9911796707
TMI Blog2019 (8) TMI 554X X X X Extracts X X X X X X X X Extracts X X X X ..... ssessment Year 2009-10 in IT(TPA) No. 2060/Bang/2016 are as under: - "1. The Ld. CIT(A) has erred in not appreciating the fact that Compulsory Convertible Debenture (CCD) are in the nature of equity and not debt. 2. The Ld. CIT(A) has erred in not appreciating the fact and circumstances brought out by the TPO to arrive at the conclusion that CCDs are in the nature of equity and not debentures. 3. The Ld. CIT(A) has erred in allowing the interest expenditure incurred for CCDs without acknowledging the TPO's conclusion that CCDs are equity in nature." 3. The grounds raised by the assessee for Assessment Year 2009-10 in C.O. No. 83/Bang/2017 are as under: - "1. That the contention in the appeal filed by the revenue is bad in law while stating that the Learned Commissioner of Income-tax (Appeals) ["Learned CIT(A)"] erred in not appreciating the fact that compulsorily convertible debentures ("CCD") are in nature of equity and not debt. 2. That the contention in the appeal filed by the revenue is bad in law while stating that the Learned CIT(A) has erred in not appreciating the fact and circumstances brought out by the Transfer Pricing Officer ("TPO") to arrive at th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... On the facts and circumstances of the case and in law, the learned AO/learned Panel erred in applying 12 month average of LIBOR rates in determining the arm's length price of international transaction with respect to interest paid on CCDs by the Appellant to its AEs. Further, adopting 12 month LIBOR rates was completely ad-hoc, as the learned AO/learned Panel did not undertake suitable adjustments thereby failing to align the LIBOR rates to the prevalent interest rates for CCDs. 5. On the facts and circumstances of the case and in law, the learned AO/learned Panel erred in not appreciating the Appellant's argument that the CCDs should be benchmarked only in the year of issue and that the terms and conditions prevalent at the time of issue continues to hold good until the redemption/ conversion of CCDs. 6. On the facts and circumstances of the case and in law, the learned AO/learned Panel erred in not appreciating that the CCDs were issued in INR and therefore the Prime Lending Rate ("PLR") followed by the Indian Public Sector Banks would be the ideal basis for determining the arm's length nature of interest payments on CCDs. That the Appellant craves leave to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... erred in law as well as on facts, in directing the TPO to make an estimated 1% adjustment on account of Risk when Transfer pricing regulations in India is against any assumption in respect to any adjustment and further when there is also no reliable method to convert the qualitative difference into quantitative difference for making adjustment on account of risk level. 10. For these and other grounds that may be urged at the time of hearing, it is prayed that the directions of the Dispute Resolution Panel in so far as it relates to the above grounds may be reversed. 11. The appellant craves leave to add, alter, amend and / or delete any of the grounds mentioned above." 6. The grounds raised by the assessee for Assessment Year 2011-12 in IT(TP)A No. 599/Bang/2016 are as under:- "Each of the grounds and/ or sub-grounds of the appeal are independent and without prejudice to the others. 1. On the facts and in the circumstances of the case and in law, the learned Dispute Resolution Panel (learned "Panel") erred in confirming the action of the learned Deputy Commissioner of Income-tax, Circle - 1(1)(2), Bangalore (learned "Transfer Pricing Officer" or learned "TPO")/ learne ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... earing of this Appeal." 7. The grounds raised by the assessee for Assessment Year 2012-13 in IT(TP)A No. 2178/Bang/2016 are as under:- "Each of the grounds and/ or sub-grounds of the appeal are independent and without prejudice to the others. 1. On the facts and in the circumstances of the case and in law, the learned Dispute Resolution Panel (learned "Panel") erred in confirming the action of the learned Deputy Commissioner of Income-tax, Circle - 1(1)(2), Bangalore (learned "Transfer Pricing Officer" or learned "TPO")/ learned Deputy Commissioner of Income-tax, Circle - 2(1)(1), Bangalore (learned "Assessing Officer" or "AO") in making an adjustment of Rs. 16,54,49,610/- to the income of the Appellant in respect of international transaction for payment of interest on compulsorily convertible debentures ("CCDs") by the Appellant to its Associated Enterprise ("AEs"). 2. In doing so, the learned Panel / learned AO grossly erred in 2.1. upholding the approach of the learned TPO of re-classifying the CCDs issued by the Appellant to its AEs from debt to equity, completely ignoring the basic principles associated with the issuance of the debt instruments. 2.2. upholding ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... xpenses of Rs. 15,68,93,828/- on compulsory convertible debentures (CCDs) which are actually Equity capital in nature of FDI as per RBI guidelines." 9. The grounds raised by the assessee for Assessment Year 2013-14 in C.O. No. 09/Bang/2018 are as under:- "1. That the contention in the appeal filed by the Revenue is bad in law in stating that the Learned Commissioner of Income-tax (Appeals) ["Learned CIT(A)"] erred in not appreciating the fact that Compulsorily Convertible Debentures ("CCD") are in the nature of equity and not debt. 2. That the contention in the appeal filed by the Revenue is bad in law in stating that the Learned CIT(A) has erred in allowing the interest expenditure of INR 156,893,828 incurred for CCDs which are actually Equity capital in nature of FDI as per RBI guidelines. That the Respondent craves leave to add to and/or to alter, amend, rescind, modify the grounds herein above or produce further documents before or at the time of hearing of this appeal." 10. The facts in detail are noted by the TPO in the order for A. Y. 2009 - 10 being the first year as CCDs were issued in December 2008. Hence, we reproduce Para 6 to 9 of this order of TPO.:- " ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y will be that of an investor and not a lender. The arm's length principle focuses on determining the true nature and effect of each constituent of the arrangement and the arrangement as a whole, allowing due weight to the legal form of each constituent to the arrangement, the business context in which they occur and any relationship between different elements of the arrangement. Where, an investment in an associated enterprise may be structured in the form of interest-bearing debt when, at arm's length, having regard to the economic circumstances of the borrowing company, the investment would not be expected to be structured in this way. Depending on the facts and circumstances of the particular case, it may be appropriate for tax administrations in applying the relevant transfer pricing provisions to examine the purpose and object of providing the funding in the form of debt vis-àvis infusion of equity. The permissibility of infusing additional amounts of funding required in the form of debt would need to be viewed from a commercial viability perspective and whether such loans would have been advanced by third parties in the instant case. 2.2 UK Transfer Pricing ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... and * the "would" argument - what a borrower acting in the best interests of their own business would have borrowed." "60. In the context of applying Australia's transfer pricing rules, the principal factors that will be taken into account in determining whether a particular loan agreement should be treated as equivalent to a contribution to equity It should be noted herein, that no where it is mentioned that all the conditions mentioned below should be met collectively for the recharecterisation of loan to equity. are detailed below. (a) The legal effect of the transaction A loan would ordinarily create the legal relationships of creditor and debtor. Where the rights and obligations of the provider of funds are similar to the rights and obligations of a shareholder, this will be taken as a factor indicating that the contribution might be akin to the supply of equity capital. For example, the lender may have, in relation to the loan, voting rights, a return dependent upon profits, or other rights that usually attach to ownership. (b) Repayment of principal A loan repayable on demand or within a short period of time will not be considered as equivalent to equi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... en from the extracts of the Ruling, there are several clauses contained within the said Ruling which would apply to treat the loan provided as an equity contribution. 3.0 Further, the concept of thin capitalisation itself stems from the arm's length principle and therefore, it will not be right to argue that thin capitalization rules are not applicable. Therefore, in Transfer Pricing Analysis a debt may be characterized as equity investment, if under the conditions existing in related party transaction no third party would have given loan. A company is said to be thinly capitalized when its capital is made up of a much greater proportion of debt than equity, i.e. its gearing or leverage, is too high. This is perceived to create problems for two classes of people. * consumers and creditors bear the solvency risk of the company, which has to repay the bulk of its capital with interest; and * revenue authorities, who are concerned about abuse by excessive interest deductions. In view of Transfer Pricing issues, an entity (which may be part of a group) may be said to be thinly capitalized when it has excessive debt in relation to its arm's length borrowing capacity, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... her than an equity investment. For instance, a local property firm raising $30 million by issuing CCDs will give an undertaking that it will buy back the securities after two years for $33 million. 3.3 While real estate companies are barred from tapping debt through ECBs (except for the 100-acre or more projects), there is no restriction on pure equity investment, subject to certain conditions such as minimum capital requirement and a three-year lock-in. CCDs are treated as FDI, so essentially there is nothing that contravenes the regulations. Put option on CCDs has the potential of being misused unless it is exercised post-conversion into equity. Analysts say CCDs are a financial innovation resorted to by companies to bring in foreign loans masquerading as equity. The option is used to sell securities to international investors who, in turn, are promised an assured return and an easy exit. 3.4 Once the conversion option is exercised, it becomes an equity investment. Since conversion is compulsory, it is normally treated as equity even as it has debt like features for some time. Confusion has arisen because sometimes CCDs are structured in a way that takes them closer to debt ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he Assessee Company as at 2009 is highly skewed. This position of the Company is after taking amount from AEs through CCDs. The ratio of debt (if for a time being CCDs are considered as debt) and equity capital is 8.1 In this highly skewed balance sheet the operating revenue is very small compared to expenditures. The operating revenue is only 7.73 Crores whereas the expenditures are 28.41 Crores. It includes interest on debenture from December 2008 to March 2009 on CCDs for Rs. 5.38 crores whereas revenues are for the whole period. When in subsequent period when interest ill be payable On CCDs for whole year revenues will not be enough to service the debt. Even in FY 2008-09 relevant for AY 2009-10 the revenues are not sufficient and there is loss Rs. 20.67 Crores. In such company no third party would invest in the debts of the company which has very low credit rating which is even lower than investment grade bonds having BBB (-)credit rating. Thus, in the case of Assessee having junk credit rating, having no operating income, no source of cash flow to service the interest payable at the rate of 15%, no third party would make investment in CCDs. Therefore, it is nothing but thin c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... line with the order of TPO by holding that no interest on CCDs is allowable and made adjustment of Rs. 16,54,49,612/-. DRP in this year held that CCDs are Debt and not equity. DRP also held that Thin Capitalisation principle is not applicable. Having held this, DRP also held that ALP for interest on CCDs has to be worked out at LIBOR Plus rate and directed the AO to adopt ALP of interest on CCDs at 1.559%. DRP also held that additional 1% should be added to the prevailing LIBOR rate of interest to cover risk adjustment. Against this direction of DRP, the revenue is in appeal. One of the issues raised by the revenue is this that CCD is equity and not debt and hence, interest on CCDs is not an allowable expenditure. Second issue raised is this that even if it is held that interest on CCDs is allowable, the ALP should be 1.2848% as against 1.559 %. Third issue raised is about granting of 1% Risk Adjustment. 13. In this year, the assessee has also filed an appeal. One of the issues raised by the assessee is this that interest on CCDs should be benchmarked in the year of issue only and not every year. Second issue raised is this that since CCDs are issued in INR, PLR of Indian Public ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e, we should also examine and decide the applicability Thin Capitalisation Principle invoked by the TPO/AO. (b) If we come to this conclusion that it is equity and interest on it is not allowable than nothing remains to be decided further but if we come to this conclusion that it is Debt and interest on it is allowable then we have to decide this second issue as to what should be the amount to be allowed which essentially means what is ALP of such interest to be allowed? For quantifying the ALP, this is the first aspect as to whether it should be bench marked in A. Y. 2009 - 10 only being the year of issue or in each year? Second aspect is this as to whether it should be bench marked on the basis of LIBOR plus or PLR. Third aspect is this that if LIBOR is adopted then whether Risk Adjustment is to be allowed or not and if it is to be allowed, at what rate? 19. The ld. DR of revenue has submitted written submissions which are reproduced hereinbelow. "May it please Your Honours, The above mentioned appeals have been heard by the Hon'ble Bench on 27.6.2019 and arguments have been made by the learned AR and the undersigned on the issue in dispute i.e. TPO's action of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... scussion on page 9 of the TPO's order. 5. In support of the TPO's conclusion that the money collected through CCDs is in the nature of equity, reliance was placed on the decision of the Hon'ble ITAT, Special Bench in the case of Ashima Syntex Ltd. vs ACTT, Central Circle-2(3) reported at (2006) 100 lTD 247 (AHD.)(SB) and a copy of the same was submitted to the Hon'ble Members during the hearing. In this decision, it was held that in the case of convertible debenture, it is nothing but raising capital by way of equity shares increasing the capital base via media being issue of convertible debentures. The loan or borrowings are not to be repaid but retained by converting into equity shares and therefore, it cannot be said to be a borrowing or a loan. In so far as the decision of ITAT, Mumbai Bench in the case of Besix Kier Dabhol, SA on which the learned AR placed reliance, it was argued that facts in that case are different and distinguishable. In that case, the assessee company raised foreign borrowings from its shareholders and claimed interest deduction u/s.37(1) of the I.T.Act, 1961 which was denied by the AO on the reasoning that in view of provisions of Arti ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rned . A copy of this Circular is also enclosed. 8. As the assessee issued CCDs pursuant to Convertible Debentures subscription agreement with the subscribers entered into on 24.12.2008 (kindly see page 250 of PB), the above RBI Circulars shall apply. Therefore, the TPO has rightly relied on these policy circulars to treat CCDs as equity capital and proceeded to make ALP adjustment. 9. In the light of the above submissions, it is respectfully prayed that the Hon'ble Bench may be pleased to uphold the ALP adjustment made by the TPO and render justice." 20. The ld. AR of assessee also submitted written submissions which are reproduced hereinbelow. "Subject : Notes on Arguments placed before Hon'ble Income Tax Appellate Tribunal Bench 'A', Bangalore in the case of CAE Flight Training India Private Limited (PAN : AADCC1248A) for Assessment Year 2009-10 (Deptt. Appeal No.- 2060/Bang/2016 and Assessee CO No.- 83/Bang/2017); Assessment Year 2010-11 (Deptt. Appeal No.- 63/Bang/2015 and Assessee Appeal No.- 84/Bang/2017); Assessment Year 2011-12 (Assessee Appeal No.- 599/Bang/2016); Assessment Year 2012-13 (Assessee Appeal No.- 2178/Bang/2016); Assessment Year 201 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lected under Comparable Uncontrolled Price (CUP) method. The argument of the Transfer Pricing Officer for this rejection was that the comparables selected by the Assessee were for dissimilar periods and were in the context of Non-convertible Debentures whereas the Assessee's international transactions were in the nature of Compulsory Convertible Debentures. (Kindly refer, Para- 5 on Page- 3 of the Transfer Pricing Order for AY: 2009- 10). 2.4. The Transfer Pricing Officer did not dispute adoption of CUP method by the Assessee as the correct method. The only aspect the Transfer Pricing Officer disputed and rejected was adoption of certain comparables by the Assessee under CUP method. The Transfer Pricing Officer also did not suggest or adopt any other prescribed method to be the most appropriate method under the Income Tax Act or under the Income Tax Rules. Besides these, in spite of having accepted the Assessee's selection of CUP method as the most appropriate method and having rejected only the comparables selected by the Assessee, the Transfer Pricing Officer did not undertake the exercise of determining the arm's length price of the involved international transact ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ought by saying that under section 36(iii) of the Income Tax Act interest is payable and deductible only in respect of a debt and in the subjective opinion of the Transfer Pricing Officer the status of the Assessee was such that no third party would have provided credit to it as a borrower (Kindly refer, Para- 6 on Page- 4, Sub para- I. 1. to 1.3 of Para- 7 on Page- 4 and Sub-para- 3.1. of Para- 7 on Page- 10 of the Transfer Pricing Order for AY: 2009-10). 5.2. According to the Transfer Pricing Officer this subjective understanding was sufficient enough to decide that matter on hand is that of equity and not debt. Little did the Transfer Pricing officer realize that conjectures, surmises and commercial expediency determination are not permissible for the Revenue Authorities under Indian Tax jurisprudence. Only objective analysis based on facts and evidence within the parameters of law can enable a judicially sustainable proposition. 6.1. In a misplaced pursuit of justifying invocation of non- existing Thin Capitalization concept in Indian Tax Laws, the Transfer Pricing Officer has further transgressed the legal boundaries, by re-characterizing the debt in terms of Compulsory ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ng interest deduction in certain cases. Indian statute thus for the first time addressed the concerns thrown up in Thin Capitalization concepts abroad. Here too the Indian statute confined itself to only limit the extent alone of the interest paid to the associated enterprise upon issue of a debt. In any case even this newly introduced provision is not relevant for any of the Assessment Years involved in the present set of appeals. This fact is being mentioned here just to emphasize that even here the statute did not permit recharacterization of a transaction in order to deny an interest payment outgo. This new provision also acts just as a limitation simpliciter on an interest deduction. 7.1. Core theme and arguments of the Transfer Pricing Officer is non-existent Thin Capitalization concept in Indian context. Towards this objective the Transfer Pricing Officer has recharacterized the Compulsory Convertible Debentures (debt) in to equity as has been seen in discussion above. For this the Transfer Pricing Officer also makes reference to the Foreign Direct Investment (FDI) Policy and the Reserve Bank of India (RBI) Policy in respect of fund infusion from foreign sources in to Ind ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Income Tax Act is concerned it is enough to understand that the Government nowhere said in the given situation that a Compulsory Convertible Debenture is equity even at the time of its inception and during its continuity as a debenture prior to its compulsory and actual conversion in to equity at the appointed date. That being the case, purposes of Income Tax Act just requires to determine the nature of receipt and expense and decide the taxability of the resultant income. Thus, in the case of a Compulsory Convertible Debenture the nature of its value is that of a debt and once it is converted in to equity at the appointed date, its value is that of an equity. The resultant expense therefore correspondingly will be that of an interest and a dividend, in that sequence. Reading anything more in to the Government's Policy through RBI and FDI Policies is not only misleading but also purposive. 7.6. Moreover, in the instant case of the Assessee, RBI itself has not only allowed and approved the issue of Compulsory Convertible Debentures but has also allowed and approved remittances to respective associated enterprises in the form of interest on these Compulsory Convertible Debentu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... it. The Transfer Price Officer exceeded his statutorily prescribed role and jurisdiction. 9.1. Hon'ble ITAT, Mum bai, in the case of Besix Kier Dabhol, SA vs. DOT (ITA No.- 4249/Mum/2007) has very categorically identified that the issue on hand in this case is that of Thin Capitalization requiring re-characterization of debt as equity (Kindly refer Paras - 18 and 23 on Pages 16 and 21 of this ITAT order). The Hon'ble Tribunal then very categorically concludes in this case that the international consensus, which the Assessing Officer has referred to, is for the need of Thin Capitalization Rules. But then just because it is desirable, the Assessing Officer can not disallow the interest paid on debt, payable in the cases of thinly capitalized companies. The Honbl. ITAT In this case candidly observed that the Assessing Officer was clearly ahead of his times in disallowing the expenses based on his notions of Thin Capitalization rules when such rules have not even reached the drawing board stage in India (Kindly refer to Para - 29 and 30 on Pages - 26 and 27 of this /TAT order). 9.2. The Hon'ble Mumbai Bench in this case also concludes that once the interest has been p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d they stand in isolation amidst various other case laws that hold the issue differently. First of all the Revenue has missed the point that the case of Ashima Syntex was in the context of allowance of expenditure incurred by the Assessee on the issuance of convertible debenture as a revenue expenditure when they were basically pre-issuance expenditures. Allowance of interest expense on loan under Section 36 (1) (iii) of the IT Act was never the issue under consideration. Similarly, the case of Narendra Kumar Maheshwari was also in the context of role of the Controller of Capital Issues (CCI) in giving sanction for the issue of debentures and on the larger issue of principles of comity of courts administering the laws throughout the country. Therefore, any observation made by the courts in these cases, while dealing with entirely different issues, cannot be imported into the situations of present set of appeals and be made applicable. 10.3. That the decision in the case of Ashima Syntex stands in isolation is very much evident from the following decisions - i. In the case of CWT vs Spencer and Co. (88 1TR 429) the Honbl. Supreme Court concluded that under certain circumstance ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nture holders to convert them into equity or preferential shares at stated rate of exchange after certain period. Thus, debenture conversion is also another form of loan for a specified period till they are converted into shares. Interest is payable on convertible debentures till they are converted into shares when dividend becomes payable. vii. In the case of GE Strategic Investments India in AAR No.- 769 of 2007, the Hon'ble Authority for Advance Rulings, New Delhi concluded that payment made in the form of interest up to the date of conversion of bonds into equity shares is nothing other than interest paid on money advanced or the debt incurred. The Hon'ble Authority also concluded that the interest payments cannot be construed as dividend as a dividend presupposes that the payee holds shares in a company and the bond holder would become share holder only upon conversion of the bonds into equity shares. It was observed that mode of discharge of the debt created by debentures is not relevant. (Kindly refer Page - 3, 10, 12, 14, 17, 18 and 19 of the order of the Authority). 11.1. On the issue of legality and validity of re-characterization of an instrument and transa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... i. CIT Vs. Cotton Naturals India Private Limited, High Court of Delhi in ITA No. 233/2014; ii. Siva Industries and Holdings Limited (ITA No. 2148/Mds/2010); iii. BT (India) Private Limited ((TA No. 5953/De1/2012); iv. lndegene Lifesystems Private Limited [IT(TP) No.1504 / Bang / 2012)]. 14. A fresh Case Law Compendium with fresh indexing containing the case laws finding specific mention in this Notes on Arguments is being filed simultaneously just to facilitate quick and easy reference for this Notes on Arguments. Submitted for kind consideration of the Honbl. Bench with the prayer to kindly consider the same favourably." 21. Now we first decide the First and most important issue i.e. this that CCDs are Debts or equity and interest on it is allowable or not? On this issue, in the order of CIT (A) para 4 in the first year i.e. A. Y. 2009 - 10 is relevant and therefore, this Para is reproduced for ready reference hereinbelow. "4. Transfer pricing adjustment of Rs. 7,68,26,983: 4.1 The Transfer Pricing Officer, to whom the case was referred, noticed that the appellant had issued compulsory convertible debentures (CCDs)in December 2008 to its associated Enterpris ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ingly, the Learned TPO failed to provide to the appellant adequate opportunity to argue on the proposed classification of CCD as equity. The Learned TPO went beyond the brief of arbitrating only on the arm's Length pricing related to the rate of interest, and proceeded to question the nature of the inter-company funding. 6. That the Learned AO/Learned TPO proceeded to apply the principle of thin capitalisation, as contained in the Legislation from UK and Australia, in contravention to confining the assessment based on the principles provided in the Indian Transfer pricing regulations (as provided in the Act and the Rules). 7. The Learned TPO as part of the TP order did not refer to nor had any dispute on the rate of interest charged, and thereby making the TP order erroneous. These are taken up together in determining whether the TP adjustment made by the TPO is correct. The relevant issues raised in the above grounds are as under: i) Whether TP study has been rightly rejected? The comparisons made by the appellant with transactions of cases of other years and in respect of non-convertible debentures was not correct. The said comparisons in the TP document was th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... para 18 to 30. "18. That takes us to objection of the Revenue authorities to the effect that the borrowings by the assessee, on which interest has been claimed as deduction, are in fact part of the capital of the assessee which is brought in the garb of borrowings purely on tax considerations. Our attention is pointed out to the fact the ratio of debt to the equity is 248 : 1 which is unusually high by any standard and that such a highly geared company only shows that equity is brought in the garb of debt, and it is contended that since what is termed as borrowing by the company is de facto minimum required capital to carry out the business in India, interest cannot be allowed as a deduction on the same. In other words, Revenue's objection is that the assessee company is so thinly capitalized that its debt capital is required to recharacterized as equity capital for the purpose of examining claim of deduction for interest on such debt capital. 19. Thin capitalization refers to a situation in which capital of a business is made up of greater portion of debt than equity, and its such gearing or leverage ratio i.e. debt equity ratio, is too high. The tax treatment being given to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tion of having formal thin capitalization rules in India. However, it is not in dispute that as at the material point of time, India did not have any thin capitalization rules, nor does it have any thin capitalization rules even at present. 21. Interestingly, however, thin capitalization rules do exist in Belgium which perhaps explains, for the reasons we shall now set out, the peculiar capital structure may have been adopted by the assessee. As per the Country Survey Report on Belgium, as published by the International Bureau of Fiscal Documentation, Amsterdam (based on information as on 19th Dec., 1995) Belgium applies two sets of thin capitalization rules. Firstly, a 1:1 debt/equity ratio applies to loans granted by individual directors, shareholders and non-resident corporate directors to their company [art. 198(10) IR/WIB]. Interest relating to debt in excess of this ratio is recharacterized into a non-deductible dividend. Furthermore, the interest rate may not exceed the market rate. Secondly, a 7:1 debt/equity ratio applies to debt if the creditor (resident or non-resident) is exempt or taxed at a reduced rate in respect of the interest paid on the debt. Interest relating ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ructured now, and the borrowings having been resorted by the Indian PE directly, it could possibly be said, or at least argued, that there is no debt capital in the assessee company-i.e. the Belgian entity, and this debt capital is confined to borrowings directly by the PE. Be that as it may, it cannot be open to us to apply these thin capitalization rules in the hands of the assessee company while computing its taxable income in India, because so far as taxability in India is concerned, the limitation to be placed on deduction of expenses has to be limitation under the laws of the State in which PE is situated i.e. India. It may be useful to recall that in terms of the provisions of art. 7(3)(b) of Indo-Belgian tax treaty, "In the determination of the profits of a PE, there shall be allowed as deductions expenses which are incurred for the purposes of the business of the PE including executive and general administrative expenses so incurred, whether in the State in which the PE is situated or elsewhere, subject to the limitations of the taxation laws of that State". Admittedly, there are no limitations on deduction of interest expenses on borrowings, which can be attributed to thi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ners by the assessee. 26. Even otherwise, it is also important to bear in mind the fact that as the law stands now under s. 90 of the Indian IT Act, the provisions of a tax treaty override the provisions of the Indian IT Act-except to the extent the latter are beneficial to the assessee and this treaty override is unqualified, save and except for clarification that charge of tax in respect of a foreign company at a rate higher than the rate at which domestic company is chargeable, shall not be regarded as less favourable charge or levy in respect of such foreign company. Just in case there were any doubts on this fundamental legal position, the CBDT, vide Circular No. 333, dt. 2nd April, 1982 [(1982) 81 CTR (TLT) 18 : (1982) 137 ITR (St) 1], has set the same at rest. This circular deals with the question as to what the AOs will do when they find that the provisions of the DTAA are not in conformity with the provisions of the IT Act, 1961. Then it was laid down by the Board in the said circular as follows : "The correct legal position is that where a specific provision is made in the DTAA, that provision will prevail over the general provisions contained in the IT Act, 1961. I ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... payment of tax by restoring to dubious methods" and that "it is the obligation of every citizen to pay the taxes honestly without resorting to subterfuge". It is thus not even necessary to examine whether or not the finance structure in question constituted colourable device or sort of subterfuge. As long as finance structure adopted by the assessee was not specifically prohibited by the applicable tax treaty provisions, and as long as there was no specific anti-abuse provision to deal with the same in the tax treaty itself, the effect of the finance structure could not be ignored. 28. It is interesting to take note of the paradigm shift with regard to the treaty override, as introduced in s. 129(9) of the Direct Taxes Code Bill 2010, which provides that notwithstanding the treaty override provisions in s. 129(8) [which are in pari materia with s. 90(2) of the Indian IT Act, 1961] the provisions of the Direct Taxes Code "relating (a) general anti-avoidance rule under s. 123; (b) levy of branch profit tax under s. 111; or (c) control foreign company rules referred to in the Twentieth Schedule, shall apply to the assessee referred to in sub-s. (8), whether or not such provisions ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ed on his notions of thin capitalization rules, when such rules had not even reached the drawing board stage in India. Learned CIT(A) also did not follow the correct legal position by leaning upon restriction placed in Explanation to s. 37 of the Act, which is not applicable in respect of deduction on interest under s. 36(1)(iii) and in leaning upon restriction placed in art. 7(3)(b) on intra-organization notional payment of interest on capital, whereas the interest payment in the present case did not constitute an intra-organization transaction at all. Even if these interest payments were to be treated as intra-organization transactions by treating the same as payments made to the GE, and not to the joint venture partners, these payments cannot be viewed as notional payments because in such a situation the GE will have corresponding liability to pay the same to the joint venture partners. We have also noted that the interest paid by the assessee may have been contrary to the spirit, if not letter of the RBI guidelines, but then this fact, by itself and particularly in view of Explanation to s. 37 being confined to the amounts admissible as deduction under s. 37, does not render th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the same logic, in our considered opinion, till the date of conversion, for allowability of interest u/s 36 (1) (iii) of Income tax Act also, such CCDs are to be considered as Debt only and interest thereon has to be allowed and it cannot be disallowed by saying that CCDs are equity and not debt. We hold accordingly. This issue is decided. 24. After examining the applicability of the Tribunal order rendered in the case of Besix Kier Dabhol, SA vs. DDIT (supra), we now examine the applicability of the decision of Special Bench of the Tribunal rendered in the case of Ashima Syntex Ltd. Vs. ACIT as reported in 100 ITD 247 (Ahd.) (SB) on which reliance has been placed by ld. DR of revenue in the written submissions filed by him as reproduced above. From the facts noted by the Tribunal in this case, it is seen that in that case the assessee issued convertible debentures for subscription at the rate of Rs. 75 per debenture and these were in two parts; Part-A of Rs. 35 to be compulsorily converted into one equity share of the face value of Rs. 10 each at a premium of Rs. 25 per share on the date of allotment of the debenture and Part-B of Rs. 40 to be compulsorily converted into one eq ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 008. We would like to observe that such circular in the context of FDI policy of RBI is in a different context i.e. regarding future re-payment obligations in convertible foreign currency and to have control over such future re-payment obligations, the RBI is exercising strict and control so that such future re-payment obligations does not go beyond a point and since in the case of fully convertible debentures, there is no future re-payment obligation, the same was considered as equity for the purpose of FDI policy. In our considered opinion, any definition of any term is to be considered keeping in mind the context in which such definition was given. This definition of convertible debentures given by RBI is in the context of FDI policy to exercise control on future re-payment obligations in convertible foreign currency. In our considered opinion, such definition of the term convertible debentures cannot be applied in other context such as allowability of interest on such debentures during pre-conversion period or regarding payment of dividend on such convertible debentures during pre-conversion period or regarding granting of voting rights to the holders of such convertible debent ..... X X X X Extracts X X X X X X X X Extracts X X X X
|
