2022 (11) TMI 1323 - AT - Income Tax

TP adjustment - interest expenditure incurred on the CCD's issued by it to its non-resident AE - re-charactering and concluding that CCDs issued by the assessee are in the nature of equity investments - HELD THAT - The new section 94B of the I.T.Act is applicable with effect from 01.04.2018, and hence is applicable for the impugned assessment year, namely, A.Y. 2018-2019. Section 94B of the I.T.Act is different from transfer pricing provisions contained in sections 92 to 92F of the I.T.Act. The transfer pricing provisions deal with the determining the arm's length rate of interest payable on a debt-claim from an AE. In contrast, section 94B of the I.T.Act places a blanket threshold on the deductibility of interest paid, based on the profitability of the Assessee and not based on the debt-claim itself. Assessee did not comply with the provisions of section 94B of the I.T.Act to suo moto disallow the interest on CCD while computing the taxable income in the income tax return filed for the impugned AY (probably due to oversight). The assessee failed to appreciate that the same definition of AE as per sub section (1) and sub section (2) of section 94A is referred in section 94B of the I.T.Act and hence interest on CCD paid to PIL, who being a deemed AE as per the provisions of section 94A(2)(C) of the I.T.ACt, also comes under the purview of section 94B - In the light of the aforesaid reasoning and the impugned TP adjustment with respect to payment of interest on CCD is deleted. However, the disallowance is liable to be made u/s 94B of the I.T.Act. Appeal filed by the assessee is partly allowed.

Summary

Issues:
Transfer Pricing Adjustment on Interest Paid on Compulsorily Convertible Debentures (CCDs)

Detailed Analysis:
The appeal involved a transfer pricing adjustment concerning interest paid on CCDs to a non-resident AE. The lower authorities made a transfer pricing adjustment of INR 13,89,60,371 without conducting benchmarking or comparability analysis. They recharacterized the CCDs as equity investments, disregarding the appellant's TP documentation. The appellant argued that CCDs should be benchmarked only at the time of issue and that interest expenditure should be considered at arm's length. The lower authorities also erred in not appreciating that interest on CCDs should be deductible until conversion. The brief facts revealed that the CCDs were issued to a Cyprus-based investor and were convertible into equity shares after a specified period.

The Tribunal considered the terms of the CCDs, including the interest rate and conversion provisions. The appellant benchmarked the interest payment using external databases, treating it as at arm's length price. However, the TPO recharacterized the CCDs as equity, leading to disallowance of interest. The Tribunal cited judicial precedents that established CCDs as debt until conversion, making interest expenditure deductible. The RBI's treatment of CCDs as equity for FDI policy purposes did not affect their treatment for tax purposes. The Tribunal rejected the authorities' reliance on a decision regarding expenditure on convertibles, emphasizing the distinction between pre-conversion interest and issuance expenses.

Furthermore, the Tribunal noted the introduction of section 94B of the IT Act, relating to thin capitalization rules, limiting interest payments to non-resident AEs. The appellant failed to comply with section 94B, leading to a disallowance under this provision. The Tribunal clarified the difference between transfer pricing provisions and section 94B, applying the latter to limit interest deductibility based on profitability. Consequently, the TP adjustment on interest payment was deleted, but the disallowance was upheld under section 94B. The appeal was partly allowed based on these considerations.

This comprehensive analysis addressed the issues raised in the appeal regarding transfer pricing adjustments on interest paid on CCDs, recharacterization of CCDs as equity, benchmarking requirements, and compliance with thin capitalization rules under section 94B of the IT Act. The Tribunal's decision provided clarity on the treatment of CCDs, interest deductibility, and the applicability of different provisions in determining tax liabilities.