TaxTMI 
TaxTMI 
2022 (9) TMI 1661
X X X X Extracts X X X X
X X X X Extracts X X X X
....sing to compute the interest payable on fully convertible debentures of the assessee at by proposing a downward adjustment to the tune of Rs. 12,63,75,549/- to the international transactions, being expenditure incurred by the assessee in the nature of Interest on Fully Compulsory Convertible Debentures paid/payable by the assessee company to its associated enterprise. 3. The Learned CIT (A) has erred in sustaining the action of Ld. TPO/Assessing officer in going beyond the scope to re-characterize the Compulsory Convertible Debentures ('CCD') as loan for benchmarking the international transaction of interest payments on CCD. 4. The Learned CIT (A) has erred in sustaining the action of Ld. TPO/Assessing officer in proposing to benchmark the interest rate on Fully Compulsory Convertible Debentures at LIBOR+200 basis points ignoring that the Fully Compulsory Convertible debentures were denominated in INR and interest for the same is appropriately benchmarked to SBI Prime lending Rate." 4. Brief facts of the case : The assessee has mentioned the following international transactions as per 3CEB / TP document : A.E. Nature of transaction Amou....
X X X X Extracts X X X X
X X X X Extracts X X X X
....it is seen from the financial statements of the company, the taxpayer has earned better revenues and also better profit margin. Thus, the creditworthiness of the taxpayer is much better. However, considering the duration of the loan and the nature of the transaction being CCDs, LIBOR plus 200 points is appropriate. 7.4. For the reasons mentioned above, the TPO adopts LIBOR plus 200 basis points. The average 1 year LIBOR during the year is 0.483%. Thus, the total interest payable works out to 2.483% as arm's length interest. The excess amount paid being the adjustment u/s 92CA calculated as under : Description date from Amount Days % of interest Interest paid Arm's length interest Arm's length interest Excess paid Opening balance 01.04 2012 881.100,000 365 15.75% 138.773,250 2.48% 21.877.713 116.895.537 Issued during the year 26.04 2012 14,400,000 340 17.75% 2,380,932 2.48% 333.062 2.047,889 -do- 16.05 2012 1,300,000 320 17.75% 202,301 2.48% 28,299 174.002 -do- 25.05 2012 39,200,000 311 17.75% 5.928.597 2.48% 829.336 5.099 262 -do....
X X X X Extracts X X X X
X X X X Extracts X X X X
....y the tax payer cannot be treated as Arms Length Price. The LIBOR is the rate applicable in the transactions between the banks which is accepted internationally. In the following cases LIBOR was accepted as appropriate rate for bench marking purposes : 1. Aurionpro Solutions Ltd. Vs. ACIT in ITA No. 7872 (Mum) of 2011 dt. 12.04.2013. 2. Foursoft Limited Vs. DCIT in ITA No. 1495/Hyd/2010 dt. 09.09.2011. 3. Aurobindo Pharma Ltd. Vs. ACIT in ITA No. 1096/Hyd/2011 dt. 31.01.2014. 4. Dr. Reddy's Laboratories Ltd. Vs. ACIT in ITA No. 1739/Hyd/2017 dt. 13.06.2018. 5. Dr. Reddy's Laboratories Ltd. Vs. ACIT in ITA No. 2229/Hyd/2011 & 85/Hyd/2013 dt. 02.01.2017." 8. ITA No. 1590/Hyd/2019 for A.Y. 2014-15 Aggrieved with the order of ld.CIT(A), the assessee is now in appeal before the Tribunal by raising the following grounds : 1. The Order of CIT (A) is erroneous and contrary to the facts of the case and law on point. 2. The Learned CIT (A) has erred in sustaining the action of Ld. TPO/Assessing officer in proposing to compute the interest payable on Fully Compulsory Convertible Debentures of th....
X X X X Extracts X X X X
X X X X Extracts X X X X
....l transactions. 9.1. It was the contention of the assessee that the interest paid by the assessee to it's A.E. was chargeable with the interest rate prescribed under Rule 10TD of I.T. Rules and even otherwise, the SBI base rate as on 30.06.2013 was 14.45% which means that interest upto 17.45% would be the safe harbour limit. As against 17.45% interest rate, the assessee had only paid interest at 16.17%. The assessee contended that the interest paid by the assessee was within the ALP and no addition was required to be made in the hands of the assessee. The learned TPO had examined the T.P. Study of the assessee company, however, after examining the T.P.Study Report, had rejected the same at Page 7 in Para 11 wherein the TPO mentioned it as under : "11. Rejection of TP study of assessee company : However TP study conducted by assessee company is rejected for following reasons. Independent study conducted by TPO using step wise procedure given by assessee to arrive at comparable companies from database www.bseindia.com showed that only following 23 companies out of 78 companies selected by assessee are available in concerned link of bse India which are as follows ....
X X X X Extracts X X X X
X X X X Extracts X X X X
....terest rate also depends upon credit rating of company issuing debentures, period of maturity, frequency of interest payment, nature of scrip whether NCD/CCD/OFCD, turnover of company, expected rate of return on equity shares etc which are not at all considered by assessee. No adjustments have been made to interest rate on account of above factors. In view of all factors mentioned above TP study conducted by assessee company is rejected u/s 92 C (3) of1T Act. As FCCDs on which interest is paid by the assessee company are basically instruments, amount for FCCDs has come in the form of Foreign Currency from Fairfield Development, the company was asked to show cause why this transaction can't benchmarked using LIBOR plus 200 basis points by issuing show cause notice dated 04-102017." 9.2 Thereafter, the TPO had issued a show cause notice with a view to benchmark the international transactions and sought to benchmark by charging LIBOR plus 200 base points by issuing show cause notice. The assessee had raised the following objections : "12. Objections raised by assessee company : In response assessee company filed reply on 11.10.2017 in which f....
X X X X Extracts X X X X
X X X X Extracts X X X X
....ncy is paying interest at fixed interest rate. At the time of conversion of FCCDs into equity, assessee company squares off its debt by issuing shares. That's like repayment of debt in Kind. The payment in kind consists of repayment of principal and payment of interest. The interest paid is FMV of equity shares issued minus book value of CCD. Conversion of CCD into equity share is plainly speaking repayment of debt with interest. Therefore FCCDs are very much in the nature of debt till the time it is converted into FCCDs." 9.4. Thereafter, the learned TPO had held that FCCD is not equity as claimed by the assessee. In the order it was mentioned as under : "18. Therefore clarification regarding nature of CCDs is for the purpose of FDI policy only and in order to keep a track on FDI flows into the country. Further as mentioned above Hon'ble Apex court itself clarified in Sahara India Real estate case that CCDs are debt instruments till date of conversion. 19. Further it is also noticed from Financials of 'Fair Fields Developments Limited' for Financial years 2009-10 & 2010-11 that company itself categorized amounts advanced to Water mark residency....
X X X X Extracts X X X X
X X X X Extracts X X X X
....nding ($) from Watermarke residency: 17388020 27785126 27646945 13012790 22. It can be seen from financial statements filed by assessee company year after year that the company is not remitting entire interest amount to Fair field Development. Very nominal amounts are remitted to Fairfield towards interest payment which are as follows. Assessment Year 2012-13 2013-14 2014-15 2015-16 Outflow of Foreign Exchange ($) NIL 91777 787035 42846 23. Further financial extracts of Fair field Developments supra shows that initially interest on loans were charged only at the rate of 9% in case of water mark residency (p) Ltd Subsequently interest rate has been enhanced to 15.75%. It can be seen that whatever amount remitted towards interest is also being remitted in the form of foreign currency. In page 19 of Study report filed by assessee while discussing about foreign exchange fluctuation risk of assessee company it is mentioned as under : 24. "Currency risk is the risk of any adverse fluctuation in exchange rates, which would eventually have an impact on the profitability. Watermarke pays interest in....
X X X X Extracts X X X X
X X X X Extracts X X X X
....aid was determined at Rs. 13,40,14,403/-. The contention of the AR of the appellant was that the interest rate should be benchmarked to the interest rate payable on the currency in which the loan is denominated. The contention of the Assessing Officer was that LIBOR is the internationally accepted method for determining Ams Length Price. 1 have considered the submissions of the appellant and findings of the Assessing Officer in the assessment order, order of the Transfer Pricing Officer (TPO) carefully. The prime lending rate of state Bank of India prevailing + p.a adopted by the tax payer cannot be treated as Arms Length Price. The LIBOR is the rate applicable in the transactions between the banks which is accepted internationally. In the following cases LIBOR was accepted as appropriate rate for bench marking purposes: 1. Aurionpro Solutions Ltd. vs Addl.CIT in ITA No. 7872 (Mum) of 2011, dated 1242013. 2. Foursofi Limtied vs DCITin ITA No. 1495/Hyd/2010, dated 9-9-2011. 3. Aurobindo Pharma Ltd., vs Addl. CIT ITA No. 1096/Hyd/2011, dated 31-1-2014. 4. Dr.Reddy's Laboratories Ltd. vs ACITin ITA No. 1739/Hyd/2017, dated 13-6-2....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... infact the interest rate of the assessee was far below than the SIB PLR, as mentioned hereinabove. 14. It was submitted by the ld.DR that as per the balancesheet of the assessee as well as it's A.E., the nature of transaction has been mentioned as loan only, therefore, the TPO was right in benchmarking the transactions as loan on the basis of the LIBOR Plus 200 points. "4.6.1.7. Foreign exchange fluctuation risk: Currency risk is the risk of any adverse fluctuation in exchange rates, which would eventually have an impact on the profitability. Watermarke pays interest in Indian currency for interest on FCCD. Accordingly, it bears no foreign exchange risks. Similarly FDL receives in foreign currency interest on FCCD and pays in foreign currency for debentures. Accordingly, it bears normal foreign exchange risks." 15. Our attention was also drawn by ld.DR to Paras 28 to 31 of that TPO order which is to the following effect : "28. Further M/S Fair Field Developments Limited has invested its funds (foreign currency) in India which otherwise would have fetched it interest basing on LIBOR rate in foreign market It is also seen that Fair field Dev....
X X X X Extracts X X X X
X X X X Extracts X X X X
....r argument sake safe harbor interest rate is applicable. Hence this argument of assessee is also not accepted. 31. As mentioned in the preceding paragraph, interest rate chargeable on all debentures is not uniform. But it is SBI PLR date + 3% agreed on the date of Board meeting of directors issuing FCCDs to Fairfield developments as per terms and conditions mentioned in debenture documents. However, it is noticed from financials of assessee company that it has charged uniform interest rate of 15.75% in case of debentures issued prior to financial year 2010-11 & 17.75% interest rate on debentures issued afterwards. However correct working of interest rate taking SBI PLR dates on date of issuing of each bunch of FCCDs shows that assessee debited its P&L A/c with excess interest of Rs. 1,43,518/- for A.Y 2014-15. However, in view of detailed discussion made in preceding paragraphs Libor + 200 basis points is considered more appropriate CUP. Hence, this difference is ignored. In view of detailed discussion made, Libor plus 200 basis points is considered more appropriate CUP to determine ALP in case of Interest paid on FCCDs to Fair field Developments Limited." ....
X X X X Extracts X X X X
X X X X Extracts X X X X
....e and what other types are to be allowed with approval. 4. Reliance is placed on decision of Authority for Advance Rulings in case of LMN India LTD in Re (2008) 307 ITR 40. In this case question involved was whether TDS on Interest paid on CCDs to foreign company to be made or not. While answering that question Hon'ble AAR held interest payment on CCDs up to date of conversion to be nothing but interest paid on money advanced and such interest payment gets covered under Section 2(28) of Income Tax. Hon'ble authority also held that interest payment on FCCDs can in no way be treated as dividend since till the date of maturity CCDs holders do not become shareholders. Vide para 10 of same ruling it was held that in case there is failure on part of company in issuing shares on maturity date for some reason like company has wounded up etc, bondholders right to claim or recover debt still survives. Thus Hon'ble Authority concludes that CCDs are basically debt instruments till the date of conversion. 5. Coming to Objections of assessee wrt LIBOR+ 200 basis points applied by TPO to compute ALP, It is the argument of assessee that interest paid to its cyprus bas....
X X X X Extracts X X X X
X X X X Extracts X X X X
....o the transaction, viewed in their totality, differ from those which would have been adopted by independent enterprises behaving in a commercially rational manner and the actual structure practically impedes the tax administration from determining an appropriate transfer price the character of the transaction in circumstances mentioned above may derive from the relationship between the parties rather than be determined by normal commercial conditions as may have been structured by the taxpayer to avoid or minimize tax. In such cases, the totality of its terms would be the result of a condition that would not have been made if the parties had been engaged in arm's length dealings. 6. Coming to facts of present case, Even though investment is made in Indian denominated bonds using foreign currency received through AD bank, it was made by a foreign company and assessee has neither paid back the debentures amount nor interest but claimed interest on accrual basis and debentures amount was converted into shares. Thus there is no payment in any currency, let alone in INR so as to claim higher rate of interest on the basis of domestic PLR. Since the amount was invested by the....
X X X X Extracts X X X X
X X X X Extracts X X X X
....nly in view of section 92(3) of the Act that does, not mean that the transaction is, considered to be at ALP. 11 .In view Of above it is 'humbly submit cotton naturals case is, not applicable to facts of present case because present case involve thin capitalisaiton and also calls for recharacterization since arrangements made in relation to the transaction, if yielded, in their totality, differ from those which: would haye been adopted by independent enterprises behaving in a commercially rational manner both 'of which were not considered by Hon'ble HC while rendering above judgement as has been clearly mentioned in that Judgement. 2. Finally it is humbly submitted that one of the Sister company of assessee Water villas Pvt Ltd has also issued FCCDS to Fairfields developments Ltd on which is paying only 3% interest to the parent company which roughly works out to LIBOR + 200 basis points against interest payment in the range of 15-17.5% made by the assessee." 18. Per contra, the ld.AR has rebutted all the allegations and submitted that there was no issue of shifting of profits as argued by the ld.DR and further submitted that it is not appropriate on th....
X X X X Extracts X X X X
X X X X Extracts X X X X
....Developments Ltd, Cyprus Issue of FCCDs 2,69,00,000 20. The assessee company had issued FCCDs valued at Rs. 2.69 crores to M/s.Fairfield Development Limited. The terms and conditions of issuance of debentures as per debenture certificate vide Para 8 of the TPO order was reproduced below : "8. ...... Allotment :- The debenture are allotted on Conversion Date :- 120 (one hundred twenty) months from the date of allotment. Interest Rate :- (Benchmark + Spread) % per annum, where Benchmark means prime lending rate (PLR) of State Bank of India prevailing on the date of the meeting of the Board of Directors of the company at which the FCD is issued; and Spread means 3% per annum. Interest Payment Frequency :- Annually on 31st March of Each Year Conversion on Conversion Date :- Each Debenture would be compulsorily fully convertible into Equity Shares at a price per Equity Share that is mutually agreed upon by the company and the FCD Holder on the Conversion Date, subject to the company meeting with the minimum capitalization criteria prescribed under the applicable Law. Conversion Option before Conversion Date :- ....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... that payment of interest on equity is not an allowable expenditure under the Income Tax Act, 1961. 24. However, if we examine terms of issuance of FCCD for A.Y. 2013-14 and 2014-15 then it is amply clear that the assessee itself had treated the FCCD as debenture and claimed payment of interest as an allowable expenditure. In the documents, the terms of debenture were mentioned as under :- "Terms of Debenture are 1. Debentures would be compulsorily converted into equity shares at the end of 120 months from the date of allotment, but may be converted at any time before the conversion date at the option and sole discretion of its holder." 25. In the present case, the TPO had benchmarked the transaction after treating the FCCDs as debt. This finding of TPO was based on Terms of issuance of FCCD and balance-sheets/ financials of the assessee as well as of it's A.E, where both had mentioned FCCD as debt. We agree with the finding of lower authority that FCCD is a debt, as holder had a right to recover the debt and had a right to receive the interest on the debt from the payee. Further assessee during the hearing had also agreed that the FCCD are debt instrument t....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... 7,23,44,203 9,48,86,965 4,65,43,559 2014-15 3,74,48,500 1,57,37,358 2,17,11,142 25,75,000 27. The ld.AR for the assessee has drawn our attention to the judgment of the Hon'ble Bombay High Court in the case of PCIT Vs. India Debt Management reported in (2019) 106 Taxmann.com (Bom) 55, whereby the Hon'ble Bombay High Court had decided the issue in para 3 and 6 as under : "3. Having heard learned Counsel for the parties and having perused the materials on record, we are broadly in agreement with the view of tribunal. The significant features of the assessee's case were that the assessee was mainly engaged in identifying the companies in financial distress whose products were otherwise viable and taking over or financing of such companies. The business of the assessee was thus froth with inherent risks. Its credit rating therefore was relatively low of 'BBB-'. The assessee was raising funds for such investments through issuance of debentures to its AEs. The tribunal even on comparison found that the average rate of interest of 11.30% paid by the assessee to its AEs was ....
X X X X Extracts X X X X
X X X X Extracts X X X X
....e, for instance, a US $ loan advanced by a US lender is to him a debtclaim in national currency whereas to a German borrower it is a foreign currency debt (the situation being different, however, when an agreement in a third currency is involved). Moreover, a difference in interest levels frequently reflects no more than different expectations in regard to rates of exchange, rates of inflation and other aspects. Hence, the choice of one particular currency can be just as reasonable as that of another, despite different levels of interest rates. An economic criterion for one party may be that it wants, if possible, to avoid exchange risks (for example, by matching the currency of the loan with that of the funds anticipated to be available for debt service), such as taking out a US $ loan if the proceeds in US $ are expected to become available (say from exports). If an exchange risk were to prove incapable of being avoided (say, by forward rate fixing), the appropriate course would be to attribute it to the economically more powerful party. But, exactly where there is no 'special relationship', this will frequently not be possible in dealings with such party. Consequently, i....
X X X X Extracts X X X X
X X X X Extracts X X X X
....nsideration of the revenue's Appeal in the present case, should not be seen as putting our seal on such observations of the tribunal. In other words, we keep such question open to be examined in an appropriate case. In the present case, independent of such observations of the tribunal, we find that the conclusions arrive at, are based on evidence on record which conclusions call for no interference." 28. In our view, the decision of Hon'ble Bombay High Court as well as Delhi High Court are not applicable to the facts of the present case as both the Hon'ble Courts had not examined the issue of whether the FCCDs were in the nature of debt or equity and hence, there was no occasion to bench mark the interest payable on FCCD. In the present case, the issue involved is benchmarking of interest to be paid or payable of FCCDs before its conversion to equity. As mentioned elsewhere in the order, there would be no occasion for the assessee to repay the loan to it's A.E (on account of the nature of FCCD), therefore, the currency in which loan was taken or to be paid would not be relevant for the purpose of determining the interest rate. Therefore also, the decision in the case of Cott....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... are concerned, as long as such rights are not prohibited under any law, a rule or definition given in some provision of some other civil law, cannot change the rights agreed between the parties. Here in this case, this Corporate Debtor all through mentioned and shown this claim as a debt in the books of it. In view of the same, today this Corporate Debtor by relying upon some FEMA Regulations cannot say that it is not a debt, it is an equity invested by the applicant. As to this aspect, the applicant counsel has stated that the submission of the debtor counsel saying that this money is shown as equity in the Form filed before RBI is factually incorrect, because debt and equity are separately shown in the said Form. As to the judgment refereed by the Resolution Professional counsel, to our understanding, this ratio has been decided with regard to the Guideline IV (i) r/w IV (ii) of the Guidelines for Issue of Cumulative Convertible Preference Shares and Guideline No. 8 and 11 of the Employees Stock Option Guidelines. These Guidelines being in relation to Employees Stock Option Guidelines and Issue of Cumulative Convertible Preference Shares, this ratio cannot....
X X X X Extracts X X X X
X X X X Extracts X X X X
....e Corporate Debtor shall pay fixed returns to this applicant. The RP merely by showing this, the RP Counsel cannot come with an argument to say that this is to be treated as equity for redemption of debentures has not been envisaged in the agreement. At the time of winding up or admission of a case under IBC, if the debentures are not matured and not convertible for the period for redemption is not complete, they shal be treated as debentures and the consequence is, it will remain as debt. Same is the case here, debentures are not matured for conversion, interest shall be paid through coupons periodically. That has also not complied with. In view thereof, this application is hereby allowed directing the Resolution Professional to admit the claim as Financial Debt as envisaged under Section 5(8) (c) of the Insolvency and Bankruptcy Code, 2016. Accordingly, this application is allowed. 32. Further, we may fruitfully rely upon the decision of the Tribunal in the case of ACIT Vs. CAE Fright Training (India) Pvt. Ltd. IT(TP)A 63/Bang/2015, had held CCD as debt, whereby it was held as under : "7.1. Core theme and arguments of the Transfer Pricing Officer is nonexiste....
X X X X Extracts X X X X
X X X X Extracts X X X X
....ther Hybrid Instruments as means of fund infusion vis a vis admissibility and validity of Compulsory Convertible Debentures as an instrument and means of fund infusion from abroad. This was the need and requirement in a Regulatory environment and for Regulatory purposes. Nowhere did the Government Policy redefined or re- characterized the nature of a Compulsory Convertible Debenture as equity. 7.5. As far as need and requirement under the Income Tax Act is concerned it is enough to understand that the Government nowhere said in the given situation that a Compulsory Convertible Debenture is equity even at the time of its inception and during its continuity as a debenture prior to its compulsory and actual conversion in to equity at the appointed date. That being the case, purposes of Income Tax Act just requires to determine the nature of receipt and expense and decide the taxability of the resultant income. Thus, in the case of a Compulsory Convertible Debenture the nature of its value is that of a debt and once it is converted into equity at the appointed date, its value is that of an equity. The resultant expense therefore correspondingly will be that of an interest and ....
X X X X Extracts X X X X
X X X X Extracts X X X X
....he case of the assessee that FCCDs are equity then we must look into the substance over the form of the instrument, which can be ascertained by looking into its terms and conditions of allotment. As discussed hereinabove, the terms and conditions clearly show that the FCCDs are debt till its conversion. Yet another reason to above conclusion is that there is no recharacterization of the instrument by the Assessing Officer as there is no concept of paying the interest on the equity by the company to its holder under the Companies Act or under Income Tax Act or under the Accounting standards. The reliance of the assessee on the RBI policy for the non- convertible debenture is not relevant. In view of the above, we do not find any substance in the argument of the assessee that the Assessing Officer has recharacterized the nature of transaction. 35. Accordingly, we hold that FCCDs are debt, therefore, the benchmarking done by the learned lower authorities are correct by applying LIBOR plus 200 points, which is in consonance with the RBI guidelines issued for the purposes of FDI. 36. We may also draw support from the decision of co-ordinate Bench of the Tribunal in the case of Maa....