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TMI Blog2025 (4) TMI 83X X X X Extracts X X X X X X X X Extracts X X X X ..... NCDs/ other debentures, which are denominated in Indian currency the benchmarking is to be made by applying PLR as against LIBOR?" 2. The brief facts of the case are that the appellant, M/s Hyderabad Infratech Private Limited is a wholly owned subsidiary of Ascendas Property Fund (FDI) Pte. Ltd and is engaged in the business of development, operation and maintenance of Information Technology Parks in Special Economic Zones and incidental and associated activities. During the previous year, relevant to the assessment year 2015-16, one of the international transactions that took place between the appellant and its AE was, payment of interest on Fully and Compulsorily Convertible Debentures ("FCCDs") of Rs. 19,89,41,699/- issued by it in the financial year 2011-12. The taxpayer has carried out economic analysis in the TP study and has benchmarked the transaction of interest paid by it on FCCDs, by applying CUP method and considered similar interest payments made by comparable companies engaged in the real estate development. During the course of assessment proceedings, reference u/s 92CA(1) of the Income Tax Act, 1961 ("the Act") has been made to the Transfer Pricing Officer ("TPO"), ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to equity, the instruments are debt instruments and interest would be liable to be paid on such instruments at the agreed coupon rate. The debenture holder, in the event of liquidation, would rank pari-passu with any other unsecured creditor, if the debentures are unsecured. If secured, are at par with other secured creditors. Therefore, the question before the Bench is, as to how the ALP of the interest expense is to be determined, whether the rate should be on the basis of domestic lending rates (SBIPLR) or foreign currency rates (LIBOR). The learned Counsel for the assessee, further submitted that the FCCD in the case of the assessee herein are denominated in Indian Rupees and upon issue, the money is received in India in Indian Rupees by the issuing company, i.e. the assessee. Although a loan is different from a debt instrument, even the RBI's master directions on ECB distinguishes between ECBs denominated in foreign currency and ECBs denominated in INR. Even in the case of ECBs, the benchmark rates envisaged in foreign currency ECBs is widely accepted interbank rate (previously 6 month LIBOR) or ARR applicable to the currency of borrowing and in the case of Rupee denominat ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n the principle that it is the rate of interest in the country, where the loan is consumed. 6. The learned counsel for the assessee, further referring to Safe Harbour Rules and provisions of section 194-LD of the Act, submitted that statutory recognition of the denomination of the debt being relevant is evident from section 92CB of the Act and rule 10TD which deal with the Safe Harbour Rules, which prescription also distinguishes cases of loans denominated in foreign currency vis-à-vis loans denominated in INR. In terms of sub-rule (2A) of Rule 10TD, interest rates for INR denominated loans is to be arrived at based on the lending rate of SBI, whereas for foreign currency denominated loans, it is on the basis of LIBOR. He, further drew our attention to Notification No.56/2013 dated 29.07.2013, issued under section 194-LD, in the context of tax deduction at source on interest payments, submitted that if we go by said notification it also envisages capping of interest at the base rate of State Bank of India in the case of rupee denominated bonds. Therefore, he submitted that since the FCCDs are hybrid instruments, consisting of a loan and equity component till its conversion ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... learned counsel for the assessee, further referring to the decision of the Tribunal in the case of Watermarke Residency Limited (supra) submitted that the Tribunal distinguished the decision of High Courts in the case of India Debt Management and Cotton Naturals on the ground that the characterization of FCCDs as debt or equity was not under consideration in the said decisions although the principles for application of the benchmark rates are laid down in the said decisions. The Tribunal further held in paragraph 28 that since in the case of FCCDs there is no repayment, the currency in which the loan is taken or to be paid would not be relevant. But the fact remains that, although there is no physical repayment in the form of an outflow of funds at the time of conversion of CCDs to equity, it is as good as the issuer company redeeming the value of the debentures and the debenture holder re- investing the proceeds in Indian rupees in the shares and therefore the finding of the Tribunal is not in accordance with law. In this regard, he relied upon the decision of Hob'ble Supreme Court in M/s J.B.Boda&Co.Pvt.Ltd. Vs.CBDT (1997) 223 ITR 271 (SC), wherein, it was held that a two wa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t the appellant company has received CCDs in Indian currency and therefore the currency and the risk associated with it is strictly linked to the rate of interest applicable to such loan/ debt. Therefore applying SBI PLR for the purpose of benchmarking interest payment on FCCDs is totally contrary to the settled position of law and also facts of the present case. The learned counsel for the assessee further referring to provisions of Rule 10TD of Income Tax Rules 1962, which provides for Safe Harbour Rules submitted that, the Safe Harbour Rules provides for benchmarking different interest rates for different types of loans. As per the said Rules, advancement of intra-group loans referred to in item (iv) of rule 10TC where the amount of loan is denominated in Indian rupees, the interest rate declared in relation to eligible international transaction is not less than one year marginal cost of funds lending rate of State Bank of India as on 1st April of the relevant previous year plus appropriate basis points. In case of loans to intra groups referred to in Clause (iv) of Rule 10TC, where the amount of loan is denominated in foreign currency, the interest rate declared in relation to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ed in favour of the assessee. 11. Smt. Mamata Choudary, Sr. Standing Counsel for the Revenue, referring to conflicting decisions of various benches of ITAT on the issue of interest on rupee denominated CCDs and reference to Special Bench for determination of the issue of whether the interest on rupee denominated CCDs is to be benchmarked against the domestic PLR or LIBOR submitted that, the common underlying facts are that the assessee's are thinly capitalized subsidiaries of foreign holding companies which have invested in Compulsorily Convertible Debentures ("CCDs") under the automatic route of the statutory regulations framed by the Reserve Bank of India under the Foreign Exchange Management Act, 1999, governing Foreign Direct Investment ("FDI") in India as also restated in the Consolidated FDI Policy issued by the Government of India. Since the entire controversy revolves around the Rupee denominated CCDs, consideration of true nature and substance of such instruments as equity or debt would be fundamental and germane to the determination of the issue referred to the Special Bench. The learned Sr. Standing Counsel, referring to Clause 2.1.5 of the FDI Policy, which is appl ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ts as equity. In such circumstances, it would but follow that statutory and regulatory classification of CCDs as equity under FEMA would lie on a higher pedestal than contractual classification and ought to be given effect as such. 12. The learned Sr. Standing counsel for the Revenue further referring to the financial statements of the assessee's submitted that the assessee's have reflected these CCDs as borrowings in their balance sheets, but have subjected to TPO's recategorization as loans. In Adma India (P) Ltd Vs. DCIT in ITA No.497/Hyd/2016 dated 13.01.2017, the assessee's therein had contended that the CCDs were capital instruments and were wrongly categorized as a loan by the TPO. The Tribunal while holding them to be equity in nature, did not examine the consequential nature of the interest there on for the purpose of deduction u/s 36 of the Act, but applied SBI PLR as a benchmark, since the CCDs were denominated in INR. The decision in Watermarke Residency Ltd. Vs. DCIT (supra) was the trigger for the assesses seeking a reference to the Special Bench. The specific contention of the assessee's therein was that the FCCDs are to be categorized as equity, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ed as contemplated u/s 36(1)(iii) of the Act and interest on such non-refundable capital would not be eligible for deduction u/s 36(1)(iii) of the Act. Notwithstanding the fact that interest to the extent of LIBOR plus has been allowed in the present cases it is submitted that considering the cases referred to above, the legal position would be that since CCDs are equity instruments and there is no repayment obligations, as they are to be mandatorily converted to equity, they would not be eligible for any deduction of interest u/s 36 or 37 of the Act. Even if the FEMA Regulations and RBI Guidelines do not expressly provide or prohibit the payment of interest on CCDs it would not alter the nature of the CCDs being capital equity instruments or that such interest would be towards the permanent capital of the assesses and therefore could only be out of profits after tax. She further referring to the decision of CIT, Udaipur Vs. Secure Meters [2010] 321ITR 611 (Rajasthan) submitted that the decision was in the context of partially convertible debentures with 80% repayment obligation and therefore not applicable to the present circumstances. Therefore, she submitted that FCCDs should be ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t in India. The foreign entity's cost of debt is substantially lower than the cost of domestic debt. This arbitrage lies at the root of the ECB regulations mandating all in cost ceilings pegged to LIBOR. The assessee's cannot be permitted to profit from an arbitrage that would be nothing more than financial engineering. Therefore, even if the amounts invested in CCDs were to be examined from an ECB perspective, neither the assesses nor the foreign investors/holding companies would meet the eligibility criteria of an eligible investor, eligible borrower, debt equity ratio, end use restrictions etc. prescribed under the Foreign Exchange Management (Borrowing or Lending in Foreign Exchange Regulation) 2000 and the ECB Master Circular of the RBI, particularly on account of the thin capitalization, track record etc. of the assesses. The amounts which could have been raised as an ECB would fall far short of the amounts remitted and therefore to treat the entire amount invested as an ECB in INR would be inaccurate and the ECB component would have to be moderated accordingly. The summary submitted by the Revenue sheet reflects that the assessee's are extremely thinly capitalize ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r. Standing Counsel further without prejudice and in the alternate, submitted that Indian companies borrow from external markets to take advantage of the lower interest burdens. Similarly, had the assessee's borrowed simpliciter from the international market they would have paid LIBOR benchmarked interest. To sum up, she submitted that the rupee denominated CCDs are equity in nature and any interest thereon would be expenditure which is capital in nature not eligible for deduction u/s 36 of the Act. Foreign equity investment cannot be equated to domestic debt merely because it is Rupee denominated and nomenclated as a debenture. Therefore, she submitted that benchmarking adopted by the TPO and rate applied for benchmarking such interest payment is appropriate and therefore, the question referred to for the Special Bench should be answered accordingly. 15. Per contra, Sr.Counsel appearing for the assessee submitted that, Ld. Sr. Standing Counsel for the Revenue made altogether different arguments, which is not the case of the Revenue. First of all, the nature of the instrument is not in question before the Special Bench as is clear from the question framed. Therefore, the argum ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... B of the Act, which was introduced with effect from 01.04.2018 i.e. for a subsequent assessment year 2019-20, enacts these provisions for the first time. Thus, for assessment years prior to its insertion, a disallowance of interest on that basis is impermissible. The Ld. Counsel for the assessee further submitted that a reading of section 47(x) of the Act, indicates that upon conversion, the debentures cease to exist and a new instrument comes into place, Therefore, it is as good as the value of the debenture being repaid and the same amount being reinvested in shares. In this regard, he relied upon the decision of Hon'ble Supreme Court in the case of J.B.Boda (supra). The Ld. Counsel for the assessee further submitted that the arguments of the Ld. Sr. Standing Counsel for the Revenue in light of the decision of Hon'ble Delhi High Court in the case of CIT Vs. Cotton Naturals India Pvt.Ltd.(supra) also fails, because the principle laid down by the Hon'ble High Court was that SBI PLR would not be applicable to loans to be repaid in foreign currency and the currency in which the loans are to be repaid is what is to be considered for determining the interest rate. The prese ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ansaction and benchmarked interest paid / payable on FCCDs by applying LIBOR plus 200 basis points. 17. In this factual background, it is necessary for us to understand the nature of transaction to answer the question referred to for the Special Bench. Admittedly, the appellant has issued FCCDs. Debenture has been defined u/s 2(30) of the Companies Act, 2013, which includes debenture stock, bonds or any other instrument of a company evidencing a debt, whether constituting a charge on the assets of the company or not. The debenture is a type of debt instrument issued by companies to raise capital. Debentures are not ordinarily secured by physical assets or collateral securities. Debentures promise to pay interest and principal to the debenture holders. They are a way of companies to raise capital without issuance of shares and diluting their equity. Debenture is a common method for companies to raise long term financing. There are two types of debentures, one is convertible debentures and another is non convertible debentures. Under convertible debentures, there are two categories, one is optionally convertible debentures and the other category is fully and compulsorily convertible ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... in light of certain regulatory frameworks and the decision of the Hon'ble Supreme Court in the case of IFCI Ltd. Vs. Sutanu Sinha & Ors (supra) that debentures is an equity and interest paid on such FCCDs is not allowable expenditure, cannot be accepted and rejected. Further, the scope and powers of the Tribunal in deciding the question is limited to the extent of question referred to by the parties for the consideration of the Bench, but not beyond. Since the question before the Bench is on the issue of benchmarking of interest paid on FCCDs, in our considered view, the arguments of the Ld. Counsel on the nature of instrument is irrelevant and therefore, is rejected. 18. Having said so, let us come back to the real question before the Special Bench. Admittedly, the appellant companies have issued FCCDs to foreign holding companies in Indian Currency and also denominated debentures in the books of accounts in Indian rupees. The terms and conditions for issuing FCCDs has been regulated in the agreement between the parties and as per the said agreement, the appellant company has received amount towards debentures issue in Indian rupees. The parties have also agreed for interest, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ould be the rates prevailing in the said country, i.e. of the borrower and this principle has been supported by the decision of Hon'ble Delhi High court in the case of CIT Vs. Naturals India Pvt. Ltd. (supra), where, the Hon'ble High Court has dealt with the similar issue of benchmarking of interest received by an assessee, being a resident of India on loan extended to its foreign subsidiaries. The Hon'ble High Court in para 39 of their order clearly held that the "question, whether the interest rate prevailing in India should be applied, for the lender was an Indian company / assessee, or the lending rate prevalent in the United States should be applied, for the borrower was a resident and an assessee of the said country, in our considered opinion, must be answered by adopting and applying a commonsensical and pragmatic reasoning.". The Court further observed that "interest rate should be market determined interest rate applicable to the currency concerned in which the loan has to be repaid. Interest rates should not be computed on the basis of interest payable on the currency or legal tender of the place or the country of residence of either party. Interest rates appl ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... under which every form of investment is classified as equity or debt. Such classification under FEMA is made based on several factors by the RBI. The foreign investments through equity investments are governed by the Foreign Direct Investment regulations, while the foreign debt financing / loans are governed by the External Commercial Borrowings regulations which lay down a framework for raising funds through loans / debt instruments from non-resident parties. In the above background, FEMA regulations classify CCDs as equity for the limited purpose of regulating foreign investments, given the hybrid nature of CCDs. Unlike a traditional loan / debenture, CCDs must be mandatorily converted into equity based on the terms of the agreement. Hence, said regulations also provide for the manner and timing of determination of the conversion ratio of CCDs, i.e. the same shall be determined upfront based on the fair market value at the time of issuance of such CCDs. Therefore, liability on CCDs is extinguished by allotment of equity shares which is obviously a rupee based settlement. In other words, there is no obligation on the part of the Indian company to bear any forex fluctuations and it ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ame table deals with loans denominated in foreign currency, where the spread is based on reference rate such as SOFR/EURIBOR/SONIA etc. Although Safe Harbour Rules are applicable for outbound loans from A.Y.2021-22 and not directly relevant for the issue on hand, it is a statutory recognition of the economic difference between INR denominated and foreign currency denominated loans and therefore, a clue from the Safe Harbour Rules can be taken to strengthen the arguments of the appellant that different category of loans has to be benchmarked at different rate of interest, keeping in view, the economic parameters, currency in which such loan is accepted and repaid etc. We, further noted that CBDT has issued a Notification No.58/2013 dated 29.07.2013 u/s 194-LD in the context of tax deduction at source on interest payments, also envisages capping of interest at Base Rate of State Bank of India in the case of rupee denominated bonds. From the above, it is undisputedly clear that where the transaction is undertaken in Indian currency, then the rate of interest has to be benchmarked, by considering the rate of interest prevailing in the country of the currency, and if we go by said analo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nd therefore, does not address the issue in right perspective. 21. At this stage, it is necessary to refer to the case laws relied upon by the assessees. The ld. Counsel for the assessee relied upon the decision of Hon'ble Delhi High Court in the case of CIT vs. Cotton Naturals (I) (P) Ltd. (2015) 55 taxmann.con 523(Delhi). The Hon'ble High Court, in the context of outbound loans by an Indian parent to foreign AE, held as under: "39. The question whether the interest rate prevailing in India should be applied, for the lender was an Indian company/assessee, or the lending rate prevalent in the United States should be applied, for the borrower was a resident and an assessee of the said country, in our considered opinion, must be answered by adopting and applying a commonsensical and pragmatic reasoning. We have no hesitation in holding that the interest rate should be the market determined interest rate applicable to the currency concerned in which the loan has to be repaid. Interest rates should not be computed on the basis of interest payable on the currency or legal tender of the place or the country of residence of either party. Interest rates applicable to loans and d ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t will normally not be possible to review and adjust the interest rate to the extent that such rate depends on the currency involved. Moreover, it is questionable whether such an adjustment could be based on Art. 11 (6). For Art. 11(6), at least its wording, allows the authorities to 'eliminate hypothetically' the special relationships only in regard to the level of interest rates and not in regard to other circumstances, such as the choice of currency. If such other circumstances were to be included in the review, there would be doubts as to where the line should be drawn, i.e., whether an examination should be allowed of the question of whether in the absence of a special relationship (i.e., financial power, strong position in the market, etc., of the foreign corporate group member) the borrowing company might not have completely refrained from making investment for which it borrowed the money." 40. The aforesaid methodology recommended by Klaus Vogel appeals to us and appears to be the reasonable and proper parameter to decide upon the question of applicability of interest rate. The loan in question was given in foreign currency i.e. US $ and was also to be repaid in t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... AE, the Prime Lending Rate (PLR) of the Indian banks should be applied as the external CUP and not the LIBOR or EURIBOR rate. 10.4.10.3. A further issue in financial transactions is credit guarantee fees. With the increase in outbound investments, the Indian transfer pricing administration has come across cases of corporate guarantees extended by Indian parents to its associated entities abroad, where the Indian parent as guarantor agrees to pay the entire amount due on a loan instrument on default by the borrower. The guarantee helps an associated entity of the Indian parent to secure a loan from the bank. The Indian transfer pricing administration generally determines the ALP of such guarantee under the Comparable Uncontrolled Price Method. In most cases, interest rates quotes and guarantee rate quotes available from banking companies are taken as the benchmark rate to arrive at the ALP. The Indian tax administration also uses the interest rate prevalent in the rupee bond markets in India for bonds of different credit ratings. The difference in the credit ratings between the parent in India and the foreign subsidiary is taken into account and the rate of interest specific to a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t is provided and, while there may be some disagreement on certain points, for the most part the Subcommittee is in agreement that the guidance in those chapters reflects the application of the arm's length principle as embodied in the UN Model Tax Convention. 10.1.2. The Subcommittee recognizes that individual countries, particularly developing and emerging economies, struggle at times with the details of applying these treaty- based principles in a wide variety of practical situations. It therefore seemed appropriate to allow representatives of individual countries an opportunity to set out their individual country viewpoints and experiences for the information of readers. Those individual country views are contained in this chapter. It should be emphasized that it does not reflect a consistent or consensus view of the Subcommittee." 43. Normally there would be a difference between the lending rate and borrowing rate in each country. Some authors and writers suggest that the average or mid-point between the two should be taken. However, others like Klaus Vogel, have suggested that economic purpose and substance of the debt-claim or debt for which granting of credit calls ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of the borrower or the lender would vary and are dependent upon the fiscal policy of the Central bank, mandate of the Government and several other parameters. Interest rates payable on currency specific loans/ deposits are significantly universal and globally applicable. The currency in which the loan is to be re-paid normally determines the rate of return on the money lent, i.e. the rate of interest. Klaus Vogel on Double Taxation Conventions (Third Edition) under Article 11 in paragraph 115 states as under :- "The existing differences in the levels of interest rates do not depend on any place but rather on the currency concerned. The rate of interest on a US $ loan is the same in New York as in Frankfurt-at least within the framework of free capital markets (subject to the arbitrage). In regard to the question as to whether the level of interest rates in the lender's State or that in the borrower's is decisive, therefore, primarily depends on the currency agreed upon (BFH BSt. B1. II 725 (1994), re. 1 AStG). A differentiation between debt-claims or debts in national currency and those in foreign currency is normally no use, because, for instance, a US $ loan advanced by ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Dy. CIT v. Tech Mahindra Ltd. (supra) to reach the conclusion that ALP in the case of loans advanced to AEs would be determined on the basis of rate of interest being charged in the country where the loan is received/ consumed. Mr. Suresh Kumar the learned counsel for the Revenue informed us that the Revenue has not preferred any appeal against the decision of the Tribunal in VVF Ltd. v. Dy. CIT (supra) and Dy. CIT v. Tech Mahindra Ltd. (supra) on the above issue. No reason has been shown to us as to why the Revenue seeks to take a different view in respect of the impugned order from that taken in VVF Ltd. v. Dy. CIT (supra) and Dy. CIT v. Tech Mahindra Ltd. (supra). The Revenue not having filed any appeal, has in fact accepted the decision of the Tribunal in VVF Ltd. v. Dy. CIT (supra) and Dy. CIT v. Tech Mahindra Ltd. (supra). " 23. In view of this matter and considering the facts of the present cases, and also by considering ratios of various High Courts, we are of the considered view, that once the CCDs issued by the appellant are denominated in Indian currency, the interest payment on the said CCDs is to be benchmarked with reference to the rate of interest applicable to the ..... X X X X Extracts X X X X X X X X Extracts X X X X
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