9911796707
TMI Blog2023 (6) TMI 1385X X X X Extracts X X X X X X X X Extracts X X X X ..... he assessee on 24.09.2018. During the course of assessment proceedings, the case was referred to the Transfer Pricing Officer (TPO) to determine the Arm's Length Price (ALP) of the international transaction undertaken by the assessee with its Associated Enterprises (AEs). The TPO, vide order dated 28.01.2022, determined aggregate Transfer Pricing (TP) adjustment of Rs. 377,81,17,908/-. Following were the TP adjustments proposed by the TPO: i. TP adjustment of royalty amounting to Rs. 51,76,98,493/-. ii. TP adjustment towards payment of interest amounting to Rs. 326,04,19,415/-. 3. Pursuant to the TPO's order, the Draft Assessment Order was passed on 26.03.2022 by incorporating the aforesaid TP adjustment. Aggrieved by the Draft Assessment Order, assessee filed objections before the Dispute Resolution Panel (DRP). The DRP, vide its directions dated 29.12.2022, rejected the assessee's contentions. Pursuant to the directions of the DRP, the impugned Final Assessment Order was passed on 19.01.2023. The computation of income pursuant to the Final Assessment Order is as under: Business Income as per ROI (-)304,98,68,418/- Add: as per above para no. 6 (TP) 377,81,17,908/- ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ) method to justify the arm's length of the transaction. The assessee also benchmarked the said transaction by aggregating it to certain other transaction and by adopting the Transactional Net Margin Method (TNMM). Under both the methods, the assessee concluded the transaction to be at arm's length. The TPO rejected the methods adopted by the assessee and determined the ALP transaction at 1%. The TPO had relied on earlier Assessment Orders which was upheld by the DRP. In earlier Assessment Years, the ALP of payment of royalty was restricted to 1%. The DRP rejected the objections of the assessee by relying on the directions issued in assessee's own case for Assessment Years 2011-12 to 2014-15 and 2016-17 (refer pages 9 to 12 of DRP's directions). We find that the Tribunal on identical issue in assessee's own case for Assessment Years 2009-10 to 2016-17 and Assessment Year 2018-19 (supra) had held that the payment of royalty is to be accepted as being at arm's length. The relevant finding of the Tribunal in Assessment Year 2018-19 which had followed earlier year's orders reads as follows: "Ground No. 5 and sub-grounds (TP adjustment) 5. The assessee has benchmarked the payment of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nate bench of the Tribunal in assessee's own case (Supra) has held that - "7.4 We have heard rival submissions and perused the material on record. The Tribunal in assessee's own case for assessment year 2009- 2010 in IT(TP)A No.315/Bang/2014 (order dated 31.03.2017) and for assessment year 2010-2011 in IT(TP)A No.361/Bang/2015 (order dated 04.06.2018) had restored the issue of determination of ALP for payment of royalty to the files of the TPO. The TPO, pursuant to the Tribunal's order, passed orders accepting the payment of royalty at 4% to be at arm's length. The relevant portion of the TPO's order for assessment year 2009-2010 reads as follows:- "3. In view of above direction of the ITAT, the assessee was asked to submit the details with respect of all comparables vide letter dated 19.06.2017. In response of the same the submission was filed by the assessee on 11.06.2017 which have been considered. As per submission, assessee has stated that out of the total 17 comparable agreements, the related party relationship between licensor and licensee existed in 07 comparable agreements and remaining 10 comparables agreements have unrelated party relationship for which the average r ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... efore, we hold that the payment of royalty by the assessee is to be treated at arm's length. It is ordered accordingly. In the result, grounds 4.3 to 4.6 are allowed. 10. Payment of interest on CCDs, premium expenditure on repayment of CCDs and interest on RDBs (Ground Nos.4.7 to 4.14) (TP adjustment) During the Financial Year 2016-17, the assessee paid interest of Rs. 252,26,33,938/- on Compulsorily Convertible Debentures to Praxair Luxembourg S.A.R.L ("Praxair Luxembourg"), at interest rate of 9%, and 12%. Further, these CCDs were repurchased at a premium of 3% of the issue value. As a consideration for the repurchase/ buyback of CCDs, Praxair Luxembourg was issued RDBs/ Masala bond at Rs. 2372,39,08,630/-, on which interest amounting to Rs. 4,67,97,847/- was accrued. The assessee, in its TP study, benchmarked the transactions by applying other method, and concluded the same to be at arm's length. 11. The TPO treated the CCDs as equity and held that the payments made to the AEs are not in the nature of interest. The TPO, upon holding the arm's length price of interest payment on CCDs to be NIL, determined an adjustment of Rs. 326,04,19,415/- (refer pages 10-23 of the TP Order ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s 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 relevant grounds of appeal raised by the appellant are "3. That on the facts and in the circumstances of the case, the Learned AO/ ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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. i. 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 of Rs. 7,68,26,983/- at @ 15% is certainly not at arm's length and is also evidently in excess of the +/- 5% margin allowable. T ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... her 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 legislative anti-abuse measures including limiting deduction on interest when the company is considered to be too highly geared under applicable tax re ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ; 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 into equity. In that case, it also belongs to the second set of rules." 22. It is thus only under the Belgian tax laws, which inter alia restrict the interest ded ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... TR 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 antiabuse 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-resident taxation are again about what the law ought to be, and a pointer to the Parliament and the executive for incorporating suitable limitation provisions in the treaty itself or by domestic legislati ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... cedents 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 in the tax treaty, it cannot be open to the Revenue authorities to apply the anti-abuse provisions based on the Judge made law in India- which is essentially to be treated as a part of the IT Act as it is based on the inter ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r 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 subjected in the same circumstances and under the same conditions". In this view of the matter, it cannot be open to the Revenue authorities to put any limitation on deduction of interest, in respect of funds borrowed by the PE, while compu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... eme 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 specified time would be reckoned as equity under FDI policy. In view of this RBI Policy, the TPO concluded that these CCDs are equity and not debt and therefore, interest on it is not allowable u/s 36 (1) (iii). This finding of TPO is not by invoking ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... objections before the DRP. The DRP rejected the assessee's objections and upheld the TPO's order (refer pages 3 and 4 of the DRP's directions). 8.3 Aggrieved, the assessee has raised this issue before the Tribunal. It is submitted that the TPO and DRP grossly erred in treating the CCDs as ECBs and benchmarking the interest rate against LIBOR rate. It was submitted that CCDs being a hybrid instrument, cannot be treated as an ECB/loan. Reliance in this regard is placed on the order of the Hyderabad Bench of the Tribunal in the case of ADAMA India (P.) Ltd. v. DCIT ([2017] 78 taxmann.com 75 (Hyderabad-Trib.). It is further submitted that the CCDs having been denominated in INR, the interest having been paid in INR, and the CCDs having been repaid in INR, the same cannot be benchmarked against LIBOR. In this context, the learned AR relied on the following case laws:- (i) CIT v. Cotton Naturals (I) (P.) Ltd. (2015) 65 taxmann.com 523 (Delhi). (ii) PCIT v. India Debt Management (P.) Ltd. (2019) 106 taxmann.com 55 (Bombay) (iii) Adams India (P.) Ltd. v. DCIT (2017) 78 taxmann.com 75 (Hyderabad-Trib.). 8.4 Therefore, it was submitted that the transaction of payment of interest of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... India and also RBI effective from 01- 04-2010 also indicate that issuance of CCD is part of FDI being quasi-equity in nature and considering the same as a loan would be completely against regulations laid by DIPB, RBI and FEMA. It is to be reiterated that issuance of CCDs was denominated in Indian Rupees and not foreign currency. Therefore, TPO has erred in considering LIBOR as benchmark rate which is in complete contradiction to the principles on the issue. The following judicial precedents supports that the rate interest has to be considered in the currency in which loan has originated: i. India Debt Management Pvt. Ltd., IT(TP)A No. 7518/Mum/2014; ii. CIT Vs. Cotton Naturals (I) Ltd., ITA No. 233/2014 (Del.HC); iii. M/s. Brahma Center Development Pvt. Ltd., Vs. ITO, ITA No. 373/Del/2016 (ITAT Del). By respectfully following the Co-ordinate Bench and Hon'ble High Court decisions, we agree with the assessee's contentions that the CCDs cannot be categorised as a loan and LIBOR plus two hundred basis points benchmark cannot be accepted on the facts of the case." 8.6.2 The Hon'ble Delhi High Court in the case of CIT v. Cotton Naturals (I) Pvt. Ltd. (supra) had held that th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ed). Moreover, a difference in interest levels frequently reflects no more than different expectations in regard to rates of exchange, rates of inflation and other aspects. Hence, the choice of one particular currency can be just as reasonable as that of another, despite different levels of interest rates. An economic criterion for one party may be that it wants, if possible, to avoid exchange risks (for example, by matching the currency of the loan with that of the funds anticipated to be available for debt service), such as taking out a US $ loan if the proceeds in US $ are expected to become available (say from exports). If an exchange risk were to prove incapable of being avoided (say, by forward rate fixing), the appropriate course would be to attribute it to the economically more powerful party. But, exactly where there is no 'special relationship', this will frequently not be possible in dealings with such party. Consequently, it will normally not be possible to review and adjust the interest rate to the extent that such rate depends on the currency involved. Moreover, it is questionable whether such an adjustment could be based on Art. 11 (6). For Alt. 11 (6), at le ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... convertible debentures (CCDs) by recharacterizing the same to be External Commercial Borrowings (ECB). 15. The Ld.AR submitted that this issue is also covered in assessee's own case (supra) wherein the coordinate bench of this Tribunal has allowed the appeal in favour of the assessee. 16. The ld.DR supported the decision of the lower authorities. 17. We have heard the rival submissions and perused the materials on record. We notice that the coordinate bench of the Tribunal in assessee's own case (Supra) on the issue of interest on CCDs has held that - 8.6 We have heard rival submissions and perused the material on record. The assessee during the financial year 2009-2010, entered into a debenture subscription agreement with its AEs, Praxair International Finance. In the agreement, the term "issue price" is defined as "CCD will be issued at par at Rs. 10 each". Further, the subscription considered shall be converted into INR as per the prescribed exchange rate and the number of CCDs allotted to the holders will be the subscription consideration as converted into INR, divided by face value of the CCD instrument. The debenture certificates issued clearly reflect the face value ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... [TO, ITA No. 3 73/Del/2016 (ITA T Del). By respectfully following the Co-ordinate Bench and Hon 'ble High Court decisions, we agree with the assessee 's contentions that the CCDs cannot be categorised as a loan and LIBOR plus two hundred basis points benchmark cannot be accepted on the facts of the case." 8.6.2 The Hon'ble Delhi High Court in the case of CIT v. Cotton Naturals (I) Put. Ltd. (supra) had held that the interest rate should be the market determined interest rate applicable to the currency concerned in which the loan has to be repaid. The relevant finding of the Hon'ble High Court reads as follows:- "39. The question whether the interest rate prevailing in India should be applied, for the lender was an Indian company/assessee, or the lending rate prevalent in the United States should be applied, for the borrower was a resident and an assessee of the said country, in our considered opinion, must be answered by adopting and applying a commonsensical and pragmatic reasoning. We have no hesitation in holding that the interest rate should be the market determined interest rate applicable to the currency concerned in which the loan has to be repaid. Intere ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the economically more powerful party. But, exactly where there is no 'special relationship', this will frequently not be possible in dealings with such party. Consequently, it will normally not be possible to review and adjust the interest rate to the extent that such rate depends on the currency involved. Moreover, it is questionable whether such an adjustment could be based on Art. 11 (6). For Alt. 11 (6), at least its wording, allows the authorities to 'eliminate hypothetically' the special relationships only in regard to the level of interest rates and not in regard to other circumstances, such as the choice of currency. If such other circumstances were to be included in the review, there would be doubts as to where the line should be drawn, i.e., whether an examination should be allowed of the question of whether in the absence of a special relationship (i.e., financial power, strong position in the market, etc., of the foreign corporate group member) the borrowing company might not have completely refrained from making investment for which it borrowed the money. 40. The aforesaid methodology recommended by Klaus Vogal appeals to us and appears to be the rea ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... The Hon'ble DRP has erred in upholding the contentions of the learned TPO of re-characterizing the CCD to External Commercial Borrowings ("ECB") by not appreciating the fundamental difference between a CCD and an ECB and thereby erred in applying the 6 Month US London Inter-Bank Offered Rate ("LIB OR") with all-incelling rate of 500 basis point as a basis for benchmarking the payment of interest on CCD. 18. The Hon'ble DRP / learned TPO has erred in not appreciating the fact that in an ECB the borrower carries the risk related to foreign exchange fluctuation whereas the risk is borne by the lender in case of CCD and thereby failed to appreciate the importance of assumption of foreign exchange risk in the fixation of interest rate. 19. The Hon'ble DRP / learned TPO have erred in stating that the Appellant has not provided any comparable details to demonstrate the arm's length nature of interest payment on CCD and thereby erred in disregarding the independent benchmarking analysis identifying the comparable transactions involving the CCDs which was submitted by the Appellant. 20. The Hon'ble DRP has erred in stating that conversion price has not been fixed ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... , it is submitted that the transaction of payment of interest of CCDs ought to be treated as being at arm's length. 21. The learned Departmental Representative supported the orders of the TPO and DRP. 22. We have heard rival submissions and perused the material on record. We find that on identical facts, the Tribunal in assessee's own case for assessment year 20122013 in IT(TP)A No.2209/Bang/2016 decided the issue in favour of the assessee. The relevant finding of the Tribunal reads as follows:- "17. We have heard the rival submissions and perused the materials on record. We notice that the coordinate bench of the Tribunal in assessee's own case (Supra) on the issue of interest on CCDs has held that - 8.6 We have heard rival submissions and perused the material on record. The assessee during the financial year 2009-2010, entered into a debenture subscription agreement with its AEs, Praxair International Finance. In the agreement, the term "issue price" is defined as "CCD will be issued at par at Rs. 10 each". Further, the subscription considered shall be converted into INR as per the prescribed exchange rate and the number of CCDs allotted to the holders will be the subscri ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Pvt. Ltd., IT(TP)A No. 7518/Mum12014; ii. CIT Vs. Cotton Naturals (I) Ltd., ITA No. 23312014 (Deli-HC); iii. M/s. Brahma Center Development Pvt. Ltd., Vs. [TO, ITA No. 3 73/Del/2016 (ITA T Del). By respectfully following the Co-ordinate Bench and Hon 'ble High Court decisions, we agree with the assessee 's contentions that the CCDs cannot be categorised as a loan and LIBOR plus two hundred basis points benchmark cannot be accepted on the facts of the case." 8.6.2 The Hon'ble Delhi High Court in the case of CIT v. Cotton Naturals (I) Put. Ltd. (supra) had held that the interest rate should be the market determined interest rate applicable to the currency concerned in which the loan has to be repaid. The relevant finding of the Hon'ble High Court reads as follows:- "39. The question whether the interest rate prevailing in India should be applied, for the lender was an Indian company/assessee, or the lending rate prevalent in the United States should be applied, for the borrower was a resident and an assessee of the said country, in our considered opinion, must be answered by adopting and applying a commonsensical and pragmatic reasoning. We have no hesitati ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e (say from exports). If an exchange risk were to prove incapable of being avoided (say, by forward rate fixing), the appropriate course would be to attribute it to the economically more powerful party. But, exactly where there is no 'special relationship', this will frequently not be possible in dealings with such party. Consequently, it will normally not be possible to review and adjust the interest rate to the extent that such rate depends on the currency involved. Moreover, it is questionable whether such an adjustment could be based on Art. 11 (6). For Alt. 11 (6), at least its wording, allows the authorities to 'eliminate hypothetically' the special relationships only in regard to the level of interest rates and not in regard to other circumstances, such as the choice of currency. If such other circumstances were to be included in the review, there would be doubts as to where the line should be drawn, i.e., whether an examination should be allowed of the question of whether in the absence of a special relationship (i.e., financial power, strong position in the market, etc., of the foreign corporate group member) the borrowing company might not have completely ..... X X X X Extracts X X X X X X X X Extracts X X X X
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