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  • section 143(3) r.w.s 92CA(3) of the Income-tax Act, 1961 ('Act')
  • u/s. 143(3) r.w.s. 144C of the Income Tax Act
  • section 271(1)(c) of the Income Tax Act, 1961".
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Citation Codes
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citation codes
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  • section 143(3) r.w.s 92CA(3) of the Income-tax Act, 1961 ('Act')
  • u/s. 143(3) r.w.s. 144C of the Income Tax Act
  • section 271(1)(c) of the Income Tax Act, 1961".
Smart Summary

Factual and Procedural Background

This appeal arises from transfer pricing adjustments made by the Assessing Officer (AO) / Transfer Pricing Officer (TPO) in respect of Compulsorily Convertible Debentures (CCDs) issued in Indian currency by the assessee.

During the year under consideration the assessee issued CCDs aggregating Rs. 4,62,00,000 (face value Rs. 10 each) to Celcius Property BV. Interest was paid by the assessee at 12%, amounting to Rs. 5,22,64,414. In transfer pricing proceedings the assessee benchmarked the interest rate using the State Bank of India (SBI) Prime Lending Rate (PLR) (12.26%).

The TPO treated the CCDs as a loan (external commercial borrowing) and benchmarked interest at LIBOR plus 200 basis points, computing an Arm's Length Price (ALP) of Rs. 1,29,10,335 and making an adjustment of Rs. 3,93,54,079. The AO included that adjustment in a draft order, issued a demand notice under section 156 and initiated penalty proceedings.

The assessee appealed to the Commissioner of Income Tax (Appeals) and filed objections before the Dispute Resolution Panel (DRP). The assessee withdrew the appeal before the CIT(A) after filing objections with the DRP. The DRP ultimately rejected the assessee's contentions on the transfer pricing adjustment, treated issuance of the demand notice under section 156 as a mistake but held that the order on its face was a draft assessment order and confirmed the TPO's adjustment. The assessee appeals against the DRP/AO treatment.

Legal Issues Presented

  1. Whether the TPO/AO was justified in treating CCDs issued in Indian Rupees as a loan (external commercial borrowing) and re‑characterising them for transfer pricing purposes.
  2. Whether the appropriate benchmark for interest on the CCDs denominated in Indian Rupees is an India‑based rate (e.g., SBI PLR) rather than LIBOR plus 200 basis points.
  3. Whether the AO erred in treating a draft assessment order as a final order (i.e., procedural challenge under sections 143(3) / 144C), and whether that procedural defect is curable.
  4. Whether initiation of penalty proceedings under section 271(1)(c) should be adjudicated at this stage where penalty proceedings were only initiated but not finalized.

Arguments of the Parties

Appellant's (Assessee's) Arguments

  • The CCDs are not loans but are capital/hybrid/quasi‑equity instruments; they should not be re‑characterised as loans for transfer pricing purposes.
  • The CCDs were issued and consumed in Indian Rupees and hence the appropriate benchmark for interest is an India‑denominated rate such as SBI PLR (12.26% for the year under consideration), not LIBOR plus basis points.
  • TPO exceeded his jurisdiction/power in re‑characterising the CCDs as loans; such re‑characterisation is contrary to relevant judicial precedents and to the FDI/RBI policy treating CCDs as quasi‑equity.
  • The AO treated a draft assessment order as final and initiated demand and penalty proceedings; that procedural course was not justified and is not a curable irregularity (relying on decisions such as Vijay Television, Lionbridge Technologies and Zuari Cement).
  • Assessee also relied on public data (NSDL coupon data) showing average coupon rates (arithmetic mean 12.50%) supporting that the 12% rate paid is within arm's length range.

Respondent's / Departmental Representative's Arguments

  • The DRP/TPO had analysed the matter and adopted LIBOR plus 200 basis points as the Arm's Length Price; the DRP confirmed the TPO/AO orders and the Department relied on those findings.

Table of Precedents Cited

Precedent Rule or Principle Cited For Application by the Court
Vijay Television (P.) Ltd. v. Dispute Resolution Panel [2014] 369 ITR 113 / 225 Taxman 35 (Madras) Cited by the assessee for the proposition that treating a draft assessment order as a final order is not justified and is not a curable irregularity. The court noted this authority as relied upon by the assessee for the procedural challenge but did not decide Grounds 1 & 2 after resolving the substantive transfer pricing issue in favour of the assessee.
Lionbridge Technologies (P.) Ltd. v. Dy. CIT [2015] 62 taxmann.com 48 (Mumbai Trib.) Cited in support of the procedural contention that treating a draft order as final is a legal issue that can be raised. Referenced by the court as part of the assessee's reliance on precedent for the procedural argument; not finally adjudicated because substantive relief was granted on other grounds.
Zuari Cement Ltd. v. Asstt. CIT [WP No. 5557 of 2012] Cited in connection with the contention that procedural errors in treating draft orders as final are legally significant. Noted by the court as cited by the assessee; the court did not finally decide the procedural grounds after granting substantive relief on transfer pricing.
Sahara India Real Estate Corporation Ltd. v. SEBI [2012] 25 taxmann.com 18 / 115 SCL 478 (Supreme Court) Holds that CCDs are hybrid instruments and for certain purposes may be characterised as equity; Supreme Court recognised such instruments as quasi‑equity when assigning jurisdiction to SEBI. The court relied on this authority to support the view that CCDs are hybrid/quasi‑equity and ought not to be treated as debt for transfer pricing benchmarking in the facts of the case.
CIT v. Cotton Naturals (I) (P.) Ltd. [2015] 55 taxmann.com 523 / 231 Taxman 401 (Delhi High Court) Cited for principles limiting the TPO's power to re‑characterise transactions and for the treatment of instruments in appropriate currency/context. The court followed the principles in this decision to hold that the TPO erred in re‑characterising the CCDs as loans.
AcIT 3(1) Indore v. Mittal Appliances Ltd. [2012] 345 ITR 241 / 209 Taxman 200 (Delhi High Court) Cited by the assessee as authority on characterisation and transfer pricing related principles. The court considered it among authorities supporting that re‑characterisation by TPO was incorrect and that currency/characterisation must be respected.
Sun Pharmaceuticals Ind. Ltd. v. Asstt. CIT (Co‑ordinate Bench, Ahmedabad) [IT Appeal Nos. 1589 & 1592/Ahd/2011, dated 10‑5‑2016] Cited for the proposition that the TPO has no power to re‑characterise the transaction beyond scope. The court referenced this decision to support the proposition that the TPO erred in re‑characterising CCDs as debt.
Commissioner of Income‑Tax v. Tata Autocomp Systems Ltd. [2015] 374 ITR 516 / 230 Taxman 649 (Bombay High Court) Principle that rate of interest should be determined based on the country where the amount/loan is received/consumed (i.e., currency of origination/consumption matters). The court relied on this principle to conclude that INR‑denominated CCDs should be benchmarked by India‑denominated rates rather than LIBOR.
India Debt Management (P.) Ltd. v. Dy. CIT [2016] 69 taxmann.com 125 (Co‑ordinate Bench, Mumbai) Authority supporting that arm's length rate should be based on the currency in which CCDs/loans are denominated (Indian Rupees in that case). The court followed this decision to support the conclusion that LIBOR benchmarking was inappropriate for INR‑denominated CCDs.
Brahma Centre Development (P.) Ltd. v. ITO [IT Appeal No. 373/Delhi/2016] Cited as support for the proposition that the interest rate must be considered in the currency in which the loan or instrument originated. The court included this decision among authorities that justify using India‑denominated benchmarks for INR instruments and rejected the LIBOR + 200 bps approach.

Court's Reasoning and Analysis

The court examined the rival contentions and proceeded step‑by‑step as follows:

  1. The court noted the undisputed factual position that the CCDs were issued in Indian Rupees.
  2. Applying and following precedents of Co‑ordinate Benches and High Courts relied upon by the assessee, the court held that the TPO erred in treating the issuance of CCDs as a loan. The court characterised CCDs as hybrid/quasi‑equity instruments (equity in nature) and observed that treating them as loans was inconsistent with the nature of CCDs.
  3. The court relied on the Supreme Court's decision in Sahara India Real Estate Corpn. Ltd. (supra) which treated CCDs as hybrid instruments and identified SEBI jurisdiction on aspects treating them as equity for certain purposes. The court also noted FDI/RBI policy and FEMA/DIPB regulations (effective from 01‑04‑2010) indicating CCD issuance forms part of FDI and is quasi‑equity; treating them as loans would be contrary to those regulations.
  4. Because the CCDs were denominated in INR (and not in foreign currency), the court concluded that benchmarking the interest to LIBOR (a foreign currency/Eurodollar benchmark) was inappropriate and contrary to the cited principles. The court cited authorities (India Debt Management; Cotton Naturals; Brahma Centre Development) supporting the proposition that the interest rate should be considered in the currency in which the instrument/originated/was consumed.
  5. On benchmarking the ALP, the court considered the assessee's evidence: the SBI PLR for the year (12.26%) and NSDL coupon data showing average coupon rates with an arithmetic mean of 12.50%. These data were already before the TPO. The court held that these figures demonstrated that the rate of 12% paid by the assessee fell within the acceptable range and there was therefore no need to remit the matter back to the AO for further examination.
  6. Given the above, the court found the TPO's use of LIBOR plus 200 basis points to be incorrect on the facts and deleted the transfer‑pricing addition. Consequently, Grounds 4–6 (relating to re‑characterisation and benchmarking) were allowed.
  7. Because the primary adjustment was deleted, the court declined to consider Grounds 1 & 2 (the procedural challenge about the draft/final order) as it was not necessary to decide them in view of the substantive relief granted.
  8. With respect to Ground 7 (initiation of penalty proceedings under section 271(1)(c)), the court observed that AO had only initiated penalty proceedings and had not finalized any penalty; therefore there was no need to adjudicate the penalty ground at this stage and that ground was rejected (i.e., not entertained for final adjudication).

Holding and Implications

PARTLY ALLOWED

Holding (direct effect on the parties):

  • The transfer pricing addition of Rs. 3,93,54,079 made by the TPO/AO by benchmarking INR‑denominated CCDs at LIBOR plus 200 basis points was deleted.
  • Grounds 4–6 (challenging the re‑characterisation of CCDs as loans and the LIBOR benchmarking) were allowed.
  • Grounds 1 and 2 (procedural challenge regarding whether the AO passed a final order without a draft) were not decided because the substantive addition was deleted; the court did not adjudicate those grounds after granting substantive relief.
  • Ground 7 (initiation of penalty proceedings under section 271(1)(c)) was not adjudicated — the ground was rejected for present adjudication because penalty proceedings had only been initiated and not concluded by the AO.

Broader implications:

The court applied existing judicial and regulatory authorities to the facts and reached a decision that, on these facts, INR‑denominated CCDs should not be treated as loans for transfer pricing purposes and should be benchmarked by reference to India‑denominated interest rates. The opinion follows prior case law cited by the parties; it does not purport to lay down a new legal principle beyond its application of those authorities to the facts of this case.

Result: Appeal of the assessee is partly allowed.

    Adama India Private Limited v. Deputy Commissioner Of Income Tax .

    ORDER

    D. Manmohan, Vice-President - This is an appeal against the order of the Assessing Officer u/s. 143(3) r.w.s. 144C of the Income Tax Act [Act] consequent to the directions of the Dispute Resolution Panel [DRP]-I, Bengaluru. The issue in this appeal is with reference to Transfer Pricing adjustments made by the Assessing Officer [AO]/Transfer Pricing Officer [TPO] on the Compulsorily Convertible Debentures (CCDs) issued in Indian currency.

    2. During the year under consideration, the assessee has issued Rs. 4,62,00,000/- CCDs of Rs. 10/- each convertible into one equity share for every debenture held to Celcius Property BV of Rs. 10/-. Appellant had paid interest @ 12% on the CCDs amounting to Rs. 5,22,64,414/-. During the transfer pricing proceedings, the assessee benchmarked the weighted average rate of Prime Lending Rate (PLR) as per the State Bank of India (SBI), which was at 12.26%. Since the rate of interest paid by it is lesser than SBI PLR, Assessee has maintained that its rate of interest paid is consistent with arm's length standard from the Indian TP Regulations perspective. The Ld. TPO however, did not agree with assessee's contentions. He has considered the CCDs as loan and benchmarked the interest rate at LIBOR plus 200 basis points, thereby determining Arm's Length Price [ALP] at Rs. 1,29,10,335/- and made an adjustment of Rs. 3,93,54,079/-.

    3. The AO made the above addition in the draft order and also issued a demand notice U/s. 156 raising a demand as well as initiating penalty proceedings.

    4. Assessee preferred an appeal before the CIT(A) considering that as a final order and also preferred objections before the DRP. Since the DRP accepted the objections, the assessee withdrew the appeal before the Ld. CIT(A). However, the DRP rejected the assessee's contentions with reference to the TP adjustment made. On the objection that the assessment order passed U/s. 143(3) r.w.s. 92CA(3) dt. 19-03-2015 was invalid, the DRP however, considered that it is a mistake committed by the AO in issuing a notice U/s. 156 but since the order on the face of it clearly stated as draft assessment order, the DRP rejected the objections. It confirmed the TP adjustments made by the TPO rejecting the assessee's detailed contentions. Hence the present appeal. Assessee has raised the following grounds:

  • "1 The Learned Assessing Officer ('AO') erred in passing a final assessment order under section 143(3) r.w.s 92CA(3) of the Income-tax Act, 1961 ('Act') dated 19 March 2015 without passing a draft assessment order under section 144C of the Act and the Learned Dispute Resolution Panel ('DRP') erred in upholding the said order.
  • 2. On the facts and circumstances of the case and in law, the assessment order passed by the Ld. AO dated 19th March 2015 is contrary to law and is liable to be set aside.
  • Without prejudice to ground no. 1 and 2, the Appellant raises the following grounds of appeal:
  • 3. On facts and in the circumstances of the case and in contrary to law, the Learned transfer Pricing Officer ('TPO')/Ld. AO has erred in going beyond the scope to re-characterize the Compulsory Convertible Debentures ('CCD') as loan for benchmarking the international transaction of interest payments on CCD and the Hon'ble DRP has further erred in upholding the action of Ld. TPO/Ld. AO.
  • 4. On the facts and in the circumstances of the case and in contrary to law, the Ld. TPO/Ld. AO erred and subsequently Hon'ble DRP further erred in upholding the action of Ld. TPO/Ld. AO by not appreciating the fact that CCDs are consumed in India and interest on CCDs should be benchmarked using State Bank of India ('SBI') Prime Lending Rate ('PLR') rather than London Inter-Bank Offered Rate ('LIBOR') rate.
  • 5. The Ld. TPO/Ld. AO erred and subsequently DRP further erred in upholding the action of Ld. TPO/Ld. AO in considering LIBOR plus 200 basis points i.e. 2.91 %, s an arm's length interest on CCD on ad hoc basis which is complete violation of transfer pricing provisions and against the principles of law.
  • 6. The Ld. TPO/Ld. AO erred on facts and in law in disregarding the independent alternative analysis carried out by the Appellant based on the data available from public database i.e., NSDL website; and subsequently DRP further erred in not providing any directions/findings by completely ignoring the independent analysis undertaken by the Appellant in this regard.
  • 7. The Ld. AO has erred in initiating penalty proceedings under section 271(1)(c) of the Income Tax Act, 1961".
  • 5. Ld. Counsel made detailed submissions with reference to the order dt. 19-03-2015 and the final order passed by the AO dt. 27-01-2016 to submit that issuance of notice and initiation of penalty proceedings indicate that the order was a final order and, therefore the subsequent proceedings are bad in law. When it was pointed out that assessee withdrew the appeal before the CIT(A) and accepted the objections before the DRP, Ld. Counsel fairly admitted that assessee withdrew the appeal. However, Counsel relied upon the following case law in support of the stand that the AO was not justified in treating the draft assessment order as a final order and such a course of action is not a curable irregularity; therefore, the draft assessment order should be treated as bad in law:

  • i. Vijay Television (P.) Ltd. v. Dispute Resolution Panel [2014] 369 ITR 113/225 Taxman 35/46 taxmann.com 100 (Mad.);
  • ii. Lionbridge Technologies (P.) Ltd. v. Dy. CIT [2015] 62 taxmann.com 48 (Mum. - Trib.);
  • iii. Zuari Cement Ltd. v. Asstt. CIT [WP No. 5557 of 2012]
  • Assessee submits that it is a legal issue and it can be taken at any stage even though the issue is not pressed before the CIT(A). At the same time, he urged that the issue arising out of Ground Nos. 3 to 6 is covered in favour of the assessee by catena of decisions and if a decision is taken in favour of the assessee, he may not be interested in pressing Ground Nos. 1 & 2. We therefore proceed to take up Ground Nos. 3 to 6.

    Ground Nos. 3 to 6:

    6. It was the submission of the Ld. Counsel that assessee has issued the CCDs to the AE which were wrongly categorised as loan by the TPO. Referring to the Ministry of Commerce and Industry, Govt. of India, FDI Policy Circular of 2014, it was submitted that CCDs are not loans and should be reckoned as 'capital instruments'. He further relied on the judgment of the Hon'ble Supreme Court in the case of Sahara India Real Estate Corporation Limited and Sahara India Real Estate Corpn. Ltd. v. SEBI [2012] 25 taxmann.com 18/115 SCL 478 to submit that Hon'ble Supreme Court has categorised the CCDs as 'hybrid instruments' and DRP was wrong in rejecting the principles laid down by the Hon'ble Supreme Court. It was further submitted that TPO has gone beyond the scope to re-characterise the CCD as loan ignoring the principles laid down by the Hon'ble Delhi High Court in the case of CIT v. Cotton Naturals (I) (P.) Ltd. [2015] 55 taxmann.com 523/231 Taxman 401 and also the principles laid down by the Hon'ble High Court of Delhi in the case of Acit 3(1) Indore v. Mittal Appliances Ltd. . [2012] 345 ITR 241/209 Taxman 200/24 taxmann.com 199 . It was also submitted that TPO has no power to re-characterise the transaction as laid down by the Co-ordinate Bench at Ahmadabad in the case of Sun Pharmaceuticals Ind. Ltd. v. Asstt. CIT [IT Appeal Nos. 1589 & 1592/Ahd/2011, dated 10-5-2016]. It was further submitted that TPO also erred in benchmarking the transaction with reference to LIBOR plus when both TPO as well as DRP accepted that the loans were given in Indian Rupees. Accordingly, SBI's PLR rate should have been benchmarked rather than LIBOR plus. Ld. Counsel relied on the principles laid down by the Hon'ble Bombay High Court in the case of Commissioner Of Income-Tax v. Tata Autocomp Systems Ltd. [2015] 374 ITR 516/230 Taxman 649/56 taxmann.com 206 to submit that rate of interest should be determined based on the country where the amount/loan is received/consumed. Ld. Counsel placed on record the comparison of facts between assessee's case and the above referred Tata Autocomp Systems Ltd. (supra). Referring to the decision of the Co-ordinate Bench, Mumbai in the case of India Debt Management (P.) Ltd. v. Dy. CIT [2016] 69 taxmann.com 125 , it was submitted that arm's length rate should be based on Indian Rupees in which denomination CCDs have been issued and were utilised.

    7. Ld. DR, however, submitted that DRP has analysed the issues and has adopted the LIBOR plus two hundred basis points as an ALP and relied on the orders of TPO/DRP.

    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 Co-ordinate 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 Corpn. Ltd. (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 (P.) Ltd. ( supra);
  • ii. Cotton Naturals (I) (P.) Ltd. ( supra);
  • iii. Brahma Centre Development (P.) Ltd. v. ITO [IT Appeal No. 373/Delhi/[2016].
  • 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.

    9. Coming to the issue of adopting the benchmark rate in Indian context, assessee has justified the ALP not only on the basis of SBI PLR, which was at 12.26% for the year under consideration, but also from the data from NSDL website in which average coupon rate ranged from 0.50% to 16.50% with an arithmetic mean of 12.50%. These rates were already before the TPO. Therefore, we are of the opinion that there is no need to restore the matter to the file of the AO for re-examination, when assessee has justified the issuance of CCDs at 12%. In view of that we are of the opinion that the rate at which the CCDs were given are within the range, therefore, no further addition can be considered under the TP provisions. In view of that, the addition so made is deleted and grounds of the assessee from 4 to 6 are accordingly considered allowed. Since the addition is deleted, we do not wish to consider Ground Nos. 1 & 2 as has already been indicated above.

    10. Ground No. 7 is with reference to initiation of proceedings U/s. 271(1)(c). AO has only initiated the proceedings but has not finalised the penalty as such. Therefore, there is no need to adjudicate the same at this point of time. This ground is accordingly rejected.

    11. In the result, appeal of the assessee is partly allowed.

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    Adama India Private Limited v. Deputy Commissioner Of Income Tax .
    (Jan 13, 2017)