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2025 (6) TMI 48 - AT - Income TaxTP Adjustment - adjustment by the TPO of the ALP of the international transaction of interest paid/payable to AE on Supplier credit based on LIBOR Plus 200 Basis points and adjustment by the TPO of the ALP of the international transaction of interest paid to AE on Compulsory Convertible Debentures (CCDs) on LIBOR Plus 200 Basis points Interest on Compulsorily Convertible Debentures - HELD THAT - We are of a firm conviction that no infirmity emerges from the benchmarking by the assessee company of the ALP of the transaction of interest paid on the CCDs to its AE by adopting SBI- PLR. Resultantly the impugned TP adjustment of the ALP of the interest paid by the assessee company on CCDs to its AE so made by the AO is vacated. The Grounds of appeal are allowed in terms of our aforesaid observations. Interest paid/payable on Suppliers Credit - We are of the view that as the assessee company which had not earned any revenue from the operations from the subject year had not claimed deduction for any expenditure therefore the A.O. while computing the taxable income of the assessee company could not have made any addition based on the Transfer Pricing adjustment qua the interest paid/payable by the assessee company on the supplier s credit to its AE. We thus based on our aforesaid deliberations are unable to persuade ourselves to subscribe to the addition made by the AO vide his final order of assessment u/s 143(3) r.w.s. 144C(13) r.w.s 144B dated 20.12.2023 qua the interest on supplier s credit and thus vacate the same. As vacated the addition made by the A.O. of the Transfer Pricing adjustment of the interest paid/payable on the supplier s credit in terms of our aforesaid observation therefore we refrain from adverting to and adjudicating the contentions advanced by the Ld.AR regarding the merits on the aforesaid issue which thus are left open. Grounds of appeal No.6, 7 and 8 are disposed of as per aforesaid observations.
The core legal questions considered by the Tribunal in the present appeal relate primarily to transfer pricing adjustments on international transactions involving (i) payment of interest on Compulsorily Convertible Debentures (CCDs) issued by the assessee company to its Associated Enterprise (AE), and (ii) payment of interest on supplier's credit obtained from the AE. Additional issues include the applicability of transfer pricing provisions where no deduction for interest expense is claimed, set-off of losses brought forward, computation of book profits under Section 115JB of the Income-tax Act, 1961 ("the Act"), computation of interest under Sections 234A, 234B and 234C, and initiation of penalty proceedings under Section 270A of the Act.
Regarding the transfer pricing adjustments, the Tribunal focused on the following key issues:
Issue-wise Detailed Analysis (A) Benchmarking of Interest on Compulsorily Convertible Debentures (CCDs) The assessee issued 1,200,000 CCDs at INR 50 each to its AE, raising Rs. 6 crores, with a 10-year tenure and conversion into equity on maturity. Interest was paid at 8.5% amounting to Rs. 29,18,333. The assessee adopted an "other method" as the Most Appropriate Method (MAM) for benchmarking, relying on comparable companies' interest rates (10% to 11.10% range with median 10.75%) sourced from NSDL data, SBI-PLR, RBI Master Directions, and Safe Harbour Rules. The assessee contended that the interest rate was at arm's length. The TPO rejected the assessee's benchmarking, adopting the CUP method with LIBOR plus 200 basis points as the ALP. The TPO reasoned that CCDs are hybrid instruments treated as loans until conversion, and that LIBOR is the standard benchmark for international loans. The TPO further held that the currency denomination is irrelevant since the CCDs do not require repayment but conversion into equity. The AO and Dispute Resolution Panel (DRP) upheld this approach, leading to an addition of Rs. 15,41,567. The Tribunal examined the issue in light of the authoritative Special Bench decision of the ITAT Hyderabad, which held that for FCCDs/NCDs/other debentures denominated in Indian Rupees, the appropriate benchmark for interest is the PLR prevailing in India rather than LIBOR. The Special Bench extensively analyzed the nature of CCDs as debt instruments until conversion, the regulatory framework under the Companies Act and FEMA, and the economic principles underlying transfer pricing. The Tribunal emphasized that currency denomination is a critical factor influencing the interest rate. Loans denominated in INR bear different risk profiles and economic conditions compared to foreign currency loans. The borrower's country currency and associated risks dictate the appropriate benchmark interest rate. This view is supported by decisions of the Delhi High Court and Bombay High Court, which have held that the interest rate applicable should correspond to the currency in which the loan is denominated and repaid, not the residence of the lender or borrower. The Tribunal also noted that the RBI's regulatory framework classifies CCDs as equity for FDI purposes but recognizes their hybrid nature. Since CCDs issued to non-residents are denominated in INR, the interest rate should be benchmarked against domestic lending rates such as SBI PLR. The Safe Harbour Rules under the Act also distinguish between INR-denominated and foreign currency loans, prescribing different benchmark rates accordingly. The Tribunal rejected contrary decisions that applied LIBOR plus spread without adequate analysis of currency denomination and regulatory context. It held that applying LIBOR to INR-denominated CCDs is a fundamental error in transfer pricing principles and economics. Accordingly, the Tribunal vacated the transfer pricing adjustment on interest paid on CCDs and allowed the assessee's benchmarking based on SBI-PLR. (B) Benchmarking of Interest on Supplier's Credit The assessee reported interest paid/payable on supplier's credit amounting to Rs. 44,56,273 to its AE, payable in 10 equal installments over three years, with interest calculated at six-month LIBOR plus 225 basis points. The assessee benchmarked the transaction using "other method" and also relied on SBI-PLR, RBI Master Circular, and Safe Harbour Rules, concluding the transaction was at arm's length. The TPO rejected the assessee's benchmarking for multiple reasons: inconsistencies in interest rate calculations, inappropriate comparables due to lack of related party transaction filters, absence of current year data, and inapplicability of RBI Master Circular and Safe Harbour Rules for transfer pricing purposes. The TPO adopted the CUP method with LIBOR plus 200 basis points as the ALP, resulting in a transfer pricing adjustment of Rs. 2,52,454. The Tribunal found merit in the assessee's alternative contention that since no deduction for interest on supplier's credit was claimed (the assessee had no operational revenue during the year), the transfer pricing adjustment should not result in an addition to income. Section 92(1) of the Act requires computation of income from international transactions at ALP, including allowance for expenses or interest. However, if no deduction is claimed, no adjustment to income is warranted. Accordingly, the Tribunal vacated the transfer pricing adjustment on interest on supplier's credit. Since the addition was vacated on this ground, the Tribunal refrained from adjudicating other contentions on benchmarking methodology. (C) Set-off of Losses Brought Forward The assessee contended that the AO erred in not granting set-off of losses brought forward while computing assessed income. The Tribunal found this issue required verification and accordingly restored this grievance to the AO for reconsideration in accordance with law. (D) Computation of Book Profits under Section 115JB The assessee challenged the AO's computation of book profits, arguing that additions under Chapter X (transfer pricing adjustments) cannot enhance book profits. Since the transfer pricing adjustments were vacated, the Tribunal held the contention as academic and did not adjudicate on it. (E) Interest under Sections 234A, 234B and 234C The assessee challenged the AO's computation of interest under these sections. The Tribunal directed the AO to recompute interest in accordance with the final order, given the vacating of transfer pricing adjustments. (F) Initiation of Penalty Proceedings under Section 270A The assessee contended that penalty proceedings were wrongly initiated. The Tribunal considered this grievance premature and disposed of it without adjudication. Significant Holdings On the pivotal issue of benchmarking interest on INR-denominated CCDs, the Tribunal, relying on the Special Bench decision, held: "As regards TP adjustment made in respect of interest paid / payable on FCCDs / NCDs / other debentures, which are denominated in Indian currency, the benchmarking is to be made by applying PLR as against LIBOR." The Tribunal preserved the principle that currency denomination is a fundamental economic factor in determining arm's length interest rates, and that applying foreign currency benchmarks (such as LIBOR) to INR-denominated instruments is erroneous. On the issue of transfer pricing adjustment on interest on supplier's credit where no deduction was claimed, the Tribunal held that no addition to income can be made on account of transfer pricing adjustment, as the ALP adjustment relates to allowance of expense which was not claimed. Other significant principles established include:
Consequently, the Tribunal allowed the appeal by vacating the transfer pricing adjustments on interest on CCDs and supplier's credit, restored the issue of set-off of losses to the AO, and directed consequential recalculations of interest and other related matters.
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