ACIT Vs CAE Flight Training (India) Pvt. Ltd. (ITAT Bangalore)
The Bangalore Bench of the Income Tax Appellate Tribunal (ITAT) dealt with a batch of appeals and cross-objections involving a common issue: whether Compulsorily Convertible Debentures (CCDs) issued by the assessee to its associated enterprises should be treated as debt or equity, whether interest paid on such CCDs is allowable, and how the arm’s length price (ALP) of such interest should be determined.
The Transfer Pricing Officer (TPO) had concluded that CCDs were in the nature of equity and not debt. Relying on RBI policy and FEMA regulations that treat fully and mandatorily convertible instruments as equity for FDI purposes, the TPO held that interest paid on CCDs was not really “interest” on borrowed capital. The TPO further viewed the arrangement as involving thin capitalization and determined the ALP of interest at nil, resulting in transfer pricing adjustments.
For Assessment Year (AY) 2009-10, the CIT(A) held that CCDs were debt and not equity and therefore interest was allowable. However, the CIT(A) held that the claimed interest rate of 15% was not at arm’s length and directed the ALP to be computed at 12.62%.
For AY 2010-11, the DRP also held that CCDs were debt and not equity and further held that the principle of thin capitalization was not applicable. The DRP nevertheless directed determination of ALP based on LIBOR plus an additional risk adjustment.
