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TMI Blog2020 (12) TMI 110X X X X Extracts X X X X X X X X Extracts X X X X ..... ty Commissioner of Income Tax (Transfer Pricing Officer) - IV ('Ld. TPO') which does not have any bearing on the taxability of the income for the relevant AY. 3. Disallowance of capitalisation of interest expenditure on CCDs 3.1. The Ld. TPO has erred in law by recharacterising the CCDs into equity shares since a Transfer Pricing Officer ('TPO') does not have powers under the Act to recharacterise any international transaction and has further erred in law by not providing an opportunity to the Appellant before recharacterising the compulsorily convertible debentures (`CCDs') as equity shares and therefore the orders of Ld. TPO and Ld. AO are bad in law. The Hon'ble CIT(A) erred in upholding the actions of the Ld. AO/ Ld. TPO. 3.2 The Ld. AO and Ld. TPO have erred in law by recharacterising the transaction relating to compulsorily convertible debentures ('CCDs') issued by Appellant to its Associated Enterprise ('AE') as equity and thereby not allowing interest payment on such CODs as expenditure. The Hon'ble CIT(A) erred in upholding the actions of the Ld. AO/ Ld. TPO. 3.3. The Ld. AO and Ld. TPO have erred in law by not apprecia ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... and fact by not undertaking an objective analysis for identifying the comparable transaction and concluding the arm's length price for the international transaction entered by AE to be NIL. 5. Initiation of penalty proceedings under section 271(1)(c) of the Act 5.1 On the facts and in the circumstances of the case and in law, the Ld. AO has erred in initiating penalty proceedings under section 271(1)(c) of the Act. 6. Relief 6 1. The Appellant prays that directions be given to grant all such relief arising from the preceding grounds as also all reliefs consequential thereto. The Appellant craves leave to add to or alter, by deletion, substitution or otherwise, any or all of the above grounds of appeal, at any time before or during the hearing of the appeal 2. The facts relating to Assessment Year 2009-10 are the assessee has incurred an expenditure of Rs. 21,26,25,004/- by way of interest on Rs. 13,50,00,000/- compulsorily convertible debentures (CCD's) with a face value of rs.10/- each issued to Green Banatelis Ltd, Cyprus. This being in the nature of an international transaction, the AO referred the issue to the TPO, who in his report relying upon the regulatio ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ital of the assessee which is brought in the garb of borrowings purely on tax considerations. Our attention is pointed out to the fact the ratio of debt to the equity is 248 : 1 which is unusually high by any standard and that such a highly geared company only shows that equity is brought in the garb of debt, and it is contended that since what is termed as borrowing by the company is de facto minimum required capital to carry out the business in India, interest cannot be allowed as a deduction on the same. In other words, Revenue's objection is that the assessee company is so thinly capitalized that its debt capital is required to recharacterized as equity capital for the purpose of examining claim of deduction for interest on such debt capital. 19. Thin capitalization refers to a situation in which capital of a business is made up of greater portion of debt than equity, and its such gearing or leverage ratio i.e. debt equity ratio, is too high. The tax treatment being given to the equity capital and debt capital being fundamentally different, it is often more advantageous in international context to arrange financing of a company by loan rather than by equity. It does affect the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... talization rules even at present. 21. Interestingly, however, thin capitalization rules do exist in Belgium which perhaps explains, for the reasons we shall now set out, the peculiar capital structure may have been adopted by the assessee. As per the Country Survey Report on Belgium, as published by the International Bureau of Fiscal Documentation, Amsterdam (based on information as on 19th Dec., 1995) Belgium applies two sets of thin capitalization rules. Firstly, a 1:1 debt/equity ratio applies to loans granted by individual directors, shareholders and non-resident corporate directors to their company [art. 198(10) IR/WIB]. Interest relating to debt in excess of this ratio is recharacterized into a non-deductible dividend. Furthermore, the interest rate may not exceed the market rate. Secondly, a 7:1 debt/equity ratio applies to debt if the creditor (resident or non-resident) is exempt or taxed at a reduced rate in respect of the interest paid on the debt. Interest relating to debt in excess of this ratio is considered a non-deductible business expense [art. 198(11) IR/WIB]. In a 2008 IBFD publication "International Tax Planning and Prevention of Abuse" (by Dr Luc De Broe : ISB ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... his debt capital is confined to borrowings directly by the PE. Be that as it may, it cannot be open to us to apply these thin capitalization rules in the hands of the assessee company while computing its taxable income in India, because so far as taxability in India is concerned, the limitation to be placed on deduction of expenses has to be limitation under the laws of the State in which PE is situated i.e. India. It may be useful to recall that in terms of the provisions of art. 7(3)(b) of Indo-Belgian tax treaty, "In the determination of the profits of a PE, there shall be allowed as deductions expenses which are incurred for the purposes of the business of the PE including executive and general administrative expenses so incurred, whether in the State in which the PE is situated or elsewhere, subject to the limitations of the taxation laws of that State". Admittedly, there are no limitations on deduction of interest expenses on borrowings, which can be attributed to thin capitalization rules, in India. 23. The question then arises whether even in the absence of any specific thin capitalization rules in India, it could be open to the Revenue authorities to recharacterize the deb ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the extent the latter are beneficial to the assessee and this treaty override is unqualified, save and except for clarification that charge of tax in respect of a foreign company at a rate higher than the rate at which domestic company is chargeable, shall not be regarded as less favourable charge or levy in respect of such foreign company. Just in case there were any doubts on this fundamental legal position, the CBDT, vide Circular No. 333, dt. 2nd April, 1982 [(1982) 81 CTR (TLT) 18 : (1982) 137 ITR (St) 1], has set the same at rest. This circular deals with the question as to what the AOs will do when they find that the provisions of the DTAA are not in conformity with the provisions of the IT Act, 1961. Then it was laid down by the Board in the said circular as follows : "The correct legal position is that where a specific provision is made in the DTAA, that provision will prevail over the general provisions contained in the IT Act, 1961. In fact the DTAAs which have been entered into by the Central Government under s. 90 of the IT Act, 1961, also provide that the laws in force in either country will continue to govern the assessment and taxation of income in the respective ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... uestion constituted colourable device or sort of subterfuge. As long as finance structure adopted by the assessee was not specifically prohibited by the applicable tax treaty provisions, and as long as there was no specific anti-abuse provision to deal with the same in the tax treaty itself, the effect of the finance structure could not be ignored. 28. It is interesting to take note of the paradigm shift with regard to the treaty override, as introduced in s. 129(9) of the Direct Taxes Code Bill 2010, which provides that notwithstanding the treaty override provisions in s. 129(8) [which are in pari materia with s. 90(2) of the Indian IT Act, 1961] the provisions of the Direct Taxes Code "relating (a) general anti-avoidance rule under s. 123; (b) levy of branch profit tax under s. 111; or (c) control foreign company rules referred to in the Twentieth Schedule, shall apply to the assessee referred to in sub-s. (8), whether or not such provisions are beneficial to him". The treaty override is thus quite restricted in scope in this new paradigm. Unlike in the proposed code and in sharp contrast to this paradigm, the treaty override in the IT Act, 1961, save and except for the higher ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Act, which is not applicable in respect of deduction on interest under s. 36(1)(iii) and in leaning upon restriction placed in art. 7(3)(b) on intra organization notional payment of interest on capital, whereas the interest payment in the present case did not constitute an intraorganization transaction at all. Even if these interest payments were to be treated as intra-organization transactions by treating the same as payments made to the GE, and not to the joint venture partners, these payments cannot be viewed as notional payments because in such a situation the GE will have corresponding liability to pay the same to the joint venture partners. We have also noted that the interest paid by the assessee may have been contrary to the spirit, if not letter of the RBI guidelines, but then this fact, by itself and particularly in view of Explanation to s. 37 being confined to the amounts admissible as deduction under s. 37, does not render the interest paid by the assessee as not deductible, and it is not even necessary to examine the scope of Explanation to s. 37. It is also quite possible that tax considerations may have played a role in assessee's planning the capital structure, bu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e disallowed by saying that CCDs are equity and not debt. We hold accordingly. This issue is decided. 24. After examining the applicability of the Tribunal order rendered in the case of Besix Kier Dabhol, SA vs. DDIT (supra), we now examine the applicability of the decision of Special Bench of the Tribunal rendered in the case of Ashima Syntex Ltd. Vs. ACIT as reported in 100 ITD 247 (Ahd.) (SB) on which reliance has been placed by ld. DR of revenue in the written submissions filed by him as reproduced above. From the facts noted by the Tribunal in this case, it is seen that in that case the assessee issued convertible debentures for subscription at the rate of Rs. 75 per debenture and these were in two parts; Part-A of Rs. 35 to be compulsorily converted into one equity share of the face value of Rs. 10 each at a premium of Rs. 25 per share on the date of allotment of the debenture and Part-B of Rs. 40 to be compulsorily converted into one equity share of the face value of Rs. 10 each at a premium of Rs. 30 per share on the expiry of 15 months from the date of allotment of the debenture. Part-B debenture was to carry an interest at the rate of Rs. 14 per annum till the date of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... igations, the RBI is exercising strict and control so that such future re-payment obligations does not go beyond a point and since in the case of fully convertible debentures, there is no future re-payment obligation, the same was considered as equity for the purpose of FDI policy. In our considered opinion, any definition of any term is to be considered keeping in mind the context in which such definition was given. This definition of convertible debentures given by RBI is in the context of FDI policy to exercise control on future re-payment obligations in convertible foreign currency. In our considered opinion, such definition of the term convertible debentures cannot be applied in other context such as allowability of interest on such debentures during pre-conversion period or regarding payment of dividend on such convertible debentures during pre-conversion period or regarding granting of voting rights to the holders of such convertible debentures before the date of conversion. If you ask a question as to whether dividend can be paid on such convertible debentures in a period before the date of conversion or whether such holders of convertible debentures can be granted voting r ..... X X X X Extracts X X X X X X X X Extracts X X X X
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