Interest on FCCDs to be benchmarked to domestic PLR; rental income taxed as business; s.80IAB deduction denied.

ITAT held that interest on FCCDs should be benchmarked using domestic PLR, directing AO/TPO to recompute ALP accordingly. Rental income from letting of commercial property and allied services was held to be taxable as business income (profits and gains of business or profession) and AO was directed to recompute income under that head. Claim for deduction under s.80IAB was denied: the assessee was not a "developer" and did not fall within the second proviso to s.80IAB(2), so no deduction under s.80IAB was allowed.

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1. ISSUES PRESENTED AND CONSIDERED

1.1 Whether interest paid on Fully & Compulsory Convertible Debentures (FCCD/CCD) denominated in Indian Rupees should be bench-marked for transfer pricing purposes by reference to domestic Prime Lending Rate (PLR) rather than LIBOR plus mark-up.

1.2 Whether the taxpayer's TP documentation could properly be rejected under section 92C(3) in the benchmarking of interest on INR-denominated FCCDs.

1.3 Whether the activity of sub-letting leasehold premises together with provision of maintenance/operational services in an IT/ITeS park amounts to "profits and gains of business or profession" rather than "income from house property".

1.4 Whether an entity that takes fully developed buildings on lease and provides operation/maintenance services (without undertaking development) qualifies as a "Developer" eligible for deduction under section 80IAB.

1.5 Whether a tax refund for a different assessment year must be adjusted against demand for the year under appeal.

1.6 Whether interest under section 234B should be adjudicated at this stage or left to calculation after final tax liability is determined.

2. ISSUE-WISE DETAILED ANALYSIS

2.1 Issue 1 - Benchmarking interest on INR-denominated FCCDs: legal framework

2.1.1 Legal framework: Transfer pricing under Chapter X (sections 92-92F) requires determination of arm's-length price (ALP) for international transactions by reference to the currency and nature of the instrument; benchmarking ordinarily compares the relevant interest rate applicable to loans in the currency concerned.

2.1.2 Precedent treatment: A Special Bench of the Tribunal concluded that where CCDs/FCCDs are denominated in Indian currency, they should be benchmarked against domestic interest rates (PLR) and not against LIBOR (foreign currency benchmark). The Special Bench answer was explicitly in favour of assessee(s) that PLR applies to INR-denominated debentures.

2.1.3 Interpretation and reasoning: The Court reasons that rupee-denominated CCDs are akin to rupee loans for benchmarking purposes; therefore, foreign currency benchmarks (LIBOR + basis points) applicable to foreign currency loans are not appropriate. Interest must be compared with rates prevailing in the domestic market and with similar domestic debt instruments (PLR).

2.1.4 Precedent treatment applied: The Tribunal follows and respectfully applies the Special Bench ratio, treating that decision as controlling for the present facts.

2.1.5 Ratio versus obiter: The holding that INR-denominated CCD/FCCD interest must be benchmarked by PLR is treated as ratio and applied to set aside the TPO/AO adjustment and direct recomputation of ALP using PLR. Any subsidiary points in the Special Bench decision cited are applied as necessary.

2.1.6 Conclusion: Adjustment of interest using LIBOR + 200 bps is not sustained; ALP to be recomputed by applying PLR for INR-denominated FCCDs. Grounds 1-6 allowed.

2.2 Issue 2 - Rejection of TP documentation under section 92C(3)

2.2.1 Legal framework: Section 92C(3) permits the TPO/AO to make adjustments to ALP; admissibility of TP documentation is governed by the Act and relevant rules and is a factual/technical determination linked to whether documentation adequately benchmarks transaction.

2.2.2 Treatment in judgment: The Tribunal did not sustain the TPO/AO/DRP's rejection to the extent it resulted in use of LIBOR; by directing use of PLR it implicitly found the assessee's benchmarking approach for INR-denominated FCCDs justified following Special Bench guidance. The judgment does not separately elaborate a finding that documentation was valid in all respects, but allows reassessment consistent with PLR methodology.

2.2.3 Interpretation and reasoning: Because the core legal error identified was selection of a foreign currency benchmark, the Tribunal rectified the ALP calculation rather than remitting on a broader documentation admissibility ground.

2.2.4 Ratio versus obiter: The corrective direction to recompute ALP applying PLR is ratio; any non-decided aspects of documentation sufficiency remain obiter or unaddressed.

2.2.5 Conclusion: Rejection under section 92C(3) cannot be sustained insofar as it led to application of LIBOR; reassessment to apply PLR directed.

2.3 Issue 3 - Characterisation of income (business income v. income from house property)

2.3.1 Legal framework: Heads of income are mutually exclusive; classification depends on nature of operations, objects of the entity, and whether letting/sub-letting is part of an organized business. Relevant principles include examining memorandum of association and the manner/systematicity of activities.

2.3.2 Precedent treatment: The Tribunal relies on Supreme Court authority holding that where letting out is the main object and carried out systematically, income is business income (profits and gains) rather than house property; earlier decisions (Karanpura, Chennai Properties, Sultan Brothers) are cited to distil principles.

2.3.3 Interpretation and reasoning: The assessee's MOA expressly includes development, operation and maintenance of IT parks and leasing/management of properties. The assessee entered into separate sub-lease and service agreements and provided a package of operational/maintenance services (list of services in Annexure). The Tribunal finds the activity to be organized and systematic, not mere passive sub-letting, aligning facts with precedent where letting constituted business.

2.3.4 Ratio versus obiter: The Tribunal's conclusion that the income is business income is ratio applied to direct recomputation under the correct head; reliance on Supreme Court decisions is treated as binding precedent distinguishing cases where mere passive ownership/sub-letting was involved.

2.3.5 Conclusion: Rental and allied service income from the IT/ITeS park are taxable under "profits and gains of business or profession." Grounds 7-10 allowed; AO directed to recompute accordingly.

2.4 Issue 4 - Eligibility for deduction under section 80IAB

2.4.1 Legal framework: Section 80IAB grants deduction to a "Developer" for profits from business of developing a Special Economic Zone (SEZ), subject to conditions; the section and its provisos distinguish actual development activity from mere operation/maintenance or transferee developer situations.

2.4.2 Precedent and administrative guidance: CBDT Circular No.16/2017 clarifies scope for section 80IA but does not extend automatically to section 80IAB; section 80IAB has distinct and narrower scope and its provisos address transferee developers.

2.4.3 Interpretation and reasoning: The assessee had a certificate as co-developer but took already developed buildings on lease from the original developer; documentary record (lease clauses and timing) shows development was completed by the original developer. The assessee provided operation and maintenance services only and did not undertake development approvals or capital expenditure indicative of development. Section 80IAB requires the assessee to be a developer (or transferee developer in limited situations); mere co-developer certificate or provision of operation/maintenance is insufficient.

2.4.4 Ratio versus obiter: The Tribunal's conclusion that no deduction under 80IAB is available is ratio, based on statutory text and factual finding that no development activity was performed. The statement that CBDT Circular 16/2017 cannot be read to enlarge 80IAB is a logical statutory interpretation point forming part of the ratio.

2.4.5 Conclusion: Assessee is not a "Developer" within section 80IAB and is not entitled to deduction thereunder. Ground 11 dismissed.

2.5 Issue 5 - Adjustment of tax refund of another year against demand

2.5.1 Legal framework: Set-off/adjustment of refunds between years requires temporal and legal connection; ordinarily a refund relating to a different year is not adjusted in demand calculation for the year under consideration without specific adjudication.

2.5.2 Reasoning and conclusion: The Tribunal declines to adjudicate the claim of credit for a refund pertaining to a different assessment year in the present appeal, treating the matter as not relevant to the current year's assessment. Ground 12 dismissed without adjudication on merits.

2.6 Issue 6 - Interest under section 234B

2.6.1 Legal framework: Interest under section 234B is consequential on tax liability and is computed as per law after final tax liability determination.

2.6.2 Reasoning and conclusion: The Tribunal considers levy of section 234B interest consequential and to be worked out in law after recomputation of tax liability; it refrains from adjudicating the ground now. Ground 13 dismissed at this stage as premature.

3. FINAL RESULT IMPLIED BY REASONS

3.1 The appeal is partly allowed: (a) TP adjustment for interest on INR-denominated FCCDs to be recomputed applying PLR (grounds 1-6 allowed); (b) income from letting with allied services treated as business income and to be recomputed accordingly (grounds 7-10 allowed); (c) deduction under section 80IAB denied (ground 11 dismissed); (d) refund adjustment claim and section 234B interest not adjudicated at this stage (grounds 12 and 13 dismissed as noted).

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