Tribunal rules in favor of assessee on convertible debentures, remands ALP issue for fresh determination

The Tribunal partially allowed the appeal of the assessee. It held in favor of the assessee regarding the treatment of optionally and compulsorily convertible debentures as equity share capital, citing a previous decision. The issue of determining the Arm's Length Price (ALP) of interest paid to associated enterprises was remanded back to the Transfer Pricing Officer for fresh determination. The order was pronounced on December 18, 2020.

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Issues Involved:

1. Treatment of optionally and compulsorily convertible debentures (OCDs and CCDs) issued by the assessee company as equity share capital.
2. Determination of Arm's Length Price (ALP) of the interest paid by the assessee company to its associated enterprises (AEs).

Detailed Analysis:

1. Treatment of OCDs and CCDs as Equity Share Capital:

The primary issue was whether the optionally and compulsorily convertible debentures issued by the assessee company should be treated as equity share capital. The assessee argued that this issue was covered by a previous decision of the Pune Bench of the Tribunal in the case of M/s. Kolte Patil Developers Ltd. vs. DCIT. The Tribunal agreed with the assessee, referencing the previous decision which stated that the debentures issued were not converted into equity and were eventually redeemed. The Tribunal emphasized that borrowing and raising equity share capital are recognized modes of funding business requirements and that there was no legal bar in accepting loans from shareholders or related concerns. The Tribunal noted that thin capitalization rules and GAAR (General Anti-Avoidance Rule) were not applicable for the assessment year under consideration (2013-14), as these provisions were introduced prospectively from April 1, 2018. Consequently, the Tribunal held that the TPO could not recharacterize the transaction of debt into equity. The Tribunal concluded that the transaction of subscribing by the related companies to the debentures issued by the assessee did not fit into the description of a "Shareholder activity" and thus, the grounds pertaining to the treatment of OCDs and CCDs as equity share capital were allowed in favor of the assessee.

2. Determination of Arm's Length Price (ALP):

The second issue involved the determination of the Arm's Length Price (ALP) of the interest paid by the assessee company to its AEs. The Tribunal noted that the TPO had made an upward adjustment of interest paid on debentures, holding that the debentures issued by the assessee were in essence equity and no interest was payable on the same. The Tribunal, after analyzing the relevant documents and the orders of the subordinate authorities, concluded that the ALP of the assessee had to be freshly determined. Therefore, the Tribunal set aside the order of the CIT(A) on this matter and restored the issue to the file of the TPO/AO for fresh determination of the ALP of the assessee, ensuring compliance with the principles of natural justice. This ground of appeal was allowed for statistical purposes.

Conclusion:

The Tribunal allowed the appeal of the assessee partly for statistical purposes. The grounds pertaining to the treatment of optionally and compulsorily convertible debentures as equity share capital were allowed in favor of the assessee. The issue of the determination of the ALP was remanded back to the TPO/AO for fresh determination. The order was pronounced on December 18, 2020.

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