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TMI Blog2022 (8) TMI 1392X X X X Extracts X X X X X X X X Extracts X X X X ..... at on the facts and in the circumstances of the case and in law and based on the directions of the DRP: 1. The Ld. AO erred in law and on facts, in assessing the total income at INR 9,50,76,864/- as against returned income of INR Nil. The Appellant prays that the adjustment be deleted. Grounds of appeal relating to transfer pricing adjustment of INR 9,50,76,864/- 2. The Ld. AO and Ld. Transfer Pricing Officer ("TPO") erred in law and on facts, in making an upward adjustment of INR 9,50,76,864 to the total income of the Appellant in relation to the international transactions of payment of interest on Compulsory Convertible Debentures ("CCDs") by re-characterizing the CCDs as 'equity' and redetermining the arm's length price ("ALP"). 2.1 The Ld. AO and Ld. TPO erred in law and on facts, in disregarding the ALP and rejecting the methodical benchmarking analysis carried out by the Appellant in its Transfer Pricing Study Report using Comparable Uncontrolled Transaction ("CUP") Method undertaken in accordance with Section 92C and Section 92D of the Income-tax Act, 1961 ("the Act") read with Rule 10B, 10C and 10D of the Income-tax Rules, 1962 ("the Rules"), with ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... appropriate method. 2.9 The Ld. AO and Ld. TPO erred in law and on facts, in concluding that interest on CCDs is not allowable as deduction u/s 36(1)(iii) of the Act from total income by recharacterizing CCDs as 'Equity'. 2.10 The Ld. AO and Ld. TPO erred in law and on facts, in disregarding the without prejudice contention of the Appellant for bench marking the international transaction of payment of interest on CCDs by applying SBI Prime Lending Rate, on alternative basis and consequently taking a divergent view from the approach followed by the Ld. TPO for AY 2009-10 to AY 2013-14 in benchmarking the aforesaid transaction pursuant to order of the Hon'ble ITAT. 3. Set-off of brought forward business loss and unabsorbed depreciation 3.1 The Ld. AO has not granted credit for brought forward business losses and unabsorbed depreciation for the year under consideration. 4. Levy of consequential interest under section 234B and 234D of the Act 4.1 The Ld. AO erred in levying interest under section 234B and 234D of the Act which is consequential to the grounds of appeal in above paras; The Appellant submits that each one of our above grounds is without pr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... However, the TPO was of the view that the comparison with non-convertible debentures of years other than the relevant FYs was not valid comparisons and therefore, the ALP determined by the appellant on the interest paid was rejected by the TPO. Also, the TP Officer examined whether the 'interest' paid of Rs. 7,68,26,983 was in the nature of `interest' at all. The Assessing officer concluded that the CCDs were actually equity and not debt since it was compulsorily convertible to equity shares and that the Reserve Bank of India also recognised CCDs as equity instruments. Also, the TPO was of the view that the appellant had junk credit rating, having no operating income or source of cash flow to service the interest payable at 15% and that no third party would make investment in CCDs and that the arrangement amounted to this capitalisation. Holding this, the amount of Rs. 7,68,26,983 was held to be not in the nature of 'interest' and ALP of the transaction by CUP method was held as Nil and adjustment of Rs. 7,68,26,983 was determined u/s 92 CA (3) of Income tax Act, 1961. As grounds No. 1 and 2 are general in nature these do not require adjudication. The relevan ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s debt rather than equity although, the debt equity ratio has not been discussed in the order of the Transfer Pricing Officer. In the case of Besix Kier Dabhol, SA vs DDIT (I Tax),Circle- 3(2), Mumbai, ITAT, Mumbai in their order in ITA No.4249/Mum/07 dated 20.11.2010 have held on similar facts that in absence of specific thin capitalisation rules in India, recharacterisation of debt capital as equity capital and accordingly disregarding the interest payments as tax deductables is not in order. Drawing support from the above, I hold that the conclusion of the AO that the CCDs is equity and that interest payment is not allowable cannot be upheld. iii) Whether rate of interest charged is at arm's length? It is on record that the funds which have been raised by the appellant through CCDs and have been utilised for the business of the appellant. The appellant has paid 15% as the rate of interest to its AEs for this purpose. It is been that PLR for A.Y.2008-09 as seen from SBI corporate website varies from 12.25% as on 1.1.2009 to 13.00% as on 10.11.2008. At an average, the same can be taken at 12.6% as against 15% claimed by the appellant. Under such facts, the interest paid ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lly taxable at the same rate in the hands of the recipient in the source country, e.g. under India Belgium tax treaty WHT rate on interest, other than bank interest, as also dividend is at uniform 15 per cent, interest is tax deductible and that results in lower corporate taxes in respect of PE profits. These tax benefits could be further optimized by hybrid financing instruments such as profit participating loans, convertible loans or where instrument is treated as debt in the source country of the income (i.e. resulting in tax deductible interest) and as equity in the residence country of the lender (i.e. where lender may claim the participation exemption of interest income because of its characterization as distribution of profits). That is how tax considerations at times do result in a company being too thinly capitalized, or, to put it differently, financed by a disproportionate ratio of debts. In order to protect themselves against such erosion in their legitimate tax base, several tax jurisdictions enact rules to counter this vulnerability and these rules are termed as 'thin capitalization rules'. 20. It is for this background that many jurisdictions take several ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... domestic law provisions that are relevant for the discussion of thin capitalization, i.e. art. 26 BITC; art. 54 BITC; art. 198, 11° BITC, art. 18, 4° BITC and the Belgian GAAR. Articles 26, 54 and 198 belong to the first group of aforementioned rules. The deduction of interest is denied if the statutory conditions for deductibility are not satisfied. Articles 26 and 54 are not concerned with the question whether the borrower is undercapitalized but only whether the interest charged is at arm's length. Excessive interest (i.e. interest charged above the prevailing market conditions) is not deductible. Article 198, 11° is concerned with undercapitalized companies. Interest is not deductible if the statutory 7 : 1 debt/equity ratio is exceeded. Article 18, 4° BITC belongs to second group of aforementioned rules; it recharacterizes certain interest payments into dividends both for corporate tax purposes of debtor and for withholding tax purposes, while curiously it does not recharacterize debt into equity (neither for corporate tax, nor for capital duty purposes). In certain circumstances, the Belgian GAAR may have the potential to recharacterize purported debt int ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 24. We find guidance from Hon'ble Supreme Court's judgment in the case of Union of India & Anr. vs. Azadi Bachao Andolan & Anr. (2003) 184 CTR (SC) 450 : (2003) 263 ITR 706 (SC) wherein their Lordships have, inter alia, observed as follows : "111. In para 3.3.1 after noticing the growing practice amongst certain entities, who are not residents of either of the two Contracting States to try and avail of the beneficial provisions of the DTAAs and indulge in what is popularly known as 'treaty shopping', the report says : '3.3.1 ..there is a need to incorporate suitable provisions in the chapter on interpretation of DTAAs, to deal with treaty shopping, conduit companies and thin capitalization. These may be based on UN/OECD Model or other best global practices.' 112. In para 3.3.2 the working group recommended introduction of anti-abuse provisions in the domestic law. 113. Finally, in para 3.3.3 it is stated 'the working group recommends that in future negotiations, provisions relating to anti-abuse/limitation of benefit may be incorporated in the DTAAs also.' 114. We are afraid that the weighty recommendations of the working group on non- ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rary have been made in the agreement." 27. In the case of UCO Bank vs. CIT (1999) 154 CTR (SC) 88 : (1999) 237 ITR 889 (SC), their Lordships of Hon'ble Supreme Court had an occasion to survey the judicial precedents on the question of binding nature of the CBDT circulars. After elaborately dealing with Hon'ble Supreme Court's judgments in the cases of Navnit Lal C. Jhaveri vs. K.K. Sen, AAC (1965) 56 ITR 198 (SC) and K.P. Varghese vs. ITO & Anr. (1981) 24 CTR (SC) 358 : (1981) 131 ITR 597 (SC), their Lordships concluded that the CBDT circulars inter alia can tone down the rigour of the law and such benevolent circulars are binding on the field authorities. It cannot therefore be open to a Revenue authority to disregard the CBDT circular even if it deviates from the law--as long as it is beneficial to the assessee. Thus, where a DTAA provided for a particular mode of computation of income, the same should be followed, irrespective of the provisions in the IT Act. Where there is no specific provision in the agreement, it is the basic law, i.e., the IT Act, that will govern the taxation of income. When no such limitations on benefits or anti-abuse provisions are set out ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tted for the foreign companies, is unqualified. In the scheme of things, as it exists in the Indian IT Act, 1961, the treaty override over domestic law is much wider in scope. We cannot interpret the treaty provisions in such a manner so as to curtail, dilute or otherwise tinker with this comprehensive treaty override over the domestic tax law. 29. It is also important to bear in mind that when there are no thin capitalization rules vis-a-vis domestic thin capitalization situations and in the light of the s. 90(2) as it exists at present any attempts to neutralize thin capitalization vis-a-vis PEs of Belgian enterprise will be clearly contrary to the scheme of non-discrimination envisaged by art. 24(5) which provides that, "enterprises of a Contracting State, the capital of which is wholly or partly-owned or controlled, directly or indirectly, by one or more residents of the other Contracting State, shall not be subjected in the first-mentioned Contracting State to any taxation or any requirement connected therewith which is other, or more burdensome, than the taxation and connected requirement to which other similar enterprises of that first-mentioned State are or may be subjec ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ment of planning in structuring capital does not transform a tax-deductible expense of interest into an expense that is non-tax deductible. In view of these discussions, it is clear that the impugned disallowance is indeed contrary to the scheme of the law as it exists; the grievance of the taxpayer deserves to be upheld. We, therefore, direct the AO to delete the impugned disallowance." 23. As per above paras of this tribunal order, it comes out that even if Thin capitalization Principle is on Statute book of the other country, no disallowance can be made in India by applying this Principle. To this extent, we uphold the finding of CIT (A) by respectfully following this tribunal order. But the issue still remains because, the objections of AO/TPO are not merely on the basis of Thin capitalization Principle. Their basic objection is this that since the interest is paid on CCDs, this is not an interest on debt but on equity and hence, not allowable. On page 11 of his order for A. Y. 2009 - 10, the TPO has reproduced certain comments of RBI in 2007 Policy on convertible debentures in which it is stated that fully and mandatorily convertible debentures into equity within a specifie ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... yable half yearly on 30th June and 31st December each year and on conversion. The issue in dispute in that case was regarding the allowability of expenses incurred on issue of such debentures and the issue in that case was not of interest on debentures before its conversion as in the present case. This is also an important aspect of the matter of that case that one part of the debenture was to be converted on the date of allotment of debenture itself, second part of the debenture has to be converted only on expiry of 15 months from the date of allotment of debenture and under these facts, it was held by Special Bench of the Tribunal in that case that the expenses incurred on issue of such debentures has to be considered as expenses incurred for issue of shares because it was found that first part of the debentures was to be converted into shares on the date of allotment itself and the second part was to be converted after expiry of 15 months from the date of allotment of debenture and therefore it was held that expenses incurred were actually incurred for issue of shares and not issue of debentures. In the present case, the issue is not regarding expenses incurred on issue of share ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... voting rights of share holders during pre-conversion period, the answer will be a big NO. On the same analogy, in our considered opinion, the answer of this question is also a big NO as to whether interest paid on convertible debentures for pre-conversion period can be said to be interest on equity and interest on debentures allowable u/s. 36(1)(iii) of the IT Act. 26. Now we have to decide the second issue i.e. ALP of such interest on CCDs. We find that in the order of TPO and AO for the initial year i.e. A. Y. 2009 - 10, there is no discussion or decision on ALP aspect. Learned CIT (A) in that year has held in a very cryptic manner that 15% interest claimed by the assessee is not at arm's length because as per SBI Corporate Office Website, it is 12.25% on 01.01.2009 and 13.00% as on 10.11.2008. He directed the AO/TPO to rework the ALP at 12.62% which appears to be average of these two lower and upper rates of SBI PLR as noted. In later years, DRP has adopted ALP of interest at LIBOR plus but in those years also, TPO has not decided the ALP aspect. This is also a claim of the assessee that ALP of interest should be decided in A. Y. 2009 - 10 only being the initial year ..... X X X X Extracts X X X X X X X X Extracts X X X X
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