TMI Blog2019 (8) TMI 554X X X X Extracts X X X X X X X X Extracts X X X X ..... f TPO is not by invoking Thin Capitalisation principle and therefore, it has to be decided independently. TPO is bases on RBI policy of FDI. We all know that RBI policy of FDI is governed by this that what will be future repayment obligation in convertible foreign currency and since, CCDs does not have any repayment obligation, the same was considered by RBI as equity for FDI policy. Whether such treatment given by RBI for FDI policy can be applied in every aspect of CCDs. Whether the holder of CCDs before ins conversion can have voting rights? Whether dividend can be paid on CCDs before its conversion? - In our considered opinion, the reply to these questions is a BIG NO. On the same logic, in our considered opinion, till the date of conversion, for allowability of interest u/s 36 (1) (iii) also, such CCDs are to be considered as Debt only and interest thereon has to be allowed and it cannot be disallowed by saying that CCDs are equity and not debt. We hold accordingly. This issue is decided. In the present case, the issue is not regarding expenses incurred on issue of shares. In the present case, the dispute is regarding interest on CCDs for a period before conversion. He ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... er years, DRP has adopted ALP of interest at LIBOR plus but in those years also, TPO has not decided the ALP aspect. This is also a claim of the assessee that ALP of interest should be decided in A. Y. 2009 10 only being the initial year in which CCDs were issued. There is no decision of any of the lower authorities in any year. Considering all these facts, we feel it proper to restore the ALP aspect to AO/TPO in all of these years for a decision as per law after providing adequate opportunity of being heard to the assessee. We do not make any comment on this issue. - C.O. No. 83/Bang/2017, 09/Bang/2018, IT(TP)A No. 2060/Bang/2016, 84/Bang/2015, 63/Bang/2015, 599/Bang/2016, 2178/Bang/2016, 2006/Bang/2017 - - - Dated:- 25-7-2019 - SHRI ARUN KUMAR GARODIA, ACCOUNTANT MEMBER And SMT. BEENA PILLAI, JUDICIAL MEMBER Assessee by: Shri P. K. Prasad And Umashankar Gautam, Advocates Revenue by: Smt. C. H. Sundar Rao, CIT (DR) ORDER Per Shri A. K. Garodia, Accountant Member Out of this bunch of six appeals and two Cos. for various years, the issue involved is one and common as to whether the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of hearing of this appeal. 4. The grounds raised by the assessee for Assessment Year 2010-11 in IT(TP)A No. 84/Bang/2015 are as under: - The grounds mentioned herein by the Appellant are without prejudice to one another. 1. That the order of the learned Income-tax Officer, Ward 2(1)(1), Bangalore ( Assessing Officer or AO ) pursuant to the direction of the learned Dispute Resolution Panel (Tana), to the extent prejudicial to the Appellant, is bad in law and liable to be quashed. 2. On the facts and circumstances of the case and in law, the learned AO/ learned Panel erred in making an adjustment of INR 13,72,23,908 to the transfer price of interest paid on compulsory convertible debentures ( CCD ). 3. On the facts and circumstances of the case and in law, the learned AO/ learned Panel erred in making an adjustment of INR 13,72,23,908 to the transfer price of interest paid on compulsory convertible debentures ( CCD ) by following an ad-hoc approach of using LIBOR rates thereby grossly erred in: 3.1. upholding the rejection of comparability analysis provided in the Transfer Pr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to find out the conduct of independent party in competitive market to see their investment behavior in risky debt instruments. 3. On the facts and in the circumstances of the case whether or not DRP was justified in holding that in absence of thin capitalization rules in Transfer Pricing the TPO cannot re-characterize debt into equity. 4. On the facts and in the circumstances of the case whether or not funds brought in India declaring them as FDI as per RBI and FEMA Act can be characterized as equity. 5. On the facts and in the circumstances of the case whether or not the CCDs may be characterized as debt in spite of Hon'ble Supreme Court in the case of Narender Kumar Maheshwarai Vs Union of India 1989 SC whether or not the CCDs may be characterized as debt in spite of Hon'ble Supreme Court in the case of Narender Kumar Maheshwarai Vs Union of India 1989 SC 138 holding that compulsorily convertible debentures does not postulate any repayment of the principal and therefore it does not constitute a debenture in classic sense. 6. On the facts and in the circumstances of the case whether or not the DRP can ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ant to its Associated Enterprise ( AEs ). 2. The Appellant prays that the adjustment be deleted. In doing so, the learned Panel / learned AO grossly erred in 2.1. disregarding the arm's length price ( ALP ) and the methodical benchmarking process carried out by the Appellant in the Transfer Pricing ( TP ) documentation maintained by it in terms of Section 92D of the Indian Income-tax Act, 1961 ( the Act ) read with Rule 10D of the Income-tax Rules, 1962 ( the Rules ); 2.2. upholding the approach of the learned TPO of re-classifying the CCDs issued by the Appellant to its AEs from debt to equity, completely ignoring the basic principles associated with the issuance of the debt instruments. 2.3. upholding the approach of the learned TPO of applying the principle of thin capitalization, as contained in the legislation from United Kingdom, in contravention to confining the assessment based on the principles provided in the Act and the Rules 2.4. upholding the approach of learned TPO of disregarding the commercial expediency for the issuance of CCD by the Assessee. 3. On the f ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tion, as contained in the legislation from United Kingdom, in contravention to confining the assessment based on the principles provided in the Indian Income-tax Act, 1961 ( the Act ) read with Rule ioD of the Income-tax Rules, 1962 ( the Rules ). 2.3. upholding the approach of learned TPO of disregarding the commercial expediency for the issuance of CCD by the Assessee. 3. On the facts and circumstances of the case and in law, the learned AO/learned Panel erred in 3.1. not appreciating the Appellant's argument that the CCDs should be benchmarked only in the year of issue and that the terms and conditions prevalent at the time of issue continues to hold good until the redemption/ conversion of CCDs; 3.2. disregarding the arm's length price ( ALP ) and the methodical benchmarking process carried out by the Appellant in the Transfer Pricing ( TP ) documentation maintained by it in terms of Section 92D of the Act read with Rule ioD of the Rules; 3.3. not appreciating that the CCDs were issued in INR and therefore, the Prime Lending Rate ( PLR ) followed by the Indian Public Sector Banks w ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d by the TPO in the order for A. Y. 2009 10 being the first year as CCDs were issued in December 2008. Hence, we reproduce Para 6 to 9 of this order of TPO.:- 6. Before I proceed to determine the ALP of the interest rate payable on the debentures issued by the Assessee Company, it is necessary to first ascertain as to whether the amount paid ₹ 76826983/- is in the nature of 'interest' or not. It is also necessary to find out in Transfer Pricing as to whether Assessee would have been in a position to borrow amount as debt from third parties in the conditions in which it exists visualizing that it is a standalone entity and not having any support from other entities. It is also to be seen as to whether CCDs are debt or shareholding service. In case it is found that amount received by the Assessee from AEs is not debt then it is quite proper to decide that amount paid by the Assessee to its AEs for ₹ 76826983 is not interest and therefore not allowable as deduction in determination of total income for the relevant A.Y. This approach of the TPO is based on following information the TPO has gathered on CCDs. 7. Relevant informati ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ibility of infusing additional amounts of funding required in the form of debt would need to be viewed from a commercial viability perspective and whether such loans would have been advanced by third parties in the instant case. 2.2 UK Transfer Pricing Guidelines which states thin capitalisation is nothing but a terminology used for addressing the companies which are structured to have excessive amounts of debt funding to extract profits in the form of interest payments. Relevant extracts from different INTMs support the view for ascertaining the extent of arm's length debt amount. These have been reproduced for ease of reference as follows: INTM542005 ... In the commercial world, a company is said to be thinly capitalised when it has more debt than equity, and many thin cap cases boil down to a company with more debt than it could and would have borrowed on its own resources, because it is borrowing either from or with the support of connected persons. INTM542005 When a company operates at arm's length from its sources of funding, commercial considerations drive the decision to raise funds either through debt, equity ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... hts and obligations of the provider of funds are similar to the rights and obligations of a shareholder, this will be taken as a factor indicating that the contribution might be akin to the supply of equity capital. For example, the lender may have, in relation to the loan, voting rights, a return dependent upon profits, or other rights that usually attach to ownership. (b) Repayment of principal A loan repayable on demand or within a short period of time will not be considered as equivalent to equity unless other facts associated with the loan demonstrate conclusively that the loan is equivalent to a contribution to equity. Conditions regarding repayment of the loan that are not consistent with an equity investment would be a factor indicating that the loan is not equivalent to equity. Similarly, where the contributor's claim to repayment of the contribution is not effectively subordinated to the claims of other creditors, this is a factor indicating that the contribution is not the equivalent of equity. (c) Purpose of the contribution The use of the funds by the borrower for investme ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sting in related party transaction no third party would have given loan. A company is said to be thinly capitalized when its capital is made up of a much greater proportion of debt than equity, i.e. its gearing or leverage, is too high. This is perceived to create problems for two classes of people. consumers and creditors bear the solvency risk of the company, which has to repay the bulk of its capital with interest; and revenue authorities, who are concerned about abuse by excessive interest deductions. In view of Transfer Pricing issues, an entity (which may be part of a group) may be said to be thinly capitalized when it has excessive debt in relation to its arm's length borrowing capacity, leading to the possibility of excessive interest deductions. An important parallel consideration is whether the rate of interest is one which would have been obtained at arm's length rate while comparing from independent lender as a standalone entity. Arm's length Principle: In order to determine whether an entity (or a group of entities) is thinly capitalized, it is necessary to: ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s), there is no restriction on pure equity investment, subject to certain conditions such as minimum capital requirement and a three-year lock-in. CCDs are treated as FDI, so essentially there is nothing that contravenes the regulations. Put option on CCDs has the potential of being misused unless it is exercised post-conversion into equity. Analysts say CCDs are a financial innovation resorted to by companies to bring in foreign loans masquerading as equity. The option is used to sell securities to international investors who, in turn, are promised an assured return and an easy exit. 3.4 Once the conversion option is exercised, it becomes an equity investment. Since conversion is compulsory, it is normally treated as equity even as it has debt like features for some time. Confusion has arisen because sometimes CCDs are structured in a way that takes them closer to debt. For example, at times CCDs have a put option which requires the issuing companies to buy back the shares issues on conversion at a fixed price. This structuring makes it debt like. 3.5 Currently, under regulations of Foreign Exchange Management Act CCDs are treated as FDI. Hence, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... this highly skewed balance sheet the operating revenue is very small compared to expenditures. The operating revenue is only 7.73 Crores whereas the expenditures are 28.41 Crores. It includes interest on debenture from December 2008 to March 2009 on CCDs for ₹ 5.38 crores whereas revenues are for the whole period. When in subsequent period when interest ill be payable On CCDs for whole year revenues will not be enough to service the debt. Even in FY 2008-09 relevant for AY 2009-10 the revenues are not sufficient and there is loss ₹ 20.67 Crores. In such company no third party would invest in the debts of the company which has very low credit rating which is even lower than investment grade bonds having BBB (-)credit rating. Thus, in the case of Assessee having junk credit rating, having no operating income, no source of cash flow to service the interest payable at the rate of 15%, no third party would make investment in CCDs. Therefore, it is nothing but thin capitalization. In Transfer Pricing thin capitalization is the outcome of the study of debt equity ratio and analysis as to whether Assessee could have borrowed from third parties. I find that the financial positio ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s year held that CCDs are Debt and not equity. DRP also held that Thin Capitalisation principle is not applicable. Having held this, DRP also held that ALP for interest on CCDs has to be worked out at LIBOR Plus rate and directed the AO to adopt ALP of interest on CCDs at 1.559%. DRP also held that additional 1% should be added to the prevailing LIBOR rate of interest to cover risk adjustment. Against this direction of DRP, the revenue is in appeal. One of the issues raised by the revenue is this that CCD is equity and not debt and hence, interest on CCDs is not an allowable expenditure. Second issue raised is this that even if it is held that interest on CCDs is allowable, the ALP should be 1.2848% as against 1.559 %. Third issue raised is about granting of 1% Risk Adjustment. 13. In this year, the assessee has also filed an appeal. One of the issues raised by the assessee is this that interest on CCDs should be benchmarked in the year of issue only and not every year. Second issue raised is this that since CCDs are issued in INR, PLR of Indian Public Sector Banks should be used for ALP of interest on CCDs and not LIBOR. 14. In A. Y. 2011 12, the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ide the applicability Thin Capitalisation Principle invoked by the TPO/AO. (b) If we come to this conclusion that it is equity and interest on it is not allowable than nothing remains to be decided further but if we come to this conclusion that it is Debt and interest on it is allowable then we have to decide this second issue as to what should be the amount to be allowed which essentially means what is ALP of such interest to be allowed? For quantifying the ALP, this is the first aspect as to whether it should be bench marked in A. Y. 2009 10 only being the year of issue or in each year? Second aspect is this as to whether it should be bench marked on the basis of LIBOR plus or PLR. Third aspect is this that if LIBOR is adopted then whether Risk Adjustment is to be allowed or not and if it is to be allowed, at what rate? 19. The ld. DR of revenue has submitted written submissions which are reproduced hereinbelow. May it please Your Honours, The above mentioned appeals have been heard by the Hon'ble Bench on 27.6.2019 and arguments have been made by the learned AR and the undersigned on the issue in dispute ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ring any security by way of floating CCDs. This is evident from the discussion on page 9 of the TPO's order. 5. In support of the TPO's conclusion that the money collected through CCDs is in the nature of equity, reliance was placed on the decision of the Hon'ble ITAT, Special Bench in the case of Ashima Syntex Ltd. vs ACTT, Central Circle-2(3) reported at (2006) 100 lTD 247 (AHD.)(SB) and a copy of the same was submitted to the Hon'ble Members during the hearing. In this decision, it was held that in the case of convertible debenture, it is nothing but raising capital by way of equity shares increasing the capital base via media being issue of convertible debentures. The loan or borrowings are not to be repaid but retained by converting into equity shares and therefore, it cannot be said to be a borrowing or a loan. In so far as the decision of ITAT, Mumbai Bench in the case of Besix Kier Dabhol, SA on which the learned AR placed reliance, it was argued that facts in that case are different and distinguishable. In that case, the assessee company raised foreign borrowings from its shareholders and claimed interest deduction u/s.37(1) of the I.T.Act ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... en in Master Circular issued by the RBI on 01.07.2008, there is no change in the policy in so far as the CCDs are concerned . A copy of this Circular is also enclosed. 8. As the assessee issued CCDs pursuant to Convertible Debentures subscription agreement with the subscribers entered into on 24.12.2008 (kindly see page 250 of PB), the above RBI Circulars shall apply. Therefore, the TPO has rightly relied on these policy circulars to treat CCDs as equity capital and proceeded to make ALP adjustment. 9. In the light of the above submissions, it is respectfully prayed that the Hon'ble Bench may be pleased to uphold the ALP adjustment made by the TPO and render justice. 20. The ld. AR of assessee also submitted written submissions which are reproduced hereinbelow. Subject : Notes on Arguments placed before Hon'ble Income Tax Appellate Tribunal Bench 'A', Bangalore in the case of CAE Flight Training India Private Limited (PAN : AADCC1248A) for Assessment Year 2009-10 (Deptt. Appeal No.- 2060/Bang/2016 and Assessee CO No.- 83/Bang/2017); Assessment Year 2010-11 (Deptt. Appeal No.- 63/Bang/2015 and As ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... pecific provisions of Chapter - X of the Income Tax Act. (Kindly refer to Paras- 1 2 on Pages- 1 2 of the Transfer Pricing Order for AY: 2009-10). 2.3. Upon reference, the Transfer Pricing Officer first rejected the Assessee's adoption of the comparables selected under Comparable Uncontrolled Price (CUP) method. The argument of the Transfer Pricing Officer for this rejection was that the comparables selected by the Assessee were for dissimilar periods and were in the context of Non-convertible Debentures whereas the Assessee's international transactions were in the nature of Compulsory Convertible Debentures. (Kindly refer, Para- 5 on Page- 3 of the Transfer Pricing Order for AY: 2009- 10). 2.4. The Transfer Pricing Officer did not dispute adoption of CUP method by the Assessee as the correct method. The only aspect the Transfer Pricing Officer disputed and rejected was adoption of certain comparables by the Assessee under CUP method. The Transfer Pricing Officer also did not suggest or adopt any other prescribed method to be the most appropriate method under the Income Tax Act or under the Income Tax Rules. Besides these, in spite of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ited Kingdom and conceptualizations of OECD in the context of Thin Capitalization. There is no reference or reliance on any Indian Tax Law because obviously there is none. (Kindly refer, Sub-para- 2.2 of Para- 7 to Sub-para- 3.0 of Para- 7on Page- 5 to of the Transfer Pricing Order for AY: 2009-10). 5.1. Further justification in this regard has been sought by saying that under section 36(iii) of the Income Tax Act interest is payable and deductible only in respect of a debt and in the subjective opinion of the Transfer Pricing Officer the status of the Assessee was such that no third party would have provided credit to it as a borrower (Kindly refer, Para- 6 on Page- 4, Sub para- I. 1. to 1.3 of Para- 7 on Page- 4 and Sub-para- 3.1. of Para- 7 on Page- 10 of the Transfer Pricing Order for AY: 2009-10). 5.2. According to the Transfer Pricing Officer this subjective understanding was sufficient enough to decide that matter on hand is that of equity and not debt. Little did the Transfer Pricing officer realize that conjectures, surmises and commercial expediency determination are not permissible for the Revenue Authorities under Indian Tax jurispr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ng its value at Nil and thus by denying its claim as expense. This impermissible predetermined objective has been attempted to be accomplished in the instant case by way of another impermissible act of re-characterization of debenture as equity based on presumption of Thin Capitalization concept. 6.4. Finance Act 2017 introduced Section 94B in the Income Tax Act w.e.f. 01.04.2018. This provision was introduced with the sole purpose of limiting interest deduction in certain cases. Indian statute thus for the first time addressed the concerns thrown up in Thin Capitalization concepts abroad. Here too the Indian statute confined itself to only limit the extent alone of the interest paid to the associated enterprise upon issue of a debt. In any case even this newly introduced provision is not relevant for any of the Assessment Years involved in the present set of appeals. This fact is being mentioned here just to emphasize that even here the statute did not permit recharacterization of a transaction in order to deny an interest payment outgo. This new provision also acts just as a limitation simpliciter on an interest deduction. 7.1. Core theme and a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... bility and non-validity of Optionally or Partially Convertible Debentures and other 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 recharacterized 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 in to equity at the appointed date, its value is that of an e ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Obviously, the Assessing Officer was satisfied with the genuineness and nature of the transaction and therefore was satisfied with the admissibility of the interest paid on Compulsory Convertible Debentures as genuine expense. The Assessing Officer referred the matter to the Transfer Pricing Officer only to determine the genuine extent of the claimable interest by way of arm's length determination exercise as prescribed under law and rules. The transactions were not referred to the Transfer Pricing Officer to determine the genuineness and nature of the transaction and to re-characterize it. The Transfer Price Officer exceeded his statutorily prescribed role and jurisdiction. 9.1. Hon'ble ITAT, Mum bai, in the case of Besix Kier Dabhol, SA vs. DOT (ITA No.- 4249/Mum/2007) has very categorically identified that the issue on hand in this case is that of Thin Capitalization requiring re-characterization of debt as equity (Kindly refer Paras - 18 and 23 on Pages 16 and 21 of this ITAT order). The Hon'ble Tribunal then very categorically concludes in this case that the international consensus, which the Assessing Officer has referred to, is for the need of T ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rcumstances of the present set of appeals under consideration. 10.1. The revenue placed reliance on two case laws namely Ashima Syntex Ltd. in ITA No.- 831 (AHD) of 1998 by Hon'ble ITAT Ahmedabad 'B' Special Bench and Narendra Kumar Maheshwari vs Union of India and others (1989 AIR 2138) of Hon'ble Supreme Court. This was to emphasize the point that in the case of convertible debentures it is nothing but raising capital by way of equity shares increasing the capital base, via media being, issue of convertible debentures. 10.2. Reliance placed on these two case laws by the Revenue are misplaced as they do not lay down good law and they stand in isolation amidst various other case laws that hold the issue differently. First of all the Revenue has missed the point that the case of Ashima Syntex was in the context of allowance of expenditure incurred by the Assessee on the issuance of convertible debenture as a revenue expenditure when they were basically pre-issuance expenditures. Allowance of interest expense on loan under Section 36 (1) (iii) of the IT Act was never the issue under consideration. Similarly, the case of Narendra Kum ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d therefore the expenditure thus incurred would be admissible as revenue expenditure. v. In the case of CIT vs. ITC Hotels Limited (190 Taxmann 430), the Honble. Karnataka High Court has also concluded that even if the debentures were to be converted into shares at a later date the expenditure incurred on such convertible debentures has to be treated as revenue expenditure. vi. In the case of DCIT vs. Modern Syntex India Limited (95 TTJ JP 161), the Honble ITAT Jaipur, has also very clearly held that debenture is nothing but just another form of loan on which interest is payable. The debentures cannot be equated with shares. As regards convertible debentures, the company may also issue other debentures in which case the option is given to the debenture holders to convert them into equity or preferential shares at stated rate of exchange after certain period. Thus, debenture conversion is also another form of loan for a specified period till they are converted into shares. Interest is payable on convertible debentures till they are converted into shares when dividend becomes payable. vii. In the case of GE Strategic Investments I ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... in the case of Bharati Airtel Limited vs. ALIT (161 TTJ 428); iv. Order of the Honble ITAT Delhi in the case of Unitech Limited vs. DCIT in ITA No. 6585/Del/2015. 12. Thus, all the positions taken by the Revenue have been met both on facts and law and the Honble Bench may kindly consider them favorably, both in terms of the arguments made during hearing and in this Notes on Arguments. 13. Besides the above, there is an issue emanating from the applicability of LIBOR vs. PLR rate, to determine the rate of interest to be paid to the associated enterprises. In the instant cases, debentures have been raised in INR, therefore the interest benchmarking has to be done in PLR and not in LIBOR. This is a very well settled issue for which copies of case laws have been submitted before the Honble Bench before the commencement of the hearing. Some of the case laws for ready reference are as below - i. CIT Vs. Cotton Naturals India Private Limited, High Court of Delhi in ITA No. 233/2014; ii. Siva Industries and Holdings Limited (ITA No. 2148/Mds/2010); iii. BT (India) Private Limited (( ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ' and ALP of the transaction by CUP method was held as Nil and adjustment of ₹ 7,68,26,983 was determined u/s 92 CA (3) of Income tax Act, 1961. As grounds No. 1 and 2 are general in nature these do not require adjudication. The relevant grounds of appeal raised by the appellant are 3. That on the facts and in the circumstances of the case, the Learned AO/Learned TPO erred in making adjustment to the transfer price of the Appellant international transactions with related parties by INR 7,68,26,983 for interest on debentures and considering the same to be nil. 4. That the Learned AO/Learned PO erred in rejection of comparability analysis undertaken in the Transfer Pricing documentation by the Appellant in accordance with the provisions of the Act read with the Income tax Rules, 1962 ((the Rules ). 5. That the Learned AO/Learned TPO erred in reclassifying the debenture issued by the appellant form CCD to equity. The Learned YPO during the course of the hearing had not contended on the nature f the intercompany funding and had queried only on the rate of interest charged. Accordingly, the Learned TPO f ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... It is on record that the funds which have been raised by the appellant through CCDs and have been utilised for the business of the appellant. The appellant has paid 15% as the rate of interest to its AEs for this purpose. It is been that PLR for A.Y.2008-09 as seen from SBI corporate website varies from 12.25% as on 1.1.2009 to 13.00% as on 10.11.2008. At an average, the same can be taken at 12.6% as against 15% claimed by the appellant. Under such facts, the interest paid of ₹ 7,68,26,983/- at @ 15% is certainly not at arm's length and is also evidently in excess of the +/- 5% margin allowable. The AO/TPO is therefore required to rework the ALP taking into account, 12.62% rate of interest as the Arm s Length rate of interest on the borrowing i.e. CCDs and rework the addition made u/s 92CA accordingly. It is held accordingly. 22. As per above para, it is noted that it is noted by CIT (A) that as per the tribunal order of Mumbai Bench rendered in the case of Besix Kier Dabhol, SA vs. DDIT as reported in 131 ITD 299 in which the issue was decided in favour of the assessee on this basis that in the absence of specific Thin capitalization Rules in India, re ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ome because of its characterization as distribution of profits). That is how tax considerations at times do result in a company being too thinly capitalized, or, to put it differently, financed by a disproportionate ratio of debts. In order to protect themselves against such erosion in their legitimate tax base, several tax jurisdictions enact rules to counter this vulnerability and these rules are termed as thin capitalization rules . 20. It is for this background that many jurisdictions take several legislative anti-abuse measures including limiting deduction on interest when the company is considered to be too highly geared under applicable tax regulations. India has woken up now to neutralize this kind of manoeuvring and the Direct Taxes Code Bill, 2010, does seek to provide a legislative framework for remedial measures to counter erosion of tax base by thin capitalization. Under s. 123(1)(f) of the proposed Direct Taxes Code Bill, 2010 (Bill No. 11 of 2010 as introduced in the Parliament on 30th Aug., 2010) as a part of the general anti-avoidance rule, any arrangement entered into by a person may be declared as an impermissible avoidance arrangement and the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rcapitalized companies. Interest is not deductible if the statutory 7 : 1 debt/equity ratio is exceeded. Article 18, 4 BITC belongs to second group of aforementioned rules; it recharacterizes certain interest payments into dividends both for corporate tax purposes of debtor and for withholding tax purposes, while curiously it does not recharacterize debt into equity (neither for corporate tax, nor for capital duty purposes). In certain circumstances, the Belgian GAAR may have the potential to recharacterize purported debt into equity. In that case, it also belongs to the second set of rules. 22. It is thus only under the Belgian tax laws, which inter alia restrict the interest deductions only to the extent of debt capital ratio of 1:7 in sharp contrast to the debt ratio in the present case which is 1:248, that the mode of borrowings, i.e. via GE or via PE, may have some tax implication even though at somewhat superficial level. That perhaps explains as to why the borrowings are claimed to have been resorted to by the Indian PE and not the Belgian GE directly. If these borrowings were resorted to by the Belgian GE directly, prima facie the thin capitalization rul ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he chapter on interpretation of DTAAs, to deal with treaty shopping, conduit companies and thin capitalization. These may be based on UN/OECD Model or other best global practices. 112. In para 3.3.2 the working group recommended introduction of anti-abuse provisions in the domestic law. 113. Finally, in para 3.3.3 it is stated the working group recommends that in future negotiations, provisions relating to anti-abuse/limitation of benefit may be incorporated in the DTAAs also. 114. We are afraid that the weighty recommendations of the working group on non-resident taxation are again about what the law ought to be, and a pointer to the Parliament and the executive for incorporating suitable limitation provisions in the treaty itself or by domestic legislation. This per se does not render an attempt by resident of a third party to take advantage of the existing provisions of the DTAC illegal. (Emphasis, by underlining, italicized in print, supplied by us) 25. It is thus clear that merely because a suitable limitation provision in the treaty or the domestic legislation is considered desirable, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r Lordships concluded that the CBDT circulars inter alia can tone down the rigour of the law and such benevolent circulars are binding on the field authorities. It cannot therefore be open to a Revenue authority to disregard the CBDT circular even if it deviates from the law-as long as it is beneficial to the assessee. Thus, where a DTAA provided for a particular mode of computation of income, the same should be followed, irrespective of the provisions in the IT Act. Where there is no specific provision in the agreement, it is the basic law, i.e., the IT Act, that will govern the taxation of income. When no such limitations on benefits or anti-abuse provisions are set out in the tax treaty, it cannot be open to the Revenue authorities to apply the anti-abuse provisions based on the Judge made law in India-which is essentially to be treated as a part of the IT Act as it is based on the interpretation of provisions under the IT Act and apply the same. As observed by this Tribunal, in the case of Motorola Inc. vs. Dy. CIT (2005) 96 TTJ (Del)(SB) 1 : (2005) 95 ITD 269 (Del)(SB), a tax treaty is an alternative tax regime. It has to be treated as a complete code in itself, in that sense. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e light of the s. 90(2) as it exists at present any attempts to neutralize thin capitalization vis-a-vis PEs of Belgian enterprise will be clearly contrary to the scheme of non-discrimination envisaged by art. 24(5) which provides that, enterprises of a Contracting State, the capital of which is wholly or partly-owned or controlled, directly or indirectly, by one or more residents of the other Contracting State, shall not be subjected in the first-mentioned Contracting State to any taxation or any requirement connected therewith which is other, or more burdensome, than the taxation and connected requirement to which other similar enterprises of that first-mentioned State are or may be subjected in the same circumstances and under the same conditions . In this view of the matter, it cannot be open to the Revenue authorities to put any limitation on deduction of interest, in respect of funds borrowed by the PE, while computing income in accordance with the provisions of art. 7 of Indo-Belgium tax treaty, when no such limitations are placed on the domestic enterprise. 30. For the reasons set out above, we are of the considered view that the assessee is indeed justif ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... italization Principle is on Statute book of the other country, no disallowance can be made in India by applying this Principle. To this extent, we uphold the finding of CIT (A) by respectfully following this tribunal order. But the issue still remains because, the objections of AO/TPO are not merely on the basis of Thin capitalization Principle. Their basic objection is this that since the interest is paid on CCDs, this is not an interest on debt but on equity and hence, not allowable. On page 11 of his order for A. Y. 2009 10, the TPO has reproduced certain comments of RBI in 2007 Policy on convertible debentures in which it is stated that fully and mandatorily convertible debentures into equity within a specified time would be reckoned as equity under FDI policy. In view of this RBI Policy, the TPO concluded that these CCDs are equity and not debt and therefore, interest on it is not allowable u/s 36 (1) (iii). This finding of TPO is not by invoking Thin Capitalisation principle and therefore, it has to be decided independently. We find that the decision of TPO is bases on RBI policy of FDI. We all know that RBI policy of FDI is governed by this that what will be future repayme ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ment of debenture itself, second part of the debenture has to be converted only on expiry of 15 months from the date of allotment of debenture and under these facts, it was held by Special Bench of the Tribunal in that case that the expenses incurred on issue of such debentures has to be considered as expenses incurred for issue of shares because it was found that first part of the debentures was to be converted into shares on the date of allotment itself and the second part was to be converted after expiry of 15 months from the date of allotment of debenture and therefore it was held that expenses incurred were actually incurred for issue of shares and not issue of debentures. In the present case, the issue is not regarding expenses incurred on issue of shares. In the present case, the dispute is regarding interest on CCDs for a period before conversion. Hence in our considered opinion, this decision of special bench of the Tribunal is not applicable in the facts of present case because the issue in dispute is different. In that case the issue in dispute is regarding expenditure incurred on issue of convertibles whereas in the present case the issue is regarding allowability of in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e second issue i.e. ALP of such interest on CCDs. We find that in the order of TPO and AO for the initial year i.e. A. Y. 2009 10, there is no discussion or decision on ALP aspect. Learned CIT (A) in that year has held in a very cryptic manner that 15% interest claimed by the assessee is not at arm s length because as per SBI Corporate Office Website, it is 12.25% on 01.01.2009 and 13.00% as on 10.11.2008. He directed the AO/TPO to rework the ALP at 12.62% which appears to be average of these two lower and upper rates of SBI PLR as noted. In later years, DRP has adopted ALP of interest at LIBOR plus but in those years also, TPO has not decided the ALP aspect. This is also a claim of the assessee that ALP of interest should be decided in A. Y. 2009 10 only being the initial year in which CCDs were issued. There is no decision of any of the lower authorities in any year. Considering all these facts, we feel it proper to restore the ALP aspect to AO/TPO in all of these years for a decision as per law after providing adequate opportunity of being heard to the assessee. We do not make any comment on this issue. 27. In the result, Both the C. Os. Of the assessee are d ..... X X X X Extracts X X X X X X X X Extracts X X X X
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