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Background:

The Hon’ble Ahmedabad Tribunal in the case of Intas Pharmaceuticals Ltd. Vs. The ACIT [ITA Nos. 1334/Ahd/2017 & Ors.] has ruled on TP adjustments w.r.t interest on advances/loans. The Hon’ble Tribunal opined that the nature of the loan, whether it is quasi-capital or not, has to be seen at the time of advancement of the loan by the Assessee to its AEs.

A summary of the judgment is provided below.

Facts:

• The AEs were captive entities incorporated to market and distribute Assessee’s products in respective territories.
• The Assessee had advanced amounts to its AEs for the purpose of using the same towards the filing of registration and other activities in overseas jurisdictions.
• The Assessee did not charge any interest on such advances given to its AEs since the Assessee was of the view that the advances were of a commercial nature as obtaining registration for the Assessee’s products was essential for selling its products in the respective local overseas territories.
• The Assessee treated such advances as quasi-equity as they were to be converted into equity at the option of the Assessee.

Ld. CIT(A)’s Actions:

• The Ld. CIT(A) deleted the upward adjustment w.r.t loans/advances given to 3 AEs, which were converted into equity in the subsequent year.
• The Ld. CIT(A) confirmed the upward adjustment with respect to other AEs where there was no conversion of loans/advances into equity in the subsequent year.

Hon’ble Tribunal’s Rulings:

• The Hon’ble Tribunal rejected the argument that loans/advances in the present case are in the nature of quasi-capital basis the following:
• The test for determining whether the advances/loan given is quasi capital in nature has to be seen “at the time of granting of the loan.”
• Advances could be in the nature of quasi capital in the situations where (a) advances made as capital could not be subscribed due to regulatory issues and the advancing of loans was only for the period till the same could be converted into equity, and (b) advances were made for subscribing to the capital but the issuance of shares was delayed, even if not inordinately[1].
• The fact that the loan/advance the loan/advance has been converted into equity (at the option of the assessee) in the subsequent year would not alter such loan / advance as being in the nature of quasi-capital.
• The reliance placed by the taxpayer on the judgment of Micro Inks[2] was distinguished, stating that, unlike Assessee, in the case of Micro Inks, there was indeed a technical problem in subscribing to the capital directly.
• The Hon’ble Tribunal further rejected the argument of the commercial expediency, stating that if the argument of commercial expediency were to be accepted as a guiding tool for the non-applicability of transfer pricing adjustments to international transactions, then no transfer pricing adjustment can be made in respect of all / most of the international transactions between Associated Enterprises.
• The Hon’ble Tribunal further placed reliance in the case of Tata Autocomp Systems Ltd. 21 taxmann.com 6 (Mumbai ITAT), wherein it was observed that the transaction of granting interest-free loans by the Assessee to its non-resident Associated Enterprise comes within the ambit of international transaction. Thus, such a transaction can be a subject matter of Arm’s Length Price under Section 92 of the Act.
• Further, the Hon’ble Tribunal also rejected the argument of the taxpayer regarding the increase in export turnover or that the advances were given out of interest-free funds available with the assessee.
• The Hon’ble Tribunal, therefore, upheld the levy of interest on such loan/advance to Aes; however, it remitted the matter back to CIT(A) to give a specific finding on the correct amount of interest to be charged by the taxpayer from its AEs.

KNAV Comments:

While there are various aspects to deep dive into to consider the advance as a pure loan or quasi-equity, some of the key criteria to be considered are a) Who is the ultimate beneficiary b) Do AEs have the financial ability to fetch loan? Independently / pay interest c) Business and Commercial Rationale for placing advances, etc. There are a plethora of Indian and International jurisprudence to support the taxpayers and tax departments, but the fact that advances that have been converted into equity itself demonstrates the intent that the investment is equity in nature. A few key takeaways from this recent ruling are below:

• Appropriately determining the terms and conditions and entering into the agreement before granting the loans/advances to AEs would enable the Assessee to defend that the convertible loan/advance was quasi-capital in nature.
• The above judgment is debatable since certain tribunals or courts have held that convertible debentures are in the nature of debt till the time of conversion, and hence, levy of arm’s length interest is applicable.
• Further, it may be worth noting the judgment of the Hon’ble Mumbai Tribunal[3] wherein the Tribunal evaluated the interplay between the Treaty and TP provisions and stated that though Chapter X aims at preventing avoidance/evasion of tax, there would be no occasion for any tax avoidance/evasion when the income itself is not chargeable to tax by virtue of the Tax Treaty. The Tribunal observed that “Chapter X containing section 92 and other provisions are in the nature of machinery provisions and subject to section 4 of the Act which is the charging provision”, and opined that if a particular item of income does not come within the purview of the charging provision as contained u/s. 4, the machinery provisions as contained under Chapter X would be inapplicable, even though they might be in the nature of special provisions.

[1] Placed reliance on Soma Textile & Industries Ltd. [2015] 59 taxmann.com 152 (Ahd ITAT)

[2] Micro Inks Ltd. 36 taxmann.com 50 (Ahd ITAT)

[3] Gurgaon Investment Ltd. (Formerly known as Indopark Investments Limited) [TS-1073-ITAT-2019(Mum)- TP]