TMI Blog2022 (8) TMI 1392X X X X Extracts X X X X X X X X Extracts X X X X ..... portunity of being heard to the assessee Respectfully following the same, we also direct the Ld.AO/TPO to compute the ALP of the interest for the year under consideration in accordance with the transfer pricing provisions. Accordingly, Ground raised by assessee stands allowed for statistical purposes. - IT(TP)A No. 520/Bang/2022 - - - Dated:- 2-8-2022 - SHRI CHANDRA POOJARI, ACCOUNTANT MEMBER AND SMT. BEENA PILLAI, JUDICIAL MEMBER For the Assessee : Shri Ketan Ved, CA For the Revenue : Shri Sumer Singh Meena, CIT DR-1 ORDER PER BEENA PILLAI, JUDICIAL MEMBER Present appeal is filed by assessee against assessment order dated 12/04/2022 by the Ld. DCIT, Central Circle 2(2), Bangalore on following grounds of appeal: Based on the facts and circumstances of the case and in law, M/s. CAE Flight Training (India) Private Limited (hereinafter referred to as the Appellant ) respectfully craves leave to prefer an appeal under section 253 of the Income-tax Act, 1961 ( the Act ) against the order passed by The Deputy Commissioner of Income-tax, Central Circle 2(2), BLR ( Assessing Officer or AO ) dated 12 April 2022 in pursuance of the Directions ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ly disregarding observations of Hon'ble ITAT in Assessee's own case for earlier assessment years having similar facts. 2.6 The Ld. AO and Ld. TPO erred in law and on facts, in placing reliance on FEMA/FDI Regulations to recharacterize the CCDs to Equity and thereby failed to appreciate that the treatment of CCDs under FEMA/FDI Regulations cannot determine/change the character of the instrument when it comes to other regulations including the Income-tax Act and completely disregarding observations of Hon'ble ITAT in Assessee's own case for earlier assessment years having similar facts. 2.7 The Ld. AO and Ld. TPO erred in law and on facts, in arbitrarily determining the ALP of payment of interest to AE on CCDs as 'Nil' on ad-hoc basis and thereby not following the provisions relating to determination of ALP as prescribed in the Act and the Rules. 2.8 The Ld. TPO erred in law and on facts, in transgressing his jurisdiction by questioning a genuine transaction and commercial expediency, and there by, concluding that CCDs are controversial instrument used to erode the base and shift profit, as the Ld. TPO is empowered only to determine the ALP a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ity shares. He submitted that the DRP has not considered the view adopted by this Tribunal. 5. On the contrary, the Ld.DR relied on orders passed by authorities below. 6. We have perused the submissions advanced by both sides in the light of records placed before us. 7. Nothing has been brought on record by revenue factually in order to deviate from the above view. 8. We note that the Coordinate Bench of this Tribunal in assessee s own case (supra) has considered the issue by observing as under: 21. Now we first decide the First and most important issue i.e. this that CCDs are Debts or equity and interest on it is allowable or not? On this issue, in the order of CIT (A) para 4 in the first year i.e. A. Y. 2009 - 10 is relevant and therefore, this Para is reproduced for ready reference hereinbelow. 4. Transfer pricing adjustment of Rs. 7,68,26,983: 4.1 The Transfer Pricing Officer, to whom the case was referred, noticed that the appellant had issued compulsory convertible debentures (CCDs)in December 2008 to its associated Enterprises in Mouritius, Dubai and Hungary at the rate of 15% interest on the funds borrowed as detailed in the TP order dated 29. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n of CCD as equity. The Learned TPO went beyond the brief of arbitrating only on the arm's Length pricing related to the rate of interest, and proceeded to question the nature of the inter-company funding. 6. That the Learned AO/Learned TPO proceeded to apply the principle of thin capitalisation, as contained in the Legislation from UK and Australia, in contravention to confining the assessment based on the principles provided in the Indian Transfer pricing regulations (as provided in the Act and the Rules). 7. The Learned TPO as part of the TP order did not refer to nor had any dispute on the rate of interest charged, and thereby making the TP order erroneous. These are taken up together in determining whether the TP adjustment made by the TPO is correct. The relevant issues raised in the above grounds are as under: i) Whether TP study has been rightly rejected? The comparisons made by the appellant with transactions of cases of other years and in respect of non-convertible debentures was not correct. The said comparisons in the TP document was therefore rightly rejected by the Transfer Pricing Officer as detailed in the order dated 29.1.2013. ii) Wheth ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the borrowings by the assessee, on which interest has been claimed as deduction, are in fact part of the capital 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 adv ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... not in dispute that as at the material point of time, India did not have any thin capitalization rules, nor does it have any thin capitalization 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 busin ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tly, it could possibly be said, or at least argued, that there is no debt capital in the assessee company--i.e. the Belgian entity, and this 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 whethe ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... essee. 26. Even otherwise, it is also important to bear in mind the fact that as the law stands now under s. 90 of the Indian IT Act, the provisions of a tax treaty override the provisions of the Indian IT Act--except to 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 t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... able to avoid the payment of tax by restoring to dubious methods and that it is the obligation of every citizen to pay the taxes honestly without resorting to subterfuge . It is thus not even necessary to examine whether or not the finance structure in question 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... isallowing the expenses based on his notions of thin capitalization rules, when such rules had not even reached the drawing board stage in India. Learned CIT(A) also did not follow the correct legal position by leaning upon restriction placed in Explanation to s. 37 of the 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 intra-organization 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 unde ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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) of Income tax Act 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. 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 t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ent in India dated 02.07.2007 and 01.07.2008. We would like to observe that such circular in the context of FDI policy of RBI is in a different context i.e. regarding future repayment obligations in convertible foreign currency and to have control over such future re-payment obligations, the RBI is exercising strict and control so that such future repayment 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X
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