2023 (3) TMI 399 - AT - Income Tax

Tribunal rejects Transfer Pricing Officer's adjustments on management fee and CCD interest, characterizes CCDs as debt.

The Tribunal allowed the appeal filed by the assessee, rejecting the Transfer Pricing Officer's adjustments for both the management fee and interest on ... TP adjustment in respect of management fee - these payments were made after deducting taxes prescribed under the relevant DTAA - TPO conclusion on Alleged failure of the assessee to prove the actual receipt of the said service - HELD THAT:- Section 92A(2)(g) get attracted only when one AE provides service to the other AE by allowing the AE to use the know-how, patents, trademark, franchise, etc. and the business of the assessee is wholly dependent on such IP/franchise. Once the foundational condition is receipt of IP/franchise of which the assessee company’s business is wholly dependent and only on that basis, the AE relationship was established, consequently TP provisions were applicable, it is unsustainable then to turn around and hold that the assessee did not receive the IP/franchise from its deemed AE. When the TPO alleges that the assessee has not received any of the above services, it would indicate that the very relationship based on which the assessee company and WeWork Global have been established as AE would be nonexistent. The very fact that the entire business model of the assessee is dependent on foreign AE which has provided the concept, design, trademark, software, etc. for the assessee’s day to day operation clearly establishes that services were rendered by the foreign AE to the assessee (independent of the legal point that the AE relationship itself has been established only due the existence of the services and in absence thereof, AE relationship would fail, and consequently, the jurisdiction of the TPO itself would also fail.) Therefore on the facts on record, it is beyond doubt that the assessee is wholly dependent on the use of know-how, patents, copyright, trademark, licences, franchise and other services of We Work Global, for its day to day operation in India. Thus TPO is not justified in treating the ALP of management fee paid by assessee to WeWork Global at ‘NIL’. It is ordered accordingly. Interest on CCDs issued by the assessee - assessee had issued 33,75,000 Compulsory Convertible Debentures (CCD) to WeWork Netherlands under the Debenture Subscription Agreement - HELD THAT:- The Bangalore coordinate bench of the Tribunal in the case Summit Development Pvt. Ltd.[2022 (11) TMI 1323 - ITAT BANGALORE] had held that CCD are in the nature of debt and cannot be recharacterised as equity till the time the same is converted into equity. In the instant case the assessee had duly made disallowance u/s 94B of the Act in its return of income for the relevant assessment year. The said disallowance therefore address the issue of thin capitalisation in the manner envisaged by the Legislature. Hence, it cannot be disallowed under TP provisions on the same basis. It is submitted that the assessee is not arguing that the TP provisions ought not to apply where a disallowance is made under Section 94B of the Act but only is contending that thin capitalisation cannot be the basis for such TP disallowance and the same may be tested for arm’s length compliance and held to be excessive based on benchmarking exercises. In such an event, the excessive interest of ALP will account for permanent disallowance, while balance interest would be subject to Section 94B of the Act which would be in the nature of a temporary disallowance permitted to be carry forward - Thus the impugned TP adjustment with reference to payment of interest on CCD is deleted. Assessee appeal allowed. Issues Involved:1. Transfer Pricing adjustment in respect of management fee.2. Transfer Pricing adjustment in respect of interest on Compulsorily Convertible Debentures (CCDs).Issue-wise Detailed Analysis:1. Transfer Pricing Adjustment in Respect of Management Fee:The assessee, a private limited company engaged in leasing shared workspaces, paid a management fee to WeWork Netherlands and WeWork UK under an Operations and Management Agreement (OMA). The assessee used the Comparable Uncontrolled Price (CUP) method to determine the arm's length price (ALP) of the management fee, concluding that the fee was within the arm's length range of 8% to 16%. However, the Transfer Pricing Officer (TPO) determined the ALP of the management fee to be 'NIL', citing the assessee's failure to prove the actual receipt of services and the non-satisfaction of the need/benefit test.The Dispute Resolution Panel (DRP) upheld the TPO's decision despite the assessee providing evidence of services received, including emails and software applications. The Tribunal, however, found that the assessee's entire business model was dependent on the services provided by WeWork Global, including digital services, real estate services, design services, corporate services, implementation services, training services, billing services, and access to WeWork brand/trademarks. The Tribunal concluded that the TPO was not justified in treating the ALP of the management fee at 'NIL' and allowed the assessee's appeal on this ground.2. Transfer Pricing Adjustment in Respect of Interest on Compulsorily Convertible Debentures (CCDs):The assessee issued CCDs to WeWork Netherlands with an interest rate of 6% per annum. The TPO re-characterized the CCDs as equity and determined the ALP of the interest to be NIL, arguing that an uncontrolled party would not have subscribed to the CCDs given the assessee's financials. The DRP upheld the TPO's decision.The Tribunal referred to the Bangalore coordinate bench's decision in Summit Development Pvt. Ltd., which held that CCDs constitute debt and interest payable thereon is deductible until conversion into equity. The Tribunal noted that the assessee had made a disallowance under Section 94B of the Income Tax Act, addressing the issue of thin capitalization. The Tribunal concluded that the TPO exceeded his jurisdiction in re-characterizing the CCDs as equity and deleted the TP adjustment with respect to interest on CCDs.Conclusion:The Tribunal allowed the appeal filed by the assessee, rejecting the TPO's adjustments for both the management fee and interest on CCDs. The Tribunal emphasized the importance of the services provided by WeWork Global to the assessee's business and the proper characterization of CCDs as debt until conversion.