2025 (1) TMI 446 - AT - Income Tax

TP adjustment - Addition towards interest on Compulsory Convertible Debenture ( CCDs ) - selection of MAM - HELD THAT - The assessee company in order to justify the arm's length price of the interest due on CCD s had selected in its TP study Comparable Uncontrolled Price method as the most appropriate method and performed a detailed benchmarking analysis arriving at a list of 57 comparable issuance of CCD s. Based on such analysis, the assessee arrived at an arm's length range of 10.00% to 12.65% and concluded that the coupon rate of 11% was at ALP. The TPO ignored the benchmarking analysis undertaken by the assessee company without giving any cogent reasons, held that the ALP is NIL. TPO did not conduct any search in accordance with TP regulations under the Act and Rule. As decided in case of India Debt Management (P.) Ltd 2019 (9) TMI 920 - BOMBAY HIGH COURT that where TPO made addition to assessee's ALP in respect of interest paid to AE on CCD, in view of fact that interest rate of comparables was ranging between 11% to 12%, 11.30% interest paid by assessee to its AE was very much within arm's length rate. Accordingly, the Hon ble High Court deleted the impugned addition. In the instant case, the coupon rate of 11% paid by the assessee was well within the arm s length range based on the benchmarking conducted by the assessee and hence the same is at ALP. Therefore, the action of the TPO / DRP in treating that CCDs as in the nature of equity is not permissible since CCDs remain as debt until they are converted. Bench had asked the ld.AR regarding the applicability of section 94B of the Act. The ld.AR by referring to the audit report at page 49 of the paper-book submitted that no disallowance is called for u/s. 94B of the Act (since interest payment on CCD s did not exceed 30% of EBITDA). However, this aspect needs to be examined if need be, by the AO. In the result, the Grounds are allowed. Disallowance of depreciation on goodwill on slump sale - assessee had entered into a Business Transfer Agreement ( BTA ) on 20.09.2017 pertaining to assessment year 2018-19 to acquire the marketing and sales division of leather chemical business of BASF India Limited ( BASF India ) by way of a slump sale - HELD THAT - As per section 32 of the Act, depreciation would be available in respect of the assets owned, wholly or partly, by the assessee company and used for the purposes of the business or profession. Explanation 3 to section 32(1) of the Act, defines intangible assets to include know-how, patents, copyrights, trademarks, licenses, franchises or any other business or commercial rights of similar nature. The issue regarding whether goodwill constitutes a business or commercial right of similar nature is no longer res integra. The Hon ble Apex Court in the case of Smifs Securities 2012 (8) TMI 713 - SUPREME COURT had held that goodwill constitutes an intangible asset as envisaged under section 32 of the Act. The Hon ble Jurisdictional High Court in the case of Mobis India Ltd. 2018 (2) TMI 307 - MADRAS HIGH COURT had held though in the context of challenging the notice issued u/s. 148 had approved the original assessment order wherein the AO had allowed depreciation on goodwill acquired under business acquisition under BTA. As goodwill came into existence for the first time pursuant to slump sale. Thus, in absence of an asset already recorded in the hands of predecessor company, the provisions of Explanation 7 to section 43(1) of the Act will have no application Thus we hold that the depreciation on goodwill arising out of the slump sale is to be allowed under Section 32 of the Act for the concerned assessment year. Decided in favour of assessee.

Summary

1. ISSUES PRESENTED and CONSIDERED

The judgment primarily addresses two core legal questions:

Issue 1: Whether the Transfer Pricing (TP) adjustment towards interest on Compulsory Convertible Debentures (CCDs) is justified, particularly in light of the re-characterization of CCDs as equity by the Transfer Pricing Officer (TPO).

Issue 2: Whether the disallowance of depreciation on goodwill arising from a slump sale is valid, especially considering the provisions of the Income Tax Act, 1961, and relevant judicial precedents.

2. ISSUE-WISE DETAILED ANALYSIS

Issue 1: TP adjustment towards interest on CCDs

Relevant legal framework and precedents: The legal framework involves sections 92C(3), 92D, and 94B of the Income Tax Act, 1961, concerning transfer pricing and the treatment of interest on CCDs. Precedents include judicial pronouncements that CCDs constitute debt until converted into equity, allowing interest as a deductible expenditure.

Court's interpretation and reasoning: The Tribunal found that the TPO exceeded its jurisdiction by re-characterizing CCDs as equity, which contradicts established judicial interpretations that CCDs are debt instruments until conversion. The Tribunal emphasized that interest on CCDs is deductible until conversion.

Key evidence and findings: The assessee issued CCDs with a coupon rate of 11%, deemed reasonable based on a benchmarking analysis of comparable transactions. The TPO's determination of the Arm's Length Price (ALP) as NIL was unsupported by a proper benchmarking analysis.

Application of law to facts: The Tribunal applied the principle that CCDs are debt instruments, thus allowing the interest deduction. The Tribunal also considered the applicability of section 94B but found no disallowance was warranted.

Treatment of competing arguments: The Tribunal distinguished the TPO's reliance on certain judgments and regulations, clarifying their inapplicability to the present case.

Conclusions: The Tribunal allowed the grounds related to TP adjustment on CCDs, affirming that the interest is deductible, and the re-characterization by the TPO was incorrect.

Issue 2: Disallowance of depreciation on goodwill on slump sale

Relevant legal framework and precedents: The legal framework involves sections 32 and 43(1) of the Income Tax Act, 1961, concerning depreciation on intangible assets like goodwill. Precedents include the Supreme Court's decision in Smifs Securities, which recognized goodwill as a depreciable intangible asset.

Court's interpretation and reasoning: The Tribunal held that goodwill arising from a slump sale qualifies as an intangible asset eligible for depreciation under section 32. The Tribunal rejected the DRP's reliance on explanations to section 43(1) and the sixth proviso to section 32, finding them inapplicable.

Key evidence and findings: The Tribunal noted that the goodwill did not pre-exist in the books of the predecessor company and was recognized for the first time in the slump sale transaction.

Application of law to facts: The Tribunal applied the principle that goodwill is an intangible asset eligible for depreciation, as established by various judicial pronouncements.

Treatment of competing arguments: The Tribunal distinguished the DRP's reliance on certain explanations and judicial decisions, underscoring their inapplicability to the present case.

Conclusions: The Tribunal allowed the grounds related to the depreciation of goodwill, affirming its eligibility for depreciation under section 32.

3. SIGNIFICANT HOLDINGS

Preserve verbatim quotes of crucial legal reasoning:

"It has been a judicially well settled proposition that CCDs constitute debt and interest payable thereon is a deductible expenditure till the time the same are converted into equity."

"The Hon'ble Apex Court in the case of Smifs Securities reported in 348 ITR 302, had held that goodwill constitutes an intangible asset as envisaged under section 32 of the Act."

Core principles established:

- CCDs are considered debt instruments until conversion, allowing interest as a deductible expenditure.

- Goodwill arising from a slump sale is an intangible asset eligible for depreciation under section 32 of the Income Tax Act.

Final determinations on each issue:

- The Tribunal allowed the appeal concerning TP adjustment on CCDs, affirming the deductibility of interest and rejecting the TPO's re-characterization.

- The Tribunal allowed the appeal concerning the disallowance of depreciation on goodwill, affirming its eligibility for depreciation under section 32.

In conclusion, the Tribunal's judgment provided clarity on the treatment of CCDs and goodwill in the context of transfer pricing and depreciation, respectively, aligning with established legal principles and precedents.