2020 (12) TMI 110 - AT - Income Tax

Appeals partly allowed, AO/TPO to re-examine issues. Adherence to legal principles stressed.

The Tribunal partly allowed the appeals, directing the AO/TPO to re-examine the issues in light of the Tribunal's findings and to provide appropriate ... TP adjustment - Recharacterising the compulsorily convertible debentures (`CCDs') as equity shares - Disallowance of capitalisation of interest expenditure on CCDs - Whether TPO has erred in law by recharacterising the CCDs into equity shares since a Transfer Pricing Officer ('TPO') does not have powers under the Act to recharacterise any international transaction? - HELD THAT:- As decided in M/S. CAE FLIGHT TRAINING (INDIA) PVT. LTD. (VICE-VERSA) [2019 (8) TMI 554 - ITAT BANGALORE] as per the tribunal order of Mumbai Bench rendered in the case of Besix Kier Dabhol, SA [2010 (11) TMI 589 - ITAT, MUMBAI] in which the issue was decided in favour of the assessee on this basis that in the absence of specific Thin capitalization Rules in India, recharacterization of Debt Capital as equity Capital and disregarding of interest is not in order. Interest payment in the present case did not constitute an intraorganization 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 u/s. 37, does not render the interest paid by the assessee as not deductible, and it is not even necessary to examine the scope of Explanation to s. 37. Tax considerations may have played a role in assessee’s planning the capital structure, but an element 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. 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. -Being so, taking a consistent view, we remit the issues in dispute to the file of AO/TPO on similar directions. Issues Involved:1. Incorrect interpretation of law by CIT(A) and AO.2. Referral of transaction to TPO.3. Disallowance of capitalisation of interest expenditure on CCDs.4. Determination of arm's length price by TPO.5. Initiation of penalty proceedings under section 271(1)(c) of the Act.6. Relief sought by the appellant.Issue-wise Detailed Analysis:1. Incorrect Interpretation of Law by CIT(A) and AO:The appellant contended that the orders of the CIT(A) and AO were based on an incorrect interpretation of the law, rendering them bad in law. The Tribunal did not provide a specific ruling on this general ground but addressed the specific issues raised in subsequent grounds.2. Referral of Transaction to TPO:The appellant argued that the AO erred in law by referring the transaction to the TPO, which did not bear on the taxability of the income for the relevant assessment years. The Tribunal did not specifically address this ground but focused on the substantive issues raised regarding the TPO's findings.3. Disallowance of Capitalisation of Interest Expenditure on CCDs:3.1 Recharacterisation of CCDs as Equity Shares:The TPO recharacterised the CCDs as equity shares, which the appellant argued was beyond the TPO's powers and done without providing an opportunity to the appellant. The Tribunal referred to the Mumbai Bench decision in Besix Kier Dabhol, SA vs. DDIT, which held that in the absence of specific thin capitalisation rules in India, recharacterisation of debt as equity is not in order.3.2 Treatment of Interest on CCDs:The TPO and AO disallowed the interest payment on CCDs by treating them as equity. The Tribunal held that until the date of conversion, CCDs should be considered as debt, and interest thereon should be allowed under Section 36(1)(iii) of the Income Tax Act.3.3 Absence of Thin Capitalisation Rules:The Tribunal reiterated that in the absence of thin capitalisation rules in India, the recharacterisation of debt as equity is not permissible, following the precedent set by the Mumbai Bench in Besix Kier Dabhol, SA vs. DDIT.3.4 Nature of CCDs Before Conversion:The Tribunal concluded that CCDs should be treated as debt instruments until conversion, and interest on them should be allowed as a deduction.3.5 Application of FEMA and FDI Regulations:The Tribunal noted that the RBI's classification of CCDs as equity for FDI purposes does not affect their treatment under the Income Tax Act for the purpose of interest deduction.3.6 Justification of Capitalisation of Interest Expense:The Tribunal held that the appellant was justified in capitalising the interest expense in accordance with applicable accounting standards.3.7 Disallowance of Capitalisation and Future Deduction:The Tribunal directed the AO to allow the capitalisation of interest expenditure on CCDs and to ensure that the appellant's claim for deduction against such capitalisation in future years is not denied.4. Determination of Arm's Length Price by TPO:4.1 Economic Analysis by Appellant:The Tribunal found that the TPO and AO erred in not accepting the economic analysis undertaken by the appellant in accordance with the provisions of the Act and Rules.4.2 Use of Multiple Year Data:The Tribunal held that the TPO and AO erred in rejecting the use of multiple year data of comparable companies by the appellant.4.3 Rejection of Comparable Identified by Appellant:The Tribunal found that the TPO and AO erred in rejecting the comparables identified by the appellant for computing the arm's length price.4.4 Objective Analysis of Comparable Transactions:The Tribunal noted that the TPO failed to undertake an objective analysis for identifying comparable transactions and determining the arm's length price.5. Initiation of Penalty Proceedings under Section 271(1)(c) of the Act:The appellant contended that the AO erred in initiating penalty proceedings under Section 271(1)(c). The Tribunal did not specifically address this ground but focused on the substantive issues raised.6. Relief Sought by the Appellant:The Tribunal directed the AO/TPO to reconsider the issues in dispute, following the directions provided, and to grant appropriate relief to the appellant.Conclusion:The Tribunal partly allowed the appeals, directing the AO/TPO to re-examine the issues in light of the Tribunal's findings and to provide appropriate relief to the appellant. The Tribunal emphasized the importance of adhering to established legal principles and precedents in the absence of specific legislative provisions.