Re-characterization of Equity and the “Sufficient Own Funds” Rule
This ruling for AY 2016-17 provides a significant dual victory for taxpayers regarding Transfer Pricing and interest disallowances. The Tribunal reaffirmed that the Revenue cannot second-guess a company’s commercial wisdom by turning equity into debt or by assuming that interest-bearing loans were diverted to subsidiaries.
I. Transfer Pricing: No Re-characterization of Preference Shares as Loans
The Legal Dispute
The Transfer Pricing Officer (TPO) attempted to “re-characterize” the assessee’s investment in the preference shares of its Associated Enterprise (AE). Because the shares were non-cumulative and yielded no dividend, the TPO argued they were effectively an interest-free loan and imputed a notional interest of 11.91%.
The Decision (In Favour of Assessee)
The Tribunal struck down the adjustment based on these core principles:
Respect for Commercial Expediency: The TPO does not have the authority to tell a businessman how to structure his capital. Unless the transaction is proven to be a “sham” or there are exceptional circumstances showing concealment, the TPO must accept the transaction as it is—an equity investment.
No Fresh Subscription: It was noted that the preference shares were merely an opening balance from previous years. The TPO cannot disregard the “apparent transaction” (equity) and substitute it with another (debt) without material evidence of a tax-evasive motive.
Judicial Precedents: Following the assessee’s own case from earlier years, the Tribunal held that preference share subscriptions cannot be treated as debt, and therefore, no notional interest can be imputed.
II. Business Disallowance: The Presumption of “Own Funds”
The Legal Dispute
The Assessing Officer (AO) disallowed interest under Section 36(1)(iii), claiming the assessee had diverted borrowed (interest-bearing) funds to provide interest-free advances to its sister concerns and subsidiaries. The AO applied a rate of 11.91% for this disallowance.
The Decision (In Favour of Assessee)
The Tribunal deleted the disallowance by applying the settled “Presumption Rule”:
The Mixing of Funds: When a company has a mix of its own interest-free funds (share capital/reserves) and interest-bearing loans, and it gives an interest-free advance, the law presumes the advance came out of the interest-free funds.
Sufficiency of Funds: Since the assessee had substantial own funds—more than the amount advanced to the sister concerns—no nexus could be established between the borrowed funds and the interest-free advances.
Consistency: As there was no change in material facts from previous years where this position was accepted, the “Rule of Consistency” protected the assessee’s claim.
Key Takeaways for Corporate Taxpayers
Capital Structure Protection: As long as your investment in a subsidiary is legally documented as “Shares” (Equity), the TPO cannot arbitrarily call it a “Loan” just because it doesn’t pay a dividend.
Maintain a “Capital vs. Loan” Ledger: To defend against Section 36(1)(iii) disallowances, always keep a statement ready showing that your Share Capital + Reserves are greater than the Interest-Free Advances given to group companies.
Commercial Wisdom: The tax department cannot act as a “super-board of directors.” They must tax the transaction as you have structured it, provided it is genuine.
Summary of the “Presumption” Rule (Section 36(1)(iii))
Condition: Assessee has both own funds and borrowed funds.
Action: Assessee gives an interest-free loan to a subsidiary.
Presumption: The loan came from “Own Funds” first.
Result: No interest disallowance is allowed for the AO.
IN THE ITAT MUMBAI BENCH ‘K’
Assistant Commissioner of Income-tax
v.
Aegis Ltd.*
Pawan Singh, Judicial Member
and Girish Agrawal, Accountant Member
and Girish Agrawal, Accountant Member
IT(TP) Appeal No. 7000 (MUM) of 2025
[Assessment year 2016-17]
[Assessment year 2016-17]
MARCH 10, 2026
Ms. Neena Jeph, CIT DR for the Appellant. Rajan Vora and Pranay Gandhi, CAs for the Respondent.
ORDER
Girish Agrawal, Accountant Member.- This appeal filed by the revenue is against the order of CIT(A) 55-Mumbai, vide order no. ITBA/APL/S/250/2025-26/1079371729(1), dated 07.08.2025, passed against the assessment order by DCIT, Cir.6(1)(1), Mumbai, u/s. 143(3) r.w.s. 144C(3) of the Income-tax Act (hereinafter referred to as the “Act”), dated 13.02.2020, for Assessment Year 2016-17.
2. Grounds taken by revenue are reproduced as under:
“A On Transfer Pricing TP Issue Deletion of Adjustment of 1699276587
1 Whether on the facts and in the circumstances of the case and in law, the Ld CIT A erred in not considering the material evidence and findings of the TPO demonstrating that the transactions involving frequent subscription to and redemption of redeemable preference shares at par without any dividend or capital appreciation were in substance an advancement lending of money to the AE in the garb of preference shares and not a simple share transaction thus attracting the provisions of Section 92B of the Income-tax Act 1961.
2 Whether on the facts and in the circumstances of the case and in law, the Ld CIT A was justified in deleting the transfer pricing adjustment by relying solely on judicial precedents without appreciating that the instant case falls under the exception to the non re characterization rule as the nomenclature used by the assessee subscription to preference shares did not reflect the true nature and conduct of the transaction running account loan, as evidenced by the lack of commercial justification and absence of essential documentation.
3 Whether, on the facts and in the circumstances of the case and in law, the Ld CIT A erred in disregarding the TPOs contention that the investment in nonconvertible non dividend paying redeemable preference shares constitutes debt and falls within the purview of an international transaction under Explanation i c to Section 92B of the Act and relevant RBI circulars thereby mandating benchmarking
B Non TP Issue Disallowance u/s 36(1)(iii) of 5731580
4 Whether, on the facts and in the circumstances of the case and in law, the Ld CIT A erred in deleting the disallowance of 15731580 made u/s. 36(1)(iii) of the Act without appreciating that the assessee s own funds were already invested in fixed assets and long-term investments and were not available for advancing interest free loans and therefore the presumption that advances were made from own funds is factually incorrect and contrary to the findings recorded by the Assessing Officer
5 Whether on the facts and in the circumstances of the case and in law the Ld CIT A was justified in deleting the disallowance u/s. 36(1)(iii) by mechanically relying on prior year ITAT High Court orders without acknowledging the AO s analysis that the assessee utilized mixed funds for making interest free advances to subsidiaries and related concerns in the absence of any direct evidence from the assessee establishing that borrowed funds were not utilized.”
3. Brief facts of the case are that assessee is engaged in providing customer interaction which includes customer acquisition, customer service, back office that is order management and data management, recovery and collection services to its Associated Enterprises (AEs) and third parties. Assessee serves the telecom, retail, financial, services, energy, education and logistic sectors. It provides call center services through various centers in India. Return of income was filed on 29.11.2016 reporting total income at nil, claiming a loss of Rs. 5,30,45,288/-. This was revised against which the loss claim remained the same. Assessee had entered into international transactions with its AEs for which a reference was made to ld. Transfer Pricing Officer (TPO) who passed an order u/s.92CA(3), proposing an adjustment of Rs.69,92,76,587/- on account of compensation receivable on preference shares purchased from AE. Further, in the course of assessment proceedings, ld. AO noted that assessee has diverted substantial part of interest bearing funds to its subsidiaries. According to him, even though interest free borrowed funds and own funds exceeded the funds on which the interest was required to be paid as reported in the balance sheet, however, the own fund and interest free loans according to him had already been invested in the investment and fixed assets and therefore were no longer available for advancing interest free loans. As per ld. Assessing Officer, assessee has advanced loans to its subsidiaries or related parties from where no business has been generated during the year and no income shown to this account. Thus, by placing reliance on the decision of Hon’ble S.A. Builders Ltd. v. CIT (Appeals) (SC)/[2007] 288 ITR 1 (SC)] and by applying the provisions of section 36(1)(iii), he computed the disallowance on account of interest expense relating to the interest bearing funds diverted to subsidiaries. In this respect, he applied the rate of 11.91% which was adopted by the ld. TPO while computing the adjustment on account of redemption of preference shares capital. The disallowance so computed by ld. AO u/s. 36(1)(iii) is tabulated below:
| A. | Total amount of loans advance to subsidiaries at lower rate of 9% | 2,91,10,000 |
| B. | Total Interest bearing funds diverted Interest free | 4,10,11,577 |
| C. | Rate at which interest is to be disallowed | 11.91% |
| D. | Interest chargeable for lower rate of interest D= “A*” (11.91-9)% | 8,47,101 |
| E. | Interest chargeable on interest free advances E= “B*” 11.91% | 48,84,479 |
| F. | Interest disallowable u/s 36(1)(iii) F = D+E | 57,31,580 |
3.1. Assessment was completed at total income assessed at Rs.70,50,08,167/- by making two additions, details of which is tabulated below:
| S. No. | Particulars | Amount (INR) |
| Transfer prising matters: | ||
| 1. | Addition on account of recharacterization of preference shares as loan and imputing interest income thereon 11.91% | 69,92,76,587 |
| Total transfer pricing adjustments (A) | 69,92,76,587 | |
| Corporate tax matters: | ||
| 2. | Disallowance of interest expenses claimed by the appellant u/s. 36(1)(m) of the Act | 57,31,580 |
| Total corporate tax adjustments (B) | 57,31,580 | |
| Total adjustment (A+B) | 70,50,08,167 | |
3.2. At this juncture, it is important to take note of the fact that ld. TPO resorted to follow the approach of his predecessor in assessment year 2009-10 when the assessee had subscribed and also redeemed such preference shares and also benchmarked the same and held that outstanding balance of preference shares amounts to Rs. 587,41,59,862/- held by assessee, constituted international transaction for the purpose of section 92B and determined the arms length price thereof by re-characterizing the same as unsecured loan extended to the AE upon which notional interest be imputed at the rate of 11.91% and charged the same, disregarding the order of the Coordinate Bench and Hon’ble High Court of Bombay in assessee’s own case for the said assessment year by citing the pendency of appeal by the department before the Hon’ble Supreme Court. Ld. TPO arrived at an interest rate based on his assumption of credit rating of the associated enterprise and yield on corporate bonds in India and applied it to the transaction at hand.
3.3. Fact of the matter is that assessee had shown certain transactions of subscription to preference share capital as also the redemption of preference shares with its AE, ESSAR Services (Mauritius) which was an AE of the assessee. Ld. TPO noted that the said shares were non-cumulative and redeemable at par without dividend. He observed that assessee had a running account with the said AE in terms of which money was being advanced as and when the need arose. Considering the overall nature and frequency of transaction in the form of running account, ld. TPO held that such subscription and redemption of shares on which no dividend was paid/payable were in the nature of loan and not investment in shares. Thus, the said transaction was, according to him, in the nature of loan on which he computed the arms length price by charging interest as compensation for use of money advanced to an AE. According to the ld. TPO, no independent third party would subscribe to such preference shares at par without any reasonable return on investment and therefore, it is justified to treat the same as loan to be benchmarked by applying an interest rate. Ld. TPO applied the interest rate of 11.91% to impute interest cost on the same.
3.4. This issue has been a legacy issue since assessment year 200910, fact of which is noted by ld. TPO in his order, whereby he noted the decision held in favour of the assessee by the Coordinate Bench in assessee’s own case for AY 2009-10 in ITA No. 1213/Mum dated 27.07.2015, whereby TP adjustment made by the ld. TPO was directed to be deleted as held to be wrongly re-characterized, since the transaction is apparently in the nature of subscription of preference sharess and not loans. Similar favourable orders of the Coordinate Bench were taken note of for assessment year 2010-11 and assessment year 2014-15. Ld. TPO also took note of the decision of Hon’ble Jurisdictional High Court of Bombay in respect of appeal by the Revenue for Assessment Year 2009-10 which was held to be in favour of the assessee. However, ld. TPO noted that filing of SLP before the Hon’ble Supreme Court against the decision of Hon’ble High Court had been recommended and is pending and therefore, concluded to adopt the same approach as has been taken in earlier years, starting from AY 2009-10. Thus, ld. TPO benchmarked the transaction on similar lines as in earlier years, by adopting the rate of interest at 11.91% to work out an upward adjustment of Rs.69,92,76,587/-.
4. It is important to note that during the year under consideration, there is only an opening balance of preference shares held in ESSAR Services (Mauritius) and there is no fresh subscription of the preference shares. However, there is redemption of Rs.5,00,000/- preference shares in the year under consideration. The issue of transfer pricing upward adjustment has already been dealt by the Coordinate Bench in assessee’s own case for AY 2009-10 wherein it has been held that TPO/AO cannot disregard any apparent transaction and substitute it without any material of exception circumstance highlighting that the assessee had tried to conceal the real transaction or some sham transaction has been unearthed. According to the Coordinate Bench, the TPO cannot question the commercial expediency of the transaction entered into by the assessee unless there are evidence and circumstances to doubt. Further, the appeal filed by the Revenue against the order of Coordinate Bench for AY 2009-10 has been dismissed and no question of law is admitted and therefore, the issue had attained finality though ld. TPO noted that filing of SLP before the Hon’ble Supreme Court is under consideration.
4.1. The relevant paragraph from the order of Coordinate Bench in assessee’s own case for AY 2009-10 is reproduced below for ready reference.
“27. . We are unable to appreciate such an approach of TPO and under what circumstances, leave above any exceptional circumstances, a transaction of subscription of shares can be re-characterized as Loan transaction. The TPO /Assessing Officer cannot disregarded any apparent transaction and substitute it, without any material of exception circumstance highlighting that assessee has tried to conceal the real transaction or some sham transaction has been unearthed. The TPO cannot question the commercial expediency of the transaction entered into by the assessee unless there are evidence and circumstances to doubt. Here it is a case of investment in shares and it cannot be given different colour so as to expand the scope of transfer pricing adjustments by re-characterizing it as interest free loan. Now. whether in a third party scenario, if an independent enterprise subscribes to a share, can it be characterize as loan. If not, then this transaction also cannot be inferred as loan. The contention of the Ld. Counsel is also supported by the Hon’ble jurisdictional High Court in the case of Bexiskier Dhboal SA, ITA No. 776 of 2011 order dated 30th August, 2012 and by various other decisions, as cited by him. The Coordinate Benches of the Tribunal have been consistently holding that subscription of shares cannot be characterizes as loan and therefore no interest should be imputed by treating it as a loan. Accordingly, on this ground alone, we delete the adjustment of interest made by the Assessing Officer. Thus, ground no. 14 is treated as allowed.”
(Emphasis supplied)
4.2. Also, reproduced is the relevant paragraph from the order of Hon’ble High Court of Bombay in assessee’s own case for Assessment Year 2009-10 whereby the revenue’s appeal was dismissed:
“we are broadly in agreement with the view of the tribunal. the facts on record would suggest that the assessee had entered into a transaction ofpurchase and sale of shares of an AE. Nothing is brought on record by the Revenue to suggest that the transaction was sham. in absence of any material on record, the TPO could not have treated such transaction as a loan and charged interest thereon on notional basis. No question of law arises.”
(Emphasis supplied)
4.3. Further, following the order of the Coordinate Bench for AY 200910 on this issue, this legacy issue has been repeatedly held in favour of the assessee by deleting the upward adjustment made by the ld. TPO/AO in the following assessment years:-
| i. | AY 2010-11 in ITA No. 7694/Mum/2015 and 1209/Mum/2015 dated 8 February, 2017/Aegis Ltd. v. Dy. CIT (Mumbai) |
| ii. | AY 2011-12 (ITA No. 962/Mum/2016) and AY 2012-13 (ITA No 1556/Mum/2015) dated 12 May/Aegis Ltd. v. ITO (Mumbai – Trib.) |
| iii. | AY 2013-14 (ITA No 7438/Mum/2017) dated 6 February, 2019 |
| iv. | AY 2014-15 (ITA No 125/Mum/2019) dated 30 April, 2019 |
| v. | AY 2017-18 (ITA No 717/Mum/2022) dated 06 January, 2023 |
| vi. | AY 2018-19 (ITA No 2247/Mum/2019) dated 30 April, 2019 |
5. We note that ld. CIT(A) has followed the decision of Hon’ble High Court of Bombay as well as the decision of Coordinate Bench of ITAT in assessee’s own case for Assessment Years listed above, wherein it has been held that preference shares subscription by Aegis Ltd. of ESSAR Services (Mauritius) cannot be re-characterized as debt and notional interest cannot be imputed on the same. Respectfully following the decision of Hon’ble High Court of Bombay in assessee’s own case on the very same issue as well as judicial precedents of the Coordinate Bench for the preceding years, when there is no change in fact and position of law, we do not find any reason to interfere with the findings arrived at by ld. CIT(A). Accordingly, ground Nos. 1,2 and 3 raised by the Revenue in this regard are dismissed.
6. On the second issue relating to disallowance made u/s.36(1)(iii) of Rs. 1,57,31,580/- by the ld. Assessing Officer, fact of the matter is that assessee had debited Rs. 27,78,06,357/- in its Profit and Loss account. Ld. Assessing Officer has made the disallowance of Rs. 57,31,580/- on the basis that assessee has not established the commercial expediency for advancing interest-free loans to sister concerns/subsidiaries. He considered the bond yield rate of 11.91% as adopted by ld. TPO for the purpose of making the disallowance.
6.1. As on 31.03.2016, assessee had given interest-free and interestbearing advances, totalling to Rs. 79,75,88,353/-. Breakup of this can be noted into three buckets:
| i. | Interest-free advances to related parties for Rs. 4,10,11,577/- |
| ii. | Interest-bearing advance with interest at the rate of 9% granted to its associated enterprise ESSAR Services (Mauritius) Rs. 2,91,10,000/- |
| iii. | Interest-bearing advances with interest rate higher than 13.50% of Rs.72,74,66,776/- . |
6.2. For the interest-free advances to related parties, ld. Assessing Officer has adopted the bond yield rate of 11.91% as taken by ld. TPO to compute the disallowance of notional interest. In respect of interestbearing advance given to its AE, ESSAR Services (Mauritius), which was at the rate of 9%, ld. Assessing Officer has made a disallowance for the difference in the rate of 11.91% and 9%. Details in this respect, are already tabulated in the above paragraphs.
7. Case of the assessee is that it has its own funds to the tune of Rs. 1,359.1 crores out of which it has lent funds to its sister concerns and subsidiaries. It has factually demonstrated by placing material on record of the availability of having own cash funds for onward lending to sister concerns and subsidiaries. Details in this respect is extracted below for ready reference:
| Particulars | 31st March, 2016 (A) | 31st March, 2015 (B) |
| Source of Funds | Rs. in crores | Rs. in crores |
| Share capital | 262.70 | 282.70 |
| Other Reserves | 812.10 | 811.80 |
| Retained Earnings | 264.30 | 291.20 |
| Net Worth-Own funds (A) | 1359.10 | 1386.70 |
| Application of Funds | ||
| Tangible Assets | 77.50 | 115.80 |
| Intangible Assets | 79.20 | 90.10 |
| Investments (Current and NonCurrent) | 977.80 | 680.30 |
| Loans and advances to Group concerns (Refer Note 1) | 7.01 | 52.96 |
| Total (B) | 1141.51 | 1239.16 |
| Funds Available (A-B) | 217.59 | 146.54 |
7.1. Details of Advances given to sister concerns/subsidiaries (Rs. in Crs.)
| Name of party | 31st March, 2016 (A) | 31st March, 2015 (B) |
| AGC Networks Ltd. | 0.25 | 0.22 |
| ABSGL | ^^B | 0.02 |
| Aegis tech | ^^B | 0.12 |
| GVPL | ^^B | 0.62 |
| Essar Steel | ^^B | 0.00 |
| Aegis Aspire Consultancy Services Ltd. | 3.83 | ^^B |
| Aegis Global Services Pvt. Ltd. | 0.02 | ^^B |
| Essar services Mauritius | 2.91 | 51.98 |
| Total | 7.01 | 52.96 |
8. This issue is also a legacy issue dealt by the Coordinate Bench in the preceding years as already noted above, starting from assessment year 2009-10. In the decision for Assessment Year 2009-10 of the Coordinate Bench it was held that where the assessee had substantial own funds, then presumption is that assessee has given advance to its sister concern from its own funds. Thus, following the ratio laid down by the Hon’ble Jurisdictional High Court of Bombay in the case of CIT v. Reliance Utilities & Power Ltd. (Bombay)/[2009] 313 ITR 340 (Bombay) which has been followed in various other decisions, it was held that no disallowance of interest is called for. Furthermore, the Hon’ble Jurisdictional High Court of Bombay, on an appeal by the Revenue against the decision of Coordinate Bench for Assessment Year 2009-10, upheld the order of the Tribunal and dismissed the appeal filed by the Revenue. Relevant extract from the decision of Coordinate Bench in appeal for Assessment Year 2009-10 is as under:
“57 in such a situation, where the assessee has substantial own funds, then presumption is that assessee has given advance to its sister concern from its own funds. Thus, following the ratio laid down by the Hon’ble jurisdictional High Court in the case of Reliance Utilities and Power Ltd (supra) which have been followed in various other decisions, we hold that no disallowance of interest is called for. Accordingly, ground no. 22 is treated as allowed.”
(Emphasis supplied)
8.1. Extracted below is the relevant paragraph from the decision of Hon’ble High Court of Bombay in assessee’s own case for Assessment Year 2009-10:
“4. Tribunal came to the conclusion that the assessee had sufficient interest free loans out of which subject advances are made. The Tribunal referred to and relied upon the decision of this Court in the case of Commissioner of Income-tax Vis. Reliance Utilities and Power Ltd. reported in (2009) 313 ITR 340 (Bom) and deleted the disallowances.
5. No question of law in this respect arises.”
(Emphasis supplied)
8.2. Order of Coordinate Bench for Assessment Year 2009-10 has been subsequently followed in assessee’s own case for several subsequent assessment years as listed below:
| i. | AY 2010-11 in ITA No 7694/Mum/2015 and 1209/Mum/2015 dated 8 February, 2017 |
| ii. | AY 2011-12 (ITA No. 962/Mum/2016) and AY 2012-13 (ITA No 1556/Mum/2016) dated 12 May, 2017 |
| iii. | AY 2013-14 (ITA No 7438/Mum/2017) dated 6 February, 2019 |
| iv. | AY 2014-15 (ITA No 125/Mum/2019) dated 30 April, 2019 |
| v. | AY 2018-19 (ITA No 2247/Mum/2019) dated 30 April, 2019 |
8.3. Also, there is a long line of decisions wherein it has been held that, where an assessee has both, borrowed and owned funds, it shall be assumed that investments have been made from assessee’s own funds and not from the borrowed funds. Few such judicial precedents are as under:
| i. | South Indian Bank Ltd. v. CIT (SC)/[2021] 438 ITR 1 (SC) |
| ii. | CIT v. Reliance Utilities & Power Ltd. (Bombay)/[2009] 313 ITR 340 (Bombay) |
| iii. | HDFC Bank Ltd. v. Dy. CIT (Bombay)/[2016] 383 ITR 529 (Bom) |
| iv. | CIT v. Ashok Commercial Enterprises [IT Appeal (L) No. 2985 of 2009] |
9. We note that ld. CIT(A) has followed the decision of Hon’ble Jurisdictional High Court of Bombay in assessee’s own case for Assessment Year 2009-10 and the decision of Coordinate Bench in assessee’s own case listed above to hold that interest-free borrowed fund and owned funds amounting to Rs.1,359.10 crores exceeds the interest-bearing funds and therefore, it has to be assumed that the interest-free funds have been utilised for the purpose of advancing interest-free loans. He has also taken note of the fact that interest-free advances given during the year are Rs. 7.01 crores only which are not substantial as compared to the preceding year. In addition to the above, it is brought to our knowledge that in the decision of Coordinate Bench for Assessment Year 2014-15 whereby on similar issue addition made was deleted, Revenue has not challenged the same before the higher forum of Hon’ble High Court and thus, the issue has attained finality. Furthermore, it is brought to our knowledge that no adjustment has been made by the ld. Assessing Officer in Assessment Year 2017-18 u/s. 36(1)(iii).
10. In conspectus of the above narration, there being no change in the material facts and the position of law, we find that there is nothing brought on record to controvert the finding arrived at by ld. CIT(A). Thus, concurring with the same, ground nos. 4 and 5 raised by the Revenue in this regard are dismissed.
11. In the result, appeal of the Revenue is dismissed.