • www.kpmg.com/in Ahmedabad Commerce House V, 9th Floor, 902 & 903,Near Vodafone House,Corporate Road, Prahlad Nagar, Ahmedabad – 380 051 Tel: +91 79 4040 2200 Fax: +91 79 4040 2244 Bangalore Maruthi Info-Tech Centre 11-12/1, Inner Ring Road Koramangala, Bangalore 560 071 Tel: +91 80 3980 6000 Fax: +91 80 3980 6999 Chandigarh SCO 22-23 (Ist Floor) Sector 8C, Madhya Marg Chandigarh 160 009 Tel: +91 172 393 5777/781 Fax: +91 172 393 5780 Chennai No.10, Mahatma Gandhi Road Nungambakkam Chennai 600 034 Tel: +91 44 3914 5000 Fax: +91 44 3914 5999 Delhi Building No.10, 8th Floor DLF Cyber City, Phase II Gurgaon, Haryana 122 002 Tel: +91 124 307 4000 Fax: +91 124 254 9101 Hyderabad 8-2-618/2 Reliance Humsafar, 4th Floor Road No.11, Banjara Hills Hyderabad 500 034 Tel: +91 40 3046 5000 Fax: +91 40 3046 5299 Kochi 4/F, Palal Towers M. G. Road, Ravipuram, Kochi 682 016 Tel: +91 484 302 7000 Fax: +91 484 302 7001 Kolkata Infinity Benchmark, Plot No. G-1 10th Floor, Block – EP & GP, Sector V Salt Lake City, Kolkata 700 091 Tel: +91 33 44034000 Fax: +91 33 44034199 Mumbai Lodha Excelus, Apollo Mills N. M. Joshi Marg Mahalaxmi, Mumbai 400 011 Tel: +91 22 3989 6000 Fax: +91 22 3983 6000 Pune 703, Godrej Castlemaine Bund Garden Pune 411 001 Tel: +91 20 3050 4000 Fax: +91 20 3050 4010 The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation. © 2014 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity“ are registered trademarks of KPMG International Cooperative (“KPMG International”), a Swiss entity. © 2014 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.