Income Tax Appellate Tribunal - Hyderabad
Adama India Private Limited ,Hyderabad vs Income Tax Officer, Ward-1(1), ... on 29 January, 2025
IN THE INCOME TAX APPELLATE TRIBUNAL,
SPECIAL BENCH, HYDERABAD
BEFORE
JUSTICE(Retd.) C.V.BHADANG, Hon'ble PRESIDENT,
SHRI MAHAVIR SINGH, Hon'ble VICE PRESIDENT
AND
SHRI G.MANJUNATHA, Hon'ble ACCOUNTANT MEMBER
ITA-TP No.1856/Hyd/2019
AssessmentYear:2015-16
Hyderabad Infratech Vs. Deputy Commissioner of
Private Limited Income Tax
Hyderabad Circle-2(2)
[PAN : AACCH6263K] Hyderabad
(Appellant) (Respondent)
Assessee by: Shri Percy Pardiwala, AR
Revenue by: Smt. Mamata Choudhary,
Senior Standing Counsel
for Revenue and
Shri S.Bala Krishna, CIT-
DR
ITA-TP No.1771/Hyd/2019
AssessmentYear:2015-16
Adama India Private Limited Vs. Income Tax Officer
Hyderabad Ward-1(1)
[PAN : AABCM8797N] Hyderabad
(Appellant) (Respondent)
ITA-TP No.111/Hyd/2022 & 506/Hyd/2022
AssessmentYear:2015-16 & 2018-19
Invesco (India) Private Limited Deputy Commissioner of
Hyderabad Income Tax
[PAN : AACCH8216L] Circle-2(1)
Hyderabad
(Appellant) (Respondent)
Assessee by: Shri Shriram Seshadri, AR
Revenue by: Smt. Mamata Choudhary,
Senior Standing Counsel
for Revenue and
Shri S.Bala Krishna, CIT-
DR
-2-
ITA-TP Nos.1856/Hyd/2019, 1771/Hyd/2019
111 & 506/Hyd/2022 and 663/Hyd/2022
ITA-TPNo.663/Hyd/2022
AssessmentYear:2016-17
Mylon Laboratories Ltd. Vs. ACIT
Hyderabad Circle-5(1)
[PAN : AADCM3491M] Hyderabad
(Appellant / Intervenor) (Respondent)
Assessee by: Shri PVSS Prasad, Ld.AR
Revenue by: Smt. Mamata Choudhary,
Senior Standing Counsel
for Revenue
Date of hearing: 29.11.2024
Date of pronouncement: 29.01.2025
ORDER
PER MANJUNATHA G., ACCOUNTANT MEMBER:
This Special Bench is constituted by the President with following question for our consideration and decision:
"(i) Whether as regards TP adjustment made in respect of interest paid / payable on FCCDs/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 -3- ITA-TP Nos.1856/Hyd/2019, 1771/Hyd/2019 111 & 506/Hyd/2022 and 663/Hyd/2022 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"), to determine Arms Length Price ("ALP") in respect of the international transaction reported by the taxpayer company for the financial year relevant to the A.Y.2015-16. During the transfer pricing proceedings, the TPO observed that the appellant company has benchmarked interest payment on FCCDs, by considering CUP method and claimed interest paid towards issue of FCCDs @11.1765%. The TPO benchmarked TP adjustment at Rs.15,28,39,699/- by holding the transaction to be a loan transaction and applied LIBOR plus 200 basis points as appropriate rate of interest payable on FCCDs and therefore, excess interest paid by the appellant has been treated as ALP adjustment. Incorporating the said TP adjustment, the AO passed a draft assessment order on 26.12.2018 and proposed TP adjustment of Rs.15,28,39,699/-
3. Aggrieved by the said draft assessment order, the appellant filed its objections before the Dispute Resolution Panel ("DRP"). The DRP vide its directions dated 30.09.2019 issued u/s -4- ITA-TP Nos.1856/Hyd/2019, 1771/Hyd/2019 111 & 506/Hyd/2022 and 663/Hyd/2022 144C(5) of the Act, inter-alia confirmed the TP adjustment. Pursuant to the directions of the DRP, the Assessing Officer passed final assessment order u/s 144C(13) of the Act on 28.10.2019 in line with the directions issued by the DRP. Aggrieved by the final assessment order, the assessee is now in appeal before the Tribunal.
4. Shri Percy Pardiwala, learned counsel for the assessee, referring to the question which arises for consideration before this Special Bench, submitted that debentures are debt instruments. Fully and Compulsorily Convertible Debentures and other convertible debentures are hybrid instruments and are a type of debenture in which, the whole value of the debenture must be converted into equity at a specified time. Till such conversion takes place, the instrument is a debt instrument. Appropriate stamp duty is paid on its issue and thereafter, on the conversion, stamp duty is again payable on the issue of the shares. Only upon conversion of the FCCDs into equity, the authorised capital of the company would be increased and necessary compliances with the Registrar of Companies would have to be carried out. The conversion ratio of the FCCDs is decided by the issue of such FCCDs, either at the time of issue or at the time the actual conversion takes place and upon conversion, the investors become the shareholders of the company. Therefore, until conversion of FCCDs into 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 -5- ITA-TP Nos.1856/Hyd/2019, 1771/Hyd/2019 111 & 506/Hyd/2022 and 663/Hyd/2022 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 denominated ECBs, it is the prevailing yield of the Govt. of India securities of corresponding maturity.
5. The learned counsel for the assessee, further referring to various judicial precedents, submitted that the determination of an ALP of interest paid on FCCDs is no longer res integra. Several High Courts and various Benches of the Tribunal have dealt with the issue and consistently held that while benchmarking the interest payment on FCCDs, the rate prevailing in the location where the borrower is situated and in the currency in which the debt is availed and repaid is relevant to determine the rate of interest. Although in the case of FCCDs, -6- ITA-TP Nos.1856/Hyd/2019, 1771/Hyd/2019 111 & 506/Hyd/2022 and 663/Hyd/2022 the debt is not repaid, but, an actual outflow of funds, it is substituted by issuance of shares for equivalent value which, in turn is denominated in INR and therefore, the FCCDs finally consumed in India. Thus, the place where the debt is consumed or utilised is relevant. The learned counsel for the assessee, referring to the decision of Hon'ble Bombay High Court in the case of PCIT Vs. India Debt Management (P.) Ltd. [2019) 108 taxmann.com 55 (Bombay)], submitted that the Hon'ble High Court, while upholding the findings of the Tribunal held that, once the tested transaction is an INR denominated debt, interest rate must necessarily be based on the economic and market factors affecting Indian currency and date of debt issuance in India, rather than foreign currency rate or external data. The learned counsel for the assessee, further referring to the decision of Hon'ble High Court of Delhi in the case of CIT Vs.Cotton Naturals India Pvt. Ltd. [(2015) 55 taxmann.com 523(Delhi)], submitted that in the case of an outbound loan, by an Indian parent to a foreign AE, held that interest rate should be the market rate applicable to the currency in which the loan is to be repaid and accordingly, in that case, since the loan was to be repaid in foreign currency, the domestic prime lending rate would have no applicability. In the assessee's own case for the A.Y.2013-14 and 2014-15, the Tribunal has directed application of SBI PLR as the benchmark rate for benchmarking interest paid on the very same FCCDs. The Ld.Counsel further, referring to the decisions of various Benches of the Tribunal submitted that in case of debentures issued in INR by an Indian company, the interest ought to be imputed considering PLR based on the -7- ITA-TP Nos.1856/Hyd/2019, 1771/Hyd/2019 111 & 506/Hyd/2022 and 663/Hyd/2022 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 into equity, it is predominantly in nature of a loan and further, since the said FCCDs are denominated in Indian currency, the benchmarking should be at the rate of SBI PLR, but not at the LIBOR plus 200 spread as considered by the TPO/DRP.
7. The learned Counsel for the assessee, further referring to the orders of Maanaveeya Development & Finance (P.) Ltd. Vs. ACIT (2022) 136 taxmann.com 65 (Hyderabad Bench) and -8- ITA-TP Nos.1856/Hyd/2019, 1771/Hyd/2019 111 & 506/Hyd/2022 and 663/Hyd/2022 Watermarke Residency Ltd. Vs. DCIT, order dated 21.09.2022 in ITA No.740/Hyd/2019, submitted that Maanaveeya Development & Finance (P.) Ltd. was a case, where the Tribunal upheld the application of LIBOR as the benchmark rate on the basis that the Form 3CEB mentioned that the FDI had been received in Euros and INR value is recorded in the books of account. But, fact remains that, it is quite possible that investments may hit the bank account of the issuer in foreign currency as the same is inbound into India from outside India and, then, converted to INR. Therefore, the currency in which the monies are received is irrelevant and what is required to be seen is the currency in which the debenture is denominated and debt is consumed. Similarly, in Watermarke Residency Ltd., the Tribunal predominantly dealt with the characterization of FCCDs as to whether FCCDs were in the nature of equity or debt. The Tribunal held that until conversion to equity, CCDs are debt instruments and therefore, there is inherent inconsistency in the order of the Tribunal in this regard. The assessee before the Special Bench do not contest that CCDs are indeed not in the nature of debt and in fact, the revenue in the course of their submissions have sought to argue to the contrary. Having held so, on the issue of benchmark rate, the Tribunal erroneously holds that there would be no occasion for the assessee to repay the loan to its AE and therefore, the currency in which the loan was taken or to be paid would not be relevant for the purpose of determining the interest rate. This finding is erroneous for the simple reason that the Tribunal upholds the application of LIBOR rate as being in consonance -9- ITA-TP Nos.1856/Hyd/2019, 1771/Hyd/2019 111 & 506/Hyd/2022 and 663/Hyd/2022 with the RBI guidelines, but there are no such guidelines issued by the RBI capping interest payments on FCCDs to LIBOR rates. In fact, the RBI master direction itself recognizes the supremacy and relevance of the currency of the loan in the determination of the interest rates. The 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 way traffic in terms of remittance is unnecessary.
8. To sum up, the learned Counsel for the assessee submitted that TPO is erred in benchmarking interest payment on FCCDs -10- ITA-TP Nos.1856/Hyd/2019, 1771/Hyd/2019 111 & 506/Hyd/2022 and 663/Hyd/2022 by applying LIBOR plus 200 basis points as appropriate rate of interest, even though the Hon'ble High Court of Bombay and Delhi have clearly held that it is the currency, in which such loan is received or repaid is relevant for determination of the rate of interest. Since, in the present case, the FCCDs are denominated in Indian currency and also consumed in India, the appellant has rightly benchmarked payment of interest on FCCDs by applying SBI PLR, which is the rate of interest for benchmarking inbound loans like FCCDs. Therefore, he submitted that the question referred to for the Special Bench on the issue of benchmarking of interest payment of FCCDs/ CCDs denominated in Indian rupees should be answered in favour of the assessee.
9. Shri Shriram Seshadri, Chartered Accountant, learned Counsel for the assessee appearing for the Adama India Private Ltd. and Invesco India Private Ltd. fully endorsed the submissions made by Shri Percy Pardiwala, appearing for Hyderabad Infratech Private Limited. He further submitted that in order to understand the issue of benchmarking of interest on FCCDs basic concepts and economic principles in relation to interest on cross border loans / debt instruments needs to be examined. Admittedly CCDs are hybrid securities issued by companies which combine features of both debt and equity instruments. Initially CCDs function as debt but are converted into equity at a later date. Legally and for tax purposes, until the conversion of the CCD into equity it remains as a debt. Although for the purpose of Foreign Exchange Management Act 1999, -11- ITA-TP Nos.1856/Hyd/2019, 1771/Hyd/2019 111 & 506/Hyd/2022 and 663/Hyd/2022 FCCDs are treated as equity but at no stage, the appellant has argued that CCD should be treated as equity and it has been accepted as a debt and the interest arising from the CCDs has been subjected to TP and related benchmarking. Hence until conversion, the issuing company is liable to pay interest on the face value of the CCDs issued by it to the investors as per the terms of agreement. The conversion of CCDs into equity shares is typically undertaken at a pre-determined time or upon the occurrence of specific events, based on the terms of the agreement. In the present case, there is no dispute with regard to the fact that 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 1 st 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, -12- ITA-TP Nos.1856/Hyd/2019, 1771/Hyd/2019 111 & 506/Hyd/2022 and 663/Hyd/2022 where the amount of loan is denominated in foreign currency, the interest rate declared in relation to the eligible international transaction is not less than the reference rate of the relevant foreign currency as on 30th September of the previous year plus appropriate basis points. For the purpose of this rule 'reference rate' means for US dollar 6 month term secured overnight financing rate and for the purpose of Indian rupees denominated loan it is SBI PLR. Therefore, he submitted that when the Safe Harbour Rules itself provide for differential benchmark at different rate of interest depending upon the currency in which such loan is received, applying SBI PLR is incorrect. The learned counsel for the assessee further referring to section 194-LD of the Act, and notification issued by the CBDT dated 29.07.2013, submitted that as per said Notification, in the case of bonds issued on or after 1st of April 2010, the rate of interest shall not exceed 500 basis points over the base rate of SBI applicable on the date of issue of such bonds. Therefore, from the provisions of section 194-LD and the notification issued by the CBDT, it is very clear that for in bound loans denominated in Indian currency, the rate of interest applicable will be SBI PLR, but not LIBOR rate applied by the TPO. Therefore, he submitted that the TPO is erred in benchmarking interest payment on FCCDs by applying LIBOR plus basis points as against the method followed by the assessee by applying CUP method and benchmarking at the rate of SBI PLR. Therefore, he submitted that the question referred to for the Special Bench should be answered in favour of the assessee.
-13-ITA-TP Nos.1856/Hyd/2019, 1771/Hyd/2019 111 & 506/Hyd/2022 and 663/Hyd/2022
10. Shri PVSS Prasad, CA, appearing for Mylan Laboratories Limited as Intervenor fully endorsed the arguments of Shri Shriram Seshadri, Chartered Accountant, learned Counsel for the assessee appearing for the Adama India Private Ltd. and Invesco India Private Ltd. and Shri Percy Pardiwala appearing for Hyderabad Infratech Private Limited and further submitted that admittedly, FCCDs / CCDs are hybrid instruments, which are convertible into equity at a later point of time on agreed terms and conditions and therefore, till such conversion, the said instruments construed to be debt instruments and accordingly, for the purpose of payment of interest, same needs to be considered as debt and appropriate rate of interest should be applied. Therefore, he submitted that the question referred to for the Special Bench should be answered 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 -14- ITA-TP Nos.1856/Hyd/2019, 1771/Hyd/2019 111 & 506/Hyd/2022 and 663/Hyd/2022 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 applicable to foreign equity investments in Indian Companies, submitted that FDI Policy defines capital as equity shares, fully and compulsorily and mandatorily convertible preference shares and fully, compulsorily and mandatorily convertible debentures. Clause 2.1.11 defines FDI to mean an investment by a non-resident entity / person resident outside India in the capital of an Indian Company. The types of instruments which can be issued by an Indian Company subject to pricing guidelines and sans any assured returns are reiterated in Clause 3.3. It also makes clear that optionally and partially convertible preference shares / debentures are considered as debt and the regulations and norms governing external commercial borrowings(ECB) would be applicable to such instruments. It further clarifies that since such optionally / partially convertible instruments would necessarily be denominated in INR, the interest on such borrowings would be based on the swap equivalent of LIBOR plus the permissible spread for ECBs. Rule 2(k) of The Foreign Exchange Management (Non-debt Instruments) Rules, 2019 issued under FEMA also defines equity instruments which include FCCDs. Since India has not embraced free capital account convertibility, all capital instruments and other -15- ITA-TP Nos.1856/Hyd/2019, 1771/Hyd/2019 111 & 506/Hyd/2022 and 663/Hyd/2022 instruments convertible into shares, whether fully / partially / optionally, must necessarily be denominated in INR. The CCDs being capital / equity instruments, the fact that the CCDs are denominated in INR would have no bearing whatsoever on the determination of their character or any benchmarking of interest. The present circumstances pertain to foreign holding companies which have made foreign inward remittances under the automatic route to their Indian subsidiaries and the Indian assessee's have issued capital by way of CCDs to the foreign holding companies in terms of the existing FEMA regulations and FDI policy. In consequence of the legal framework within which the investments are made, the CCDs are equity instruments with no repayment obligation, no exchange risks and no assured returns. The learned Sr. Standing Counsel further referring to the decision of Hon'ble Supreme Court in the case of IFCI Ltd. Vs. Sutanu Sinha & Ors [2023 SCC Online SC 1529], submitted that the Hon'ble Supreme Court has held that CCDs are equity, while giving effect to contractual classification of such instruments 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 -16- ITA-TP Nos.1856/Hyd/2019, 1771/Hyd/2019 111 & 506/Hyd/2022 and 663/Hyd/2022 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, since no repayment was to be made in foreign currency, therefore ought not to be compared to ECBs. The Tribunal also records that the assessee's did not bring to its notice any guideline or regulation issued by the RBI, treating the FCCD as equity. It could be surmised that had those statutory regulations been brought to the notice of the Tribunal, it may have affected the decision. Therefore, submitted that the stand of the assessee's that the nature of CCD/FCCD being debt or equity would not fall for consideration of the Special Bench is not correct, as the assessee's themselves have asserted that CCDs are equity and have all objected to the classification of CCDs as debt and would be an issue before the Special Bench. She further submitted that reliance by the assesses on the judgements in the case of Prakash L.Shah [2008] 115 ITD 167(SB) is in the context of that specific case and not applicable while that of Mahindra & Mahindra Ltd. Vs. Deputy CIT [2009]122 TTJ 577(SB) in fact reiterates that the Tribunal has jurisdiction to examine any question of law, which arises from the facts before the -17- ITA-TP Nos.1856/Hyd/2019, 1771/Hyd/2019 111 & 506/Hyd/2022 and 663/Hyd/2022 authorities below and has a bearing on the assessee's liability. Even though the CCDs are capital equity instruments, the assesses sought to equate these CCDs to domestic debt in their TP study merely because they are nomenclated as debentures and denominated in INR for the purposes of claiming a deduction u/s 36 of the Act and to maximize such claim by benchmarking it against a higher domestic PLR. The TPO pegged them as a foreign debt at best and applied LIBOR as benchmark. The learned Sr. Standing Counsel further referring to ITAT Special Bench in Adama Syntex Ltd. Vs. ACIT [2006]100 ITD 247 submitted that the issue of CCDs results in increasing the capital base of the company and the expenditure incurred towards the issue of CCDs would therefore be capital in nature and not eligible for deduction u/s 37 of the Act. She, further referring to Hon'ble High Court of Punjab & Haryana in Pepsu Road Transport Corporation Vs. CIT [1981 SCC Online P&H 441] submitted that, the Hon'ble Court, in the context of interest to be allowed u/s 36(1)(iii) of the Act has held that an element of refund or repayment is inherent in the concept of borrowing and that if there is no obligation to refund or repay the capital, it cannot be said to be capital borrowed 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 -18- ITA-TP Nos.1856/Hyd/2019, 1771/Hyd/2019 111 & 506/Hyd/2022 and 663/Hyd/2022 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 treated as equity in nature and since the amount in question is equity in nature the question of payment of interest does not arise and therefore no question of benchmarking. The learned Sr. Standing Counsel for the Revenue, further, without prejudice to the above submissions submitted that even if the CCDs are considered to be a loan on account of reflection as such in the assessees' balance sheets because the instruments are nomenclated as debentures which are conventionally considered to be debt, such loan would not cease to be an amount received by way of foreign inward remittance and would consequently be an external borrowing, i.e. an ECB and would not transform into a domestic debt merely because it is denominated in INR.
13. The ld. Senior Standing Counsel, further submitted that while currency denomination may be a factor in determination of arms length price of a plain vanilla debt, it certainly cannot be the only factor and would depend on various other factors -19- ITA-TP Nos.1856/Hyd/2019, 1771/Hyd/2019 111 & 506/Hyd/2022 and 663/Hyd/2022 affecting such transaction. In the present scenario, CCDs are nomenclated in INR because they are equity instruments and therefore not convertible. There is no voluntary assumption of risk which is being compensated by a higher rate of interest as there is no repayment obligation whatsoever and consequently no exchange risk either. Therefore, the INR denomination of the CCDs is irrelevant for any benchmarking purposes. She further submitted that equating foreign equity investment by way of CCDs to domestic debt and claiming interest at domestic PLR merely because they are denominated in INR would not lie. The substance of the transactions being investments made as equity for the purpose of entry into the country, but seeking to shift profits by way of high tax-free returns by treating it as a debt in the balance sheet would militate against the profit shifting safeguards and initiatives of the OECD and would not entitle the assessee's to any beneficial inferences or interpretation. Therefore, merely, because the CCDs are denominated in INR would not render the amount to be treated as a domestic borrowing. The source of funds and the cost of funds is a key element for consideration. There is clear arbitrage which is sought to be regulated since a foreign entity cannot be permitted to raise funds overseas at LIBOR and to then to make an onward loan to earn domestic borrowing interest 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, -20- ITA-TP Nos.1856/Hyd/2019, 1771/Hyd/2019 111 & 506/Hyd/2022 and 663/Hyd/2022 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 capitalized with CCDs even being 1700-1800 times the paid up capital. The purpose of this structuring is for shifting profits to lower tax jurisdictions by way of higher interest rates and consequent reduction of the assessee's taxable income. Even though an aspect of thin capitalization has been codified in the Act by way of Section 94B only in 2018, the issue has been internationally long recognized by the OECD and would also attract anti avoidance principles -both statutory and judicial. Therefore, she submitted that reclassifying equity instrument as debt and benchmarking by applying domestic lending rate is incorrect.
14. The learned Sr. Standing Counsel for the Revenue, further referring to the decision of the Delhi High Court in the case of CIT Vs. Cotton Naturals Pvt. Ltd (supra) submitted that, said judgement was in the context of a simple debt extended by an -21- ITA-TP Nos.1856/Hyd/2019, 1771/Hyd/2019 111 & 506/Hyd/2022 and 663/Hyd/2022 Indian company to its foreign subsidiary with repayment obligations and does not in any manner deal with the circumstances being considered presently. It has, in fact, specifically left the issues of thin capitalization and recharacterization of transactions where structure impedes tax administration open. The transactions of the nature contemplated in the present reference are all between related parties and there are no uncontrolled transactions available for comparison. The terms and the conditions for the subscription to the CCDs are also vague, minimalist and have no default provisions and are prima facie, not at arm's length. The Transfer Pricing studies undertaken by the assessee's have sought to either compare themselves to other similarly controlled transactions or to domestic CCDs, both of which are unviable and incomparable. Therefore, even though investment is made in INR denominated CCDs, there is no payment in any currency, let alone in INR to claim a higher rate of interest on this basis. The nearest comparable instrument would be optionally / partially convertible debentures. The FDI Policy itself prescribed that such instruments are to be treated as ECB and since they are necessarily to be denominated in INR and the interest is to be benchmarked on the swap equivalent of LIBOR plus the permissible spread. Therefore, the appropriate rate for benchmarking interest payment on FCCDs is LIBOR plus the permissible spread, but not SBI PLR as claimed by the assessee's. The ld. Sr. Standing Counsel further without prejudice and in the alternate, submitted that Indian companies borrow from external markets to take advantage of the lower -22- ITA-TP Nos.1856/Hyd/2019, 1771/Hyd/2019 111 & 506/Hyd/2022 and 663/Hyd/2022 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 argument of the Revenue, at this stage, that CCDs are to be treated as equity instruments is not permissible and the Revenue cannot now expand the scope of the appeal before the Tribunal, let alone the question raised before this Special Bench and argue a different case altogether. The very fact the TPO determined the ALP at a positive figure and on that basis allowed a part of the interest as deduction is indicative of the fact that it is not open to the Revenue to argue to the contrary as acceptance of such an argument would put the appellant in a worse position. In this regard, he relied upon -23- ITA-TP Nos.1856/Hyd/2019, 1771/Hyd/2019 111 & 506/Hyd/2022 and 663/Hyd/2022 the decision of Mahindra & Mahindra Ltd. Vs. DCIT (supra) and ACIT Vs. Prakash L.Shah (supra). Secondly, as regard the decision of the Hon'ble Supreme Court in the case of IFCI Ltd. Vs. Sutanu Sinha & Ors (supra), the said judgement was rendered in the context of the IBC proceedings and turned on the facts in that case and therefore, is distinguishable. In IFCI case, the terms of the concessionaire agreement entered into between the parties itself provided that equity would include CCDs and prior to lodging of the claim before the Resolution Professional, the CCDs were already converted into equity and only the formality of issuance of shares was pending. Therefore, the treatment of CCDs as equity in IFCI's case was purely on account of the analysis of the transaction in question before the Court in the context of the IBC and the general principle that a debenture is a debt instrument until conversion has not been disturbed. In this regard, he placed reliance on the decision of Hon'ble High Court of Rajasthan in the case of CIT Vs. Secure Meters Ltd. [(2008) 175 Taxman 567 (Rajasthan)]. The Ld. Counsel for the assessee further referring to FDI policies relied upon by the Revenue submitted that, FDI policy is only for the purpose of governing and regulating FDI in various fields and it is for this purpose that the term 'capital' has been defined in the said policies. There is nothing in the FDI regulations regulating the rate of interest payable on FCCDs. In any event, even in terms of the FDI policies, the rupee interest rate payable on debentures denominated in INR would be the swap equivalent of LIBOR plus the spread and not LIBOR as contended by the Revenue. The argument of the Revenue based on thin -24- ITA-TP Nos.1856/Hyd/2019, 1771/Hyd/2019 111 & 506/Hyd/2022 and 663/Hyd/2022 capitalization is completely misplaced. Section 94B 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 present case of CCDs is a converse case of debts issued in INR and consumed in INR and, therefore, a fortiori the SBI PLR ought to be applied. The Ld. Counsel for the assessee's further submitted that there is no substance in the arguments of the Ld.Sr.Standing Counsel for the Revenue that no comparable transactions chosen by the assessee's, because, the assessee's in its TP study benchmarked the interest rate by taking coupon rates adopted by uncontrolled Indian Companies. Those being -25- ITA-TP Nos.1856/Hyd/2019, 1771/Hyd/2019 111 & 506/Hyd/2022 and 663/Hyd/2022 independent transactions, CUP is applied and, therefore, the argument that no comparable transactions are found is incorrect. Therefore, he submitted that the Bench may be pleased to answer the question in favour of the assessee's, in the interest of justice.
16. We have heard both the parties and perused relevant material available on record in light of the question which arises for consideration before this Special Bench on the issue of benchmarking interest paid / payable on FCCDs/NCDs/other debentures, which are denominated in Indian currency. We have also carefully considered various case laws referred to by both the sides in support of their arguments. The question, which arises for consideration before the Special Bench is whether as regards TP adjustment made in respect of interest paid / payable on FCCDs/NCDs/other debentures, which are denominated in Indian currency, the benchmarking is to be made by applying PLR as against LIBOR?. In order to answer the question, it is necessary for us to refer to relevant facts of the case. The facts borne out from the record indicates that the appellant in the present cases is a wholly owned subsidiary of foreign holding company and 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 FCCDs. The appellant company issued FCCDs in the financial year 2011-12. The appellant has benchmarked the -26- ITA-TP Nos.1856/Hyd/2019, 1771/Hyd/2019 111 & 506/Hyd/2022 and 663/Hyd/2022 transaction of interest paid on FCCDs by applying the CUP method and selected comparable companies which are in similar line of business and paid interest on FCCDs. The TPO determined the TP adjustment by holding the transaction to be a loan transaction 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 debentures. Fully and compulsorily convertible debentures are hybrid instruments and are a type of debenture, in which the whole -27- ITA-TP Nos.1856/Hyd/2019, 1771/Hyd/2019 111 & 506/Hyd/2022 and 663/Hyd/2022 value of the debenture must be converted into equity at specified time. Till such conversion takes place, the instrument is a debt instrument. Only upon conversion of FCCDs into equity, the authorised capital of the company would be increased and the debenture holders will receive shares in lieu of debenture certificates. The conversion ratio of FCCDs is decided by issuer of such FCCDs, either at the time of issue or at the time the actual conversion takes place and upon conversion, the investors become the shareholders of the company. Until the conversion of such FCCDs, the instrument becomes debt instrument and in the nature of a loan or borrowing for the company which issues debentures. Therefore, from the definition of debentures, as per section 2(30) of the Companies Act, 2013 and the nature of instrument, there is no dispute of whatsoever with regard to fact that, the nature of the transaction is a loan / borrowing or a liability. Even in the present cases, the appellant companies have treated the debentures as a long term borrowing and classified under the head liabilities in their financial statements. In fact, the TPO/Assessing Officer has also considered debentures as a loan and benchmarked the interest as a long term borrowing. Therefore, the first and preliminary argument advanced by the Sr. Standing Counsel for the Revenue in light of Clause 2.1.5 of the FDI Policy and Rule 2(k) of the Foreign Exchange Management (Non-debt Instruments) Rules, 2019 that debentures are equity instruments and it is not a loan cannot be accepted. Although the Hon'ble Supreme Court in the case of IFCI Ltd. Vs. Sutanu Sinha & Ors (supra) held them to be -28- ITA-TP Nos.1856/Hyd/2019, 1771/Hyd/2019 111 & 506/Hyd/2022 and 663/Hyd/2022 equity, while giving effect to contractual classification of such instruments as equity, but fact remains that the question before us is not the nature of debentures, whether it is capital or liability, but it is only on the benchmarking of interest paid / payable on the FCCDs and therefore, the arguments of the counsel for the revenue becomes purely academic. Since the TPO himself has accepted the transaction to be a loan and also benchmarked the interest payable on FCCDs by applying LIBOR plus 200 basis points, in our considered view, the argument advanced by the Ld. Standing Counsel 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 -29- ITA-TP Nos.1856/Hyd/2019, 1771/Hyd/2019 111 & 506/Hyd/2022 and 663/Hyd/2022 the said agreement, the appellant company has received amount towards debentures issue in Indian rupees. The parties have also agreed for interest, which varies from period to period. The appellant companies in the present cases have paid interest ranging from 9.5% to 13.5% and benchmarked interest by applying SBI PLR, because the debentures issued by the appellant companies to its foreign subscribers is in the nature of loans extended in Indian currency. Since debentures are issued is INR and denominated as such in books of account, in our considered view, while deciding the rate of interest, among the many factors which would influence coupon / interest rates, such as credit rating of the borrower, tenor of the loan, currency would be one of the most important factors, which influence the rate of interest. The currency and the risk associated with it are directly linked to the rate of interest applicable on such loan / debt. Further, when the loan is borrowed in Indian currency, there would be no risk of foreign exchange fluctuation on the borrower, but the lender is exposed to the risk of under realization of principal, against which the lender must hedge with appropriate forward cover, which would be an additional cost. At the same time, when the loan is denominated foreign currency, the lender does not bear any foreign exchange risk, whereas the borrower does for this and in the situation, the borrower has to hedge and may have to enter into appropriate forward contracts which would cost additionally. The economic condition between these two situations i.e. issuance of INR denominated loan and foreign currency denominated loan is radically different and cannot be compensated on the same -30- ITA-TP Nos.1856/Hyd/2019, 1771/Hyd/2019 111 & 506/Hyd/2022 and 663/Hyd/2022 basis of LIBOR plus. This is a fundamental percept of transfer pricing, one has to delineate the differences in transactions undertaken and apply the benchmarking based on the functions, risks and assets. If this difference is effaced, as has been done in the rulings against the taxpayer, it would be fundamentally erroneous application of TP principles. Another key influencer of the rate of interest on a cross-border loan is the economic output, market maturity and the country credit risk of the borrower's country vis-à-vis the lender's country. From the above, it is undisputedly clear that the currency of the borrowing is a critical factor influencing the interest of a loan / debt instrument and that an appropriate benchmark in respect of a loan issued in the currency of the borrower's country would 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 -31- ITA-TP Nos.1856/Hyd/2019, 1771/Hyd/2019 111 & 506/Hyd/2022 and 663/Hyd/2022 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 borrowers 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 repaid normally determines the rate of return on the money lent, i.e. the rate of interest. The Hon'ble Delhi High Court discussed this issue at length in light of the theory of Klaus Vogel on Double Taxation Conventions (Third Edition) under Article 11 and after considering the relevant U.N. Transfer Pricing Manual, clearly held that in order to determine the rate of interest, the currency in which the loan is to be repaid normally determines the rate of return on the money lend i.e. the rate of interest. A similar view has been taken by the Hon'ble High Court of Bombay in the case of PCIT Vs. India Debt Management (P.) Ltd., wherein, it has been clearly held that once the tested transaction is an INR denominated debt, interest rate must necessarily be based on the economic and market factors affecting Indian currency and data available for debt issuance in India rather than foreign currency rate or external data. This principle has been reiterated in the case of CIT Vs. Tata Autocomp Systems Ltd.[2015] 56 taxmann.com 206 (Bombay). From the ratios laid down by the Hon'ble High Court of Delhi and Hon'ble High Court of Bombay, -32- ITA-TP Nos.1856/Hyd/2019, 1771/Hyd/2019 111 & 506/Hyd/2022 and 663/Hyd/2022 it is undisputedly clear that while deciding the rate of interest for the purpose of benchmarking interest payment, it is the currency concerned in which the loan is borrowed and to be repaid is alone relevant, but not the basis of interest payable on the currency or legal tender of the place or country of resident of either party. Since the appellant in the present case has issued FCCDs to its foreign subsidiaries and denominated in Indian rupees, in our considered view, while benchmarking the rate of interest paid / payable on FCCDs, it is only the PLR rate is appropriate, but not the LIBOR plus spread as considered by the TPO.
19. Having said so, let us come back to the Regulatory framework in India for foreign investments in CCDs. Any cross border financing into India is subject to foreign exchange regulations provided under Exchange Control Regulations 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 -33- ITA-TP Nos.1856/Hyd/2019, 1771/Hyd/2019 111 & 506/Hyd/2022 and 663/Hyd/2022 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 is left to the lender or investor to hedge the forex risks. From the regulatory treatment of CCDs issued by an Indian company to a non- resident, as equity instruments under the FDI regulations, the same can be determined only in the domestic currency, i.e. INR. It is not the case of the appellant that any loan issued to non- resident investors by an Indian Company shall be denominated in INR and shall therefore be benchmarked against the interest rates in domestic markets. Therefore, once FEMA Regulations permit foreign investments in various types of debt instruments, which may be denominated in Indian Rupees or in Foreign Currency and these instruments are governed by the ECB regulations and therefore, in our considered view when the regulatory framework is allowed to issue debentures in Indian denominated currency, the obvious nature of such instrument becomes a loan or debt extended in Indian currency and rate applicable for benchmarking such interest is PLR based rates, but not LIBOR plus spread as considered by the TPO. Further, from the above discussion, it is undisputedly clear that the currency of a loan has a significant impact on the corresponding interest, and therefore, interest on loans denominated in different currencies cannot be benchmarked against the same -34- ITA-TP Nos.1856/Hyd/2019, 1771/Hyd/2019 111 & 506/Hyd/2022 and 663/Hyd/2022 rate of interest which is considered for foreign currency loans/debt. In other words, the benchmark interest rate is different for loans with different currency denominations. The above position is well recognized even under the TP provisions of the Act and the related Rules. In this regard, the appellant refers to section 92CB of the Act and Rule 10TD, providing for Safe Harbour Rules. Safe Harbour Rules provide for certain circumstances, where the transfer price declared by an eligible assessee in respect of the specified international transactions, shall be accepted to be at arm's length by the tax authorities. The said rules recognizes above position that loans denominated in different currencies cannot be benchmarked against the same interest rate and provide separate criteria / benchmark rates for loans denominated in INR as against those denominated in a foreign currency. On this point it is relevant to refer Sub Rule (2A), which deals with loans denominated in INR for which SBI lending rate plus spread is prescribed based on applicable credit rating, whereas Point 5 in the same 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 -35- ITA-TP Nos.1856/Hyd/2019, 1771/Hyd/2019 111 & 506/Hyd/2022 and 663/Hyd/2022 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 analogy, in our considered view, there is an error in the reasons given by the TPO/DRP for applying LIBOR plus spread for the purpose of benchmarking rate of interest paid / payable on FCCDs.
20. Coming back to contrary decisions in Maanaveeya Development & Finance (P.) Ltd. Vs. ACIT and Watermarke Residency Ltd. Vs. DCIT (supra). Maanaveeya was a case where the Tribunal upheld the application of LIBOR as the benchmark rate on the basis that the Form 3ECB mentioned that the FDI had been received in Euros and INR value is recorded in the books of account. It is quite possible that investments may hit the bank account of the issuer in foreign currency as the same is inbound into India from outside India and, then, converted to INR. Therefore, the currency in which the monies are received is irrelevant and what is required to be seen is the currency in which the debenture is denominated or debt is consumed. Similarly, in Watermarke, the Tribunal predominantly dealt with the characterization of FCCDs as to whether FCCDs were in the nature of equity or debt. The Tribunal held that until conversion -36- ITA-TP Nos.1856/Hyd/2019, 1771/Hyd/2019 111 & 506/Hyd/2022 and 663/Hyd/2022 to equity, CCDs are debt instruments. In our considered view, there is inherent inconsistency in the order of the Tribunal in this regard. In fact, the assessee's before the Special Bench do not contest that CCDs are indeed in the nature of equity and in fact, the revenue in the course of their arguments have sought to argue on the contrary. Having said so, on the issue of benchmark rate, the Tribunal erroneously holds that there would be no occasion for the assessee's to repay the loan to its AE (on account of the nature of FCCD). Therefore, the currency in which the loan was taken or to be paid would not be relevant for the purpose of determining the interest rate. This finding is erroneous, because, the Tribunal upheld the adoption of LIBOR plus 200 basis points without any discussion. Further it upholds the application of LIBOR rate as being in consonance with the RBI guidelines, but there are no such guidelines issued by the RBI capping interest payments on FCCDs to LIBOR rates. In fact, the RBI Master direction itself recognizes the supremacy and relevance of the currency of the loan in the determination of the interest rates. Therefore, in our considered view, the decision rendered by the Tribunal on the basis of reasoning is contrary to the facts on record and 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 -37- ITA-TP Nos.1856/Hyd/2019, 1771/Hyd/2019 111 & 506/Hyd/2022 and 663/Hyd/2022 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 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 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 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 -38- ITA-TP Nos.1856/Hyd/2019, 1771/Hyd/2019 111 & 506/Hyd/2022 and 663/Hyd/2022 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 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 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 are 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.
41. Counsel for the Revenue had made reference to Chapter 10 of -39- ITA-TP Nos.1856/Hyd/2019, 1771/Hyd/2019 111 & 506/Hyd/2022 and 663/Hyd/2022 the U.N. Transfer Pricing Manual, relevant portion of which reads:--
"10.4.10. Financial Transactions 10.4.10.1. Intercompany loans and guarantees are becoming common international transactions between related parties due to the management of cross-border funding within group entities of an MNE group. Transfer pricing of inter-company loans and guarantees are increasingly being considered some of the most complex transfer pricing issues in India. The Indian transfer pricing administration has followed a quite sophisticated methodology for pricing inter-company loans which revolves around: ♦ Examination of the loan agreement;
♦ A comparison of terms and conditions of loan agreements; ♦ The determination of credit ratings of lender and borrower; ♦ The identification of comparable third party loan agreements: and ♦ Suitable adjustments to enhance comparability.
10.4.10.2. The Indian transfer pricing administration has come across cases of outbound loan transactions where the Indian parent has advanced to its associated entities (AE) in a foreign jurisdiction either interest free loans or loans at LIBOR (London Interbank Offered Rate) or EURIBOR (Euro Interbank Offered Rate). The main issue before the transfer pricing administration is benchmarking of these loan transactions to arrive at the ALP of the rates of interest applicable on these loans. The Indian transfer pricing administration has determined that since the loans are advanced from India and Indian currency has been subsequently converted into the currency of the geographic location of the 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 -40- ITA-TP Nos.1856/Hyd/2019, 1771/Hyd/2019 111 & 506/Hyd/2022 and 663/Hyd/2022 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 credit rating of Indian bonds is also considered for determination of the arm's length price of such guarantees.
10.4.10.4. However, the Indian transfer pricing administration is facing a challenge due to nonavailability of specialized databases and of comparable transfer prices for cases of complex intercompany loans as well as mergers and acquisitions that involve complex inter-company loan instruments as well as an implicit element of guarantee from the parent company in securing debt."
42. The first paragraph quoted above, rightly stipulates that inter- company loans would require examination of the loan agreement, comparison of the terms and conditions of loan agreements, the determination of credit rating of the lender and the borrower, identification of comparable third party loan agreements and suitable adjustments should be made. In addition to the aforesaid factors, the comparability analysis should also take into account the business relationship and the functions performed by the subsidiary AE for the parent company. In the present case, we are not concerned with paragraph 10.4.10.3 of the United Nations Transfer Pricing Manual. However, we are unable to agree with the position set out and asserted in paragraph 10.4.10.2 of the Manual. The reasoning given therein is contrary to the accepted international tax jurisprudence and the rules adopted and applied. There is no justification or a cogent reason for applying PLR for outbound loan transactions where the Indian parent has advanced loan to an AE abroad. Chapter 10 of the United Nations Practical Manual on Transfer Pricing relates to country practices. The said Chapter sets out an individual country's view point and its experiences for the information of the readers. The said Chapter does not reflect the view of the Manual. Paragraph 10.1 of the United Nations Practical Manual on Transfer Pricing for Developing Countries reads:--
"10.1. Preamble by the Subcommittee on Transfer Pricing:-41-
ITA-TP Nos.1856/Hyd/2019, 1771/Hyd/2019 111 & 506/Hyd/2022 and 663/Hyd/2022 Practical Aspects 10.1.1. In the first nine chapters of this Manual, the Subcommittee has sought to provide practical guidance on the application of transfer pricing rules based on Article 9(1) of the UN Model Tax Convention and the arm's length principle embodied in that Article. With regard to chapters one through nine, the Subcommittee has discussed and debated the merits of the guidance that 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 for the lending rate would be determinative. Thus, in case of a capital investment, the borrowing rate will apply, whereas in case of credit allowed to a customer on sale of goods, the lending rate would apply."
22. The assessees relied upon the decision of Hon'ble Bombay High Court in the case of PCIT vs. India Debt Management (P) Ltd. (2019) 106 Taxmann.com 55 (Bombay). The Hon'ble High Court, while upholding tribunal finding held as under:
-42-ITA-TP Nos.1856/Hyd/2019, 1771/Hyd/2019 111 & 506/Hyd/2022 and 663/Hyd/2022 "3. Having heard learned Counsel for the parties and having perused the materials on record, we are broadly in agreement with the view of tribunal. The significant features of the assessee's case were that the assessee was mainly engaged in identifying the companies in financial distress whose products were otherwise viable and taking over or financing of such companies. The business of the assessee was thus froth with inherent risks. Its credit rating therefore was relatively low of 'BBB-'. The assessee was raising funds for such investments through issuance of debentures to its AEs. The tribunal even on comparison found that the average rate of interest of 11.30% paid by the assessee to its AEs was not excessive and was in any case lower than in the comparable instances. The tribunal rejected the transfer pricing adjustment comparing the rate of return for the assessee's US based AE. This later conclusion of the Tribunal is supported by following decisions.
4. Division Bench of Delhi High Court in case of CIT v. Cotton Naturals (I) (P.) Ltd. [2015] 55 taxmann.com 523/231 Taxman 401, had held and observed 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 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 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 -43- ITA-TP Nos.1856/Hyd/2019, 1771/Hyd/2019 111 & 506/Hyd/2022 and 663/Hyd/2022 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 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 Art. 11(6), at least its wording, allows the authorities to 'eliminate hypothetical' 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." "
5. Similarly this Court in case of CIT v. Tata Autocomp Systems Ltd. [2015] 374 ITR 516/230 Taxman 649/56 taxmann.com 206, had observed as under;
"7. We find that the impugned order of the Tribunal inter alia has followed the decisions of the Bombay Bench of the -44- ITA-TP Nos.1856/Hyd/2019, 1771/Hyd/2019 111 & 506/Hyd/2022 and 663/Hyd/2022 Tribunal in cases of VVF Ltd. v. Dy. CIT (supra) and 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 loans extended in currency concerned. Since the CCDs issued by the appellant are in the nature of rupee denominated loan, in our considered view, FCCD/CCD cannot be construed on par with the foreign currency loan for the purpose of benchmarking. Further, LIBOR plus 200 basis points being the interest rate prevalent in the international market and applicable to foreign curreny loans cannot be applied to benchmark interest on the appellants CCDs. Further, the said interest has to be benchmarked against the interest rates prevailing in the domestic market and similar debt instrument, such as the domestic prime lending rate (PLR). Therefore, we are of the considered view that as regards TP -45- ITA-TP Nos.1856/Hyd/2019, 1771/Hyd/2019 111 & 506/Hyd/2022 and 663/Hyd/2022 adjustment made in respect of interest paid / payable on CCD/NCD/other debentures, which are denominated in Indian currency, the benchmark is to be by applying PLR against LIBOR. Accordingly, we answer the question referred to for the Special Bench as under :
Whether as regards (i) Yes, in favour of the
TP adjustment made in respect assessees.
of interest paid / payable on (ii) Interest paid / payable on
FCCDs / NCDs / other FCCDs / NCDs / other
debentures, which are debentures, which are
denominated in Indian denominated in Indian currency
currency the benchmarking is to be bench marked by applying
to be made by applying PLR as PLR rates.
against LIBOR?"
Order pronounced in the open court on
29th January,2025.
Sd/- Sd/- Sd/-
(MAHAVIR SINGH) (C.V.BHADANG) (MANJUNATHA G.)
VICE PRESIDENT PRESIDENT ACCOUNTANT MEMBER
Hyderabad,
Dated 29th January, 2025
L.Rama,Sr.PS
-46-
ITA-TP Nos.1856/Hyd/2019, 1771/Hyd/2019
111 & 506/Hyd/2022 and 663/Hyd/2022
Copyto:
1. M/s Hyderabad Infratech Private Limited, Admin Building, Mariner, he V, Plot No.17, Software Units Layout, Madhapur, Hyderabad
2. M/s Adama India Private Limited,D.S.-13, IKP Knowledge Park, Sy.No.542/2, Genome Valley, Turkapally, Shameerpet, Hyderabad
3. M/s Invesco (India) Private Limited, 15th Floor, Block- 6, North Tower, Divyasree Orion SEZ, Raidurgam, Serlingampally, Hyderabad
4.The Dy.Commissioner of Income Tax, Central Circle- 2(2), Hyderabad.
5.The Pr.CIT(Central), Hyderabad.
6.The D.R.ITAT,Hyderabad.
7.GuardFile.