Preference shares cannot be treated as debt for transfer pricing, and own funds defeat interest disallowance on advances.

A preference-share investment with an associated enterprise could not be re-characterised as a loan for transfer pricing purposes absent material showing sham, concealment, or other exceptional circumstances; notional interest therefore could not be imputed and the adjustment failed. Interest disallowance under section 36(1)(iii) was also unwarranted because the assessee had sufficient own funds to cover the advances to subsidiaries and related concerns, so the advances were presumed to have been made from those funds rather than borrowed money. Both additions were deleted in the assessee's favour.

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Issues: Whether subscription and redemption of redeemable preference shares with an associated enterprise could be re-characterised as a loan for transfer pricing purposes and whether interest could be imputed thereon; whether disallowance of interest under section 36(1)(iii) was justified in respect of advances to subsidiaries and related concerns.

Issue (i): Whether subscription and redemption of redeemable preference shares with an associated enterprise could be re-characterised as a loan for transfer pricing purposes and whether interest could be imputed thereon.

Analysis: The transaction was treated in earlier years as an investment in preference shares and not as a loan. No material was brought to show sham, concealment, or exceptional circumstances warranting disregard of the apparent form of the transaction. In the assessee's own case, the coordinate bench and the jurisdictional High Court had already held that such share subscription could not be re-characterised as debt merely because no dividend was paid and no notional return was realized.

Conclusion: The transfer pricing adjustment by imputing notional interest on the preference shares was not sustainable and the deletion made by the first appellate authority was upheld, in favour of the assessee.

Issue (ii): Whether disallowance of interest under section 36(1)(iii) was justified in respect of advances to subsidiaries and related concerns.

Analysis: The assessee had substantial own funds exceeding the advances made, and the record showed that the advances were comparatively small. Applying the settled presumption that, where mixed funds exist and own funds are sufficient, advances are attributable to own funds, no nexus was established between borrowed funds and the interest-free advances. The issue had also been consistently decided in earlier years in the assessee's favour.

Conclusion: The disallowance of interest under section 36(1)(iii) was rightly deleted, in favour of the assessee.

Final Conclusion: The appeal failed on both issues and the additions made by the Assessing Officer did not survive.

Ratio Decidendi: An apparent equity investment cannot be re-characterised as a loan for transfer pricing purposes absent material showing sham or exceptional circumstances, and where an assessee's own funds are sufficient, advances are presumed to have been made from those own funds rather than borrowed money.

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