JM FINANCIAL INSITUTIONAL SECURITIES P. LTD ( FORMELRY KNOWN AS JM FINANCIAL CONSULTANTS P.LTD),MUMBAI vs. DCIT CIR 3(2), MUMBAI

15/03/2016 सुनवाई क� तार�ख / Date of Hearing : 27/04/2016 आदेश क� तार�ख /Date of Order: आदेश / O R D E R Per Ashwani Taneja (Accountant Member): This appeal has been filed by the assessee against the assessment order dated 8th October, 2012, passed in pursuance to the directions given by the Dispute Resolution Panel (in short referred to as “DRP”) vide its order dated 30th August 2012, on the following grounds: –

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Grounds of Appeal

1. The transfer pricing proceedings initiated by the AO under section 92CA(1) of the Act are without any jurisdiction and ought to be quashed.

2. The learned DRP erred in not directing the Transfer Pricing Officer (TPO) that the Transfer Pricing Regulations do not apply in respect of the transactions entered into between the appellant and its joint venture (JV) partner.

3. Without prejudice to the above, the learned DRP erred in not considering the fact that the JV partners mutually agreed to split the JV on 22 February 2007 and therefore, the appellant and the JV partners (including its associated entities) were not associated enterprises as per section 92A(1) of the Act.

4. Without prejudice to the above, the learned DRP erred in confirming the action of the TPO in rejecting the segmental accounts prepared by the appellant as not reliable.

5. Without prejudice to the above, the learned DRP erred in not appreciating that the appellant has not performed well after the separation of JV (loss incurred on stand- alone basis post separation). Therefore, it cannot be said that there was a shifting of profit to AEs before the separation of JV; accordingly, no transfer pricing adjustment should be made.

6. The learned DRP erred in not directing the TPO to compute transfer pricing adjustment using the financial information of the comparable companies, which was available at the time of assessment; although such information was not available at the time when the appellant complied with the TP regulations, as per the Act.

7. The learned DRP erred in confirming the action of the TPO in considering the operating margins earned by comparable companies based on the financial data pertaining to the year ended 31 March 2008 only and rejecting the financial data of comparable companies for prior two years or use of multiple year data.

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the Assessee and by Shri N.K. Chand, Departmental Representative (CIT-DR) on behalf of the Revenue.

3.1. The brief facts as summarised by the DRP in its order are that the assessee company was incorporated as a Joint Venture between the Morgan Stanley Group (MSG) and JM Financial Group (JMFG) to carry on the business of investment banking services. MSG and JMFG respectively held share capital in the ratio of 49:51. In February, 2007, the Joint venture was decided to be discontinued. MSG agreed to sell its 49% share holding to JMFG. However, closing of the transaction took time and the actual transfer of shares happened only on 5-10-2007 when the assessee became a wholly owned subsidiary of JMFG.

3.2. It was further noted by the DRP that during the relevant financial year 2007-08, the assessee continued to function as a Joint Venture upto the end of September, 2007 and entered into international transactions of provision of advisory services in the capital market segment as well as in relation to mergers and acquisitions. The total value of transactions entered into during the 6 months period was Rs.34,25,06,275/-, the details of which are as under:-

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Sr.No. International AEs Nature of Amount Transaction transaction 1 Unitech AIM MS & Co. Capital 1,14,15,044 International Ltd. Market 2 Sterlite US MS & Co. Capital 22,30,75,148 IPO International Ltd. Market 3 Genpact US MS & Co. Capital 3,17,02,495 IPO International Ltd. Market 4 HDFC ADR MS & Co. Capital 1,75,04,662 International Ltd. Market 5 Project MS Japan M&A 5,88,08,926 Maharani Securities Co. Ltd Total 34,25,06,275 3.3. During the course of proceedings before the Transfer Pricing Officer, it was noted that the assessee had benchmarked its international transactions using TNMM method with operating margin as the PLI. The TPO rejected some of the comparables and finally arrived at a list of 14 comparables and taking OP to TC as PLI, worked out their arithmetic mean at 114.06%, and thereby made an adjustment of Rs. 17.88 crores.

3.4. The assessee raised objections before the DRP and submitted that since the two Joint venture partners of the assessee were unrelated entities and the international transactions were entered into with entities related to one of the joint venture partners, the transaction must intrinsically be accepted as being at arm's length. Neither of the joint venture partners would agree to transfer of profits as this 6 J.M. Financial Institutional S.P. Ltd. would affect the joint venture itself. It is also stated that the joint venture had in fact been discontinued in February, 2007 and hence during the relevant year the MSG group should not be considered as having any stake in the assessee company.

3.5. But the DRP did not accept this objection of the assessee and held that these arguments of the assessee are without merits. It is a fact that the assessee company had entered into transactions with companies of the MSG group which were related to the companies owning 49% of the share capital in the assessee company. These transactions were thus covered in the definition of international transaction as defined in Section 92B. Therefore, the income arising from the transactions has to be computed having regard to the arms length price in accordance with Section 92C. The existence or otherwise of any intention of shifting profits was immaterial.

3.6. The next contention taken by the assessee before the DRP was that it had furnished segment wise accounts to the TPO which have not been considered. It was stated that only 5 deals were entered into during the impugned period with the AEs while 78 deals were entered into with non-related parties. The direct expenses incurred were allocated to the AE segment as all such expenses related to the merchant banking activities carried out for non-related parties. Indirect costs were allocated on the basis of sales. It was submitted that during the TP proceedings segmental accounts certified by an auditor were also furnished to the TPO. However, these have 7 J.M. Financial Institutional S.P. Ltd. not been accepted on the ground that sales had been used as the allocation key even though it is the sales transactions which were being bench marked. The TPO also observed that no direct costs were debited to the AE accounts and that different sets of segmental accounts had been filed at different times. He also held that the AE and non-AE transactions were interlinked and could not have been separated. It was also submitted that direct costs were actually incurred in the non- AE segment and that the different sets of segmental accounts were furnished only because the auditors in the second set had allocated the entire expenses of the year on the basis of sales. It was also submitted that even if the accounts submitted earlier were not accepted, such segment accounts could be adopted by allocating the entire expenses on the basis of the ratio of operating profit to sales and operating profit to costs. A revised working was submitted computing the operating cost relating to the AE segment at Rs.18.57 crores, applying the mean operating cost margin computed by the TPO to such operating cost. It was submitted that the total revenues should be computed at Rs.39.75 crores as against, Rs.34.25 crores shown in the AE segment. The adjustment should therefore be limited to Rs.5.50 crores.

3.7. The DRP considered the submissions of the assessee and partly accepted the same. After considering the submissions of the assessee, the DRP made a re- working of the adjustment to be made in the case of assessee. The DRP held as under:-

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“……….. However, the assessee's submissions regarding the AE and Non AE segments are found to have some merit. It is noted that the gross income from operations during the relevant period was Rs.11.27 crores while the gross income from the AE segment was only Rs.35.24 crores. By applying the mean margin on the entire operating cost of Rs.60.34 crores, the TPO has determined an adjustment of Rs.17.88 crores which is apparently excessive when viewed in the light of the gross revenue of only RS.34.25 crores in the AE segment. It is also a fact that only 5 deals were entered into with AEs as against 78 transactions with Non AEs during the period. We are in agreement with the TPO that the segmental accounts submitted are not reliable for the reasons mentioned by him. However, in the interest of justice, we direct that such segment accounts may now be prepared and the allocation of expenses may be made in the same ratio as the ratio of total operating cost to total operating income and the operating cost related to the AE segment may be determined accordingly. The calculations of adjustment would then be as under:-

Particulars Total Non AE AE Segment Segment Income from Operations 1,112,720,443 770,214,168 342,506,275 Operating Cost 603,363,588 417,642,353 185, 721,235 Operating Profit 509,356,855 352,571,815

Operating Profit to sales 45.78% 45.78% 45.78% Operating Profit to Cost 84.42% 84.42% 84.42% Operating Cost related to 185,721,235 AE segment 114.06% (a)Comparable companies 21,18,33,641 margins derived by TPO ALP determined by considering the comparable's margin given by TPO (c) 39,75,54,876 [(a) + (b)) Actual Revenue from AE 34,25,06,275 (d) Total Adjustment Difference 5,50,48,601

9 J.M. Financial Institutional S.P. Ltd. between ALP and Actual revenue (c) - (d)

Thus, on the basis of above said analysis, the DRP confirmed the addition on account of transfer pricing adjustment to the extent of Rs 5,50,48,601/-.

3.8. During the course of hearing before us, learned counsel submitted that the DRP made an error in not accepting the contention of the assessee in a complete manner and therefore result of the decision given by the DRP was illogical and not in accordance with law and facts. It was submitted that though DRP accepted the stand of the assessee in principle that the law does not permit to apply TNMM method on entity level in the given facts of the case, especially when complete segmental data was available giving proper break-up of the AE and Non- AE transactions, but while working out the amount of operating profits and operating costs of AE and Non-AE segment factual figures were not taken. He drew our attention on various pages of the paper book showing that complete accounts were maintained giving details of separate transactions for AE and Non-AE segments. He requested for correction of mistake done by the DRP.

3.9. On the other hand, Ld. CIT-DR submitted that complete segmental accounts were not shown to the lower authorities. It was further submitted that the assessee has not been able to show what expenses were incurred for earning income from foreign AE, as all the expenses had been allocated towards the 10 J.M. Financial Institutional S.P. Ltd. domestic income only. It cannot be accepted that no expenses were incurred for earning the income from foreign AE.

3.10. In rejoinder, it was submitted by the Ld Counsel that whatever expenses were incurred for earning of income from foreign AE, these were reimbursed by the foreign AE and that is why these were not debited in the profit and loss account. He drew our attention on various pages of the paper book showing that some of the expenses were reimbursed by the foreign AE to the assessee.

3.11. We have gone through the submissions made by both the sides. It is noted by us that it is a fit case where circumstances suggest that the TNMM method should not be applied on entity level. It is noted that the assessee is maintaining separate accounts for AE and non-AE segments. The objection of the learned CIT-DR was that the assessee could not show proper correlation between the foreign income earned and expenses incurred by the assessee in relation to that. It has been vehemently contended by the assessee that it can show that the transactions were recorded in the books of accounts meticulously in the respective segment and complete evidences are available in support of the transactions done by the assessee. It is further submitted that the expenses have been correctly debited in the non-AE segment and that there is no expense which was incurred by the assessee relating to the AE segment but which has not been provided in the books of accounts or which has been wrongly debited in the non-AE segment. Thus, keeping in view facts and circumstances of the 11 J.M. Financial Institutional S.P. Ltd. case and submissions made before us by both the parties, we find it appropriate to send this issue back for verification of requisite facts to the file of the Transfer Pricing Officers who shall keep in mind the principle that the method of TNMM has to be applied segment wise, as stated above. The assessee shall furnish complete facts and documents to show that separate segmental records are maintained. The TPO is free to examine the nature of expenses incurred under both the segments to verify that expenses have been correctly debited in the respective segments. The assessee can also raise issues of inclusion or exclusion of comparables, if desired necessary. The TPO is permitted to carry out fresh search of comparables, if needed. The assessee is permitted to raise all legal and factual issues as may be considered appropriate as per law and facts. The assessee shall extend requisite cooperation to the TPO in terms of providing desired details and documents. The TPO shall give adequate opportunity of hearing to the assessee before passing the fresh order. Thus, we remit all these grounds back to the file of the TPO along with the directions as given above. These grounds may be treated as partly allowed for statistical purposes.

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4.1. During the course of hearing, it was submitted by the learned Counsel at the outset that this issue is covered by the order of the Tribunal in assessee’s own case for assessment year 2009-10 in ITA number 1863/M/2013 vide order dated 7/10/2015.

4.2. Before proceeding further, we have gone through the aforesaid order of the Tribunal. Relevant para of the said order is reproduced below: –

“6.2. Hon’ble Mumbai Bench has held that once all the details were made available along with entire accounts of the assessee, the AO was required to satisfy himself that having regard to the accounts of the assessee, claim of the assessee in respect of expenditure debited is not correct, and that there could have been certain other expenditures which can be said to have been incurred in relation to the earning of exempt income. As per mandate of the law, the AO is obliged to record such satisfaction, with reasoning. 6.3. In the present case, it is seen that conditions of sub- section 2 of section 14A are not satisfied. The AO has not cared to examine the accounts of the assessee and correctness of the claim made by the assessee. Ld. AO in the present case has straight away proceeded to apply Rule 8D for the purpose of disallowance u/s 14A, without satisfying or applying with the mandatory requirement of section 14A(2) r.w. Rule 8D. It is seen that the Assessee has given item wise justification for determination of the proportionate expense incurred on making investments

13 J.M. Financial Institutional S.P. Ltd. earning tax-free income. No discrepancies have been pointed out by the AO before rejecting the claim of the Assessee. Since the AO has failed to comply with the statutory requirement, he could not have proceeded to make disallowance u/s 14A. It is further noted that out of total dividend income of Rs 3,70,61,654/- received by the assessee company during the year, an amount of Rs 3,00,71,654/- was on the investments in Mutual Funds of group companies for strategic reasons and Rs. 50,00,000/- on the preference shares of subsidiary company. Both of these amounts have been received on the investments made ostensibly for strategic reasons. In our considered view, strategic investments are not made for the purpose of earning tax-free income. These should not be considered for making disallowance u/s 14A/. Recently, Hon’ble Delhi High court has taken same view in the case of Cheminvest Ltd vs CIT, order dt 9-9-2015. The relevant observations are reproduced hereunder:

“18. In the present case, the factual position that has not been disputed is that the investment by the Assessee in the shares of Max India Ltd. is in the form of a strategic investment. Since the business of the Assessee is of holding investments, the interest expenditure must be held to have been incurred for holding and maintaining such investment. The interest expenditure incurred by the 14 J.M. Financial Institutional S.P. Ltd.

Assessee is in relation to such investments which gives rise to income which does not form part of total income.

6.4 The remaining amount of dividend was received on the investment in equity shares, only for an amount of Rs19,90,000/-. Thus, viewed from this angle also, the disallowance made by the AO is not justified. In view of the aforesaid discussion and keeping in mind the facts and circumstances of the case, disallowance made by the AO is reduced to the amount of Rs.7,64,949/-, as was voluntarily offered by the assessee.”

4.3. We have carefully gone through the aforesaid order of the Tribunal. We have also heard both the parties at length on this issue. With the assistance of the learned Counsel, we examined various pages of the paper book. It is noted that during the course of proceedings before the assessing officer, the assessing filed a revised computation sheet of income wherein it offered a voluntary disallowance of Rs 17,93,351/-. With the assistance of the parties, it was noted by us that the 15 J.M. Financial Institutional S.P. Ltd. facts of this year are identical to the facts of the assessment year 2009 – 10. In our considered opinion, the said decision of the Tribunal is squarely applicable on the facts of the case of this year. Therefore, respectfully following the same, we hold that the disallowance could not have been made of an amount more than the amount voluntarily made by the assessee, which was properly justified with facts and figures. Thus, the disallowances is reduced to Rs 17,93,351/-, and the balance amount of disallowance is deleted. As a result, this ground is partly allowed.

Order pronounced in the open court on 27th April, 2016.