Compulsorily convertible debentures retain debt character until conversion, and capitalised interest may still need arm's length benchmarking.

Compulsorily convertible debentures retained debt character until conversion, so they could not be re-characterised as equity merely because of compulsory convertibility; on that basis, setting the arm's length price of interest at nil was unsustainable. Capitalised interest on CCDs forming part of work-in-progress did not cease to be relevant for transfer pricing, because it could still affect profits, income, losses, or assets when reversed or capitalised later. The arm's length determination on that interest was therefore remitted for fresh examination on the merits, with any consequential adjustment to follow in the year of reversal of work-in-progress.

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Issues: (i) Whether compulsorily convertible debentures could be re-characterised as equity for transfer pricing purposes and the arm's length price of interest on such debentures determined at nil; (ii) whether capitalised interest on CCDs forming part of work-in-progress could still constitute an international transaction requiring arm's length benchmarking.

Issue (i): Whether compulsorily convertible debentures could be re-characterised as equity for transfer pricing purposes and the arm's length price of interest on such debentures determined at nil.

Analysis: The debentures, until conversion, retained the character of a debt instrument. Mere compulsory convertibility at the end of the tenure did not justify treating the instrument as equity from inception. The transfer pricing authorities therefore could not discard the assessee's debt characterisation merely on the basis of the conversion feature and set the interest ALP at nil on that footing.

Conclusion: Re-characterisation of the CCDs as equity was not justified, and the nil ALP determination on that basis was unsustainable.

Issue (ii): Whether capitalised interest on CCDs forming part of work-in-progress could still constitute an international transaction requiring arm's length benchmarking.

Analysis: Capitalisation of interest into work-in-progress did not eliminate its character as an expense arising from borrowing. Such interest could still affect profits, income, losses, or assets when the work-in-progress was later reversed or capitalised in subsequent years. The existence of an international transaction therefore remained relevant, but the arm's length price required fresh examination on the merits rather than a blanket disallowance.

Conclusion: The issue of arm's length determination was restored for fresh consideration by the transfer pricing authorities, with consequential proportionate adjustment, if any, to follow in the year of reversal of the work-in-progress.

Final Conclusion: The appeal was allowed in part: the CCDs were held not to be equity merely because they were compulsorily convertible, but the arm's length price of the interest transaction was remitted for fresh determination with consequential effect in later years.

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