2022 (11) TMI 1323 - AT - Income Tax

Tribunal Decides on Interest Payment Treatment for Compulsorily Convertible Debentures

M/s. Summit Developments Private Limited Versus The Deputy Commissioner of Income-tax, Circle 6 (1) (1), Bangalore.

M/s. Summit Developments Private Limited Versus The Deputy Commissioner of Income-tax, Circle 6 (1) (1), Bangalore. - TMI Issues:Transfer Pricing Adjustment on Interest Paid on Compulsorily Convertible Debentures (CCDs)Detailed Analysis:The appeal involved a transfer pricing adjustment concerning interest paid on CCDs to a non-resident AE. The lower authorities made a transfer pricing adjustment of INR 13,89,60,371 without conducting benchmarking or comparability analysis. They recharacterized the CCDs as equity investments, disregarding the appellant's TP documentation. The appellant argued that CCDs should be benchmarked only at the time of issue and that interest expenditure should be considered at arm's length. The lower authorities also erred in not appreciating that interest on CCDs should be deductible until conversion. The brief facts revealed that the CCDs were issued to a Cyprus-based investor and were convertible into equity shares after a specified period.The Tribunal considered the terms of the CCDs, including the interest rate and conversion provisions. The appellant benchmarked the interest payment using external databases, treating it as at arm's length price. However, the TPO recharacterized the CCDs as equity, leading to disallowance of interest. The Tribunal cited judicial precedents that established CCDs as debt until conversion, making interest expenditure deductible. The RBI's treatment of CCDs as equity for FDI policy purposes did not affect their treatment for tax purposes. The Tribunal rejected the authorities' reliance on a decision regarding expenditure on convertibles, emphasizing the distinction between pre-conversion interest and issuance expenses.Furthermore, the Tribunal noted the introduction of section 94B of the IT Act, relating to thin capitalization rules, limiting interest payments to non-resident AEs. The appellant failed to comply with section 94B, leading to a disallowance under this provision. The Tribunal clarified the difference between transfer pricing provisions and section 94B, applying the latter to limit interest deductibility based on profitability. Consequently, the TP adjustment on interest payment was deleted, but the disallowance was upheld under section 94B. The appeal was partly allowed based on these considerations.This comprehensive analysis addressed the issues raised in the appeal regarding transfer pricing adjustments on interest paid on CCDs, recharacterization of CCDs as equity, benchmarking requirements, and compliance with thin capitalization rules under section 94B of the IT Act. The Tribunal's decision provided clarity on the treatment of CCDs, interest deductibility, and the applicability of different provisions in determining tax liabilities.