Executive Summary
The Mumbai bench of the Income Tax Appellate Tribunal (“the Tribunal”) recently pronounced its ruling in case of Carlyle India Advisors Private Limited (“the taxpayer”), wherein the Tribunal ruled out that the comparable companies selected by the taxpayer cannot be rejected by the Transfer Pricing Officer (“TPO”) without providing any cogent reasons. The Tribunal also observed that the comparables selected by TPO were not functionally comparable, by virtue of being engaged in merchant banking, earning syndication fees, issue management fees, brokerage commission, underwriting fees etc., which are not functionally comparable to investment advisory services.
Facts
The taxpayer is a subsidiary of Carlyle Asia Investment Advisors Limited (“Carlyle Hong Kong”). The taxpayer is engaged in providing investment advisory related support services to Carlyle Hong Kong. In consideration for the said support services provided, the taxpayer is remunerated on an operating cost plus 15% basis.
During the financial year („FY”) 2006-07, the taxpayer adopted Transaction Net Margin Method (“TNMM”) as the most appropriate for benchmarking the international transaction (provision of investment advisory services) entered into with its AE.
In applying the TNMM, the taxpayer identified two comparable companies and computed their arithmetic mean mark-up on cost to be at 14.80% as against its own mark-up of 15.02% and concluded that international transaction was at arm‟s length.
During the assessment proceedings, the taxpayer submitted the single year arithmetic mean of comparable companies selected in the TP study report which worked out to 18.97% as against 15.02% earned by the taxpayer and stated that the same was within the range of +/- 5% of the arithmetic mean.
However, the TPO rejected the transfer pricing analysis of the taxpayer and initially identified a set of 15 comparable companies primarily engaged in providing investment management services with a mean operating profit/operating cost of 42%.
Thereafter, the TPO considered the rejection reasons of the taxpayer and identified an entirely new set of comparable companies with a mean operating profit/operating cost of 81% and made an upward adjustment to the total income of the taxpayer.
Against the order of the TPO, the taxpayer approached the Dispute Resolution Panel (“DRP”). The DRP upheld the transfer pricing adjustment.
The taxpayer being aggrieved by the DRP‟s direction filed an appeal before the Tribunal.
Ruling of the Tribunal
The tribunal observed that:
The TPO has not spelled out as to how the comparable companies selected in the taxpayer‟s TP report were not functionally comparable to the taxpayer.
The TPO has not considered any of the objections raised by the taxpayer with regard to the functional comparability of the comparable companies relied upon by him.
The comparable companies selected by the TPO were not functionally comparable:
‒ Three of the comparable companies viz. Chartered Capital & Investment Ltd, Khandwala Securities Ltd and Sumedha Fiscal Services Ltd selected by the TPO have in fact been rejected by the TPO himself in his initial benchmarking exercise on the grounds of functional incomparability. The TPO has not provided any reasons for the change in his position. Further, based on the reasons provided by the taxpayer the above companies are not functionally comparable in any event.
‒ Some of the comparable companies viz. Centrum Capital Ltd, Edelweiss Capital Ltd, L&T Capital Company Ltd and Keynote Corporate Services Ltd, S.R.E.I Capital Markets Ltd. were not functionally comparable, by virtue of being engaged in merchant banking, portfolio management, mutual fund distribution, earning syndication fees, issue management fees, brokerage commission, underwriting fees etc, which are not functionally comparable to the investment advisory services provided by the taxpayer.
‒ The comparable activity in Keynote Corporate Services Ltd of “equity research” could not be selected as segmental data was not available.
The Tribunal considering the decision of Maersk Global Service Center India Pvt Ltd. held that if the TPO himself does not reject comparable companies of the tax payer on functional incomparability then the revenue cannot later take the plea of incomparability.
Conclusion
In cases of Private Equity advisory and other Financial Services advisory business in India, tax authorities have determined high cost plus mark-ups during recent audits. Contentious issues have been the use of investment banking companies and the rejection of taxpayers‟ comparables selected in the TP report. The above decision by Mumbai tribunal, gives a positive indication that at the Tribunal level, substantial relief could be available on merits.
This decision also highlights the fact that the TPO should give reasons for rejecting the comparable companies used by the taxpayer. Further, the Tribunal has reemphasised the importance of FAR analysis of the tested party and held that the companies selected should be functionally comparable.
Source: Carlyle India Advisors Pvt Ltd vs. Assistant Commissioner of Income Tax (ITA No.7901/MUM/2011) AY 2007-08, Mumbai Bench of the Tribunal dated 4 April 2012
The Mumbai bench of the Income Tax Appellate Tribunal (“the Tribunal”) recently pronounced its ruling in case of Carlyle India Advisors Private Limited (“the taxpayer”), wherein the Tribunal ruled out that the comparable companies selected by the taxpayer cannot be rejected by the Transfer Pricing Officer (“TPO”) without providing any cogent reasons. The Tribunal also observed that the comparables selected by TPO were not functionally comparable, by virtue of being engaged in merchant banking, earning syndication fees, issue management fees, brokerage commission, underwriting fees etc., which are not functionally comparable to investment advisory services.
Facts
The taxpayer is a subsidiary of Carlyle Asia Investment Advisors Limited (“Carlyle Hong Kong”). The taxpayer is engaged in providing investment advisory related support services to Carlyle Hong Kong. In consideration for the said support services provided, the taxpayer is remunerated on an operating cost plus 15% basis.
During the financial year („FY”) 2006-07, the taxpayer adopted Transaction Net Margin Method (“TNMM”) as the most appropriate for benchmarking the international transaction (provision of investment advisory services) entered into with its AE.
In applying the TNMM, the taxpayer identified two comparable companies and computed their arithmetic mean mark-up on cost to be at 14.80% as against its own mark-up of 15.02% and concluded that international transaction was at arm‟s length.
During the assessment proceedings, the taxpayer submitted the single year arithmetic mean of comparable companies selected in the TP study report which worked out to 18.97% as against 15.02% earned by the taxpayer and stated that the same was within the range of +/- 5% of the arithmetic mean.
However, the TPO rejected the transfer pricing analysis of the taxpayer and initially identified a set of 15 comparable companies primarily engaged in providing investment management services with a mean operating profit/operating cost of 42%.
Thereafter, the TPO considered the rejection reasons of the taxpayer and identified an entirely new set of comparable companies with a mean operating profit/operating cost of 81% and made an upward adjustment to the total income of the taxpayer.
Against the order of the TPO, the taxpayer approached the Dispute Resolution Panel (“DRP”). The DRP upheld the transfer pricing adjustment.
The taxpayer being aggrieved by the DRP‟s direction filed an appeal before the Tribunal.
Ruling of the Tribunal
The tribunal observed that:
The TPO has not spelled out as to how the comparable companies selected in the taxpayer‟s TP report were not functionally comparable to the taxpayer.
The TPO has not considered any of the objections raised by the taxpayer with regard to the functional comparability of the comparable companies relied upon by him.
The comparable companies selected by the TPO were not functionally comparable:
‒ Three of the comparable companies viz. Chartered Capital & Investment Ltd, Khandwala Securities Ltd and Sumedha Fiscal Services Ltd selected by the TPO have in fact been rejected by the TPO himself in his initial benchmarking exercise on the grounds of functional incomparability. The TPO has not provided any reasons for the change in his position. Further, based on the reasons provided by the taxpayer the above companies are not functionally comparable in any event.
‒ Some of the comparable companies viz. Centrum Capital Ltd, Edelweiss Capital Ltd, L&T Capital Company Ltd and Keynote Corporate Services Ltd, S.R.E.I Capital Markets Ltd. were not functionally comparable, by virtue of being engaged in merchant banking, portfolio management, mutual fund distribution, earning syndication fees, issue management fees, brokerage commission, underwriting fees etc, which are not functionally comparable to the investment advisory services provided by the taxpayer.
‒ The comparable activity in Keynote Corporate Services Ltd of “equity research” could not be selected as segmental data was not available.
The Tribunal considering the decision of Maersk Global Service Center India Pvt Ltd. held that if the TPO himself does not reject comparable companies of the tax payer on functional incomparability then the revenue cannot later take the plea of incomparability.
Conclusion
In cases of Private Equity advisory and other Financial Services advisory business in India, tax authorities have determined high cost plus mark-ups during recent audits. Contentious issues have been the use of investment banking companies and the rejection of taxpayers‟ comparables selected in the TP report. The above decision by Mumbai tribunal, gives a positive indication that at the Tribunal level, substantial relief could be available on merits.
This decision also highlights the fact that the TPO should give reasons for rejecting the comparable companies used by the taxpayer. Further, the Tribunal has reemphasised the importance of FAR analysis of the tested party and held that the companies selected should be functionally comparable.
Source: Carlyle India Advisors Pvt Ltd vs. Assistant Commissioner of Income Tax (ITA No.7901/MUM/2011) AY 2007-08, Mumbai Bench of the Tribunal dated 4 April 2012
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