Embassy One Developers Pvt. Ltd. Vs DCIT (ITAT Bangalore)
The assessee filed appeals against separate orders of the Commissioner of Income Tax (Appeals) for Assessment Years 2009-10 and 2010-11. The principal issue in both appeals concerned the disallowance of capitalisation of interest expenditure incurred on Compulsorily Convertible Debentures (CCDs) issued to its Associated Enterprise. The Assessing Officer (AO) had referred the matter to the Transfer Pricing Officer (TPO), who treated the CCDs as equity instead of debt by relying on the Reserve Bank of India (RBI) policy under the Foreign Direct Investment (FDI) framework. On this basis, the TPO concluded that the interest paid on the CCDs was not allowable as expenditure, and the AO accordingly disallowed the capitalisation of interest.
The assessee argued that the RBI’s FDI policy should not determine the treatment of CCDs under the Income Tax Act. It contended that the interest had been correctly capitalised in accordance with the applicable accounting standards and that CCDs remained debt instruments until their conversion into equity. The assessee also challenged the TPO’s power to recharacterise CCDs as equity and submitted that thin capitalisation provisions were not part of the Income Tax Act for the relevant assessment years.
The Tribunal examined its earlier decision in CAE Flight Training (India) Pvt. Ltd., which had relied on the Mumbai Bench decision in Besix Kier Dabhol SA v. DDIT. Those decisions held that, in the absence of statutory thin capitalisation rules in India, the Revenue could not recharacterise debt as equity and deny deduction of interest on that basis. The Tribunal observed that although some foreign jurisdictions had enacted thin capitalisation rules, India did not have such provisions during the relevant years. Consequently, the Revenue could not invoke such principles to deny the assessee’s claim.
