Transfer pricing and securities gains: market spread allocation must reflect functions, assets and risks, while FII securities gains follow capital gains treatment.

Transfer pricing for fees linked to marketing fixed income and interest rate derivative products had to reflect the respective functions, assets and risks of the Indian marketer and the associated trading entities; the market spread could not be allocated entirely to the Indian branch merely because the transaction was executed in India. The transfer pricing adjustment was deleted. On gains from transfer of debt securities, the article notes that prior decisions treating a foreign institutional investor's purchase and sale of securities as capital gains, rather than business income, were followed for the year under appeal. The securities gains were therefore assessed as capital gains.

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Issues: (i) Whether the transfer pricing adjustment on fees received for marketing fixed income products and interest rate derivative products was sustainable. (ii) Whether gains from transfer of debt securities were to be assessed as business income or capital gains.

Issue (i): Whether the transfer pricing adjustment on fees received for marketing fixed income products and interest rate derivative products was sustainable.

Analysis: The dispute concerned allocation of market spread between the marketing location in India and the trading associated enterprises under the assessee's global transfer pricing policy. The pricing of the transaction could not be determined by treating the entire market spread as belonging to the Indian branch alone. The functions performed, assets employed and risks assumed by the trader-associated enterprises had to be considered while allocating the commission. The local spread already earned by the marketer was wholly attributable to it, and the remaining market spread could not be fully shifted to the Indian branch merely because the transaction was executed in India.

Conclusion: The transfer pricing adjustment was deleted and the issue was decided in favour of the assessee.

Issue (ii): Whether gains from transfer of debt securities were to be assessed as business income or capital gains.

Analysis: The issue was covered by the assessee's own earlier decisions, which had held that income of a foreign institutional investor from sale and purchase of securities is assessable as capital gains and not as business income. Those decisions had also held that the Indian banking branch did not create taxability of such income as business profits in India on the facts under consideration. The same view had continued to hold the field and was followed for the year under appeal.

Conclusion: The Revenue's challenge failed and the income was to be assessed as capital gains, in favour of the assessee.

Final Conclusion: The assessee succeeded on the transfer pricing issue and the Revenue's appeal failed on the securities gains issue, resulting in a composite outcome in favour of the assessee.

Ratio Decidendi: For allocation of remuneration in a marketing and trading structure, the transfer pricing analysis must reflect the respective functions, assets and risks of the parties, and income from sale and purchase of securities by a foreign institutional investor is taxable as capital gains where binding precedent so holds.

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