Income Tax Appellate Tribunal - Bangalore
Praxair India Private Limited, ... vs Deputy Commissioner Of Income Tax, ... on 14 June, 2023
IN THE INCOME TAX APPELLATE TRIBUNAL
"A" BENCH : BANGALORE
BEFORE SHRI CHANDRA POOJARI, ACCOUNTANT MEMBER
AND SHRI GEORGE GEORGE K, JUDICIAL MEMBER
IT(TP)A No.187/Bang/2023
Assessment Year : 2017-18
M/s. Praxair India Private Limited, The Deputy Commissioner of
Level 6, Prestige Khoday Tower, Income Tax,
No.5, Raj Bhavan Road, Vs. Central Circle - 1(3),
Bengaluru - 560 001. Bengaluru.
PAN : AAACP 9993 J
APPELLANT RESPONDENT
Assessee by : Shri. T. Suryanarayana, Sr. Advocate
Revenue by : Shri. D. K. Mishra, CIT(DR)(ITAT), Bengaluru.
Date of hearing : 14.06.2023
Date of Pronouncement : 15.06.2023
ORDER
Per George George K, Judicial Member:
This appeal at the instance of the assessee is directed against the Final Assessment Order of DCIT, dated 19.01.2023, passed under section 143(3) r.w.s. 144C(13) of the Income Tax Act, 1961 (hereinafter called 'the Act'). The relevant Assessment Year is 2017-18.
2. The brief facts of the case are as follows:
Assessee is a company engaged in the business of manufacture and supply of industrial gases. For the Assessment Year 2017-18, the return of income was filed on 30.11.2017 admitting Nil income after setting off the current year's losses from IT(TP)A No.187/Bang/2023 Page 2 of 36 Income from Other Sources. The assessment was selected for scrutiny and notice under section 143(2) was issued and served on the assessee on 24.09.2018. During the course of assessment proceedings, the case was referred to the Transfer Pricing Officer (TPO) to determine the Arm's Length Price (ALP) of the international transaction undertaken by the assessee with its Associated Enterprises (AEs). The TPO, vide order dated 28.01.2022, determined aggregate Transfer Pricing (TP) adjustment of Rs.377,81,17,908/-. Following were the TP adjustments proposed by the TPO:
i. TP adjustment of royalty amounting to Rs.51,76,98,493/-. ii. TP adjustment towards payment of interest amounting to Rs.326,04,19,415/-.
3. Pursuant to the TPO's order, the Draft Assessment Order was passed on 26.03.2022 by incorporating the aforesaid TP adjustment. Aggrieved by the Draft Assessment Order, assessee filed objections before the Dispute Resolution Panel (DRP). The DRP, vide its directions dated 29.12.2022, rejected the assessee's contentions. Pursuant to the directions of the DRP, the impugned Final Assessment Order was passed on 19.01.2023. The computation of income pursuant to the Final Assessment Order is as under:
Business Income as per ROI (-)304,98,68,418/-
Add: as per above para no. 6 (TP) 377,81,17,908/-
Total addition 377,81,17,908/-
Assessed business Income 72,82,49,490/-
Add:- Income from other sources as 7,51,17,936/-
per ROI
Assessed income 80,33,67,426/-
IT(TP)A No.187/Bang/2023
Page 3 of 36
4. Aggrieved by the impugned Final Assessment Order, assessee has filed the present appeal before the Income Tax Appellate Tribunal (in short 'Tribunal'). The assessee has raised 7 grounds and various sub-grounds. However, during the course of hearing, the learned AR had only raised arguments to the following issues:
i. TP adjustment of Rs.51,76,98,493/- in respect of payment of royalty by the assessee to its AE by restricting the same to 1%. ii. TP adjustment of Rs.326,04,19,415/- in respect of payment of interest on Compulsory Convertible Debentures (CCDs), premium expenditure on repayment of CCDs and interest on Rupee Denominated Bonds (RDBs), by recharacterizing the same to be equity.
iii. Short credit of tax deducted at source
5. We shall adjudicate the above issues as under:
6. TP adjustment of Rs.51,76,98,493/- (in respect of payment of royalty) Ground Nos.4.3 to 4.6 The learned AR submitted that the above issue was considered by the Tribunal in assessee's own case in the earlier Assessment Years and the matter was decided in favour of the assessee by holding that the payment of royalty was at arm's length. The learned AR placed on record copies of orders of the Tribunal in assessee's own case for the earlier Assessment Years. The details of orders of the Tribunal in assessee's own case are detailed below:
1. IT(TP)A No. 915/Bang/2022 2018-19 Order dated 28.02.2023
2. IT(TP)A No. 200/Bang/2021 2016-17 Order dated 14.11.2022 IT(TP)A No.187/Bang/2023 Page 4 of 36
3. IT(TP)A No. 3336/Bang/2018 & 2014-15 & Order dated IT(TP)A No. 199/Bang/2021 2015-16 22.11.2022
4. IT(TP)A No. 2839/Bang/2017 2013-14 Order dated 25.08.2022
5. IT(TP)A No. 2209/Bang/2016 2012-13 Order dated 25.02.2022
6. IT(TP)A No. 506/Bang/2016 2011-12 Order dated 06.12.2021 In view of the above orders of the Tribunal, the learned AR submitted that the payment of royalty for the year under consideration ought to be treated as at arm's length.
7. Learned DR supported the orders of the TPO and the DRP.
8. We have heard the rival submissions and perused the material on record. The assessee had benchmarked the transaction of payment of royalty by using Comparable Uncontrolled Price (CUP) method to justify the arm's length of the transaction. The assessee also benchmarked the said transaction by aggregating it to certain other transaction and by adopting the Transactional Net Margin Method (TNMM). Under both the methods, the assessee concluded the transaction to be at arm's length. The TPO rejected the methods adopted by the assessee and determined the ALP transaction at 1%. The TPO had relied on earlier Assessment Orders which was upheld by the DRP. In earlier Assessment Years, the ALP of payment of royalty was restricted to 1%. The DRP rejected the objections of the assessee by relying on the directions issued in assessee's own case for Assessment Years 2011-12 to 2014-15 and 2016-17 (refer pages 9 to 12 of DRP's directions). We find that the Tribunal on identical issue in assessee's own case for Assessment Years 2009-10 to 2016-17 and Assessment Year 2018-19 (supra) had held that the payment of royalty is to be accepted as being at arm's length. The relevant finding IT(TP)A No.187/Bang/2023 Page 5 of 36 of the Tribunal in Assessment Year 2018-19 which had followed earlier year's orders reads as follows:
"Ground No. 5 and sub-grounds (TP adjustment)
5. The assessee has benchmarked the payment of Royalty by aggregating it with certain other transactions. The TPO rejected the method adopted by the assessee. The TPO applied CUP as the most appropriate method to determine the ALP of the transaction at 1% (assessee had claimed 4%). Aggrieved, assessee filed objections before the DRP. The DRP rejected the objections of the assessee by relying on the directions issued in assessee's own case for AY 2015-16 (refer page 8 of the DRP directions). Aggrieved the assessee has raised this issue before the Tribunal. The learned A.R. submitted that the issue in question is squarely covered by the orders of the Tribunal in assessee's own case for AY 2012-13 to 2016-17.
6. The learned D.R. supported the orders of the TPO and DRP.
7. We have heard the rival contentions and perused the material on record. We find that on identical facts the Tribunal in assessee's own case for assessment years 2011-12 to 2016-17 had decided the issue in favour of the assessee. The details of the Tribunal orders for assessment years 2011-12 to 2016-17 are as follows: -
i) IT(TP)A No. 200/Bang/2021 - AY 2016-17 (order dated 14.11.2022)
ii) IT(TP)A No. 3336/Bang/2018 - AY 2014-15 & IT(TP)A No. 199/Bang/2021 - AY 2015-16 (order dated 22.11.2022)
iii) IT(TP)A No. 2939/Bang/2017 - AY 2013-14 (order dated 25.08.2022) iv) IT(TP)A No. 2209/Bang/2016 - AY 2012-13 (order dated 25.02.2022) v) IT(TP)A No. 506/Bang/2016 - AY 2011-12 (order dated 06.12.2021)
8. The relevant findings of the Tribunal in AY 2015-16 in IT(TP)A 2839/Bang/2017 read as follows: -
10. We have heard rival submissions and perused the material on record. We find that on identical facts, the Tribunal in assessee's own case for assessment year 2012- 2013 in IT(TP)A No.2209/Bang/2016 (supra) decided the issue in favour of the assessee. The relevant finding of the Tribunal reads as follows:-
"9. The first issue we will take up the transfer pricing adjustment made by the TPO with respect to payment of royalty @ 1%.
IT(TP)A No.187/Bang/2023 Page 6 of 36
10. The ld.AR submitted that this issue is covered in assessee's own case in ITA No.506/Bang/2016 vide order dated 6/12/2021 for the asst. year 2011-12 wherein the coordinate bench of this Tribunal has allowed the appeal in favour of the assessee.
11. The ld. DR relied on the written submissions.
12. We have heard the rival submissions and perused the materials on record. We notice that the coordinate bench of the Tribunal in assessee's own case (Supra) has held that -
"7.4 We have heard rival submissions and perused the material on record. The Tribunal in assessee's own case for assessment year 2009- 2010 in IT(TP)A No.315/Bang/2014 (order dated 31.03.2017) and for assessment year 2010-2011 in IT(TP)A No.361/Bang/2015 (order dated 04.06.2018) had restored the issue of determination of ALP for payment of royalty to the files of the TPO. The TPO, pursuant to the Tribunal's order, passed orders accepting the payment of royalty at 4% to be at arm's length. The relevant portion of the TPO's order for assessment year 2009-2010 reads as follows:-
"3. In view of above direction of the ITAT, the assessee was asked to submit the details with respect of all comparables vide letter dated 19.06.2017. In response of the same the submission was filed by the assessee on 11.06.2017 which have been considered. As per submission, assessee has stated that out of the total 17 comparable agreements, the related party relationship between licensor and licensee existed in 07 comparable agreements and remaining 10 comparables agreements have unrelated party relationship for which the average royalty rate is computed at 4.10. Submission of the assessee has been considered. As the average rate of royalty paid by the comparables is more than payment made by the assessee, i.e. at 4%, payment towards royalty is being treated to be at arm's length."
7.5 The relevant portion of the TPO's order for assessment year 2010- 2011, reads as follows:-
"6. In view of above direction of the ITAT, the assessee was asked to submit the details with respect of all comparables vide letter dated 27.11.2018. In response of the same the submission was filed by the assessee on 12.12.2018 which have been considered. As per submission, assessee has stated that out of the total 17 comparable agreements, the related party relationship between licensor and licensee existed in 07 comparable agreements and remaining 10 IT(TP)A No.187/Bang/2023 Page 7 of 36 comparables agreements have unrelated party relationship for which the average royalty rate is computed at 4.10%. Submission of the assessee has been considered. As the average rate of royalty paid by the comparables is more than payment made by the assessee, i.e., at 4%, payment towards royalty is being treated to be at arm's length. Taking all these into consideration, the Royalty payment @ 4% made by the taxpayer to its AE is considered at Arm's Length, hence no adjustment on account of royalty payment is required to be made 7.6 In view of the above orders of the TPO, accepting the payment of royalty at 4% to be at arm's length, we hold that the payment of royalty at 4% in the year under consideration is to be treated as being at arm's length. Accordingly ground 3 is allowed."
13. Considering the decision of coordinate Bench in assessee's own case (supra) we allow this ground in favour of the assessee and hold that payment of royalty @ 4% is at arm's length."
11. In view of the above order of the Tribunal, in assessee's own case (supra), we hold that payment of royalty at 4% on sale is to be treated at arm's length. It is ordered accordingly."
9. In view of the above order of the Tribunal which is identical facts of the instant case (since the agreement for payment of Royalty is the same for earlier years and the relevant AY) we hold that the payment of Royalty at 4% is to treated at ALP. It is ordered accordingly."
9. In the relevant Assessment Year also, we find the facts are identical to the facts of the earlier Assessment Year cited supra. Therefore, we hold that the payment of royalty by the assessee is to be treated at arm's length. It is ordered accordingly. In the result, grounds 4.3 to 4.6 are allowed.
10. Payment of interest on CCDs, premium expenditure on repayment of CCDs and interest on RDBs (Ground Nos.4.7 to 4.14) (TP adjustment) During the Financial Year 2016-17, the assessee paid interest of Rs.252,26,33,938/- on Compulsorily Convertible Debentures to Praxair IT(TP)A No.187/Bang/2023 Page 8 of 36 Luxembourg S.A.R.L ("Praxair Luxembourg"), at interest rate of 9%, and 12%. Further, these CCDs were repurchased at a premium of 3% of the issue value. As a consideration for the repurchase/ buyback of CCDs, Praxair Luxembourg was issued RDBs/ Masala bond at Rs. 2372,39,08,630/-, on which interest amounting to Rs. 4,67,97,847/- was accrued. The assessee, in its TP study, benchmarked the transactions by applying other method, and concluded the same to be at arm's length.
11. The TPO treated the CCDs as equity and held that the payments made to the AEs are not in the nature of interest. The TPO, upon holding the arm's length price of interest payment on CCDs to be NIL, determined an adjustment of Rs. 326,04,19,415/- (refer pages 10-23 of the TP Order).
12. The DRP rejected the assessee's objections and upheld the TPO's order, by relying on the directions issued in the assessee's case for the Assessment Years 2014-15 and 2015-16 (refer pages 14 and 21 of the DRP's directions).
13. It was submitted that the TPO and DRP grossly erred in treating the CCDs as equity. Reliance in this regard is placed on the decision of this Tribunal in the case of CAE Flight Training (India) Pvt. Ltd. Vs. ITO, Bangalore (Order dated 25.07.2019 in ITA No. 84/Bang/2015) and the decision of this Hon'ble Tribunal in the assessee's own case for the Assessment Years 2014-15 and 2015-16 (supra).
14. Learned DR supported the Orders of the TPO and DRP.
15. The Tribunal, in assessee's own case for Assessment Years 2014-15 and 2015-16, had restored the matter to the files of the AO/TPO. The relevant finding of the Tribunal in this regard is as follows:
IT(TP)A No.187/Bang/2023 Page 9 of 36 5.1. After hearing both the parties, we are of the opinion that CCDs are nothing but debt till the date of conversion and re-characterization of the same is impermissible and this issue stands covered by the order of the Tribunal in the case of ACIT Vs. CAE Flight Training India Pvt. Ltd. in IT(TP)A No.2060/Bang/2016, IT(TP)A No.84/Bang/2015, IT(TP)A No.599/Bang/2016, IT)(TP) No.2178/Bang/2016 & ITA No.2006/Bang/2017 vide Tribunal's consolidated order dated 25.7.2019 wherein held 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 29.1.2013. The total payment of Rs. 7,68,26,983 was treated to be at Arm's length by the appellant in its TP Study by comparing it with 4 uncontrolled comparables (though of multiple years) by CUP method. However, the TPO was of the view that the comparison with non-convertible debentures of years other than the relevant FYs was not valid comparisons and therefore, the ALP determined by the appellant on the interest paid was rejected by the TPO. Also, the TP Officer examined whether the 'interest' paid of Rs. 7,68,26,983 was in the nature of `interest' at all. The Assessing officer concluded that the CCDs were actually equity and not debt since it was compulsorily convertible to equity shares and that the Reserve Bank of India also recognised CCDs as equity instruments. Also, the TPO was of the view that the appellant had junk credit rating, having no operating income or source of cash flow to service the interest payable at 15% and that no third party would make investment in CCDs and that the arrangement amounted to this capitalisation. Holding this, the amount of Rs. 7,68,26,983 was held to be not in the nature of 'interest' and ALP of the transaction by CUP method was held as Nil and adjustment of Rs. 7,68,26,983 was determined u/s 92 CA (3) of Income tax Act, 1961.
IT(TP)A No.187/Bang/2023 Page 10 of 36 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 of the intercompany funding and had queried only on the rate of interest charged. Accordingly, the Learned TPO failed to provide to the appellant adequate opportunity to argue on the proposed classification 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 IT(TP)A No.187/Bang/2023 Page 11 of 36 therefore rightly rejected by the Transfer Pricing Officer as detailed in the order dated 29.1.2013.
ii) Whether borrowing is debt or equity; Whether thin capitalisation rules apply?
The Assessing Officer has in effect held that CCDs amount to equity, and that the case is of thin capitalisation as the appellant has shown the funds as debt rather than equity although, the debt equity ratio has not been discussed in the order of the Transfer Pricing Officer. In the case of Besix Kier Dabhol, SA vs DDIT (I Tax),Circle-3(2), Mumbai, ITAT, Mumbai in their order in ITA No.4249/Mum/07 dated 20.11.2010 have held on similar facts that in absence of specific thin capitalisation rules in India, recharacterisation of debt capital as equity capital and accordingly disregarding the interest payments as tax deductables is not in order. Drawing support from the above, I hold that the conclusion of the AO that the CCDs is equity and that interest payment is not allowable cannot be upheld.
i. Whether rate of interest charged is at arm's length?
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 Rs.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, recharacterization of Debt Capital as equity Capital and disregarding of interest is not in order.
IT(TP)A No.187/Bang/2023 Page 12 of 36 We reproduce the relevant paras of this tribunal order i.e. para 18 to
30.
"18. That takes us to objection of the Revenue authorities to the effect that 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 advantageous in international context to arrange financing of a company by loan rather than by equity. It does affect the legitimate tax revenues of the source country in which business is carried out because while dividends and interest are generally taxable at the same rate in the hands of the recipient in the source country, e.g. under India Belgium tax treaty WHT rate on interest, other than bank interest, as also dividend is at uniform 15 per cent, interest is tax deductible and that results in lower corporate taxes in respect of PE profits. These tax benefits could be further optimized by hybrid financing instruments such as profit participating loans, convertible loans or where instrument is treated as debt in the source country of the income (i.e. resulting in tax deductible interest) and as equity in the residence country of the lender (i.e. where lender may claim the participation exemption of interest income 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'.
IT(TP)A No.187/Bang/2023 Page 13 of 36
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 consequences, under this Code, of the arrangement may be determined by re-characterising any equity into debt or vice versa". That is the first step taken by the India's tax administration in the direction of having formal thin capitalization rules in India. However, it is 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 nondeductible 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 . ISBN 978- 90-8722-035-08; @ p. 502), these thin capitalization rules are summed up as follows .
"Belgium has five domestic law provisions that are relevant for the discussion of thin capitalization, i.e. art. 26 BITC; art. 54 BITC; art. 198, 11° BITC, art. 18, 4° BITC and the Belgian GAAR. Articles 26, 54 IT(TP)A No.187/Bang/2023 Page 14 of 36 and 198 belong to the first group of aforementioned rules. The deduction of interest is denied if the statutory conditions for deductibility are not satisfied. Articles 26 and 54 are not concerned with the question whether the borrower is undercapitalized but only whether the interest charged is at arm's length. Excessive interest (i.e. interest charged above the prevailing market conditions) is not deductible. Article 198, 11° is concerned with undercapitalized 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 rules would have restricted the interest disallowance in excess of borrowings exceeding seven times the equity capital, whereas in the present case borrowings are two hundred fortyeight times the equity capital. As the capital is structured now, and the borrowings having been resorted by the Indian PE directly, 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, IT(TP)A No.187/Bang/2023 Page 15 of 36 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 debt capital as equity capital and, accordingly, disregard the interest payments as tax deductibles.
24. We find guidance from Hon'ble Supreme Court's judgment in the case of Union of India & Anr. vs. Azadi Bachao Andolan & Anr. (2003) 184 CTR (SC) 450 . (2003) 263 ITR 706 (SC) wherein their Lordships have, inter alia, observed as follows .
"111. In para 3.3.1 after noticing the growing practice amongst certain entities, who are not residents of either of the two Contracting States to try and avail of the beneficial provisions of the DTAAs and indulge in what is popularly known as 'treaty shopping', the report says .
'3.3.1 ..there is a need to incorporate suitable provisions in the 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, and attempts IT(TP)A No.187/Bang/2023 Page 16 of 36 are being made to legislate the anti-abuse provisions subsequently, it would not render the effort to take advantage of existing provisions of the treaty illegal. We are thus unable to accept the plea of the Revenue authorities, and we uphold the claim of deduction of interest in respect of capital borrowed from the shareholders or joint venture partners by the assessee.
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 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 country except where provisions to the contrary have been made in the agreement."
27. In the case of UCO Bank vs. CIT (1999) 154 CTR (SC) 88 . (1999) 237 ITR 889 (SC), their Lordships of Hon'ble Supreme Court had an occasion to survey the judicial precedents on the question of binding nature of the CBDT circulars. After elaborately dealing with Hon'ble Supreme Court's judgments in the cases of Navnit Lal C. Jhaveri vs. K.K. Sen, AAC (1965) 56 ITR 198 (SC) and K.P. Varghese vs. ITO & Anr. (1981) 24 CTR (SC) 358 . (1981) 131 ITR 597 (SC), their 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 IT(TP)A No.187/Bang/2023 Page 17 of 36 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. There are thus no legally sustainable merits in learned Departmental Representative's passionate plea for invoking principles laid down by Hon'ble Supreme Court in McDowell & Co. Ltd. vs. CTO (1985) 47 CTR (SC) 126 : (1985) 154 ITR 148 (SC), which, inter alia, holds that "colourable devices cannot be part of tax planning and it is wrong to encourage or entertain the belief that it is honourable 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 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 tax rate being permitted for the foreign companies, is unqualified. In the scheme of things, as it exists in the Indian IT Act, 1961, the treaty override over domestic law is much wider in scope. We cannot interpret the treaty provisions in such a manner so as to curtail, dilute or otherwise tinker with this comprehensive treaty override over the domestic tax law.
IT(TP)A No.187/Bang/2023 Page 18 of 36
29. It is also important to bear in mind that when there are no thin capitalization rules vis-a-vis domestic thin capitalization situations and in the 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 justified in claiming deduction on account of interest paid on borrowings from its shareholders/joint venture companies. The international consensus that the AO has referred to is for the need of thin capitalization rules, but then just because it is desirable to curb thin capitalization, the AO cannot disallow the interest paid on debt capital in the cases of thinly capitalized companies. The AO was clearly ahead of his times in disallowing 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 intraorganization 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 IT(TP)A No.187/Bang/2023 Page 19 of 36 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, but an element of planning in structuring capital does not transform a taxdeductible expense of interest into an expense that is non-tax deductible. In view of these discussions, it is clear that the impugned disallowance is indeed contrary to the scheme of the law as it exists; the grievance of the taxpayer deserves to be upheld. We, therefore, direct the AO to delete the impugned disallowance."
23. As per above paras of this tribunal order, it comes out that even if Thin capitalization 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 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. Now the question is that 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) 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."
IT(TP)A No.187/Bang/2023 Page 20 of 36 5.2 Further, as regards the ALP of the interest paid, the Tribunal in assessee's own case in assessment year 2011-12 in ITA No.506/Bang/2016 vide order dated 6.12.2021 has held as under:
"Payment of Interest on Compulsory Convertible Debentures (Ground
4) (Transfer pricing issue)
8. During the financial year 2009-2010, the assessee had entered into a debenture subscription agreement with its AEs, Praxair International Finance.
As per the terms of the debenture subscription agreement, the assessee issued unsecured and compulsory convertible debentures bearing interest at the rate of 9% per annum of the issue price. For the relevant assessment year, the assessee paid interest amounting to Rs.61,50,22,027. In the TP study, the assessee benchmarked the transaction of payment of interest by applying CUP method. Using the CCD benchmarking study, the assessee selected two companies as comparables and since the arithmetical mean of interest paid by the two companies stood at 9.5%, the assessee concluded the international transaction of payment of interest at 9% to be at arm's length.
8.1 The TPO treated the CCDs as External Commercial Borrowings (ECB) and benchmarked the interest rate paid against LIBOR rate of 4.13% (being LIBOR + 350 basis points). (Refer page 25 to 29 of the TPO's order).
8.2 Aggrieved, the assessee filed objections before the DRP. The DRP rejected the assessee's objections and upheld the TPO's order (refer pages 3 and 4 of the DRP's directions).
8.3 Aggrieved, the assessee has raised this issue before the Tribunal. It is submitted that the TPO and DRP grossly erred in treating the CCDs as ECBs and benchmarking the interest rate against LIBOR rate. It was submitted that CCDs being a hybrid instrument, cannot be treated as an ECB/loan. Reliance in this regard is placed on the order of the Hyderabad Bench of the Tribunal in the case of ADAMA India (P.) Ltd. v. DCIT ([2017] 78 taxmann.com 75 (Hyderabad-Trib.). It is further submitted that the CCDs having been denominated in INR, the interest having been paid in INR, and the CCDs having been repaid in INR, the same cannot be benchmarked against LIBOR. In this context, the learned AR relied on the following case laws:-
IT(TP)A No.187/Bang/2023 Page 21 of 36
(i) CIT v. Cotton Naturals (I) (P.) Ltd. (2015) 65 taxmann.com 523 (Delhi). (ii) PCIT v. India Debt Management (P.) Ltd. (2019) 106 taxmann.com 55 (Bombay)
(iii) Adams India (P.) Ltd. v. DCIT (2017) 78 taxmann.com 75 (Hyderabad-Trib.).
8.4 Therefore, it was submitted that the transaction of payment of interest of CCDs ought to be treated as being at arm's length.
8.5 The learned Departmental Representative supported the findings of the Income Tax Authorities.
8.6 We have heard rival submissions and perused the material on record. The assessee during the financial year 2009-2010, entered into a debenture subscription agreement with its AEs, Praxair International Finance. In the agreement, the term "issue price" is defined as "CCD will be issued at par at Rs.10 each". Further, the subscription considered shall be converted into INR as per the prescribed exchange rate and the number of CCDs allotted to the holders will be the subscription consideration as converted into INR, divided by face value of the CCD instrument. The debenture certificates issued clearly reflect the face value of debenture at INR at Rs.10 each. The CCDs are recorded in the financial statements in INR. The CCDs were also subsequently repaid in INR. The true copy of the statement setting out the details of payment and demand deposit transaction clearly demonstrate that the remittance is in INR.
8.6.1 The TPO and DRP erred in treating CCDs as ECBs and benchmarked the interest rate against LIBOR rate. The CCDs is a hybrid instrument and cannot be per se treated as ECB / loan. The Hyderabad Bench of the Tribunal in the case of Adama India (P.) Ltd. v. DCIT (supra) had held that CCDs cannot be categorized as a loan. The relevant finding of the Tribunal reads as follows:-
"8. We have considered the issue and examined the rival contentions. There is no dispute with reference to the fact that the CCDs were issued in Indian Rupees. Accordingly, following the principles laid down by the Coordinate Benches and the Hon'ble High Court as relied on by the assessee in the submissions, we have to hold that TPO has wrongly treated the issuance of CCDs as a loan, by treating it as an external commercial borrowing, ignoring the fact that loan is a debt, whereas CCD is hybrid instrument in nature basically categorised as equity in nature. It was accepted by the Hon'ble Supreme Court in the case of Sahara India Real Estate Corporation Limited and Sahara Housing Investment Corporation IT(TP)A No.187/Bang/2023 Page 22 of 36 Limited & Ors. Vs. Securities and Exchange Board of India & Anr. in Civil Appeal No. 9813 of 2011 dt. 31-08-2012 (supra) while assigning the jurisdiction to SEBI as an 'equity instrument'. Further, the policy of Govt. of India and also RBI effective from 01- 04-2010 also indicate that issuance of CCD is part of FDI being quasi-equity in nature and considering the same as a loan would be completely against regulations laid by DIPB, RBI and FEMA. It is to be reiterated that issuance of CCDs was denominated in Indian Rupees and not foreign currency. Therefore, TPO has erred in considering LIBOR as benchmark rate which is in complete contradiction to the principles on the issue. The following judicial precedents supports that the rate interest has to be considered in the currency in which loan has originated:
i.India Debt Management Pvt. Ltd., IT(TP)A No. 7518/Mum/2014; . CIT Vs. Cotton Naturals (I) Ltd., ITA No. 233/2014 (Del.HC); . M/s. Brahma Center Development Pvt. Ltd., Vs. ITO, ITA No. 373/Del/2016 (ITAT Del).
By respectfully following the Co-ordinate Bench and Hon'ble High Court decisions, we agree with the assessee's contentions that the CCDs cannot be categorised as a loan and LIBOR plus two hundred basis points benchmark cannot be accepted on the facts of the case."
8.6.2 The Hon'ble Delhi High Court in the case of CIT v. Cotton Naturals (I) Pvt. Ltd. (supra) had held that the interest rate should be the market determined interest rate applicable to the currency concerned in which the loan has to be repaid. The relevant finding of the Hon'ble High Court reads as follows:-
"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 deposits in the national currency 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 IT(TP)A No.187/Bang/2023 Page 23 of 36 globally applicable. The currency in which the loan is to be repaid 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.B 1. 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 a US lender is to him a debt-claim in national currency whereas to a German borrower it is a foreign currency debt (the situation being different, however, when an agreement in a third currency is involved). Moreover, a difference in interest levels frequently reflects no more than different expectations in regard to rates of exchange, rates of inflation and other aspects. Hence, the choice of one particular currency can be just as reasonable as that of another, despite different levels of interest rates. An economic criterion for one party may be that it wants, if possible, to avoid exchange risks (for example, by matching the currency of the loan with that of the funds anticipated to be available for debt service), such as taking out a US $ loan if the proceeds in US $ are expected to become available (say from exports). If an exchange risk were to prove incapable of being avoided (say, by forward rate fixing), the appropriate course would be to attribute it to the economically more powerful party. But, exactly where there is no 'special relationship', this will frequently not be possible in dealings with such party. Consequently, it 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 Alt. 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 IT(TP)A No.187/Bang/2023 Page 24 of 36 borrowing company might not have completely refrained from making investment for which it borrowed the money.
40. The aforesaid methodology recommended by Klaus Vogal 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 tobe repaid in the same currency i.e. US $. Interest rate applicable to loans granted and to be returned in Indian Rupees would not be the relevant comparable. Even in India, interest rates on FCNR accounts maintained in foreign currency and different and dependent upon the currency in question. They are not dependent upon the PLR rate, which is applicable to loans in Indian Rupee. The PLR rate, therefore, would not be applicable and should not be applied for determining the interest rate in the extant case. PLR rates are not applicable to loans to be re-paid in foreign currency. The interest rates vary and are thus dependent on the foreign currency in which the repayment is to be made. The same principle should apply."
8.6.3 In the instant case, admittedly, the CCDs are issued in INR, interest is paid in INR and CCD's are repaid also in INR. Therefore, placing reliance on the judgment of the Hon'ble Delhi High Court in the case of CIT v. Cotton Naturals (I) Pvt. Ltd. (supra), we hold that the TP study of the assessee to justify the interest rate by arriving at average rupee cost and comparing the same with SBI prime lending rate is correct. It is ordered accordingly.
8.6.4 Hence, ground 4 is allowed."
5.3 Further, in assessment year 2012-13 in IT(TP)A No.2209/Bang/2016 vide order dated 25.2.2022 the Tribunal has held as under:
14. "The next issue is the adjustment made by the TPO with regard to payment of interest on compulsory convertible debentures (CCDs) by re-
characterizing the same to be External Commercial Borrowings (ECB).
15. The Ld.AR submitted that this issue is also covered in assessee's own case (supra) wherein the coordinate bench of this Tribunal has allowed the appeal in favour of the assessee.
16. The ld.DR supported the decision of the lower authorities.
IT(TP)A No.187/Bang/2023 Page 25 of 36
17. We have heard the rival submissions and perused the materials on record. We notice that the coordinate bench of the Tribunal in assessee's own case (Supra) on the issue of interest on CCDs has held that -
8.6 We have heard rival submissions and perused the material on record. The assessee during the financial year 2009-2010, entered into a debenture subscription agreement with its AEs, Praxair International Finance. In the agreement, the term "issue price" is defined as "CCD will be issued at par at Rs.10 each". Further, the subscription considered shall be converted into INR as per the prescribed exchange rate and the number of CCDs allotted to the holders will be the subscription consideration as converted into INR, divided by face value of the CCD instrument. The debenture certificates issued clearly reflect the face value of debenture at INR at Rs.10 each. The CCDs are recorded in the financial statements in INR. The CCDs were also subsequently repaid in INR. The true copy of the statement setting out the details of payment and demand deposit transaction clearly demonstrate that the remittance is in INR.
8.6.1 The TPO and DRP erred in treating CCDs as ECBs and benchmarked the interest rate against LIBOR rate. The CCDs is a hybrid instrument and cannot be per se treated as ECB / loan. The Hyderabad Bench of the Tribunal in the case of Adama India (P.) Ltd. v. DCIT (supra) had held that CCDs cannot be categorized as a loan. The relevant finding of the Tribunal reads as follows:-
"8. We have considered the issue and examined the rival contentions. There is no dispute with reference to the fact that the CCDs were issued in Indian Rupees. Accordingly, following the principles laid down by the Coordinate Benches and the Hon'ble High Court as relied on by the assessee in the submissions, we have to hold that TPO has wrongly treated the issuance of CCDs as a loan, by treating it as an external commercial borrowing, ignoring the fact that loan is a debt, whereas CCD is hybrid instrument in nature basically, categorised as equity in nature. It was accepted by the Hon'ble Supreme Court in the case of Sahara India Real Estate Corporation Limited and Sahara Housing Investment Corporation Limited & Ors. Vs. Securities and Exchange Board of India & Anr. in Civil Appeal No. 9813 of 2011 dt. 31-08-2012 (supra) while assigning the jurisdiction to SEBI as an 'equity instrument'. Further, the policy of Govt. of India and also RBI effective from 01- 04-2010 also indicate that issuance of CCD is part of FDI being quasi-equity in nature and considering the same as a loan would be completely, against regulations laid by DIPB, RBI and FEMA. It is IT(TP)A No.187/Bang/2023 Page 26 of 36 to be reiterated that issuance of CCDs was denominated in Indian Rupees and not foreign currency. Therefore, TPO has erred in considering LIBOR as benchmark rate which is in complete contradiction to the principles on the issue. The following judicial precedents supports that the rate interest has to be considered in the currency in which loan has originated. i. India Debt Management Pvt.
Ltd., IT(TP)A No. 7518/Mum12014; ii, CIT Vs. Cotton Naturals (I) Ltd., ITA No. 23312014 (Deli-HC); iii. M/s. Brahma Center Development Pvt. Ltd., Vs. [TO, ITA No. 3 73/Del/2016 (ITA T Del). By respectfully following the Co-ordinate Bench and Hon 'ble High Court decisions, we agree with the assessee 's contentions that the CCDs cannot be categorised as a loan and LIBOR plus two hundred basis points benchmark cannot be accepted on the facts of the case." 8.6.2 The Hon'ble Delhi High Court in the case of CIT v. Cotton Naturals (I) Put. Ltd. (supra) had held that the interest rate should be the market determined interest rate applicable to the currency concerned in which the loan has to be repaid. The relevant finding of the Hon'ble High Court reads as follows:-
"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 deposits in the national currency 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 specfic loans/ deposits are significantly universal and globally applicable. The currency in which the loan is to be repaid 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 IT(TP)A No.187/Bang/2023 Page 27 of 36 to the question as to whether the level of interest rates in the lenders State or that in the borrowers is decisive, therefore, primarily depends on the currency agreed upon (BFH BSt.B 1. 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 a US lender is to him a debt-claim in national currency whereas to a German borrower it is a foreign currency debt (the situation being different, however, when an agreement in a third currency is involved). Moreover, a difference in interest levels frequently reflects no more than different expectations in regard to rates of exchange, rates of inflation and other aspects. Hence, the choice of one particular currency can be just as reasonable as that of another, despite different levels of interest rates. An economic criterion for one party may be that it wants, if possible, to avoid exchange risks (for example, by matching the currency of the loan with that of the funds anticipated to be available for debt service), such as taking out a US $ loan if the proceeds in US $ are expected to become available (say from exports). If an exchange risk were to prove incapable of being avoided (say, by forward rate fixing), the appropriate course would be to attribute it to the economically more powerful party. But, exactly where there is no 'special relationship', this will frequently not be possible in dealings with such party. Consequently, it 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 Alt. 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 Vogal 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 the same currency i.e. US $. Interest rate applicable to loans granted and to be returned in Indian Rupees would not be the relevant comparable. Even in India, interest rates on FCNR accounts maintained in foreign IT(TP)A No.187/Bang/2023 Page 28 of 36 currency and different and dependent upon the currency in question. They are not dependent upon the PLR rate, which is applicable to loans in Indian Rupee. The PLR rate, therefore, would not be applicable and should not be applied for determining the interest rate in the extant case. PLR rates are not applicable to loans to be re-paid in foreign currency. The interest rates vary and are thus dependent on the foreign currency in which the repayment is to be made. The same principle should apply."
8.6.3 In the instant case, admittedly, the CCDs are issued in JNR, interest is paid in INR and CCD's are repaid also in INR. Therefore, placing reliance on the judgment of the Honble Delhi High Court in the case of CIT v. Cotton Naturals (I) Pvt. Ltd. (supra), we hold that the TP study of the assessee to justify the interest rate by arriving at average rupee cost and comparing the same with SBI prime lending rate is correct. It is ordered accordingly.
18. Respectfully following the decision of the coordinate bench of the Bangalore Tribunal we uphold the TP study done by the assessee to arrive at the interest rate of 9% and 12% calculated based on the average rupee cost comparing the same with SBI prime lending rate. The assessee's claim in this ground is allowed."
5.4 Further, in assessment year 2013-14 in IT(TP)A No.2839/Bang/2017 vide order dated 25.8.2022, wherein it was held as under:
"Grounds 16 to 21 [TP adjustment of Rs.67,08,42,381 on payments of interest on Compulsory Convertible Debentures (CCDS)]
18. Grounds 16 to 21 in respect of Compulsory Convertible Debenture (CCD), reads as follow:-
"16. The Hon'ble DRP / learned TPO has erred in rejecting the transfer pricing analysis undertaken by the Appellant in the transfer pricing documentation to determine the arm's length nature of the international transaction pertaining to payment of interest on CCD and thereby erred in making an addition ofRs.67,08,42,381/- to the total `of the Appellant.
17. The Hon'ble DRP has erred in upholding the contentions of the learned TPO of re-characterizing the CCD to External Commercial Borrowings ("ECB") by not appreciating the fundamental difference between a CCD and an ECB and thereby erred in applying the 6 IT(TP)A No.187/Bang/2023 Page 29 of 36 Month US London Inter-Bank Offered Rate ("LIB OR") with all-in- celling rate of 500 basis point as a basis for benchmarking the payment of interest on CCD.
18. The Hon'ble DRP / learned TPO has erred in not appreciating the fact that in an ECB the borrower carries the risk related to foreign exchange fluctuation whereas the risk is borne by the lender in case of CCD and thereby failed to appreciate the importance of assumption of foreign exchange risk in the fixation of interest rate.
19. The Hon'ble DRP / learned TPO have erred in stating that the Appellant has not provided any comparable details to demonstrate the arm's length nature of interest payment on CCD and thereby erred in disregarding the independent benchmarking analysis identifying the comparable transactions involving the CCDs which was submitted by the Appellant.
20. The Hon'ble DRP has erred in stating that conversion price has not been fixed upfront either by a fixed method or formula based and thereby erred in concluding that the nature of Appellant's borrowing are closer to ECB.
21. The Hon'ble DRP / learned TPO have erred in not taking cognizance of the fact that a part of the interest paid on CCD amounting to INR 118,54,82,351/- formed part of 'capital work in progress' as on 31 5t March, 2013 which was not claimed as a business expenditure during A Y 2013-] 4 and therefore, the same cannot be added to the total income of the Appellant."
19. During the financial year 2012-2013, the assessee paid interest of Rs.166,32,46,020 to Praxair International Finance (PIxF Ireland) at interest rate of 9% and 12% on CCDs which have been transferred to Praxair Luxembourg S.A.R.L. with effect from March 2013, the assessee, in its TP study, benchmarked the transactions of payment of interest by applying CUP method. Using a CCD benchmarking study, the assessee selected certain companies as comparables, and since the arithmetic mean of the interest rate paid by the companies stood at 9.5% and 12.25%, the assessee concluded the international transaction of payment of interest at 9% and 12% to be at arm's length. The TPO treated the CCDs as ECB and bench marked the interest rate paid against LlBOR rate of 6.37% (pages 21- 27 of the TP Order). The DRP IT(TP)A No.187/Bang/2023 Page 30 of 36 rejected the Appellant's objections and upheld the TPO's order (pages 4 and 5 of the DRP's directions).
20. Aggrieved, the assessee has raised this issue before the ITAT. The learned AR submitted that the TPO and DRP grossly erred in treating the CCDs as ECBs and benchmarking the interest rate against LlBOR rate. It was submitted that CCDs being a hybrid instrument, cannot be treated as a ECB/loan. In this context, the learned AR relied on the decision of the Hyderabad Bench of the Tribunal in the case of ADAMA India (P.) Ltd. v. DCIT ([2017] 78 taxmann.com 7 (HyderabadTrib.). It is submitted that the CCDs having been denominated in INR the interest having been paid in INR, and the CCDs having been repaid in INR the same cannot be benchmarked against LlBOR. Reliance in this regard is placed on the following decisions:
(i) CIT v. Cotton Naturals (I) (P.) Ltd. ([2015] 55 taxmann.com 523 (Delhi)
(ii) Assessee's own case for the assessment year 2012-13 (Order date 25.02.2022 passed in IT(TP)A No.2209/ Bang /2016).
Therefore, it is submitted that the transaction of payment of interest of CCDs ought to be treated as being at arm's length.
21. The learned Departmental Representative supported the orders of the TPO and DRP.
22. We have heard rival submissions and perused the material on record. We find that on identical facts, the Tribunal in assessee's own case for assessment year 20122013 in IT(TP)A No.2209/Bang/2016 decided the issue in favour of the assessee. The relevant finding of the Tribunal reads as follows:-
"17. We have heard the rival submissions and perused the materials on record. We notice that the coordinate bench of the Tribunal in assessee's own case (Supra) on the issue of interest on CCDs has held that -
8.6 We have heard rival submissions and perused the material on record. The assessee during the financial year 2009-2010, entered into a debenture subscription agreement with its AEs, Praxair IT(TP)A No.187/Bang/2023 Page 31 of 36 International Finance. In the agreement, the term "issue price" is defined as "CCD will be issued at par at Rs.10 each". Further, the subscription considered shall be converted into INR as per the prescribed exchange rate and the number of CCDs allotted to the holders will be the subscription consideration as converted into INR, divided by face value of the CCD instrument. The debenture certificates issued clearly reflect the face value of debenture at INR at Rs.10 each. The CCDs are recorded in the financial statements in INR. The CCDs were also subsequently repaid in INR. The true copy of the statement setting out the details of payment and demand deposit transaction clearly demonstrate that the remittance is in INR.
8.6.1 The TPO and DRP erred in treating CCDs as ECBs and benchmarked the interest rate against LIBOR rate. The CCDs is a hybrid instrument and cannot be per se treated as ECB / loan. The Hyderabad Bench of the Tribunal in the case of Adama India (P.) Ltd. v. DCIT (supra) had held that CCDs cannot be categorized as a loan. The relevant finding of the Tribunal reads as follows:-
"8. We have considered the issue and examined the rival contentions. There is no dispute with reference to the fact that the CCDs were issued in Indian Rupees. Accordingly, following the principles laid down by the Coordinate Benches and the Hon 'ble High Court as relied on by the assessee in the submissions, we have to hold that TPO has wrongly treated the issuance of CCDs as a loan, by treating it as an external commercial borrowing, ignoring the fact that loan is a debt, whereas CCD is hybrid instrument in nature basically, categorised as equity in nature. It was accepted by the Hon'ble Supreme Court in the case of Sahara India Real Estate Corporation Limited and Sahara Housing Investment Corporation Limited & Ors. Vs. Securities and Exchange Board of India & Anr. in Civil Appeal No. 9813 of 2011 dt. 31- 08-2012 (supra) while assigning the jurisdiction to SEBI as an 'equity instrument'. Further, the policy of Govt. of India and also RBI effective from 01- 04-2010 also indicate that issuance of CCD is part of FDI being quasi-equity in nature and considering the same as a loan would be completely, against regulations laid by DIPB, RBI and FEMA. It is to be reiterated that issuance of CCDs was denominated in Indian Rupees and not foreign currency. Therefore, TPO has erred in considering LIBOR as benchmark rate which is in complete contradiction IT(TP)A No.187/Bang/2023 Page 32 of 36 to the principles on the issue. The following judicial precedents supports that the rate interest has to be considered in the currency in which loan has originated.
i. India Debt Management Pvt. Ltd., IT(TP)A No. 7518/Mum12014;
ii. CIT Vs. Cotton Naturals (I) Ltd., ITA No. 23312014 (Deli- HC);
iii. M/s. Brahma Center Development Pvt. Ltd., Vs. [TO, ITA No. 3 73/Del/2016 (ITA T Del).
By respectfully following the Co-ordinate Bench and Hon 'ble High Court decisions, we agree with the assessee 's contentions that the CCDs cannot be categorised as a loan and LIBOR plus two hundred basis points benchmark cannot be accepted on the facts of the case."
8.6.2 The Hon'ble Delhi High Court in the case of CIT v. Cotton Naturals (I) Put. Ltd. (supra) had held that the interest rate should be the market determined interest rate applicable to the currency concerned in which the loan has to be repaid. The relevant finding of the Hon'ble High Court reads as follows:-
"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 deposits in the national currency 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 IT(TP)A No.187/Bang/2023 Page 33 of 36 loans / deposits are significantly universal and globally applicable. The currency in which the loan is to be repaid 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 lenders State or that in the borrowers is decisive, therefore, primarily depends on the currency agreed upon (BFH BSt.B 1. 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 a US lender is to him a debt claim in national currency whereas to a German borrower it is a foreign currency debt (the situation being different, however, when an agreement in a third currency is involved). Moreover, a difference in interest levels frequently reflects no more than different expectations in regard to rates of exchange, rates of inflation and other aspects. Hence, the choice of one particular currency can be just as reasonable as that of another, despite different levels of interest rates. An economic criterion for one party may be that it wants, if possible, to avoid exchange risks (for example, by matching the currency of the loan with that of the funds anticipated to be available for debt service), such as taking out a US $ loan if the proceeds in US $ are expected to become available (say from exports). If an exchange risk were to prove incapable of being avoided (say, by forward rate fixing), the appropriate course would be to attribute it to the economically more powerful party. But, exactly where there is no 'special relationship', this will frequently not be possible in dealings with such party. Consequently, it 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 Alt. 11 (6), at least its wording, allows the authorities to 'eliminate hypothetically' the special relationships only in regard to the level of interest IT(TP)A No.187/Bang/2023 Page 34 of 36 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 Vogal 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 the same currency i.e. US $. Interest rate applicable to loans granted and to be returned in Indian Rupees would not be the relevant comparable. Even in India, interest rates on FCNR accounts maintained in foreign currency and different and dependent upon the currency in question. They are not dependent upon the PLR rate, which is applicable to loans in Indian Rupee. The PLR rate, therefore, would not be applicable and should not be applied for determining the interest rate in the extant case. PLR rates are not applicable to loans to be re-paid in foreign currency. The interest rates vary and are thus dependent on the foreign currency in which the repayment is to be made. The same principle should apply."
8.6.3 In the instant case, admittedly, the CCDs are issued in JNR, interest is paid in INR and CCD's are repaid also in INR. Therefore, placing reliance on the judgment of the Hon'ble Delhi High Court in the case of CIT v. Cotton Naturals (I) Pvt. Ltd. (supra), we hold that the TP study of the assessee to justify the interest rate by arriving at average rupee cost and comparing the same with SBI prime lending rate is correct. It is ordered accordingly.
18. Respectfully following the decision of the coordinate bench of the Bangalore Tribunal we uphold the TP study done by the assessee to arrive at the interest rate of 9% and 12% calculated based on the average rupee cost comparing the same with SBI prime lending rate. The assessee's claim in this ground is allowed."
IT(TP)A No.187/Bang/2023 Page 35 of 36 In view of the above order of the Tribunal, in assessee's own case, the issue raised in grounds 16 to 21 with regard to payment of interest on CCDs is decided in favour of the assessee. It is ordered accordingly."
5.5 In view of the above order, taking a consistent view, we remit this issue to the file of AO/TPO in both the years for a decision as per law as discussed in earlier years as above and pass fresh order. This issue is partly allowed for statistical purposes in both the appeals."
16. In light of the above order of the Tribunal in assessee's own case for Assessment Years 2014-15 and 2015-16, we restore the matter to the files of the AO/TPO to pass fresh orders. The AO/TPO shall comply with the direction of the Tribunal for Assessment Years 2014-15 and 2015-16 while deciding the issue afresh. Therefore, ground Nos.4.7 to 4.14 are partly allowed for statistical purposes.
17. Short deduction of TDS (Corporate Tax) Ground No.5 In the above ground, it is contended that assessee is eligible for credit of tax deducted at source amounting to Rs.6,39,26,468/-. However, the AO had granted credit only for Rs.6,33,49,371/-.
18. We heard the rival submissions and perused the material on record. The AO is directed to examine whether the assessee is entitled to the entire credit claimed and pass order after affording a reasonable opportunity of being heard to the assessee. In the result, ground No.5 is allowed for statistical purposes.
IT(TP)A No.187/Bang/2023 Page 36 of 36
19. In the result, appeal filed by the assessee is partly allowed.
Pronounced in the open court on the date mentioned on the caption page.
Sd/- Sd/-
(CHANDRA POOJARI) (GEORGE GEORGE K)
Accountant Member Judicial Member
Bangalore.
Dated: 15.06.2023.
/NS/*
Copy to:
1. Appellants 2. Respondent
3. CIT 4. CIT(A)
5. DR, ITAT, Bangalore. 6. Guard file
By order
Assistant Registrar,
ITAT, Bangalore.