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TMI Blog2012 (4) TMI 154X X X X Extracts X X X X X X X X Extracts X X X X ..... e value of Re.1 each at an amount of Rs.BBB. The investment was made as per the Share Holders Agreement (SHA) and Securities Subscription Agreement (SSA), both dated 11.8.2007, entered into amongst Z, V and S. 2. Applicant states that as per the terms of SHA, CCDs are to be fully and mandatorily converted into equity shares @ Rs.C per equity share after the expiry of 72 months from the investment date, CCDs held by the holder. Prior to the mandatory conversion date, Z was given the put option to sell specific number of shares and CCDs on specified dates to V. A call option was also given to V to purchase the said shares and CCDs from Z. Z further states that V has exercised the said option and proposes to purchase the entire stake held by it in S to V for a total consideration of approximately Rs.CCC crores. The applicant‟s submission that capital gains arising to it from transfer of securities held in S are exempt from tax in India under Article 13.4 of the Indo-Mauritius DTAA and no tax is required to be withheld was not accepted by the assessing officer and V was asked to deposit withholding tax on the capital gains that arose from the sale of shares and CCDs. 3. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... SHA. Reliance placed by the Revenue on the ruling in LMN India Ltd 307 ITR 40 is misplaced as in that case the debenture carried interest on it. The applicant is an investor and has no place of business in India and the fact that the agreements were signed in India would not create a permanent establishment of the applicant in India. 6. Further written submissions were made by the Revenue stating therein that Govt. policy on FDI mandates that investment in optionally and partly convertible debentures and preference shares will not constitute FDI but External Commercial Borrowing (ECB), where end-use restrictions are more stringent. Debenture recognizes the existence of a debt which remains so till it is discharged LMN India Ltd. 307 ITR 40. It does not cease to be a debt just because it is redeemed not by returning the money but by getting shares of the equivalent value. The legal character of CCD as debt does not change. Here, the conversion is to be at the behest of V. Till the conversion of CCD, the investment is purely in debentures secured by V against the land owned by it through put option. To get around the restrictions, SSA and SHA have been entered into. What in e ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... S is a subsidiary of V with applicant as second shareholder. The well settled legal principle is that a holding company and a subsidiary are considered as separate and legal entities10 and the business of the subsidiary is not the business of the holding company. The purchase of CCDs by V from the applicant cannot be regarded as redemption of CCDs by S. The applicant and V are totally unrelated parties. There is no reason for the parties involved, to share a common intention to create a legal facade, as benefit on account of tax avoidance for any of the reason in the hands of one would not result in any corresponding benefit in the hands of other. As V cannot urge that any part of the price paid Vijaya Bank 187 ITR 541 by it to acquire CCD can be regarded as a interest, the Revenue cannot also argue that a part of the consideration received by the applicant must be regarded as interest received by the applicant. The applicant submits that had it been a loan transaction it would not have been possible to make additional equity payment, representation on the board of directors of S and decision making in S as a equity share holder. Without prejudice, the applicant submits that the m ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he said development rights. Upon the transfer of the said rights from V to S, Z invested Rs.DDD crore in S, for which S issued A No. of equity shares of face value of Rs. 10 and B No. zero percent Compulsory Convertible Debentures (CCDs) of Rs.1 each. These Debentures are convertible at Rs.4447 per share at the end of 6 years from the date of first closing i.e. November 6, 2007. A part of the Debentures are also convertible earlier at the option of the Debenture holder at the end of 42 months, 48 months, 54 months and 60 months from the date of first closure. Thus, V and Z became the shareholders in S. Three nominees of V and two nominees of Z became directors of S, with the Chairman of the Board of S being one of the three directors nominated by V. The Chairman of the Board of S was not given right of casting vote. 11. On 8.4.2010, V exercised partly its call option under the call option agreement with Z dated 4.9.2009. Pursuant to the exercise, V purchased A-1 equity shares of Rs.10 and B-1 zero percent CCDs of Re.1 each held in S from Z for a total consideration of Rs. „y-1‟ crores. The transaction took place in less than 42 months from the first closing date ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ts." In SEBI (Disclosure and Investor Protection) Guidelines, 2000, a „debt instrument‟ is defined to mean "an instrument which creates or acknowledges indebtedness and includes debenture, stock, bonds and such other securities of a body Corporate, whether constituting a charge on the assets of body Corporate or not. The Companies Act, 1956 has an inclusive definition of debenture. „Debenture‟ includes debenture stock, bonds and any other security of a company whether constituting a charge on the assets of the company or not". The Company Law Committee gave the meaning of „debenture‟ as a document which either creates or acknowledges a debt13. In the case of Shree Rajasthan Syntex Ltd vs. CIT 269 ITR 461, a division bench of the Rajasthan High Court quoted the following observations of Chitty J. in Edmonds vs. Blaina Furnaces Co. [1887] 36 Ch. D.215: "The term itself imports a debt - an acknowledgement of a debt - and speaking of the numerous and various forms of instrument which have been called debentures without anyone being able to say the term is incorrectly used, I find that generally, if not always, the instrument imports an obli ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... definitions it was concluded that there is an "inseverable relation between debenture and debt. An acknowledgement of indebtedness is inherent in it." While answering the question whether by reason of execution of debenture for the moneys advanced, a debt was incurred, it was ruled that: "Issuance of debentures is a mode of borrowing money. The raising of funds by means of fully convertible debentures is a well known commercial and business practice. Debenture, as already noted, creates or recognizes the existence of a debt which remains to be so till it is repaid or discharged. ......Does it cease to be a debt merely because the bonds are redeemed not by returning the money but by getting shares of the equivalent value? Does convertibility of debentures affect the characteristic of debt and transform it into something else? We do not think so. If the mode of discharging the debenture debt is by issuing equity shares in lieu of payment in cash, it does not in any way detract from its legal character as debt." The legal position has been succinctly stated by the Supreme Court in CWT vs. Spencer & Co 88 ITR 429. The Supreme Court observed thus: "In respect of the assets purchased b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he component of „interest‟ is embedded in the sale proceeds of CCDs. As per SHA, Z is to pay the first, second, third and fourth subscription amounts of Rs. „y-2‟ crore, Rs.‟y-3‟ crore, Rs.‟y-4‟ crore and Rs.‟y-5‟ crore respectively, in consideration of which equity shares and CCDs as envisaged in the SSA are to be allotted. Accordingly, Z was allotted A-3, A-4, A-5 and A-6 equity shares and B No. CCDs. Out of these equity shares and CCDs, the applicant made sale of A-1 equity shares and B-1 CCDs for a consideration of Rs.‟y-1‟ crores on 8.4.2010 to V. The terms of the agreement specifically lay down that only V can purchase the investor‟s equity securities. Since V exercised the call option from the second anniversary of the first closing date, the "Purchase Price" was a sum of the following as per para 10.1 (b) of SHA: i. The investor investment amount (less any bought back subscription amount) ii. Amount equal to the accrued return till the completion date iii. Equity payment iv. An amount equal to 8% per annum of the investment amount (less any bought back subscription amount) calculated from the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ifferent period of investment in the project and is ranging from 20% to 24% or even extends to 30%. "Equity Payment" shall mean an amount equal to 10% of the project value. The project value "shall mean an amount equal to the entire project (except the excluded building) gross value, as determined by the appraiser, plus any proceeds received (including by way of lease rentals) till the date of exercise notice (other than proceeds relating to the excluded building) less the sum of (a) total cost to built the assets (other than the excluded building; (b) the investor subscription amount; and (c) the amount of accrued return. It means that the amount equal to gross value of the entire project whether completed or not as determined by the appraiser plus proceeds received including rental / lease value till date of exercise notice but excluding total cost to build assets, investor subscription amount and amount of accrued return. Through this clause an arbitrary figure can be derived in determining the value of gross amount of project value by the appraiser even on the un-executed part of the project. We notice from the above that the calculation of the purchase price is almos ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... uity shares at the end of the specified period at the conversion price amounts to constructive repayment of debt. So there is no escape from the conclusion that there is a debt and what is paid is as interest towards that debt. The debt is extinguished on making over fully paid equity shares at the agreed price and at the agreed time to the debenture holder. It was held that the ingredients of section 2(28A) are clearly satisfied. This applies on all fours to the applicant before us. 15. Applicant contends that the consideration received is for the sale of assets and the gains arising are exempt from tax under Article 13.4 of the Indo-Mauritius DTAA. We need to apply the "look at" test to ascertain the true legal nature of the transaction. While doing so, we need to look at the substance of the transaction, inter se relation amongst the parties to the SHA and SSA, and the transaction as a whole, to appreciate the true nature of the consideration received. This is discussed as under. 16. We must look at the understanding that the parties have amongst them under the two agreements, SHA and SSA. Under the Company Law, the management and control of a company vests with the Board of D ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... servicing status, repayment or payment of interest to its lenders, progress of construction work and such other reports that Z may request from time to time (7.3). When the CCDs are issued by S, it is S who through its Board of Directors should look into these details rather than Z asking about the affairs of V. vi) The decision making process by S in respect of a transaction with the related party is required to be with the consent of Z and V (8.1).This shows that the Board of Directors of S are not at the helm of its affairs and not been given free hand to run its business. vii) The management of S run by the Board of Directors can release any payment under the construction contract only after such payments are authorised in writing by the Asset Manager i.e. Project, altogether an outsider (9.7). viii) In the event that V does not exercise the call option before maturity or does not pay the option price to Z, then V would cause the S to perform certain rights mentioned in 11.1(a). ix) Z does not want it to be identified as a promoter of S (9.8). x) In para 4 of schedule 15 forming part of the financial statement for the year ended March, 2011, it is stated therein that S has ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ‟s) directors. They cannot be reduced to puppets. The decisive criteria is whether the parent company‟s management has such steering interference with the subsidiary‟s core activities that subsidiary can no longer be regarded to perform those activities on the authority on the executive directors". "It is the task of the court to ascertain the true legal nature of the transaction and while doing so it has to look at the entire transaction as a whole and not to adopt a dissecting approach". That being the law, the acknowledgement of debt with commitment to pay is factually upon V and the role of S is reduced to a puppet of V. In the above context, the argument that the sale of CCDs is not to the debtor, but to a third party and what is realized cannot be said to include interest, has no force. 18. Let us refer to the cases, mentioned supra, relied by the learned counsel for the applicant. In the case of M P Financial Corpn., it was held that the gains on the sale of bonds are assessable as Capital Gains and not as business income. In the case of Vijaya Bank Ltd., as the purchase price of securities included interest, it was held that the entire payment was a capit ..... X X X X Extracts X X X X X X X X Extracts X X X X
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