Interest on rupee-denominated CCDs, FCCDs and NCDs must be benchmarked to domestic PLR, not LIBOR

ITAT held for the taxpayer that interest on rupee-denominated CCDs/FCCDs/NCDs and similar debentures must be benchmarked against domestic lending rates (PLR) rather than international rates (LIBOR). The tribunal found that where instruments are denominated in Indian currency they constitute rupee loans for transfer-pricing purposes, so applying LIBOR plus a margin was inappropriate. The TP adjustment was reversed and the appeal allowed, directing benchmark comparison with domestic prime lending rates.

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ISSUES PRESENTED and CONSIDERED

The core legal question considered by the Special Bench was whether the Transfer Pricing (TP) adjustment made in respect of interest paid or payable on Fully and Compulsorily Convertible Debentures (FCCDs), Non-Convertible Debentures (NCDs), or other debentures denominated in Indian currency should be benchmarked using the Prime Lending Rate (PLR) as opposed to the London Interbank Offered Rate (LIBOR).

ISSUE-WISE DETAILED ANALYSIS

Relevant Legal Framework and Precedents

The legal framework involved includes the Income Tax Act, 1961, particularly the provisions related to Transfer Pricing, and the Foreign Exchange Management Act (FEMA) regulations. The decision also considers the Safe Harbour Rules under Section 92CB and Rule 10TD of the Income Tax Rules, 1962, which provide guidance on benchmarking interest rates for loans denominated in different currencies. Precedents from the Delhi High Court in CIT Vs. Cotton Naturals India Pvt. Ltd. and the Bombay High Court in PCIT Vs. India Debt Management (P.) Ltd. were pivotal in determining the applicable interest rate based on the currency in which the loan is denominated.

Court's Interpretation and Reasoning

The Court interpreted that the nature of FCCDs as hybrid instruments, which are initially debt instruments until converted into equity, necessitates the application of interest rates pertinent to the currency in which they are denominated. The Court emphasized that the currency in which the loan is borrowed and repaid is critical in determining the applicable interest rate. The Court rejected the argument that LIBOR should be applied, as the FCCDs were denominated in Indian currency, and thus, the PLR should be the benchmark.

Key Evidence and Findings

The appellant companies treated the FCCDs as debt instruments in their financial statements, and the TPO also considered them as loans for benchmarking purposes. The Court found that the appellant companies had issued FCCDs in Indian currency, and the interest payments were benchmarked using the SBI PLR, which aligns with the economic and market factors affecting Indian currency.

Application of Law to Facts

The Court applied the principles from the aforementioned legal precedents to conclude that the interest rate for FCCDs denominated in Indian currency should be based on the PLR. The Court noted that the economic conditions and risks associated with currency denomination are crucial factors influencing interest rates, and thus, the domestic lending rate (PLR) is appropriate for benchmarking in this context.

Treatment of Competing Arguments

The Court addressed the Revenue's argument that FCCDs should be treated as equity instruments and that LIBOR should be used for benchmarking. The Court rejected this argument, stating that the nature of the instrument as a debt until conversion into equity and the currency denomination in Indian rupees necessitate the use of PLR for benchmarking. The Court also dismissed the Revenue's reliance on certain regulatory frameworks and the Supreme Court's decision in IFCI Ltd. Vs. Sutanu Sinha & Ors, as these were not directly relevant to the question of benchmarking interest rates.

Conclusions

The Court concluded that the interest paid or payable on FCCDs, NCDs, or other debentures denominated in Indian currency should be benchmarked using the PLR, not LIBOR. This conclusion aligns with the principles established in relevant legal precedents and the economic realities of currency denomination and associated risks.

SIGNIFICANT HOLDINGS

The Court held that:

• "Interest rate should be the market determined interest rate applicable to the currency concerned in which the loan has to be repaid."
• "Once the tested transaction is an INR denominated debt, interest rate must necessarily be based on the economic and market factors affecting Indian currency and data available for debt issuance in India rather than foreign currency rate or external data."

The final determination was that for TP adjustments related to interest on FCCDs, NCDs, or other debentures denominated in Indian currency, the PLR is the appropriate benchmark, not LIBOR.

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