Income Tax Appellate Tribunal - Kolkata
Acit, Cir - 2(2), Kolkata, Kolkata vs M/S. Net Guru Ltd., , Kolkata on 23 August, 2019
IN THE INCOME TAX APPELLATE TRIBUNAL "C", BENCH KOLKATA BEFORE SHRI A.T. VARKEY, JM &DR. A.L.SAINI, AM आयकरअपीलसं./ITA No.2162/Kol/2017 ( नधारणवष / Assessment Year:2010-11) ACIT, Circle-2(2), Kolkata Vs. M/s Net Guru Ltd.
E 2-4, Block-GP, Sector-V, Salt Lake City, Kolkata-700091 थायीले खासं . /जीआइआरसं . /PAN/GIR No.: AABCR 5109 B (Assessee) .. (Revenue) Assesseeby:Shri Sanjoy Paul, Addl. CIT DR Respondent by :Smt. Rituparna Sinha, ACA सुनवाईक तार ख/ Date of Hearing : 13/06/2019 घोषणाक तार ख/Date of Pronouncement : 23/08/2019 आदे श / O R D E R Per Dr. A. L. Saini:
The captioned appeal filed by the Revenue, pertaining to assessment year 2010-11,is directed against the fair assessment order passed by the Assessing Officer u/s 143(3) /144Cof the Income Tax Act, 1961 (in short the 'Act') which incorporates the findings of the Transfer Pricing Officer (TPO) u/s 92CA(3) of the Income Tax Act, dated 23.01.2014.
2. The brief facts qua the assessee company are as follows: The assessee company, Net Guru Limited, is an Indian subsidiary of Netguru Inc. USA (hereinafter referred to as 'associated enterprise' or 'AE'). During the financial year ended 31st March, 2010, the assessee company generated revenue from sale of products and services amounting to INR 50,412,721/-. The assessee company entered into international transactions with its AE ( i.e. controlled transactions) which involved receipts of INR 1,77,88,045/- the components of which are stated below:
M/s Net Guru. Ltd.ITA No.2162/ Kol/2017
Assessment Year:2010-11 Sales to AE Nature of International Transaction Amount Percent-
Received, or age to
receivable AE sales
(INR)
Provision of software development 1,76,53,360 99.24%
services to AE
Provision of engineering design 1,34,685 0.76%
services to Gulf Lime, LLC
(unrelated customer in the overseas
market) through AE
Total 1,77,88,045
The arm's length price of the international transactions representing software services provided to the associated enterprises (AE) is determined by applying transactional net margin method (TNMM), stating to be the most appropriate method. The operating profit to operating cost ratio is taken as the profit level indicator (PLI) in TNMM analysis. The PLI of the company is arrived at 37.68% (based on segmentation made on controlled and uncontrolled transaction) on cost whereas the overage PLI of the comparables is arrived at 23.45% as per the analysis in the TP document. As the price charged in its international transactions was higher than the arithmetical mean price, the price charged in the international transactions was treated at arm's length price (ALP) by the assessee. The assessee`s detailed break-up of the revenue earned from unrelated customers in the domestic market (uncontrolled transactions) during the financial year ended 31st March, 2010, are as follows:
Domestic Sales Sl Particulars Amount in Percentage No. INR to domestic sales
1. Engineering 3,07,66,147 94.30% design & drawing services (drawing consultancy charges)
2. Charges for (i) 8,75,250 2.68% development of websites and (ii) annual maintenance of Pa g e | 2 M/s Net Guru. Ltd.ITA No.2162/ Kol/2017
Assessment Year:2010-11 web sites
3. Sale of software 5,74,038 1.76% products developed by the assessee company
4. Charges for gift- 2,39,259 0.73% online facility (supply of perishable commodities)
5. System 88,168 0.27% integration charges (annual maintenance contract for computer, printer, network, server, router, modem with resident engineers at various locations)
6. Digital media sales 42,440 0.13% (Service charge for training imparted by the assessee company to a customer for 'Pro-active' software sold by the assessee company to the said customer)
7. Studio sales (video 35,810 0.11% editing)
8. CD Sales 3,564 0.01% Total 3,26,24,676 In the Transfer Pricing Study report (hereinafter referred to as the 'TPSR' the assessee company selected the Transactional Net Margin Method (hereinafter referred to as 'TNMM') as the most appropriate method for determining the arm's length nature of the international transaction under consideration. For the purpose of application of the TNMM, the assessee company prepared a segment reporting that disclosed two separate segments viz., (l)'Transactions with Net Guru Inc. USA' and (2) 'Transactions with independent customers from separate functions'. The first segment disclosed the revenue generated from AE and the corresponding cost allocation, whi1e the second segment disclosed the revenue generated from independent/unrelated domestic customers by performing separate functions and the corresponding cost allocation.
3. The said segment report (enclosed in page no.124 to 126 of the paper book) was duly verified and certified by the independent Statutory Auditor of the assessee Pa g e | 3 M/s Net Guru. Ltd.
ITA No.2162/ Kol/2017Assessment Year:2010-11 company. The said 'Auditor's Certificate' along with annexure containing the segment reporting referred to hereinabove were duly signed by the independent Statutory Auditor of the assessee company on 11th August, 2010, having been the same date as that at which the 'Auditors' Report to the Members of NetGuru Limited', 'Balance Sheet as at 31st March, 2010' and 'Profit & Loss Account for the year ended 31st March, 2010' were signed by the same auditor as aforesaid.The assessee company incorporated the financial information contained in the segment reporting in its Transfer Pricing Study Report (TPSR) along with notes in support of segment working. The assessee company submitted the 'TPSR' and a copy of the auditor's certificate (including segment reporting being enclosed to the certificate as its annexure) to the TPO during the course of proceedings under section 92CA(3) of the Income-tax Act,1961. In the 'TPSR', the net profit indicator of the assessee company (cash profit margin on cost)was worked at 37.68%, whereas the arithmetic mean of the net profit indicators of the comparable companies selected from public domain was worked at 23.45%. In view of the above computation, the assessee company concluded that the international transaction under consideration was at arm's length under the Transactional Net Margin Method (TNMM).
4.During the TPO proceedings, the comparable companies selected by the assessee were as follows:
i) Akshay Software Technologies Ltd.
ii) Avani Cimcon Technologies Ltd.
iii) CTIL Ltd.
iv) CAT Technologies Ltd.
v) Cherrytec Intellisolve Ltd.
vi) Cignity Technologies Ltd.
vii) E-infochips Ltd.
viii) En Pointe Technologies Ltd.
ix) Green Fire Agri Commodities Ltd.
x) ICRA Techno analytics Ltd.
xi) Indium Software India Ltd.
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Assessment Year:2010-11
xii) Kals Information System Ltd.
xiii) Kireeti Soft Technologies Ltd.
xiv) Manipal Digital Systems P Ltd.
xv) Persistent Systems & solutions Ltd.
xvi) Secure Earth Technologies Ltd.
5. The ld. Transfer Pricing Officer rejected most of the comparables selected by the assessee company and selected its own comparables. The ld. TPO also analyzed the comparable company selected by the company and he has mentioned the reasons for rejection of the comparables selected by the assessee. The detailed finding of the TPO about acceptance and rejection of the comparables selected by the assessee are as follows:
Pa g e | 5 M/s Net Guru. Ltd.ITA No.2162/ Kol/2017
Assessment Year:2010-11
6. Having rejected some of the comparables selected by assessee, the TPO made a final list of comparables selected by him along with PLI (OP / TC) which is as follows:
The TPO also rejected the segment reporting of the assessee and applied the TNMM at the entity level.Thereafter, the ld. TPO computed the arm's length price Pa g e | 6 M/s Net Guru. Ltd.ITA No.2162/ Kol/2017
Assessment Year:2010-11 adjustment taking into account the PLI of the comparables selected by him (that is, 40.34% computed above) which is given below:
Percentage of transaction with related party and unrelated is calculated as under:
The arithmetic mean of the PLI is taken as the arm's length margin. Based on this, the arm's length price of the software development services segment rendered by the taxpayer to its AE(s) is computed as under:
Average PLI of Comparable 40.34%
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Assessment Year:2010-11
This way the ld. TPO worked out the transfer pricing adjustment to the tune of Rs. 1,16,82,709/-.
7. Aggrieved by the order of the ld. TPO / A.O. the assessee carried the matter in appeal before the ld. CIT(A) who has deleted the addition made by the transfer pricing officer. Aggrieved by the order of the ld. CIT(A), the Revenue is in appeal before us and raised the following revised grounds of appeal:
1. That in the facts and circumstances of the case, the Ld. CIT(A) has erred in law by deleting an adjustment of Rs.1,16,82,709/-, of international transaction of the assessee with its associated enterprise ('AE').
2. That in the facts and circumstances of the case, the Ld. CIT(A) has erred in accepting the segmental profitability statement of the assessee because of the following reasons:
a) Segmental profitability statement same is not a part of the audited financial / statement.
b) Now working notes was provided in support of the segmental profitability.
c) The cost allocation has been done without any proper allocation keys.
3. That in the facts and circumstances of the case, the Ld. CIT(A) has erred in rejecting companies accepted by the Ld. TPO even though those companies are functionally not comparable to the assessee.
4. That on the facts and in the circumstances of the case, the Ld. CIT(A) has erred in accepting Cherrytec Intelisove ltd, Cigniti Technologies Ltd. and Secure Earth Technologies Ltd., even though these companies fails the forex filter applied by the Ld. TPO.
5. That on the facts and in the circumstances of the case, the Ld. CIT(A) has erred in accepting Kireeti Soft Technologies Ltd. even though it failed the employee cost filter applied by the Ld. TPO.
6. That on the facts and in the circumstances of the case, the Ld. CIT(A) has erred in accepting Akshay Software Technologies Ltd. even though it is functionally dissimilar to that of the assessee.
7. That on the facts and in the circumstances of the case, the Ld.CIT(A) has erred in accepting AvaniCimcon Technologies Ltd., even though the cost base of the company is insignificant and with a small variation in profit, the impact in the profit margin will be very significant.
8. That on the facts and in the circumstances of the case, the Ld.CIT(A) has erred in accepting CAT Technologies Ltd., even though the related party transaction details are not available.
9. That on the facts and in the circumstances of the case, the Ld. CIT(A) has erred in selecting cash profit over sales even though the assessee is not a capital intensive Pa g e | 8 M/s Net Guru. Ltd.
ITA No.2162/ Kol/2017Assessment Year:2010-11 industry and as per the Income Tax Act,1962 net profit realised needs to be compared.
10. Without prejudice to above grounds, the assessee craves leave to add to and to alter, amend, rescind or modify the ground raised hereinabove before or at the time of hearing of the appeal.
Now we shall take these grounds of appeal one by one.
8. Ground No. 1 raised by the Revenue is general in nature therefore, it does not require adjudication.
9. In ground No. 2, the Revenue has challenged the Segmental Report of the assessee. Ground No.2 is reproduced below:
"That in the facts and circumstances of the case, the Ld. CIT(A) has erred in accepting the segmental profitability statement of the assessee because of the following reasons:
a) Segmental profitability statement is not a part of the audited financial / statement.
b) Now working notes was provided in support of the segmental profitability.
c) The cost allocation has been done without any proper allocation keys.
10. Brief facts qua the issue are that during the TPO proceedings, the ld. TPO asked the assessee to submit the segmental information and data. In response to that the assessee submitted the information about segmental data, which is reproduced below:
"......the income from software development activities constitutes 99.24% of the aggregate value of the controlled transactions. Therefore, the assessee has benchmarked the controlled transactions by selecting comparable companies engaged in software development activities. On the other hand, the uncontrolled domestic transactions involve a large variety of activities the main component whereof is receipt of drawing consultancy charges. The income from software development activities (INR 5,74,038.00) constitutes 1.76% of the aggregate value of uncontrolled transactions.
In view of the above, your kind self may please appreciate that in the instant case, the uncontrolled domestic transactions undertaken by the assessee are largely varied in nature. The comparable companies selected by your kind self (as mentioned in page no. 75 of the aforesaid notice) are engaged in software development activities. The functions performed by them do not cover the range of functions performed by the assessee on overall basis. The functional profiles of the comparable companies selected by your kind self do not conform to the functional profile of the assessee on overall basis. Hence, the computation of profit level indicator [OP/TC: (-) 15.30% and OP/OR: Q 18.07% on overall basis under the Transactional Net Margin Method goes against the basic principle of comparability analysis undertaken in transfer pricing...."
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11. However, the ld. TPO, having gone through the segmental information provided by the assessee has rejected the segmental information/data of the assessee, observing the following:
"The submission of the assessee were perused, however the TPO has no dispute regarding the use of segmental data for benchmarking the international transaction. The dispute is regarding the veracity of the data segmental produced by the assessee. The points to be noted is that • Segmental produced is not part of the audited financial account adopted by the members.
• Simply producing the certificate for making segmental from auditor without any backing of workings notes of auditor cannot be relied upon.
• Under which provision of which Act the auditor has given a certificate of segment reporting is not clear. The different provisions of different Act has cast a responsibility on chartered account. Thus under the Companies (Auditor's Report Order,2003, as audited by the companies Auditor's Report Amendment Order, 2004 (together the Order) issued by the Government of India in terms of section 227(4A) of the Companies Act 1956, the auditor has audited the financial accounts of company and given his report together with schedule 1 to 15. Nowhere in the report has the auditor given segment reporting. Now, the same has been produced by the A/R of the assessee without the authentication of the directors or under the seal of the company. Hence, the veracity of the same cannot be relied upon.
• The assessee has not produced the details of Project value, Total Man hour worked by the employee in each project and the total resource utilized, the stages of project development and the employee utilized.
• The assessee in its 3CEB report has mentioned that it has urged Cost Plus method for benchmarking the transaction, but when the case is referred to TPO the assessee in its transfer pricing report has used TNMM method.
• The assessee submitted that the uncontrolled domestic transaction are largely varied innature but the same time given a statistics that 99.24% of such transaction is drawing and Consultancy charges. However, it is to state here that the software development activities and software consultancy are one and the same and is classified under information technology sector.
• From the segment report submitted when the per employee cost is calculated it is found that for controlled transaction the per employee cost per month is Rs 26,159/- while that for uncontrolled transaction the per employee cost is Rs 15,025/-. This gives an indication that the number of employees of the company on the basis of which cost allocation have been not constant but variable and that the employees were not working in water tight projects but they were working in different projects. This argument find credence form the ledger of drawing Consultancy charges submitted by the assessee. One of the employee, Mr. Soumen kanti Roy who is said to be working in Gulf Lime LLC has also been employed in the uncontrolled project viz services Page | 10 M/s Net Guru. Ltd.
ITA No.2162/ Kol/2017Assessment Year:2010-11 provided to the Wesmann Engg Co Pvt Ltd dated 8.4.2009 to 9.04.2009, B.K Engg Project Corporation (Plate and Cool Bed) Sales dated 05.06.2009 to 07.06.2009.
• Gross Profit to sales of controlled and Uncontrolled transaction also points towards shifting of cost to Uncontrolled transaction Thus G.P of controlled transaction is 33.58% while that of uncontrolled transaction is (-)0.92%. This finds credence from the allocation of entire workman and staff welfare expenses of Rs.24,48,671/- to uncontrolled transaction.
• Regarding the reliance of the assessee on the case law it is to state here that the facts of the case relied upon by the assessee are different. Moreover, regarding the rejection of Segment reporting the facts as pointed above were not pointed in the cases referred to by the assessee."
12. Aggrieved, by the stand so taken by the TPO/AO, the assessee carried the matter in appeal before the ld CIT(A), who has accepted the segmental report of the assessee. Aggrieved by the order of the ld CIT(A), the Revenue is in appeal before us.
13. Ld DR for the Revenue vehemently argued before us that Ld. CIT(A) has grossly erred in accepting the segmental profitability statement of the assessee. The DR pointed out that the segmental profitability statement is not a part of the audited financial statement therefore it must be rejected. During the TPO proceedings the working notes was provided by the assessee in support of the segmental profitability which is not sufficient. He further pointed out that the cost allocation has been done without any proper allocation key therefore, segment report prepared by the assessee is based on arbitrary exercise and hence it should not be relied.
14. On the other hand, Ms. Rituparna Sinha, ld Counsel for the assessee argued that first of all there is no requirement to get the segment report audited separately. However, the assessee has taken a lot of precaution from his side and produced a segment report, duly verified and certified by the Statutory Auditor of the assessee, in its Transfer Pricing Documentation Report ( vide paper book page no.
24) and duly submitted to the TPO during the course of hearing. Proper allocation key has been mentioned in the segment report prepared by the assessee. However, the TPO rejected the aforementioned segment reporting and computed the net Page | 11 M/s Net Guru. Ltd.
ITA No.2162/ Kol/2017Assessment Year:2010-11 profit indicator / profit level indicator of the assessee (i.e. OP / TC) at (-) 15.30% on aggregate basis (i.e. profit level indicator at enterprise level considering international transactions as well as domestic transactions). The TPO computed the arithmetic mean of the profit level indicators of the comparable companies at 37.18% in the letter No. DDIT (TPO-III)/KOL/NL/92CA(1)/2013-14/77, dated 06.01.2014 and subsequently at 40.34% in the order dated 23/01/2014 u/s 92CA(3) of the Act. Based on the computation made in the aforesaid order, the Transfer Pricing officer recommended an adjustment to income amounting to INR 1,16,82,709/- which is not acceptable.
15. We have heard both the parties and perused the material available on record. We note that during the financial year ended 31st March, 2010, the assessee generated revenue from sales and services amounting to INR 50,412,721/- from a large variety of activities which are briefly described below:
The assessee selected and applied the Transactional Net Margin Method for determining the arm's length price of the aforesaid international transactions amounting to INR 1,77,88,045/- under section 92C of the Act read with Rule 10B of the Income Tax Rules,1962 (hereinafter referred to as the Rules). For this purpose, the assessee was selected as tested party. The assessee produced a segment reporting, duly verified and certified by the Statutory Auditor of the Page | 12 M/s Net Guru. Ltd.ITA No.2162/ Kol/2017
Assessment Year:2010-11 assessee, in its Transfer Pricing Documentation Report (pb no. 24) filed with the TPO during the course of hearing for the assessment year 2010-11 which is given below:
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Assessment Year:2010-11
i) Controlled Transactions means revenue from international transactions with AE u/s 92B of the Act and allocable cost. 'Uncontrolled Transactions' means revenue from transactions with unrelated customers (domestic transactions) and allocable cost.
ii) The total manpower of the assessee for the F.Y. 2009-10 was 154, out of it, manpower used for controlled transactions during the relevant financial year stood at 21. The balance manpower i.e. 133 persons were used for uncontrolled transactions.
iii) The total area of office of the assessee for the F.Y. 2009-10 was 42,000 sq. ft, out of it, the area used for the division engaged in controlled transactions was 600 sq. ft.
iv) The following expenses were attributable exclusively to the uncontrolled transactions and hence, were not allocated to controlled transactions:
• Advertisement and sales promotion expenses • Late delivery deduction • Recruitment expenses • Registration expenses • Seminar expenses • Permission fee
v) The following expenses were non-operating expenses and therefore, not considered for the computation of net profit indicators:
• Foreign Exchange fluctuation loss • Bank charge • Interest • Provision for depreciation • Advances written off The net profit indicator (Return on Total Cost) for the controlled transactions was worked at 37.68%, whereas the arithmetic mean of the net profit indicators of comparable companies selected from public domain was worked at 23.45%. It indicated that the international transactions undertaken by the assessee during the Page | 14 M/s Net Guru. Ltd.ITA No.2162/ Kol/2017
Assessment Year:2010-11 financial year ended 31st March, 2010, adhered to the arm's length standard prescribed by the Indian Transfer Pricing Regulations. This way, ld Counsel for the assessee submitted before the Bench that the assessee has submitted a detailed working of Segment Report before the ld TPO, as mentioned above, therefore, the allegation of the Ld DR that assessee does not have proper segmental report, is baseless.
16. We note that the first grievance of the ld DR for the Revenue is that the segment profitability was not part of the audited financial statements of the assessee company. It is pertinent to note that the dispute arising from this segment reporting issue has already been adjudicated by the Coordinate Bench of ITAT in assessee`s own case, vide ITA No. 1799/Kol/2018, order dated 24.04.2019, wherein it was held as follows:
"11. We have heard both the parties and perused the material available on record, we note that in ground No.1, the Revenue alleged that the segment reporting was prepared by the assessee company without having regard to the nature of business. According to them, had the segment reporting been prepared having regard to the nature of business, the segment reporting ought to have been part of the audited accounts considering the difference in the risk and returns of the two segments as claimed by the assessee company. So, the contention of the Revenue was that the Ld. CIT(A) erred in accepting the segment reporting prepared by the assessee company. We note that it is an undisputed fact that the assessee company belongs to the category of 'Small and Medium Sized Companies'. As a consequence, the Accounting Standard(AS)-17 is not mandatory for the assessee company. That is why, the assessee company has not disclosed segment reporting in the audited financial statements for the relevant financial year. However, it is pertinent to note that the assessee company submitted segment reporting to the Ld TPO solely for the purpose of application of the TNMM. We note that Coordinate Bench Delhi Tribunal in the matter of GSR Technology (India) (P.) Ltd vs. AGIT reported in [2018] 90 taxmann.com 85 (Delhi - Trib.), has examined the issue as to whether the TPO/DRP erred in disregarding the segmental information provided by the taxpayer for the reason that the same was not an audited one. ln this connection, the Coordinate Bench on the decision of the Coordinate Bench Chennai in the matter of Honeywell Electrical Devices & Systems India Ltd. v. Asstt. CIT reported in [2014] 42 taxmann.com 223/64 SOT 118 (Chennai - Trib.) wherein the Chennai Tribunal, placing reliance on the decision rendered in the matter of 3i Infotec Ltd. v. ITO reported in [2013] 35 txmann.com 582 (Chennai - Trib), held that even if such segmental results were not shown in the audited financial accounts, they had to be accepted. The Coordinate Bench in the matter of Infotec Ltd. v. ITO (supra) held that there was no legal requirement that the segment wise working submitted before the TPO should have been audited by the Assessee's Chartered Accountant. The Coordinate Bench Delhi Tribunal further placed reliance on the decision rendered in the matter of Lummus Technology Heat Page | 15 M/s Net Guru. Ltd.ITA No.2162/ Kol/2017
Assessment Year:2010-11 Transfer BV v. Dy. CIT reported in [2014] 42 taxmann.com 342/64 SOT 47 (URO) (Delhi - Trib) wherein it was held that segmental results could not be rejected on the ground that the same was not audited. The TPO/DRP was required to examine the segmental results if the same were maintained in the ordinary course of business. On perusal of, inter alia, the aforesaid decisions, the Coordinate Bench Delhi in the matter of CSR Technology (India) (P.) Ltd vs. ACIT (supra) held that the AO/TPO/DRP erred in disregarding the segmental result of the taxpayer by proceeding to consider the margin of the taxpayer at the entity level for the transfer pricing analysis.
In view of above judgments of coordinate benches, we note that there was valid reason for non-disclosure of segment reporting in the audited accounts of the assessee company and submission of segment reporting before the TPO. Therefore, the allegation made by the Revenue in this regard needs to be rejected.
12. So far nature of business is concerned, we note that the assessee company was primarily engaged in seven different types of revenue- generating functions such as
(i) provision of software development services to AE, (ii) provision of engineering services to unrelated domestic customers, (iii) CD sales to unrelated domestic customers, (iv) sale of software products to unrelated domestic customers, (v) digital media sales to unrelated domestic customers, (vi) website development for unrelated domestic customers and (vii) provision of 'Gift Online' services to unrelated domestic customers. The seven different types of business activities had diverse risk and return portfolios. It may be noted that the Management of the assessee company prepared the segment reporting exclusively for the purpose of application of the TNMM in relation to the international transaction involving charges received/receivable by the assessee company for provision of software development services to AE. In the segment reporting, one segment disclosed revenue received/receivable by the assessee company from its AE [which would fall under category (i) of the aforesaid activities] and associated costs, while the other segment disclosed revenue received/receivable by the assessee company from unrelated domestic customers [which would fall under category (ii) to category (vii) of the aforesaid activities] and associated costs. Based on the segment reporting, the assessee company computed the net profit indicator arising from the international transaction under consideration and thereafter, compared the net profit indicator of the company with the arithmetic mean of the net profit indicators of the comparable companies under the TNMM for the purpose of demonstrating that the international transaction under consideration was at arm's length under the TNMM.
We note that had the assessee company prepared segment reporting having regard to the nature of business, there would have been seven business segments for seven different types of revenue-generating business functions. However, as the sole objective of preparation of segment report was to compute the net profit indicator arising from the international transaction under consideration.Theassessee company disclosed only two segments viz., AE transaction segment and non-AE transaction segment ('non-AE' means unrelated customers). We note that Coordinate Bench of ITAT Chennai in the matter of 3i-Infotech Ltd vs. ITO (supra), held that the assessee prepared segment-wise Profit and Loss Account in respect of its transactions with AE and transactions with others and claimed that it has earned profit of 34.17% of the cost in respect of AE transactions and incurred loss of 60.30% of cost in respect of transactions with non-AEs. The TPO rejected the above working of the assessee. The Tribunal held that the lower authorities Page | 16 M/s Net Guru. Ltd.
ITA No.2162/ Kol/2017Assessment Year:2010-11 were not justified in not excluding profit or loss in respect of domestic transactions for determining the profit declared by the assessee in respect of AE transactions. The Tribunal further held that the lower authorities were not justified in adopting the profit level achieved by the assessee in respect of all its transactions including domestic transactions as the profit level declared in respect of AE transactions. The Tribunal, noted that the rate of profit achieved in other comparable cases were to be compared with profit level declared by the assessee in respect of its AE transactions after excluding domestic transactions. Therefore, on comparing the same, the Tribunal held that the profit level declared by the assessee in respect of its AE transactions was more than the profit level in respect of comparable cases found by the TPO. In the above circumstances, in the considered view of the Tribunal, the lower authorities were not justified in making addition to the income of the assessee. The Tribunal deleted the addition and allowed the ground of appeal of the assessee.
13. We note that the Coordinate Bench of ITAT, Pune in the matter of Tieto IT Services India (P.) Ltd vs. DCIT reported in [2018] 92 taxmann.com 8 (Pune - Trib.) observed that the TPO directed transfer pricing adjustment made in the hands of the assessee by disregarding segmental information pertaining to transactions with associated enterprises and the transactions with third party i.e. non-associated enterprises business. The assessee was aggrieved by the order of Assessing Officer/Dispute Resolution Panel (DRP) in considering the operating margins of the assessee at an entity level while determining the arm's length price of international transactions as against the segmental information pertaining to associated enterprises business filed by the assessee. The Tribunal held that while benchmarking international transactions of provision of services to Tieto Group Companies by the assessee, the segmental details of AE segment need to be applied and not the results at entity level are to be applied. The Tribunal reversed the order of Assessing officer/TPO in applying the margins at entity level and directed the Assessing Officer to accept margins shown in segmental profitability of AE segment by the assessee. In view of the above, it is to be noted that the segment report prepared by the assessee company disclosing AE segment and non-AE segment draws support from the decisions of the Coordinate Benches and hence, the allegation made by the Revenue that the assessee company prepared the segment reporting without having regard to the nature of business, has no valid basis and the same should be rejected.
14. We note that at this juncture it is relevant to quote the provision of clause (e) of sub-rule (1) of rule 10B of the Income Tax Rules, 1962 (hereinafter referred to as the 'Rules') which inter alia read as under:
"10B. (1) For the purpose of sub-section (2) of section 92C, the arm's length price relation to an international transaction [or a specified domestic transaction] shall be determined by any of the following methods, being the most appropriate method, in the following manner, namely :-
e) transactional net margin method by which -
(i) the net profit margin realized by the enterprise from an international transaction [or a specified domestic transaction] entered into with an associated enterprise is computed in relation to costs incurred or sales effected or assets employed or to be employed by the enterprise or having regard to any other relevant base;
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(ii) the net profit margin realized by the enterprise or by an unrelated enterprise from a comparable uncontrolled transaction or a number of such transactions is computed having regard to the same base;
(iii) the net profit margin referred to in sub-clause (ii) arising in comparable uncontrolled transactions is adjusted to take into account the differences, if any, between the international transaction [or the specified domestic transaction] and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect the amount of net profit margin in the open market;
(iv) the net profit margin realized by the enterprise and referred to in sub-clause
(i) is established to be the same as the net profit margin referred to in sub-clause
(iii);
(v) the net profit margin thus established is then taken into account to arrive at an arm's length price in relation to the international transaction [or the specified domestic transaction."
We note that the mandate in clause (e) of sub-rule (1) of rule 10B of the Rules is to determine the net profit margin realized by the taxpayer from an international transaction and thereafter compare the same with net profit margin realized by the enterprise or by an unrelated enterprise from a comparable uncontrolled transaction or a number of such transactions after making appropriate adjustments, if required. We note that in compliance with the aforesaid provision, the assessee company computed the net profit indicator arising solely from the international transaction under consideration based on the segment report duly verified and certified by the independent Statutory Auditor and thereafter compared the same with the arithmetic mean of the net profit indicators of comparable companies. The TPO, however, computed the net profit indicator of the assessee company arising at the entity level from all the seven different types of revenue generating transactions taken together. The aforesaid revenue-generating transactions included controlled transaction as well as six different types of uncontrolled transactions with varied risks and returns. On perusal of the provision of law, we note that the aforesaid action of the TPO goes against the basic tenet of Indian Transfer Pricing Laws. Hence, the ALP adjustment made by the TPO/AO is not justified.
15. We note that the Coordinate Bench of ITAT Kolkata in the matter of Deputy Commissioner of Income-tax v. J.J. Exporters Ltd. reported in [2017] 82 taxmann.com 8 (Kolkata-Trib.), wherein the Tribunal inter alia held as follows:
"It is clear from the statutory provisions especially Rule 10B(e) (i) to (iii) that it is only the international transaction that has to be compared with uncontrolled transaction and not the transaction undertaken by the entity as a whole. Hon'ble Mumbai ITAT in the case of UCB India (P) Ltd. (supra) had held that section 92C read with Rule 10B(I)(e) deals with the Transactions Net Margin Method and it refers to only net profit margin realized by an enterprise from an international transaction or a class of such transactions but not operating margins of enterprises as whole. This view was re-iterated by the Coordinate Bench Mumbai in the case of TejDiam (supra) and wherein tribunal held that the margin of the Page | 18 M/s Net Guru. Ltd.ITA No.2162/ Kol/2017
Assessment Year:2010-11 international transaction can only be compared with uncontrolled transaction and not otherwise."
In the light of the aforesaid decisions, we note that while determining the arm's length nature of the international transaction under the TNMM, the TPO erred in adopting the entity level TNMM approach because the assessee company had undertaken broadly seven different types of revenue generating transactions with varied risks and returns and the provision of software development service to AE was only one of them. The assessee company correctly prepared the segment reporting for the purpose of computing net profit indicator that arose solely from the international transaction under consideration and applied the TNMM only in respect thereof. Hence, we accept the ALP analysis undertaken by the assessee company under the TNMM based on the segment report submitted by the assessee company to the TPO which is duly verified and certified by the independent Statutory Auditor of the assessee company. Therefore, we are of the view that the erroneous benchmarking approach adopted by the TPO needs to be rejected, and therefore, the ground No.1 raised by the Revenue is dismissed."
17. The second grievance of the Ld DR is that no working note was provided by the assessee company in support of the segment profitability. We note that assessee has provided proper working note in support of the segment profitability, as pointed out above. In this connection, attention is invited to page no. 102, 103 and 104 of the paper book, which form part of the transfer pricing study report ('TPSR') of the assessee company kept and maintained under section 92D of the Income-tax Act, 1961,read with rule 10D of the Income-tax Rules, 1962. The assessee company submitted the aforesaid 'TPSR' to the TPO during the course of assessment proceedings under section 92CA of the Income-tax Act,1961.In the aforesaid pages, the assessee company furnished the segment report and detailed notes in support of the segment working for the understanding of the TPO.
18.The third grievance of Ld DR is that the cost allocation was done without any proper allocation keys. We note that assessee submitted segment report vide paper book page no. 125 and 126, wherein assessee has enclosed a copy of the segment report duly verified and certified by the auditor. The bases of allocation of costs are demonstrated in the fifth column of the segment report. We note that as mentioned in the segment report, such expenses as cost of software products (INR 94,35,985/-), cost of other activities (INR 3,53,03,374/-), travelling & conveyance (INR 6,85,714/-),advertisement & sales promotion Page | 19 M/s Net Guru. Ltd.
ITA No.2162/ Kol/2017Assessment Year:2010-11 expenses (INR1,15,654/-), late delivery deduction (INR 13,202/-), recruitment expenses (INR 55,128/ -), registration fee (INR 8,863), seminar expenses (INR 450/-) and permission fees (INR1,88,788/-) were allocated/charged on actual basis. We note that the statutory auditor of the assessee company verified and certified in the aforesaid report that out of the total usable area of 42000 square feet, the AE-sales segment used an area of 600 square feet whereas the domestic sales segment used an area of 41,400 square feet. As mentioned in the segment report,electricity charge (INR 15,98,142) was allocated to the aforesaid segments on the basis of area used by the respective segments.
We note that on these identical issues, the coordinate Bench of ITAT Mumbai in the matter of Deputy Commissioner of Income-tax vs. Indo American Jewellery Ltd reported in [2010] 41 SOT 1 (MUM.), ( in this case the assessee had adopted TNM method) held as follows:
"The split financials (i.e. segment report) provided by the assessee was rejected by the TPO on the ground that in allocation of manufacture expenses like employees' remuneration, rent, etc., the allocation key used was sales whereas according to the TPO, the ideal allocation key in the instant case could have been - number of employees, space utilised, etc."
It may be noted that space utilised can be selected as an appropriate allocation key for the purpose of allocation of rent because the amount of rent depends on the area used by the tenant and the rent per square feet. Similarly, the electricity consumption in an office and the amount of electricity charge depend on the area covered and price per unit of electricity. In view of this, the assessee company, in the instant case, selected area / space as an appropriate allocation key for dividing the electricity charges between the respective segments. In view of this, we note that there is proper allocation key and the statutory auditor verified and certified in the segment report that out of the total number of employees (154 persons), the AE-sales segment used 21 employees whereas the domestic sales segment used 133 employees. All the remaining allocable expenses were divided between two segments on the basis of manpower used by the respective segments.
Pa g e | 2 0 M/s Net Guru. Ltd.
ITA No.2162/ Kol/2017Assessment Year:2010-11 On the identical facts the Coordinate Bench of Bangalore Tribunal in the matter of Cisco Systems (India) (P.)Ltd v. Deputy Commissioner of Income-tax, Circle 11 (2), Bangalore reported in [2014] 50 taxrnann.com 280 (Bangalore - Trib.), held as follows:
"In the aforesaid case, the business segments of the assessee are such as:
Software Development Services Segment, Marketing Support Services Segment, Product Replacement Services Segment Administrative and Other Support Services Segment. The direct costs/expenses relatable to the specific segment(s) are accounted as costs/expenses relating to such specific segment(s). In relation to costs/expenses which cannot be directly identified with the segments are allocated on the basis of the head count of personnel employed in these segments. The AO has reallocated the common expenses on the basis of the revenue (turnover) of each of the business segments. Further, the AO has opined that the revenue method has been held to be much superior to the head count method in as much as it takes care of all issues and revenue generating activity including asset base, marketing effort, complexity of the business, value creation and profitability of each individual segments of the business of the Assessee. The DRP confirmed the action of the TPO/AO. However, in this connection, the Hon'ble Bangalore Tribunal, placing reliance on the decision of the Hon'ble Delhi High Court in the case of Commissioner of Income-tax v. EHPT India (P.) Ltd. reported in 16 taxrnann.com, 305 [Del.], confirmed the use of headcount as an appropriate basis for allocating cost in service industry."
19. We note that in the instant case the assessee provided software development services to the AE generating revenue which constituted 99.24% of total AE- sales. The assessee rendered a large variety of services to non-AEs such as drawing consultancy services (generating revenue which constituted 94.30% of the total non-AE sales), annual maintenance of website, annual maintenance contract for hardware, video editing and hiring of camera equipment, CD sales, digital media sales, charges for gift online etc., among other services. Since the services rendered by the assessee to the AE are different from the services rendered by the assessee to non-AEs, the assessee determined the arm's length nature of the international transaction under the TNMM based on segmental accounts duly certified and verified by the independent statutory auditor of the assessee dated 11th August 2010 (date of signature of annual financial statements). In the aforesaid segmental accounts, one segment is 'Sales to AE and associated expenses' and the other segment is 'Sales to Non-AEs and associated expenses'.
Pa g e | 2 1 M/s Net Guru. Ltd.
ITA No.2162/ Kol/2017Assessment Year:2010-11 We note that Ld. TPO rejected the segmental accounts and the arm's length analysis undertaken by the assessee based on the segmental accounts under the transaction-by-transaction approach, primarily based on the allegation that the segmental accounts had not formed part of audit report and hence, the same was not reliable. We note that that the Coordinate Benches of ITAT, as explained above, have accepted segmental accounts for the purpose of arm's length analysis of international transactions under the TNMM where the functions performed by the assessee under the AE-segment are different from the functions performed by the assessee under the non-AE segment, though the segmental accounts do not form part of the audit report. Having regard to the nature of functions performed by the assessee under the AE segment and the non-AE segment respectively and the relevant decisions of the Coordinate Benches of ITAT in this regard (as mentioned hereinabove), we are inclined to accept the segmental accounts used by the assessee for determination of the arm's length price of the international transaction under consideration under the TNMM on transaction-by- transaction basis. That being so, we decline to interfere with the order of Id. C.I T.(A) in accepting the segment report and hence the ground of appeal of the Revenue is dismissed.
20. Ground No. 3 raised by the Revenue reads as follows:
"That in the facts and circumstances of the case, the Ld. CIT(A) has erred in rejecting companies accepted by the Ld. TPO even though those companies are functionally not comparable to the assessee."
21. We note that the ground no. 3 raised by the Revenue is directed against the action of the Ld. CIT(A) in rejecting companies accepted by the TPO even though the companies were functionally not comparable to the assessee. We have already narrated the facts of the assessee`s case, therefore we do not repeat them for the sake of brevity. Before us ld. D.R. has reiterated the stand taken by TPO, whereas ld. Counsel defended the order passed by ld. CIT(A). We note that ld CIT(A) rejected five companies which were selected by the TPO, which are as follows:
(i) Spry Resource India Pvt Ltd,
(ii) E-infochips Bangalore Ltd,
(iii) Infinite Data Systems Pvt Ltd (merged), Pa g e | 2 2 M/s Net Guru. Ltd.ITA No.2162/ Kol/2017
Assessment Year:2010-11
(iv) Thirdware Solutions Ltd and
(v) Intech Software Ltd.
Now, we shall examine these comparable companies one by one:
(i).Spry Resources India Ltd We note that Coordinate Bench of Kolkata Tribunal in the matter of Labvantage Solutions Pvt. Ltd vs. DCIT reported in [2016] 76 taxmann.com 152 (Kolkata-
Trib.). wherein it was noted that the assessee was engaged in execution of software development and coding of software services (software services) outsourced to it by its associated enterprise namely, LVS US. The Hon'ble Tribunal rejected Spry Resource India Pvt Ltd as functionally not comparable to the assessee on the ground that the said company was engaged in provision of software consultancy services for AY 2009-10 and AY 2010-11. Similarly, in the instant case, the assessee company was engaged in provision of software services to Netguru Inc. USA. Netguru Inc. outsourced the assignments to the assessee company for the previous year relevant to the AY 2010-11. Placing reliance on the aforesaid decision, the CIT(A) rejected Spry Resources India Ltd. Based on the above factual position, we decline to interfere in the order of Ld CIT(A), his order on this issue is hereby accepted.
(ii).E-Infochips Bangalore Ltd We note that Coordinate Bench of Kolkata Tribunal in the matter of Labvantage Solutions Pvt. Ltd vs. DCIT reported in [2016] 76 taxmann.com 152 (Kolkata- Trib.). wherein it was noted that the assessee was engaged in execution of software development and coding of software services (software services) outsourced to it by its associated enterprise namely, LVS US. The Tribunal rejected E-Infochips Bangalore Ltd as functionally not comparable to the assessee on the ground that the said company was engaged in software development and IT-enabled services and no segmental income break-up was available for the respective segments in the audited financial statements. In the instant case, the assessee company was engaged in provision of software services to Netguru Inc. USA. Netguru Inc. outsourced the assignments to the assessee company for the previous year relevant Pa g e | 2 3 M/s Net Guru. Ltd.
ITA No.2162/ Kol/2017Assessment Year:2010-11 to the AY 2010-11. Placing reliance on the aforesaid decision, the CIT(A) rejected E-Infochips Bangalore Ltd. Based on the above factual position, we decline to interfere in the order of Ld CIT(A) his order on this issue is hereby accepted.
(iii).Infinite Data Systems Pvt Ltd [Merged] We observe that the 'Significant Accounting Policies and Notes on Accounts' (paragraph no. 17) of the audited financial statements of Infinite Data Systems Pvt Ltd, wherein it is mentioned that during the relevant financial year, the revenue is primarily derived from technical support and infrastructure management services. In this connection, we note that the decision of the Coordinate Bench of Kolkata Tribunal in the matter of Labvantage Solutions Pvt Ltd (supra). In the aforesaid case, the assessee was engaged in execution of software development and coding of software services (software services) outsourced to it by its associated enterprise namely, LVS US. The Tribunal rejected Infinite Data Systems Pvt Ltd as functionally not comparable to the assessee for the AY 2009-10 and AY 2010- 11 for the reason that the revenue of the aforesaid company was primarily derived from technical support and infrastructure management services. It was further noted by the Tribunal that Infinite Data Systems Pvt Ltd [Merged] was created for purposes of transfer of business. In the instant case, the assessee company was engaged in provision of software services to Netguru Inc. USA. Netguru Inc. outsourced the assignments to the assessee company for the previous year relevant to the AY 2010-11.Placing reliance on the aforesaid decision, the CIT(A) rejected Infinite Data Systems Pvt Ltd [Merged]. Based on the above factual position, we decline to interfere in the order of Ld CIT(A) his order on this issue is hereby accepted.
(iv). Thirdware Solutions Ltd We note that Coordinate Bench of Kolkata Tribunal in the matter of Sun Life India Service Centre (P.) Ltd v. DCIT reported in [2016] 71 taxmann.com 189 (Delhi - Trib.) for AY 2010-11, wherein it was noted that the assessee was rendering software development service to its AE. The Tribunal inter alia held that Thirdware Solutions Ltd could not be accepted as comparable because of the Pa g e | 2 4 M/s Net Guru. Ltd.
ITA No.2162/ Kol/2017Assessment Year:2010-11 distinguishing features of the functional profile of the company. Thirdware Solutions Ltd was engaged in software product development, implementation and consulting based on ERP and Business Intelligences. In the instant case, the assessee company was engaged in provision of software services to Netguru Inc. USA. Netguru Inc. outsourced the assignment to the assessee company for the previous year relevant to the AY 2010-11. Placing reliance on the aforesaid decision, the CIT(A) rejected Thirdware Solutions Ltd. Based on the above factual position, we decline to interfere in the order of Ld CIT(A) his order on this issue is hereby accepted.
(v). Intech Software Pvt Ltd We note that as per paragraph no.12 of schedule 15-Notes to Accounts to the audited financial statements of Inteq Software Pvt Ltd, the said company for the FY 2009-10 was engaged in development of computer software. i.e. production and sale of software. We note that Coordinate Bench of Kolkata Tribunal in the matter of DCIT v. Nomura Research Institute & Financial Technologies (P.) Ltd reported in [2017] 87 taxmann.com 169 (Kolkata-Trib.). In the aforesaid case, the assessee was engaged in the business of rendering software development services. The Tribunal rejected Intec Software Ltd, as functionally not comparable to the assessee. The relevant extract from the decision is as under:
"18. As far as Intec Software Limited is concerned, the plea of the ld. counsel for the assessee was that information regarding this company was not available in the public domain and the TPO had obtained the financial results by issuing of a notice u/s 133(6) of the Act. In the proceedings before DRP, on request by the assessee, the TPO shared some of the details that he received from the aforesaid company. The details so obtained are at pages 613 to 617 of the paper book Vol. II filed by the assessee. The information shared shows that Intec Software Limited is not purely software development service company and provides besides software development, consultancy services, data warehousing, EDI services besides Health Care BPO..... ln these circumstances we direct that Inteq Software Pvt. Limited be excluded from the final list of comparable companies to be adopted by the TPO for arriving at the average margin of comparable companies. "
In view of the above decision, we note that Intec Software Pvt Ltd was not functionally comparable to the assessee company in the instant case.Based on the Pa g e | 2 5 M/s Net Guru. Ltd.
ITA No.2162/ Kol/2017Assessment Year:2010-11 above factual position, we decline to interfere in the order of Ld CIT(A). Hence, we dismiss the ground No. 3 raised by the Revenue.
22. Ground No. 4 raised by the Revenue reads as under:
"4. That on the facts and in the circumstances of the case, the Ld. CIT(A) has erred in accepting Cherrytee Intelisove ltd, Cigniti Technologies Ltd. and Secure Earth Technologies Ltd., even though these companies fails the forex filter applied by the Ld. TPO.
23. We note that ground No. 4 raised by the Revenue is directed against the action of the Ld. CIT(A) in accepting Cherrytec Intelisolve Ltd, Cigniti Technologies Ltd and Secure Earth Technologies Ltd, as these companies failed the forex filter applied by the TPO. Ld. D.R. has stated before us that the ld. CIT(A) was grossly erred in accepting these three companies as these three companies failed to satisfy the forex filter. We note that the export turnover of the assessee company is INR 1,77,88,045/-, which constituted 35.28% of the total turnover of INR 5,04,12,721/- of the assessee company. The TPO applied the filter namely, 'companies who have less than 75% of the revenue as export sales were excluded.' Assessee has furnished below the aforesaid ratio for Cherrytec Intelisolve Ltd, Cigniti Technologies Ltd and Secure Earth Technologies Ltd:
Export turnover to total turnover ratio for Cherrytec Intelisolve Ltd, Cherrytec Intelisolve Ltd and Secure Earth Technologies Ltd. are as under:
Cherrytec Intelisolve Ltd (page no. 211 of paper book) INR Export turnover 5,27,70,014 Total turnover 8,94,71,520 Export turnover to total turnover ratio 58.98% Cigniti Technologies Ltd (Chakkilam Infotech Ltd) INR (page no. 215 and 216 of paper book).
Export turnover 2,77,00,101
Total turnover 5,05,58,955
Export turnover to total turnover ratio 54.79%
Secure Earth Technologies Ltd (Globsyn Infotech INR in
Ltd) (page no. 219 and 220 of paper book) Lacs
Pa g e | 2 6
M/s Net Guru. Ltd.
ITA No.2162/ Kol/2017
Assessment Year:2010-11
Export turnover 249.30
Total turnover 429.80
Export turnover to total turnover ratio 58.00%
We note that the TPO in the assessee company's own case for the AY 2011-12 applied the filter 'companies who have less than 50% of the revenues as export sales were excluded'. It is further pertinent to note that Cherrytec Intelisolve Ltd, Cigniti Technologies Ltd and Secure Earth Technologies Ltd had 'export turnover to total turnover ratio' is above 50%. In this connection, reliance is placed on the decision of the Hon'ble Calcutta High Court in the matter of Birla Corporation Ltd. v. Commissioner of Income-tax - II, Kolkata reported in [2014] 43 taxmann.com 267 (Calcutta), wherein it was held that the department has to have some consistency in its views and it cannot blow hot and cold at its sweet-will.
We note that Coordinate Bench of ITAT, Delhi, in the matter of American express (India) (P.) Ltd vs ACIT reported in [2018] 97 taxmann.com 180 (Delhi- Trib.). In this case the facts of the case is that the assessee is engaged in providing IT enabled service to its AE. In relation to Allsec Technologies Ltd which is selected as comparable by the assessee, the TPO has commented that: " .... The export revenues are less than 75% of total turnover, hence not a suitable comparable." The Tribunal has held as follows:
"There is no rule or mechanism for putting specific ceiling of limit in a particular filter. These are only used for quantitative analysis while the selecting comparables by applying filter. The TPO cannot suo moto apply the filter later on for selecting or rejecting the comparable of the assessee, because that amounts to cherry picking. There is no dispute with regard to otherwise functional or FAR comparability with that of the assessee. Therefore, the reasons assigned by TPO of putting such a ceiling for exclusion of this company cannot be upheld."
In view of the above decision, it may be noted that the TPO cannot suo moto apply the filter 'companies who have less than 75% of the revenue as export sales were excluded' in order to exclude Cherrytec Intelisolve Ltd, Cigniti Technologies Ltd and Secure Earth Technologies Ltd. In this connection, it is pertinent to note that Pa g e | 2 7 M/s Net Guru. Ltd.
ITA No.2162/ Kol/2017Assessment Year:2010-11 the TPO has not disputed; otherwise functional or FAR (function-asset-risk) comparability between the assessee company and Cherrytec Intelisolve Ltd, Cigniti Technologies Ltd and Secure Earth Technologies Ltd. That being so, we decline to interfere in the order passed by the ld CIT(A), his order on this issue is hereby upheld and ground No.4 raised by the Revenue is dismissed.
24. Ground No. 5 raised by the Revenue reads as under:
"5. That on the facts and in the circumstances of the case, the Ld. CIT(A) has erred in accepting Kireeti Soft Technologies Ltd. even though it failed the employee cost filter applied by the Ld. TPO."
25. We note that the ground No. 5 raised by the Revenue, is directed against the action of the Ld. CIT(A) in accepting Kireeti Soft Technologies Ltd, even though it failed the employee cost filter applied by the TPO. We note that for the A.Y. 2011-12, the CIT(A) accepted Kireeti Soft Technologies Ltd as comparable to the assessee company though the TPO rejected this company by applying the same employee cost filter as that applied for the AY 2010-11. However, the Revenue accepted the decision of the CIT(A) and did not prefer any ground of appeal before the Tribunal against the decision of the CIT(A) for the A.Y. 2011-12.The department has to have some consistency in its views and in this connection, we rely on the decision of the Hon'ble High Court of Calcutta in the matter of CIT vs. Britannia Industries Ltd reported in [2003] 132 TAXMAN 16 (CAL.), wherein it was held as follows:
"The order of the Commissioner (Appeals) in the assessment year 1980-81 had not been challenged by the department. Once the order had been accepted and when the facts were more or less similar in the assessment year at hand, there was no reason to disagree with the view taken by the Tribunal in the relevant assessment year 1979-80."
In view of the aforesaid decision, we note that if the Revenue accepts the said company as comparable for the A.Y. 2011-12, there is no reason for the Revenue Pa g e | 2 8 M/s Net Guru. Ltd.
ITA No.2162/ Kol/2017Assessment Year:2010-11 to reject it for the A.Y. 2010-11 by applying the same employee cost filter as that used by the TPO for AY 2011-12.
We note that the TPO has rejected Kireeti Soft Technologies Ltd (selected as comparable by the assessee company) solely on the ground that the said company fails to satisfy the employee cost filter used by him( vide page no. 48 of the paper book-TPO's order). That is, 'companies having the ratio of employee costs to sales less than 25% were rejected'. The assessee furnished below the computation of employee cost to sales ratio of Kireeti Soft Technologies Ltd for the financial year ended 31stMarch, 2009.
Employee cost to sales ratio of Kireeti Soft Technologies Ltd Particulars INR Personnel Expenses 1,86,97,953 Sales and Services 7,69,07,408 Employee Cost to sales ratio 24.31% We note that the employee cost to sales ratio of Kireeti Soft Technologies Ltd is 24.31%,( vide page no. 223 of the paper book),whereas the TPO set the threshold at 25% and rejected the aforesaid company. We note that 24.31% threshold is very nearto 25%, besides, it is also pertinent to note that the TPO has not disputed the otherwise functional or FAR (function-asset-risk) comparability between the assessee company and Kireeti Soft Technologies Ltd.
We note that Employee cost filter not being amenable to be used as a filter in the selection or rejection of comparables, for that we rely on the Judgment of the Coordinate Bench of ITAT Hyderabad in the matter of DCIT vs M/s. Hellosoft India Pvt. Ltd reported in ITA No. 645/Hyd/09 wherein it was held as follows:
"The CIT (A) further held that the 'employee cost to sale' filter adopted by the TPO is not appropriate as relevant data was not available in respect of all the companies available on the database. Moreover, part of the employee cost was included by certain companies under the different heads like software package cost or operating expenses etc. As a result of which the Pa g e | 2 9 M/s Net Guru. Ltd.ITA No.2162/ Kol/2017
Assessment Year:2010-11 filter cannot be uniformly and objectively applied for selection of comparables."
"In. view of the aforesaid, we uphold the decision of the CIT (A) in not sustaining the rejection of comparables selected by the assessee by applying 'employee cost to sale' filter as relevant data/information for this filter are not available. Moreover, it is also a fact that part of the employee cost is included by many companies under different other heads."
In view of the above decision, we note that employee cost filter is not amenable to be used as a filter in the selection or rejection of comparables because it is extremely difficult to track or identify actual employee costs which may be included in different heads of expenses disclosed in the Profit & Loss Account.
It is also important to note that miniscule difference may be ignored if the company is otherwise comparable, for that we rely on the Judgment of the Coordinate Bench of ITAT Ahmedabad in the matter of effective Teleservices Pvt Ltd vs ACIT reported in ITA No. 2411/ AHD/2014, wherein the Tribunal placed reliance on the decision of the Delhi Bench of Tribunal in the case of Mercer Consulting India Private Limited reported in 47 taxmann.com 84. In this case, the TPO rejected Allsec. Technologies Ltd inter alia on the grounds that the company could not satisfy the filter set by the TPO namely export revenues less than 75% of the total turnover. The actual ratio of export revenue to total turnover of Allsec Technologies Ltd stood at 74.45%.In this connection, the Tribunal held as follows:
"There can be no hard and fast rule for putting a specific ceiling in a particular filter. The filters are not sacrosanct as not statutorily prescribed. These are used or modified for selection or rejection of comparables as per the convenience of the concerned party."
"The exclusion of this company has been done by increasing the limit in filter to 75%as against 25% applied by the assessee because the percentage was 74.45%. If the actual ratio in this case had been more than 75%, and the Revenue hell bent on excluding this case, then it would have resorted to increasing the ceiling in the filter to 80% or still more so as to ensure that it remains outside the limit set by it. As the ratio of 75% is not something which is scientifically proven and the export revenue of Allsec Technologies is 74.45% as against the TPO's filter of 75%, we are of the considered opinion that the same cannot be excluded for such a minuscule difference if it is otherwise comparable. It is patent that the TPO has not disputed the otherwise functional comparability of this case with that of the assessee."
Page | 30 M/s Net Guru. Ltd.
ITA No.2162/ Kol/2017Assessment Year:2010-11 We note that in the assessee`s case under consideration, the employee cost to sales ratio of Kireeti Soft Technologies Ltd is 24.31%, whereas the TPO set the threshold at 25% and rejected the aforesaid company. The TPO has not disputed, otherwise functional or FAR (function-asset-risk) comparability between the assessee company and Kireeti Soft Technologies Ltd. In view of this, we reject the contention of the TPO and accept Kireeti Soft Technologies Ltd as comparable to the assessee company. That being so, we decline to interfere in the order of ld CIT(A) and dismiss the ground No. 5 raised by Revenue.
26. Ground No.6 raised by the Revenue reads as follows:
"6. That on the facts and in the circumstances of the case, the Ld. CIT(A) has erred in accepting Akshay Software Technologies Ltd. even though it is functionally dissimilar to that of the assessee."
27. We note that the ground No. 6 raised by the Revenue is directed against the action of the ld. CIT(A) in accepting Akshay Software Technologies Ltd. Ld. D.R. for the Revenue argued before us that Akshay Software Technologies Ltd. is functionally dissimilar to that of the assessee company, therefore, the ld. CIT(A) ought not to have accepted this company as comparable. We note that for the A.Y. 2011-12, the ld CIT(A) accepted Akshay Software Technologies Ltd, as comparable to the assessee company. The Revenue accepted the decision of the CIT(A) and did not prefer any ground of appeal before the Tribunal against the decision of the CIT(A) for the A.Y. 2011-12, there is no reason for the Revenue to reject it for the AY 2010-11, for that we rely on the decision of the Hon'ble High Court of Calcutta in the matter of CIT vs. Britannia Industries Ltd reported in [2003] 132 TAXMAN 16 (CAL.), wherein it is held as follows:
"The order of the Commissioner (Appeals) in the assessment year 1980-81 had not been challenged by the department. Once the order had been accepted and when the facts were more or less similar in the assessment year at hand, there was no reason to disagree with the view taken by the Tribunal in the relevant assessment year 1979-80."
In view of the aforesaid decision, we note that based on the similar facts and circumstances, if the Revenue accepts the said company as comparable for the AY 2011-12, there is no reason for the Revenue to reject it for the AY 2010-11.
Page | 31 M/s Net Guru. Ltd.
ITA No.2162/ Kol/2017Assessment Year:2010-11 As mentioned hereinabove, the assessee company, in the instant case, is engaged in rendering software development services to Netguru Inc. USA. We note that schedule No.13 to the Profit & Loss Account of Akshay Software Technologies Ltd, of the schedule forming parts of the accounts, where it is stated that the company generates revenue of INR 10,85,84,835/- from software services and INR 72,712/- from sale of products. Hence, we note that the predominant source of earning revenue for Akshay Software Technologies Ltd is provision of software services and hence, the company is functionally comparable to the assessee company.
At this juncture, we note that the decision of the Coordinate Bench of Kolkata Tribunal in the matter of Labvantage Solutions Pvt Ltd vs. DCIT reported in [2016] 76 taxmann.com 152 (Kolkata - Trib.) is relevant. In the aforesaid case, the assessee was involved in the execution of the software development and coding of software service (software services) outsourced to it by LVS-US. The TPO rejected Akshay software Technologies Ltd for the AY 2009-10 and AY 2010-11 on the ground that it was functionally not comparable as it provided technical support for integration of SWIFT software to its clients of the user of SWIFT in financial industry. The Tribunal rejected the contention of the TPO/AO and accepted Akshay Software Technologies Ltd as functionally comparable to the assessee for AY 2009-10 and AY 2010-11. The relevant extract of the judgment is given below:
"It is not in dispute that the assessee is engaged in software development. Hence comparable should also be in the companies engaged in the similar sector. We find that the ld. TPO had rejected this comparable on the ground that it provides technical support for integration of SWIFT software to its clients of the user of SWIFT in financial industry. We find from the annual report of this comparable enclosed in the paper book, that it is also engaged in software development activity which is quite evident from the income schedule of the said comparable. We find that the USA based subsidiary of the company i.e. Akshay Software International Inc. (Akshay US) is a registered partner of SWIFT selling SWIFT solutions and products as an extended arm of SWIFT in North America. Thus, the contention of the Id. TPO/ld.AO is erroneous since it is clearly evident from the annual report of the comparable company itself that it is engaged in rendering software development activity only. We find that this comparable i.eAkshay Page | 32 M/s Net Guru. Ltd.ITA No.2162/ Kol/2017
Assessment Year:2010-11 Software Technologies Ltd had been accepted as comparable in IT sector in the Co-ordinate Bench decision of Delhi Tribunal in the case of Qualcomm India (P.) Ltd. (supra) .... "
On similar facts, the coordinate Bench of ITAT Bangalore in the matter of LSI India Research & Development (P.) Ltd v. ITO reported in [2019] 101 taxmann.com 288 (Bangalore-Trib.), wherein the facts were that the assessee was engaged in rendering software development services for AY 2009-10. The assessee selects 17 companies as comparable out of which the Ld. TPO accepts two companies as comparable to assessee, one of them being Akshay Software Technologies Ltd. Therefore, based on the above reasoning, we accept Akshay Software Technologies Ltd as comparable. That being so, we decline to interfere in the order of ld CIT(A) and dismiss the ground No. 6 raised by Revenue.
28. Ground No.7 raised by the Revenue reads as follows:
7. That on the facts and in the circumstances of the case, the Ld.CIT(A) has erred in accepting Avani Cimcon Technologies Ltd., even though the cost base of the company is insignificant and with a small variation in profit, the impact in the profit margin will be very significant.
29. We note that ground No.7 raised by the Revenue is directed against the action of the Ld. CIT(A) in accepting Avani Cincom Technologies Ltd.: Ld. D.R. submitted before us that the cost base of this company is insignificant and with a small variation in profit, the impact in the profit margin will be very significant, hence this company should be rejected. We note that Avani Cincom Technologies Ltd earned revenue from software export( vide page no. 228 of the paper book). The revenue and cost details for F.Y. 2009-10 are furnished below:
Revenue and cost details of Avani Cincom Technologies Ltd Particulars INR Earning from software exports in foreign currency 2,83,06,444 Interest on deposit with banks 3,595 Foreign exchange fluctuation gain/loss (1,84,550) Profit on sale of investment (net) short term 1,39,486 Profit on sale of investment (net) long term 23,16,360 Pa g e | 3 3 M/s Net Guru. Ltd.
ITA No.2162/ Kol/2017
Assessment Year:2010-11
Total Revenue 3,05,81,335
Software development expenses 2,30,11,136
General & Administrative expenses 26,14,027
Depreciation 15,69,658
Interest paid to Banks 95,953
Total Cost 2,72,90,774
Profit before tax 32,90,561
We note that the total revenue of the said company stands at INR 3.05 crore out of which the operational revenue stands at INR 2.83 crore. The cost incurred by the company stands at INR 2.73 crore leading to profit before tax amounting to INR 0.33 crore. Thus, the allegation made by the Revenue that the company has insignificant cost base has no leg to stand. It is also not true that in the case of the aforesaid company, with a small variation in profit, the impact in the profit margin will be very significant. We therefore accept Avani Cincom Technologies Ltd as comparable, and for that we rely on the judgment of the Coordinate Bench of ITAT Hyderabad in the matter of CNO IT Services (India) (P.) Ltd. v. ACIT reported in [2018] 90 taxmann.com 407 (Hyderabad-Trib.). The facts of this company are that this assessee company was engaged in the business of exporting software development services. The TPO selected Avani Cimcon Technologies Ltd as comparable against which the assessee filed an appeal before the CIT(A). The Tribunal, however, accepted Avani Cimcon Technologies Ltd as comparable. The relevant extract of the judgment is given below:
"15. As regards Avani Cimcon Technologies Ltd is concerned, the assessee submitted that this company is also into the product development and that no segmental details as to product development and IT Services are available and therefore,this should be excluded from the list of comparables. He has drawn our attention to the financial results of this company which are from page 309 of the Paper Book. We have gone through the financials of the said company and we do not find any reference to development of software products. In reply to the proceedings u/s. 92CA of the Act, the said company has replied that it is pure Software Development Service Provider and that the expenditure incurred by the company is only to improve the processes and that it has not created any intangible assets nor capitalized the same. The assessee is relying upon the information available on the Website of M/s.Avani Cimcon Technologies Ltd to contend that this company is also into development of software Page | 34 M/s Net Guru. Ltd.ITA No.2162/ Kol/2017
Assessment Year:2010-11 products. However, the financial results of the company, which are audited and certified by the Auditors, do not contain any information with regard to the development of software products. Therefore, we do not see any strength in the contention of the assessee to accept that this company is functionally different. "
In view of the detailed reasoning given above we accept Avani Cimcon Technologies Ltd as comparable company. That being so, we decline to interfere in the order of ld CIT(A) and dismiss the ground No. 7 raised by Revenue.
30.Ground No.8 raised by the Revenue reads as follows:
"8. That on the facts and in the circumstances of the case, the Ld.CIT(A) has erred in accepting CAT Technologies Ltd., even though the related party transaction details are not available."
31.Ground No. 8 raised by the Revenue is directed against the action of the Ld. CIT(A) in accepting CAT Technologies Ltd, even though the related party transaction details are not available. Ld. D.R. submitted before us that this company does not have related party transaction, hence it should not be accepted comparable. We note that for the A.Y. 2011-12, the CIT(A) as well as the TPO accented CAT Technologies Ltd as comparable to the assessee company. The Revenue should follow consistency in his approach and for this we rely on the judgment of the Hon'ble High Court of Calcutta in the matter of CIT vs. Britannia Industries Ltd reported in [2003] 132 TAXMAN 16 (CAL.), wherein it is held as follows:
"The order of the Commissioner (Appeals) in the assessment year 1980-81 had not been challenged by the department. Once the order had been accepted and when the facts were more or less similar in the assessment year at hand, there was no reason to disagree with the view taken by the Tribunal in the relevant assessment year 1979-80."
Therefore, we note that if the Revenue accepts the said company as comparable for the AY 2011-12, there is no reason for the Revenue to reject it for the AY 2010-11. We note that Revenue proposed to reject CAT Technologies Ltd solely on the ground that the related party transactions are not disclosed in the annual Page | 35 M/s Net Guru. Ltd.
ITA No.2162/ Kol/2017Assessment Year:2010-11 report. We note that normally a comparable company is rejected if the value of the related party transactions disclosed in the audited financial statements is significantly high. For that we rely on the judgment of the Coordinate Bench of ITAT Pune in the matter of ACIT vs M/s Synechron Technologies Pvt Ltd reported in ITA No. 536/PUN/2015. In the instant case, the assessee was engaged in rendering software development services to its associated enterprise during the AY2010-11. The assessee selected CAT Technologies Ltd as comparable company. CAT Technologies Ltd. was rejected by the TPO as it was found to be engaged in three types of businesses i.e. medical transcription, training and software development and consultancy. The TPO also reported that no segmental data was provided by the learned Authorized Representative for the assessee. Before the DRP, the assessee pointed out that from the website of CAT Technologies Ltd., it was clear that the said company was mainly engaged in the provision of software development and consultancy services and during the said year, the company had earned around 91% of its total revenue from software development and consultancy activity. The DRP thus, directed the Assessing Officer to adopt the net margins of the said company as comparable if other filters approved by DRP were satisfied. The TPO giving effect to the directions of DRP had not objected as to whether other filters which were approved by the DRP were not satisfied. Consequently, the Tribunal accepted CAT Technologies Ltd as comparable. We note that the Coordinate Bench of ITAT Hyderabad in the matter of Oakton Global Technology Services Centre (India) (P.) Ltd. vs. ACIT reported in [2016] 76 taxmann.com 119 (Hyderabad - Trib.), for the AY 2010- 11, wherein the assessee company used to render software development services to the associated enterprise. The TPO selected 19 companies as comparables, one of them being CAT Technologies Ltd.
Therefore, considering this factual position we accept CAT Technologies Ltd as comparable. That being so, we decline to interfere in the order of ld CIT(A) and dismiss the ground No. 8 raised by Revenue.
32.Ground No.9 raised by the Revenue reads as follows:
Page | 36 M/s Net Guru. Ltd.ITA No.2162/ Kol/2017
Assessment Year:2010-11 "9. That on the facts and in the circumstances of the case, the Ld. CIT(A) has erred in selecting cash profit over sales even though the assessee is not a capital intensive industry and as per the Income Tax Act,1962 net profit realised needs to be compared."
33. We note that ground No.9 raised by the Revenue is directed against the action of the Ld. CIT(A) in accepting cash profit over sales, even though the assessee is not a capital-intensive industry and as per the Income-tax Act, 1961, read with the Income-tax Rules, 1962, net profit realized needs to be compared. Ld. D.R. argued before us that there is no concept in Transfer Pricing to use cash profit margin ratio as profit level indicators (PLI); hence PLI adopted by the assessee ocmapny should be rejected. We note that the assessee selected cash profit margin on cost as the net profit indicator for the AY 2011-12 on the same facts and circumstances of the case as those for the AY 2010-11. The TPO rejected the aforesaid net profit indicator but the same was accepted by the CIT(A). The Revenue did not take any ground of appeal before the Tribunal against the aforesaid stand taken by the CIT(A) for the AY 2011-12. In this connection, reliance is placed on the decision of the Hon'ble High Court of Calcutta in the matter of CIT vs. Britannia Industries Ltd reported in [2003] 132 TAXMAN 16 (CAL.), wherein it was held as follows:
"The order of the Commissioner (Appeals) in the assessment year 1980-81 had not been challenged by the department. Once the order had been accepted and when the facts were more or less similar in the assessment year at hand, there was no reason to disagree with the view taken by the Tribunal in the relevant assessment year 1979-80."
In view of the aforesaid decision, we note that if the Revenue accepts the said cash profit margin ratio as PLI for the AY 2011-12, there is no reason for the Revenue to reject it for the AY 2010-11 on the same facts and circumstances of the case.
We note that the term 'net profit' which is required to be computed for the purpose of application of the Transactional Net Margin Method (TNMM) under the Rule 10B(1)(e) of the Income-tax Rules, 1962, has not been defined by the Income Tax Act, 1961.At this juncture it is important to note that Coordinate Bench of Kolkata, in the matter of DCIT v. M/s EPCOS Ferrites Ltd bearing ITA No. 1597/Kol/2017 (AY 2002-03) and 1598/Kol/2017 (AY 2003-04), wherein the Page | 37 M/s Net Guru. Ltd.
ITA No.2162/ Kol/2017Assessment Year:2010-11 Tribunal has held that for determining the fair and true profit for the purpose of the application of the TNMM, it is appropriate that the effect of the depreciation must be excluded out of the operating profit for determining the operating profit ratio. The best way of computing operating profit would be to compute profit before depreciation in respect of each of the comparable companies. It would take out the inconformity or the variation in the profit level of the comparables arising due to adoption of different method of charging depreciation. For this the Tribunal placed reliance on the judgement of the Coordinate Bench of Delhi Tribunal in the matter of Schefenacker Motherson Ltd. v. Income-tax Officer [2009] 123 TTJ 509 (Delhi) wherein the Tribunal confirmed the use of cash profit for the purpose of application of the TNMM. The Kolkata Tribunal also placed reliance on the decision of the Hon'ble High Court of Bombay in the matter of CIT vs. Reuters India (P) Ltd reported in [2016] 69 taxmann.com 187 (Bombay) wherein the Hon'ble High Court confirmed the application of the cash profit margin for the purpose of computation of net profit indicator (PLI) under the TNMM. Keeping in view the aforesaid judicial precedents, the Kolkata Tribunal approved the use of cash profit margin by the assessee for placing the tested party and comparable companies on equal footing. We note that based on the similar facts, the Coordinate Bench of ITAT Kolkata in the matter of DCIT vs. AT&S India Private Ltd reported in [2015] 58 taxmann.com73(Kolkata-Trib.) has confirmed the application of cash profit margin under the TNMM. In the aforesaid case, the assessee selected cash profit margin on sales as the appropriate profit level indicator / net profit indicator under the TNMM.
In view of above discussion we accept the cash profit margin ratio as an appropriate profit level indicator(PLI) under the TNMM which places the tested party and comparable companies on equal footing. In the aforesaid decisions, nowhere it is stated that cash profit margin is an appropriate net profit indicator only for a company which operates in capital intensive industry. The cash profit margin ratio is also applicable to other companies, as profit level indicator (PLI) and it is not only restricted to capital intensive industries; that is, it is equally applicable to other industries also. We accept cash profit margin ratio as appropriate profit level indicator (PLI) in the assessee`s case under consideration.
Pa g e | 3 8 M/s Net Guru. Ltd.
ITA No.2162/ Kol/2017Assessment Year:2010-11 That being so, we decline to interfere in the order of ld CIT(A) and dismiss the ground No. 9 raised by Revenue.
34. In the result, the appeal of the revenue is dismissed.
Order pronounced in the Court on 23.08.2019
Sd/- Sd/-
(A.T. VARKEY) (A.L.SAINI)
या यकसद य / JUDICIAL MEMBER लेखासद य / ACCOUNTANT MEMBER
दनांक/ Date: 23/08/2019
(SB, Sr.PS)
Copy of the order forwarded to:
1. ACIT, Circle-2(2), Kolkata
2. M/s Net Guru Ltd.
3. C.I.T(A)- 4. C.I.T.- Kolkata.
5. CIT(DR), Kolkata Benches, Kolkata.
6. Guard File.
True copy
By Order
Assistant Registrar
ITAT, Kolkata Benches
Page | 39