TMI Blog2020 (12) TMI 747X X X X Extracts X X X X X X X X Extracts X X X X ..... fronted with a situation in which the assessee was in need of funding for its ongoing projects. It took loan through debentures, which were eventually redeemed. So the instant case falls in the general provision of accepting the transaction as such and not in the exception requiring recharacterization of the transaction of debt into equity. De hors the provisions of section 94B and the GAAR in the period anterior to their applicability, the obiter in the case of EKL Appliances [ 1979 (10) TMI 22 - MADRAS HIGH COURT] also supports the view canvassed by the ld. CIT(A) in not approving the recharacterization of the transaction of debt into equity. Thus, the first issue raised by the Revenue in its appeal is determined against it. Arm s length rate for determining the ALP of the International/Specified Domestic transactions of payment of interest - HELD THAT:- On examination of the assessee s Balance sheet for the year under consideration, it emerges that the amount payable to IDBI bank stands at Nil. This shows that the interest rate paid by the assessee to IDBI Bank that was considered as an internal comparable under the CUP method for the earlier year, is no more relevant f ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... RDER PER R.S.SYAL, VP : These two cross appeals one by the Assessee and the other by the Revenue emanate from the order dated 21-6-2017 passed by the CIT(A)-13, Pune in relation to the assessment year 2013-14. Because of certain overlapping issues in the appeals, we have clubbed them for disposal through this common order. 2. First issue raised by the Revenue in its appeal through certain grounds is against overturning by the ld. CIT(A) of the action of the Assessing Officer (AO)/Transfer Pricing Officer (TPO) in treating Optionally and Compulsory Convertible Debentures issued by the assessee-company as Equity Share Capital. 3. Succinctly, the factual matrix of the case is that the assessee, a domestic company, is engaged in the business of development of Real estate. A return was filed declaring total income of ₹ 20.08 crore. Certain international transactions and Specified Domestic transactions were reported by the assessee in the requisite form. The AO made a reference to the TPO for determining their Arm s Length Price (ALP). Dispute in the instant appeals is on the international transaction of payment of Interest on debentures to Lobrenco Ltd., Cyp ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ple of having higher proportion of debt vis- -vis equity and General Anti-Avoidance Rules (GAAR) resulting into tax avoidance. This convinced him to hold that the amount raised by the assessee in the form of debentures had a substance of equity on which no interest was payable. In reaching this conclusion, he took note of certain Tribunal orders and also the judgment of the Hon ble Delhi High Court in CIT Vs. EKL Appliances Ltd. (2012) 349 ITR 241 (Delhi) holding that re-characterization of transactions was permissible in two circumstances, inter alia, where the economic substance of a transaction differed from its form. The TPO, therefore, recharacterized the transactions of issue of debentures into shares and determined Nil ALP of international/specified domestic transactions of payment of Interest on debentures at Nil leading to proposing transfer pricing adjustment of ₹ 6,32,68,595/-. 4. The ld. CIT(A) reversed the finding of the TPO incorporated in the assessment order re-characterizing the transaction of issuance of OCDs/CCDs to its Associated Enterprises (AEs) into Equity Capital. In reaching this conclusion, he also relied on certain judgments/orders and found the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... o take several circumstances into consideration before deciding as to whether he needs to borrow or issue capital. There is no legal bar in accepting loans from shareholders/related concerns in the same way in which it is open to issue fresh shares to its existing lenders who are nonshareholders. Thin capitalization is a state of financial position of a company in which proportion between its capital and borrowings is unevenly poised towards debts. Thin capitalization can also be loosely called as thick borrowings. There are advantages and disadvantages of both the streams of funding, namely, capital and debts. However, in tax regime, their consequences are varying. Por una parte, a debt entails its service by interest, which is deductible in the computation of total income of payer, por otra parte an equity requires its service by payment of dividend, which is not only an application of income and hence not deductible but also requires the payer company to pay dividend distribution tax. The BEPS Action plan 4 notified the device of thin capitalization as a measure adopted by some related companies to erode taxation base from the concerned countries by unnecessarily opting for borr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ng recourse to the GAAR. Thus it is overt that the legislation has been provided with teeth to tackle the excess payment of interest in case of transactions of borrowing and lending between two associated enterprises specifically with section 94B and generally with the GAAR. However, it is pertinent to note that both these provisions have been brought in the statute prospectively w.e.f.1.4.2018. The TPO, for treating the assessee s debt as equity, drew support from the assessee s debt equity ratio in the light of the RBI s debt equity ratio for ECBs. However, section 94B, even after insertion at a later point of time, does not prescribe any debt equity ratio as a thin capitalization rule, thereby rendering the action of the TPO meritless. Whatever is not prohibited under the Act - generally or specifically - is impliedly permissible. In the absence of any existing provision under the Act at the relevant point of time, the TPO could not have ventured to recharacterize the transaction of debt into equity. 7. At this stage, it is befitting to note that there are different thin capitalization rules adopted by various countries depending upon host of factors, including their financia ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f the transaction actually entered into. Thus, save and except a case falls within the purview of specific or general tax avoidance provision, the authorities cannot dub a genuine transaction as sham or anti-avoidance and proceed to disregard or recharacterize the same. 9. Reverting to the facts of the case it is seen that the assessee issued debentures to its AEs, which were eventually redeemed. The TPO/AO changed the complexion of the transaction from borrowing to equity by resorting to the Thin capitalization rule and the GAAR. We have noticed supra that section 94B containing specific thin capitalization rules and GAAR came into force w.e.f. 1.4.2018. The assessment year under consideration is 2013-14. Obviously, these provisions are not applicable and resultantly the TPO could not have altered the form of the transaction. Our view is fortified by the judgment dated 30.08.2012 of the Hon ble jurisdictional High Court in DIT(IT) vs. M/s Besix Kier Dabhol SA (ITA No. 776 of 2011), copy placed at page 1 of the paper book laying down that the Tribunal was right in holding that in the absence of any specific thin capitalization rules in India, the AO could not disallow the intere ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ee have not borrowed any money for investing in the shares of the assessee company but the assessee company has borrowed money from its related enterprises through debentures. Ex consequenti, it is simple and plain that the transaction of subscribing by the related companies to the debentures issued by the assessee does not fit into the description of a Shareholder activity . Thus, the view point canvassed by the TPO in this regard cannot be countenanced. 13. In the like manner, the ld. DR has referred to Securities Subscription Agreement dated 16-10-2009 to accentuate the point that Lobrenco Ltd. has been referred to in this Agreement as Investor . In his opinion, the nomenclature used for describing Lobrenco Ltd. in the Agreement depicts the intention of the parties to consider Lobrenco Ltd. as Investor in shares. This argument is sans merits. Primarily, the term Investor from the stand point of the person investing does not confine itself to investment in shares only but equally to debentures also. Secondly, hardly any authority is needed to emphasize that nomenclature given in any agreement cannot be decisive of the true nature of the transaction. 14. It is interestin ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rd to the economic circumstances of the borrowing company, the investment would not be expected to be structured in this way. In such a case, the tax administration can recharacterize the investment in accordance with its economic substance with the result that the loan may be treated as a subscription of capital. The focus of the Revenue in the instant case is on such first exception. It goes without saying that the obiter of a judgment of a higher forum also needs utmost respect. The first exception, which the ld. DR has vigorously accentuated, applies where the amount is, in fact, taken as equity but because of close relation between the assessee and its lender, the same has been reflected in the accounts as a borrowing or vice-versa so as to take home some tax advantage. It is in such circumstances that the apparent transaction of loan can be altered so as to bring on record the real or intended transaction of equity. It does not say that in all cases of borrowings made from related entities, it must be invariably taken as equity. If a certain sum of money was understood and accepted as a loan and also reflected in the same way, the case will not fall within the ambit of the f ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... view has been reiterated in Pr. CIT VS. India Debt Management P. Ltd. (2019) 417 ITR 103 (Bom). In the light of these judgments, the rate of interest to be taken into consideration for our purpose is the rate payable in India since the assessee is recipient of the loan in the form of debentures. In principle, the ld. CIT(A) is correct in taking cognizance of the rate of interest payable on borrowings in India. 19. The assessee issued CCDs/OCDs in 2009 at interest rate of 15%. It was for the first time that the AO for the assessment year 2011-12 treated Arm s Length rate of interest at 8% on the basis of LIBOR plus certain basis points and made transfer pricing adjustment for the remaining interest equivalent to 7%. The ld. CIT(A), considering the interest paid by the assessee to IDBI Bank as Internal Comparable under the CUP method, determined the ALP of interest at 13.75%. Both the assessee as well as the Revenue preferred appeals against the order passed by the CIT(A) for the assessment year 2011-12. The Revenue did not dispute the determination of the arm s length rate of interest at 13.75% though it preferred appeal on disallowance u/s 14A of the Act. The assessee also pref ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n cess amounting to ₹ 18,97,751/- may kindly be allowed as a deduction while computing the total income of the assessee. 21. The Hon ble Supreme Court in National Thermal Power Company Ltd. Vs. CIT (1998) 229 ITR 383 (SC) has observed that the purpose of the assessment proceedings before the taxing authorities is to assess correctly the tax liability of an assessee in accordance with law. If, for example, as a result of a judicial decision given while the appeal is pending before the Tribunal, it is found that a non-taxable item is taxed or a permissible deduction is denied, we do not see any reason why the assessee should be prevented from raising that question before the tribunal for the first time, so long as the relevant facts are on record in respect of that item . Answering the question posed before it in affirmative, their Lordships held that on the facts found by the authorities below, if a question of law arises (though not raised before the authorities) which has bearing on the tax liability of the assessee, the Tribunal has jurisdiction to examine the same. Having gone through the subject matter of the additional ground taken by the assessee, it is discernible ..... X X X X Extracts X X X X X X X X Extracts X X X X
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