OECD Guidelines & Rule 10B Mandate Transaction Delineation Over Label for CCD Transfer Pricing : ITAT Bangalore

The Income Tax Appellate Tribunal, Bangalore, has delivered a landmark ruling clarifying that the arm's-length price of interest on compulsorily convertible debentures cannot be determined by merely labeling the instrument as debt or equity. The Tribunal emphasized that transfer pricing analysis must focus on the actual economic substance, contractual terms, and risk allocation of the transaction, in line with OECD Guidelines and Rule 10B of the Income Tax Rules.

Background & Facts

The Dispute

The dispute centers on the interest payment of Rs. 15 crores made by Adamas Builders Pvt. Ltd. (the assessee) to its associated enterprise, Mapletree BG Pte Ltd, Singapore, on Compulsorily Convertible Debentures (CCDs) issued for Rs. 100 crores. The Transfer Pricing Officer (TPO) determined the arm's-length price (ALP) of this interest as Rs. Nil, treating the CCDs as equity instruments, and therefore not eligible for interest. The assessee challenged this adjustment before the Commissioner of Income Tax (Appeals) [CIT(A)], who allowed the appeal, holding that CCDs are debt instruments until conversion and that interest is allowable under Section 36(1)(iii).

Key Facts

• The assessee, a real estate developer, issued CCDs to Golden Bella Holdings Ltd., Cyprus, on 28.03.2012, for Rs. 100 crores, carrying a coupon rate of 15% per annum.
• The CCDs were compulsorily convertible into equity shares at a ratio of 1:1, not later than 10 years from issuance.
• On 01.04.2013, the CCDs were transferred to Mapletree BG Pte Ltd, Singapore, a 99.5% associated enterprise of the assessee.
• Interest of Rs. 15 crores accrued during FY 2013-14.
• The assessee used the Comparable Uncontrolled Price (CUP) method to benchmark the interest rate, citing three comparables: Mysore Polymers & Rubber Products Ltd. (12%), Religare Enterprises Ltd. (15%), and Varun Beverages Ltd. (18.5%).
• The TPO rejected the CUP method, arguing that CCDs are hybrid instruments and should be treated as equity under RBI guidelines and judicial precedents, including Narendra Kumar Maheshwari v. UOI and Ashima Syntex.
• On 25.03.2022, the assessee’s Board extended the tenure of the CCDs to 2032 and 2034 and reduced the coupon rate from 15% to 12.5% based on an independent TP study.
• The CCDs have not been converted into equity as of the assessment year 2014-15 and remain outstanding.
• The assessee’s financial position showed a debt-equity mix with significant foreign equity participation through Greenwald Developments Limited, Mauritius, and Golden Bella Holdings Ltd., Cyprus.

Procedural History

• 29.11.2014: Assessee filed return of income for AY 2014-15 reporting a loss of Rs. 21,02,19,360.
• 2017: Notice under Section 143(2) and 142(1) issued; TPO referred under Section 92CA.
• 01.08.2017: Assessee submitted reply challenging recharacterization of CCDs as equity.
• 29.01.2018: Final assessment order passed by Ld. AO, disallowing interest of Rs. 15 crores and determining ALP at Rs. Nil.
• 07.10.2024: CIT(A) allowed the appeal, holding CCDs as debt instruments and interest allowable.
• 05.02.2026: Hearing before ITAT Bangalore.
• 15.04.2026: Judgment pronounced.

The Parties' Positions

For the Appellant (DCIT)

• Argued that the CIT(A) failed to determine the ALP of the international transaction and instead addressed the allowability of interest under Section 36(1)(iii), which was not the issue.
• Contended that the CCDs are hybrid instruments with equity characteristics, and the 15% interest rate is commercially unreasonable as no independent party would pay such a return on capital while also granting equity.
• Highlighted that the TPO’s findings on profit shifting, double non-taxation, and use of India-Singapore DTAA were ignored.
• Asserted that the CUP method used by the assessee was flawed due to non-comparable instruments, incorrect time periods, and lack of disclosure of terms.
• Cited IFCI Ltd. v. Sutanu Sinha (2023) to argue that CCDs cannot be treated as financial debt.
• Emphasized that the OECD Transfer Pricing Guidelines (2022), Chapter X, require transaction delineation, not label-based classification.

For the Respondent (Assessee)

• Relied on judicial precedents (Summit Developers, CAE Flight Training, Kolte Patil) holding that CCDs are debt until conversion.
• Argued that RBI FDI policy permits CCDs as FDI and allows interest payments.
• Claimed that the CIT(A) correctly followed coordinate benches and that the TPO’s recharacterization was ultra vires.
• Submitted that the interest rate of 15% was benchmarked using CUP method with three comparables.
• Contended that the OECD Guidelines are not binding and cannot override judicial precedents.
• Asserted that the extension of tenure and reduction of interest rate in 2022 validated the commercial rationale.

Relief Sought

The appellant sought to set aside the CIT(A)’s order and uphold the TPO’s determination of ALP at Rs. Nil. The assessee sought confirmation of the CIT(A)’s order allowing the interest deduction.

The Legal Issue

The central question was whether the arm's-length price of interest on compulsorily convertible debentures can be determined by classifying the instrument as debt or equity, or whether it must be determined by delineating the actual transaction under Rule 10B of the Income Tax Rules and OECD Transfer Pricing Guidelines, Chapter X.

Arguments Presented

For the Appellant

The appellant argued that the CIT(A) erred by conflating the issue of interest allowability under Section 36(1)(iii) with the determination of ALP under transfer pricing provisions. The CIT(A) failed to analyze whether the Rs. 15 crore interest payment was at arm’s length, as required under Section 92(1). The appellant emphasized that the OECD Guidelines (2022), Chapter X, mandate a functional analysis of the transaction - considering contractual terms, risks assumed, assets employed, and economic substance - not mere labels. The TPO’s findings on profit shifting, the absence of repayment obligation, and the financial incapacity of the assessee to service such debt were ignored. The CUP comparables were non-comparable due to differing instruments, tenures, and market conditions. The appellant cited IFCI Ltd. and Narendra Kumar Maheshwari to show that CCDs are equity-like instruments under Indian law.

For the Respondent

The respondent relied on coordinate bench decisions that treated CCDs as debt instruments until conversion. It argued that RBI FDI policy permits interest on CCDs and that judicial precedents support the allowability of such interest. The CUP method was correctly applied, and the comparables were valid. The respondent contended that the OECD Guidelines are persuasive only if they do not conflict with Indian law, and that the CIT(A)’s reliance on precedent was legally sound. The extension of tenure and reduction of interest rate in 2022, it argued, demonstrated commercial prudence and negated any allegation of profit shifting.

The Court's Analysis

The Tribunal held that the CIT(A)’s order was legally unsustainable because it failed to determine the ALP of the international transaction. The CIT(A) addressed the allowability of interest under Section 36(1)(iii), which was not the issue before it. The issue was the ALP under Section 92(1), which requires an independent determination of the arm’s-length price.

"The mandate of section 92(1) is that in every case of international transaction, income has to be determined having regard to ALP. Therefore, unless ALP furnished by the taxpayer is specifically accepted, the appellate authorities on the basis of material available on record has to determine ALP itself."

The Tribunal noted that the OECD Guidelines (2022), Chapter X, which were publicly available at the time of the CIT(A)’s order, provide a four-step framework for analyzing financial transactions: delineation of the transaction, selection of the most appropriate method, application of the method, and documentation. The Guidelines explicitly state that labels such as "debt" or "equity" are irrelevant; the actual economic substance governs.

The Tribunal found the assessee’s CUP method flawed: the three comparables were not sufficiently comparable in terms of instrument type, tenure, risk profile, or market conditions. The terms of the comparables were not disclosed. The CCD agreement submitted was merely a board resolution, not the actual instrument. The financial health of the assessee was not analyzed under OECD paragraph 10.18, which requires assessing whether an unrelated party would have lent such an amount given the borrower’s inability to repay.

The Tribunal also rejected the reliance on Hyderabad Infratech and Delhi High Court decisions, as they dealt with plain vanilla loans, not hybrid instruments. The SBI PLR and LIBOR benchmarks are inappropriate for CCDs, which do not require cash repayment but are settled through equity conversion.

The Tribunal concluded that neither the assessee nor the TPO had performed a proper transaction delineation. The CIT(A)’s order was therefore set aside.

The Verdict

The appeal of the Deputy Commissioner of Income Tax is allowed. The order of the CIT(A) dated 07.10.2024 is set aside. The matter is restored to the file of the Assessing Officer with directions to refer the case to the Transfer Pricing Officer for determination of the arm’s-length price of the interest payment of Rs. 15 crores on the CCDs. The assessee and the TPO must conduct a full transaction delineation under Rule 10B(2) and OECD Guidelines, Chapter X, including consideration of options realistically available to both parties under paragraphs 10.18 and 10.19. The Assessing Officer shall pass a draft assessment order under Section 144(1) upon receipt of the TPO’s report.

What This Means For Similar Cases

Transaction Delineation Trumps Instrument Labeling

• Practitioners must now abandon the practice of arguing CCDs as either debt or equity to determine ALP.
• The focus must shift to contractual terms, risk allocation, economic substance, and functional analysis under OECD Chapter X.
• Labels like "convertible debenture" or "hybrid instrument" are irrelevant; the actual transaction structure governs.

CUP Method Requires Rigorous Comparability

• Comparables must match the instrument type, tenure, currency, credit risk, and conversion terms.
• Generic financial comparables with different structures (e.g., non-convertible debentures) are inadmissible.
• Documentation must include full terms of the instrument and comparables, not just board resolutions.

Financial Capacity Must Be Analyzed

• The borrower’s ability to service debt must be assessed under OECD paragraph 10.18.
• If an unrelated lender would not have extended the full amount due to credit risk, the ALP must reflect the maximum sustainable debt.
• Taxpayers must now submit credit ratings, cash flow projections, and solvency analysis for cross-border hybrid financing.

Precedents Are Not Binding on Transfer Pricing

• Coordinate bench decisions treating CCDs as debt are not applicable if they did not analyze ALP under Section 92(1).
• Judicial precedents on allowability of interest under Section 36(1)(iii) do not govern transfer pricing.
• The CIT(A) must adjudicate the ALP issue independently, even if the TPO’s method is flawed.

Compliance Deadline

• All pending transfer pricing cases involving CCDs, convertible notes, or hybrid instruments must be reassessed under the delineation framework.
• Taxpayers must update their TP documentation to include OECD Chapter X analysis before filing returns for AY 2025-26 and onwards.