Transfer Pricing Adjustment on CCD Interest Deleted

Transfer Pricing Adjustment on CCD Interest Deleted and Section 94B Interest Computation Restored

Issue

Whether the TPO can recharacterize Compulsorily Convertible Debentures (CCDs) as equity and reduce the arm’s length price (ALP) of interest to nil under Section 92C.
Whether interest expense on CCDs can be disallowed under Section 36(1)(iii) or Section 37(1) without factual findings regarding business utility.
Whether Section 94B disallowance and interest carry-forward benefits should be restored upon deletion of the transfer pricing adjustment to avoid double disallowance.

Facts

CCD Issuance & TP Adjustment: The assessee, engaged in developing industrial and logistics parks, issued 20-year rupee-denominated CCDs carrying a 14% coupon to its Singapore Associated Enterprise (AE). The TPO recharacterized the CCDs as equity, determined the ALP of interest as nil, and proposed an adjustment of ~Rs. 3.40 crores.
Alternative Section 36(1)(iii)/37(1) Disallowance: While upholding the TP adjustment, the DRP directed the AO to disallow the interest expenditure under Section 36(1)(iii) or Section 37(1) as an alternative ground, without providing specific findings on commercial expediency or usage.
Section 94B Disallowance & Carry-Forward: The assessee had suo motu disallowed ~Rs. 41.33 lakhs under Section 94B in its tax return. To avoid double taxation, the AO reversed this Section 94B disallowance while incorporating the nil-ALP TP adjustment. The DRP restricted the Section 94B interest carry-forward claim to nil solely because it sustained the nil-ALP adjustment.

Decision

TP Adjustment Deleted (In favour of Assessee): CCDs cannot be recharacterized as equity to set the ALP of interest at nil without evidence of a sham arrangement or comparable uncontrolled nil-return instruments.
Alternative Interest Disallowance Set Aside (In favour of Assessee): The alternative disallowance under Section 36(1)(iii)/37(1) cannot stand as the DRP made no independent finding that the borrowed funds lacked business utility.
Section 94B Interest Restored (Partly in favour of Assessee / Remanded): Following the deletion of the TP adjustment, the AO must verify the original computation and grant appropriate relief under Section 94B, including allowable carry-forward, while ensuring no double disallowance occurs.

Key Takeaways

No Arbitrary Recharacterization of CCDs: Revenue authorities cannot recharacterize debt instruments like CCDs into equity solely to benchmark interest at nil, provided the transaction is genuine and commercially valid.
Burden of Proof for Expense Disallowance: Statutory interest disallowances under Section 36(1)(iii) or 37(1) require specific factual findings demonstrating non-business usage or lack of commercial expediency.
Prohibition of Double Disallowance: Tax adjustments under transfer pricing and statutory interest limitation provisions (Section 94B) must be harmonized to prevent taxing or disallowing the same income stream twice.

IN THE ITAT MUMBAI BENCH ‘H’

HCY Industrial Parks (P.) Ltd.

Assessment Unit, Income Tax Department

NARENDER KUMAR CHOUDHRY, Judicial Member
and MAKARAND VASANT MAHADEOKAR, Accountant Member

IT Appeal No. 1899 (Mum.) OF 2026
[Assessment year 2022-23]

OCTOBER 1, 2026

Vijay Mehta, Ld. A.R. for the Appellant. Pravin Salunkhe, Ld. Sr. D.R. for the Respondent.

ORDER

Makarand Vasant Mahadeokar, Accountant Member. – This appeal by the assessee is directed against the final assessment order dated 26.12.2025 passed under section 143(3) read with sections 144C(13) and 144B of the Income-tax Act, 1961[hereinafter referred to as “the Act”], pursuant to the directions dated 20.11.2025 issued by the Dispute Resolution Panel-1, Mumbai (“DRP”) under section 144C(5) of the Act.

2. The assessee is engaged in the business of developing and operating industrial and logistics parks. For the assessment year under consideration, it filed its return of income on 29.11.2022 declaring nil total income. The case was selected for scrutiny through CASS. The assessment record states that one of the matters identified for examination concerned interest expenditure and the applicability of section 94B of the Act.

3. During the relevant previous year, the assessee reported an international transaction involving interest of Rs.3,40,27,280/- on compulsorily convertible debentures (“CCDs”) issued to its associated enterprise (AE), ILP Core Ventures III Pte. Ltd. The matter was referred to the Transfer Pricing Officer (“TPO”). In the order dated 27.01.2025 passed under section 92CA(3), the TPO treated the CCDs as instruments in the nature of equity, determined the arm’s length price of the interest payment at nil and proposed an adjustment of Rs.3,40,27,280/-. The Assessing Officer incorporated that adjustment in the draft assessment order dated 28.02.2025 and proposed to assess the total income at Rs.3,40,27,280/-.

4. The assessee filed objections before the DRP. It disputed, among other matters, the characterisation of the CCDs as equity, the determination of the arm’s length price at nil, the rejection of its benchmarking analysis and the treatment of interest already disallowed by it under section 94B of the Act. The DRP, by its directions dated 20.11.2025, upheld the transfer pricing adjustment. It also directed the Assessing Officer to consider the disallowance under sections 36(1)(iii) and 37(1) of the Act as an alternative basis, without making a duplicate addition. The DRP further issued directions concerning the interest claimed for carry forward under section 94B and the interest component in the capital work-in-progress or fixed asset base.

5. In the final assessment order, the Assessing Officer added Rs.3,40,27,280/- on account of interest on the CCDs and reversed the disallowance of Rs.41,33,106/- already made by the assessee under section 94B, to avoid adding the same amount twice. After setting off the resulting business loss against income under other heads, the Assessing Officer assessed the total income at Rs.23,97,730/-.

6. Aggrieved, the assessee has raised the following grounds of appeal :

Ground No. 1 – General Ground

On the facts and in the circumstances of the case and in law, the Hon’ble Dispute Resolution Panel (‘Hon’ble DRP’)/ Transfer Pricing Officer (‘Ld. TPO’) have erred in making an addition of INR 3,40,27,280/- to the total income of the Appellant by re-characterizing the Compulsorily Convertible Debentures (‘CCDs’) as ‘Equity’ and thereby re-determining Arm’s Length Price (‘ALP’) of interest on CCDs at Nil.

Ground No. 2 – Recharacterizing CCD into equity is not permissible

The Hon’ble DRP/ Ld. AO / Ld. TPO has erred in re-characterizing the CCDs as ‘Equity’, treating the CCDs on par with advance share capital (akin to share application money), thereby disregarding the contractual terms governing the CCDs and consequently determining the ALP of the interest on CCDs as Nil.

2.1. Ignoring that CCDs are debt Instruments until converted into Equity

The Hon’ble DRP/ Ld. AO/ Ld. TPO have erred in disregarding the fact that CCDs are debt instruments until their actual conversion into equity by ignoring binding and persuasive judicial precedents which hold that CCDs constitute debt until conversion and that interest paid thereon is allowable.

2.2. Erroneous finding that ‘Conversion Ratio’ was decided in advance

The Hon’ble DRP/ Ld. AO / Ld. TPO erred in law and on facts by alleging that the ratio of conversion of CCDs into equity shares is decided in advance i.e., at the time of issuance of CCDs, while in reality, the terms of issue as per CCD subscription agreement clearly provides that conversion will be at Fair Market Value determined by an independent valuer at the time of conversion and the same was not decided in advance .

2.3. Ignoring the fact that CCDs are not appreciating in nature until conversion

The Hon’ble DRP/ Ld. AO / Ld. TPO erred in ignoring the fact that the CCDs are non-appreciating in nature i.e., AE, being the CCD holder, will only get such number of equity shares based on the Fair Market Value of the Company on the conversion date and therefore, not entitled to any appreciation in equity value until conversion.

2.4. Mere absence of redemption does not justify recharacterisation of CCDs as equity

The Ld. AO / Ld. TPO / Ld. DRP have erred in law in holding that absence of redemption or traditional cash repayment renders CCDs as equity from the date of issuance, ignoring that conversion into equity itself results in extinguishment of the debt obligation and hence akin to repayment/redemption.

Ground No. 3 – Failure to record satisfaction under section 92C(3) of the Act and incorrect rejection of benchmarking analysis by Appellant

The Hon’ble DRP/ Ld. AO/ Ld. TPO have failed to demonstrate that any of the conditions specified u/s 92C(3)(a) to (d) of the Act were satisfied before disregarding the Appellant’s Transfer Pricing Study Report (‘TPSR’) and erred in rejecting the benchmarking analysis undertaken by Appellant using SBI PLR under Other Method.

Ground No. 4 – Double taxation of interest on CCDs in India as there is no motive for shifting profits outside of India

The Hon’ble DRP/ Ld. AO / Ld. TPO erred in failing to appreciate the fact that the interest income arising from the CCDs has been offered to tax in India by the Associated Enterprises and hence, there was no intention to shift profits outside of India. Consequently, making an adjustment in the case of the Appellant is tantamount to double taxation in India.

Ground No. 5 – Factual error in DRP’s reliance on Indian Accounting Standard (Ind AS)

The Hon’ble DRP has erred in law in faulting the Appellant for not bifurcating CCDs into equity and debt components as per Ind AS, when Ind AS itself is admittedly not applicable to the Appellant, rendering the impugned reasoning perverse and unsustainable

Ground No. 6 – Factual error in DRP’s reliance on ‘Self-Recognition’ by the Appellant of equity component

On the facts and circumstances of the case and in law, the Ld. DRP has erred in holding, without due application of mind, that the Appellant has ‘self-recognized’ an equity component in respect of the CCDs, without appreciating that no such equity component has been recognized or recorded in the Appellant’s audited financial statements. The Appellant has in fact recognised the CCDs as long-term borrowings in the financial statements.

Ground No. 7 – Failure to consider the disallowance already made for interest on CCDs as per Section 94B of the Act

The Hon’ble DRP/ Ld. AO / Ld. TPO erred in disregarding the disallowance of interest expenses amounting to INR 41,33,106/- already made by the Appellant under Section 94B of the Act in its computation of income for the year under consideration, resulting in double disallowance of the same interest expenses to the tune of INR 41,33,106/-

Ground No. 8 – Characterisation of CCD as per judicial precedents and definition under other statutes is not relevant for Income-tax

The Ld. DRP erred in treating the CCDs as being in the nature of equity by relying on the definition/explanation under FEMA and judicial precedents by Hon’ble Supreme Court rendered under other statutes (Insolvency and Bankruptcy Code, 2016, Capital Issues (Control) Act, 1947/Capital Issues (Exemption) Order, 1969, Companies Act, 1956, Securities and Exchange Board of India Act, 1992, Electricity Supply Act, 1948) , while ignoring the fundamental principle, as consistently upheld by judicial precedents, that interpretations from other statutes cannot be imported for Income-tax purposes unless expressly provided under the Income-tax law.

Ground No. 9 – Incorrect alternate disallowance of interest under Section 36/Section 37 of the Act

On facts and circumstances of the case, Ld. DRP erred in making an alternative disallowance of interest on CCDs under Section 36(1)(iii)/Section 37(1) of the Act.

Ground No. 10 – Levy of interest and fee without any specification of underlying sections of the Act in the computation sheet

On the facts and in the circumstances of the case and in law, the Ld. AO has erred in levying interest without specifying the relevant sections of the Act under which the same is levied, rendering the levy unsustainable in law.

Ground No. 11 – Penalty Proceedings Under Section 270A of the Act

On the facts and circumstances of the case and in law, the Ld. AO erred in initiating penalty proceedings under section 270A of the Act.

7. During the course of hearing before us the learned Authorised Representative (AR) reiterated the facts stated in the orders of the authorities below and referred to the written synopsis filed on behalf of the assessee. He submitted that the assessee is a wholly owned subsidiary of ILP Core Ventures III Pte. Ltd. On 16.11.2015, the assessee issued 2,43,052 compulsorily convertible debentures (“CCDs”) to that associated enterprise at a face value of Rs.1,000/-each, aggregating to Rs.24,30,52,000/-. The interest paid on the CCDs during the year under consideration was Rs.3,40,27,280/-.

8. Referring to the CCD agreement dated 19.09.2016, placed at pages 49 to 54 of Paper Book 1, the learned AR submitted that the coupon rate was 14% per annum. Interest was subject to a moratorium up to 31.12.2020 and was paid from 01.01.2021. According to the assessee’s computation, the five year moratorium reduced the effective rate over the life of the instrument to 10.50% per annum. The assessee had benchmarked that rate under the “Other Method” against the State Bank of India prime lending rate of 12.23% for financial year 2021-22. The learned AR also submitted that the interest rate fell within the safe harbour limit of 11.25%.

9. The learned AR submitted that the TPO erred in treating the CCDs as equity from the date of issue. In particular, he disputed the finding that the conversion ratio had been fixed at inception. He drew attention to the following term of the CCD agreement, as reproduced below:

“The CCDs shall be compulsorily convertible upon the expiry of 20 years or at such early date at the option of majority of the CCD holder(s) or the company. The CCDs shall be converted into the equity shares at a fair market value determined as on the Conversion Date on the basis of internationally accepted pricing methodology on arm’s length basis (Conversion price) However the conversion price will not be less than the fair value as on the date of the offer”.

10. It was submitted that the number of shares receivable upon conversion would depend on the fair market value determined at that time, subject to the contractual floor stated above. The associated enterprise, according to the learned AR, had no voting or dividend rights as a shareholder before conversion and did not participate in any appreciation in the assessee’s equity during that period. He contended that a mandatory future conversion did not, by itself, make the CCDs equity at the time of issue. He further submitted that the TPO could determine the arm’s length price of the reported interest transaction but could not replace that transaction with an assumed equity investment and, on that basis, determine its interest price at nil.

11. In support of the asserted distinction between a debenture and a share before conversion, the learned AR relied on the following decisions:

CIT v. Secure Meters Ltd. [2010] 321 ITR 611 (Rajasthan)

ii.

CIT v. ITC Hotels Ltd. [2011] 334 ITR 109 (Karnataka)

iii.

EBIXCASH World Money Ltd. v. Dy. CIT (Mumbai – Trib.)

iv.

Summit Developments (P.) Ltd. v. Dy. CIT (Bangalore – Trib.)/[IT (TP)A No. 794/Bang/2022]

CAE Flight Training (India) v. DCIT [IT (TP) Appeal No. 2060/Bang/2016]

vi.

IMS Health Analytics Services (P.) Ltd. v. Dy. CIT [IT Appeal No. 1549 (Bang.) of 2019, dated 19-6-2020]

vii.

Hyderabad Infratech (P.) Ltd. v. Dy. CIT (Hyderabad – Trib.)/[ITA-TP No. 1856/Hyd/2019]

12. The learned AR distinguished the decisions relied upon by the TPO and the DRP. He submitted thatIFCI Ltd. v. Sutanu Sinha [2023] 2024] 182 SCL 27 (SC) concerned the treatment of debentures in proceedings under the Insolvency and Bankruptcy Code, 2016, and turned upon the terms of the agreement considered there. According to him, the assessee’s agreement did not treat the CCD subscription as part of an equity contribution. He submitted that the other decisions discussed by the DRP arose under securities, company or electricity legislation and did not determine the tax character of the present interest payment. He also distinguishedDy. CIT v. Mahindra Homes (P.) Ltd. [2025] (Mumbai – Trib.), cited by the learned DR during the hearing, on the ground that it concerned benchmarking of interest on CCDs rather than their re-characterisation as equity.

13. The learned AR further submitted that tax had been deducted at source on the interest at the rate claimed to be applicable under the India-Singapore Double Taxation Avoidance Agreement and that the associated enterprise had offered the interest to tax in India. As regards the DRP’s alternative direction under sections 36(1)(iii) and 37(1), he relied on the assessee’s submission dated 18.06.2025, placed at pages 91 to 97 of Paper Book 1, and disputed the premise that the CCD proceeds were not borrowed capital or that the interest lacked a business nexus. He also opposed the DRP’s direction concerning the amount claimed for carry forward under section 94B.

14. On ground no. 10, the learned AR submitted that interest of Rs.1,12,212/- had been charged in the computation without a section-wise break-up, preventing the assessee from verifying the levy. He prayed for deletion of the transfer pricing adjustment of Rs.3,40,27,280/- and the alternative disallowance upheld by the DRP, together with consequential relief.

15. The learned Departmental Representative (DR) relied on the orders of the TPO and the directions of the DRP and prayed that the adjustment be sustained. In his written submissions recording the arguments made at the hearing, he submitted that the assessee’s benchmarking proceeded on the premise that the CCDs were a loan. According to him, the TPO examined the features of the instrument, rejected that benchmarking and determined that an unrelated party would not have paid interest for a funding facility on those terms.

16. The learned DR disputed the assessee’s contention that the TPO had impermissibly recharacterised the CCDs. Referring to sections 92(1) and 92(2) of the Act, he submitted that income and expenditure arising from an international transaction must be computed having regard to the arm’s length price. His case was that the TPO had left the legal form of the CCDs undisturbed and had determined the arm’s length price of the funding facility by applying the “Other Method” under rule 10AB. The inquiry, as framed by the learned DR, was whether unrelated parties would have agreed to pay interest for a facility bearing the features of these CCDs. He characterised the determination of nil interest as a pricing conclusion, rather than a substitution of another transaction.

17. In that connection, the learned DR referred to CIT v. EKL Appliances Ltd. 345 ITR 241 (Delhi) He submitted that the decision recognises exceptions to the ordinary approach of examining an international transaction as actually undertaken: where its economic substance differs from its legal form, and where the arrangement viewed as a whole is one that independent parties would not have adopted. According to the learned DR, the reasoning of the TPO and the DRP was supported by those exceptions. This is recorded as the Revenue’s submission; the applicability of the decision has not been determined at this stage.

18. Addressing the authorities cited by the assessee, the learned DR referred to Secure Meters, Religare Finvest v. DCIT [IT Appeal No. 4796 (Del) of 2017, dated 13-7-2023], CAE Flight Training, Praxair India (P.) Ltd. v. Dy. CIT (Bangalore – Trib.)/(IT(TP)A No. 200/Bang/2021), Indorama Ventures Oxides Ankleshwar (P.) Ltd. v. Assessment Unit, Income-tax Department / DCIT (Mumbai – Trib.)/(ITA No. 4023/Mum/2024), Stahl India (P.) Ltd. v. DCIT [IT (TP) Appeal No. 52 (Chny) of 2024, dated 10-12-2024], Hyderabad Infratech, WeWork India Management (P.) Ltd. v. Dy. CIT (TP) (Bangalore – Trib.)/IT(TP)A No. 819/Bang/2022, Embassy One Developer’s (P.) Ltd. v. Dy. CIT [IT Appeal Nos.2239 and 2240 (Bang) of 2018, and Summit Developments. He submitted that the majority of those decisions, directly or through the decisions on which they relied, concerned the allowability of expenditure under sections 36(1)(iii) or 37 in ordinary assessment proceedings. In his submission, the issue under Chapter X was different: whether an independent party would have entered into this transaction on these terms and, if so, what interest it would have agreed to pay. He contended that classification as debt for company law or accounting purposes would not necessarily establish that the interest claimed had a positive arm’s length price.

19. The learned DR also relied on IFCI Ltd. (supra). As he understood that decision, the presence of a genuine obligation to repay the principal was material to the characterisation of a CCD. He submitted that, where the instrument provided for conversion into equity without repayment of principal, the holder’s position was that of a prospective equity participant rather than a creditor. He opposed the assessee’s attempt to distinguish IFCI Ltd. solely because it arose under the Insolvency and Bankruptcy Code. According to him, although the statutory consequences might differ, the reasoning concerning the obligation of repayment was of general application. He stated that the DRP had adopted that approach in its analysis at page 63 of its directions.

20. The learned DR further addressed the assessee’s reliance on S.A. Builders and Cotton Naturals on commercial expediency. He submitted that those decisions protected an assessee’s business judgment concerning the purpose of incurring an expenditure or entering into a transaction, but did not prevent a TPO from pricing an international transaction by reference to what independent parties would have agreed. In support of that submission, he relied on the TPO’s and DRP’s conclusion that “no third party would have invested in the convertible debentures issued by the assessee except by way of participation in equity”.

21. As regards the conversion terms, the learned DR submitted that fixing the number of shares by reference to fair market value on the conversion date did not alter the mandatory nature of conversion. In his submission, that mechanism determined how many shares would be issued, whereas the obligation to issue shares was certain. He therefore disputed the assessee’s contention that the absence of a conversion ratio fixed at issuance was decisive of the debt or equity character of the CCDs. He further argued that the fair market value mechanism indicated an intention that the subscriber participate in the company’s appreciation or depreciation through conversion, instead of receiving repayment of a fixed principal amount.

22. Lastly, the learned DR adopted the DRP’s reference to the treatment of such instruments under FEMA, SEBI provisions and Ind AS as further support for the Revenue’s characterisation for arm’s length price purposes. On these submissions, he prayed that the assessee’s grounds be dismissed and the orders of the authorities below be confirmed.

23. In rejoinder, the learned AR disputed the Revenue’s description of the TPO’s action as merely determining the arm’s length price of interest under the “Other Method”. According to him, the TPO had not applied section 92C read with rule 10AB to determine a price for the reported interest transaction. The determination of a nil price rested instead on treating the CCDs as equity. The learned AR therefore maintained that the adjustment involved a recharacterisation of the instrument, notwithstanding the Revenue’s description of it as a pricing exercise.

24. The learned AR disputed the applicability of the exceptions discussed in EKL Appliances Ltd. (supra). He submitted that the CCD agreement, transfer pricing study and financial statements had been furnished and, in his submission, disclosed no divergence between the transaction’s legal form and economic substance. He asserted that the transfer pricing study provided a benchmarking method supporting the interest paid to the associated enterprise, and that the TPO had not challenged that method during the assessment proceedings. He also invoked Vodafone International Holdings B.V. v. Union of India 341 ITR 1 (SC) in support of his contention that the legal form of a genuine transaction should be respected. According to him, the Assessing Officer and the TPO had brought no evidence on record to show that the CCD transaction was a sham or had been structured to avoid tax. He submitted that the purported determination of arm’s length price was, in substance, a means of treating the CCDs as equity.

25. The learned AR next disputed the Revenue’s assertion that the decisions cited by the assessee predominantly concerned deduction of interest under sections 36(1)(iii) or 37, rather than transfer pricing. He referred specifically to CAE Flight Training, Hyderabad Infratech, Summit Developments, Praxair India, Indorama Ventures, Stahl India, WeWork India and Embassy One. His submission was that those decisions addressed the treatment of CCDs in proceedings under Chapter X, including the question whether a TPO could treat them as equity instead of determining the arm’s length price of the transaction reported by the assessee. As to Secure Meters and Religare Finvest, he acknowledged that they arose in the context of deductibility, but maintained that they remained relevant to the character of a debenture before its conversion.

26. Responding to the Revenue’s reliance on IFCI Ltd. (supra), the learned AR maintained the distinction drawn in the earlier submission. He submitted that IFCI Ltd. arose under the Insolvency and Bankruptcy Code, 2016, and did not determine the treatment of the interest payment under the Income-tax Act. He also contended that the Revenue’s approach was inconsistent: it sought to distinguish authorities cited by the assessee because they arose in the context of deductions, while relying upon IFCI Ltd., which arose under another enactment. He reiterated the assessee’s submission that an interpretation under another statute could not, without the requisite basis, be adopted for determining the present adjustment.

27. The learned AR continued to rely on S.A. Builders Ltd. v. CIT (Appeals) 288 ITR 1 (SC) and CIT v. Cotton Naturals (I) (P.) Ltd. [2015] (Delhi) in answer to the Revenue’s submissions concerning commercial expediency. He submitted that the TPO’s task was confined to determining whether the interest payment conformed to the arm’s length principle. According to him, that task did not extend to questioning the commercial expediency of the assessee’s choice of funding instrument. He maintained that the TPO’s treatment of the CCDs as equity crossed that limit.

28. On the conversion mechanism, the learned AR disputed the Revenue’s submission that a fair market value-based conversion ratio reinforced the equity character of the CCDs. He submitted that, before conversion, the holder had no voting rights, entitlement to dividends or participation in appreciation or depreciation of the assessee’s equity value. According to him, the shares allotted upon conversion would represent value equivalent to the face value of the CCDs and would confer no equity linked gain for the period before conversion. He therefore maintained that the provision for mandatory conversion did not alter the character of the CCDs during the period for which interest was payable.

29. Lastly, the learned AR disputed the Revenue’s reliance on treatment under Ind AS, FEMA and SEBI provisions. Referring to notes 3 and 5 to the audited financial statements for the year ended 31.03.2022, placed at pages 7 and 8 of Paper Book 1, he submitted that the assessee did not prepare its accounts under Ind AS. He asserted that no equity component of the CCDs had been recognised and that their entire amount was disclosed as long term borrowings under the accounting principles applied by the assessee. He submitted that the same treatment appeared in Form 3CEB and the transfer pricing study. He reiterated his objection to relying on treatment under other statutes to support the transfer pricing adjustment.

30. We have considered the rival submissions, the written rejoinder, the transfer pricing order, the directions of the DRP and the material referred to by the parties. The dispute concerns interest of Rs.3,40,27,280/- on compulsorily convertible debentures CCDs issued by the assessee to its associated enterprise (“AE”). The TPO determined the arm’s length price (“ALP”) of that interest at nil. The DRP sustained that conclusion and, alternatively, considered the payment inadmissible under sections 36(1)(iii) and 37(1) of the Act.

31. The assessee issued 2,43,052 CCDs of Rs.1,000/- each to its Singapore AE. The instrument carries a stated coupon of 14%, subject to the terms concerning the initial moratorium. Conversion is compulsory on the expiry of twenty years, with provision for earlier conversion. The conversion price is linked to fair market value at conversion, subject to the stipulated floor. These provisions, rather than the word “debenture” or its classification under another regulatory regime alone, identify the rights for which the parties contracted.

32. Two features must be kept in view together. The holder cannot require ordinary repayment of the principal in cash at maturity: the instrument must convert into shares. Yet the material identified by the Revenue does not show that shares had been allotted during the relevant year, that the holder could then vote as a shareholder or receive a dividend, or that the contractual provision for pre-conversion interest had ceased to operate. The issue before us is the ALP of that present payment obligation. A conclusion about the treatment of the principal on eventual conversion does not, without further analysis, answer that issue.

33. The conversion clause also bears upon the authorities’ description of the bargain. The TPO referred to a fifteen-year period; the terms reproduced by the assessee prescribe twenty years. The DRP proceeded on the footing that the number of shares issuable on conversion was fixed from inception. The identified clause instead links the conversion price to fair market value at conversion, subject to a floor. The Revenue has pointed to no other clause fixing the number of shares at issue. We therefore cannot adopt the finding of a predetermined conversion ratio on the material identified in the impugned orders.

34. That does not mean the future equity entitlement can be ignored. Conversion at a future fair market value, and the floor applicable to the conversion price, may affect the investor’s eventual return and the price that an independent investor would require for bearing the instrument’s risks. Nor is a twenty-year instrument without a right of cash redemption necessarily comparable, without adjustment, to an ordinary short-term bank loan. Those matters call for examination when selecting and adjusting comparables. They do not, of themselves, prove that the price of the stipulated interest is zero.

35. We first address the Supreme Court decisions on which considerable emphasis was placed. In Narendra Kumar Maheshwari v. Union of India AIR 1989 SC 2138, the Court considered a proposed capital issue and the application of the guidelines governing protection of debenture holders. In examining why guidelines directed to service and repayment of ordinary debentures did not apply in the same way, it observed that a compulsorily convertible debenture “does not postulate any repayment of the principal.” The Court then referred to the distinction drawn in the capital issue guidelines between convertible and non-convertible instruments and their treatment of compulsory convertibles as equity for that purpose.

36. The judgment also records the issuer’s explanation of its proposed security: it would earn “a fixed rate of interest from the first day till it was converted into equity”, with a possible dividend entitlement thereafter. That description is part of the account of the issue placed before the Court; it is not a judicial determination of the ALP of the coupon. The Court’s reasoning prevents us from treating these CCDs as ordinary debentures whose principal is repayable in cash. It does not supply a rule that every contractual payment of interest before conversion is to be valued at nil under Chapter X.

37. In IFCI Ltd. (supra) the question was whether the CCD subscriber was a financial creditor of the company undergoing insolvency, ICTL. The Court examined the financing documents together. The concession agreement expressly included compulsorily convertible instruments in the equity component of project financing. Under the debenture subscription agreement, the 11% coupon and the buyback arrangement were obligations of the sponsor company, IVRCL, rather than ICTL. The Court’s conclusion thus depended both on the agreed place of the CCDs in the project’s capital structure and on whose obligation the subscriber sought to enforce. In paragraph 20 the Court stated: “the obligations are of the sponsor company.” It declined to create a debt against ICTL by adding an obligation that the commercial documents did not place upon it.

38. Paragraphs 21 to 24 of IFCI explain the basis of that conclusion. Commercial instruments drafted by the parties were to be read according to their terms; the Court would not supplement them to provide the investor with a recovery against ICTL when its bargain placed the relevant obligations elsewhere. The Court also considered that treating those CCDs as debt of ICTL would conflict with the concession and common loan agreements. We give full weight to its analysis of compulsory conversion and the absence of a principal repayment claim against the company concerned. In this appeal, however, the Revenue identifies the assessee itself as the issuer obliged to pay the disputed coupon. IFCI did not determine the ALP under the Income-tax Act of interest expressly payable by an issuer on its unconverted CCDs. Its reasoning requires close attention to the complete agreement and the actual obligor; its insolvency conclusion cannot simply be transposed into an ALP of nil

39. Sahara India Real Estate Corp. Ltd. v. SEBI 116 SCL 160 (SC), concerned optionally fully convertible debentures issued to investors and the operation of the securities law governing that issue. The hybrid features of a convertible instrument were pertinent to whether the issue fell within SEBI’s jurisdiction. Neither the instrument nor the statutory question was the one before us. Recognition of a security’s convertible character does not establish an uncontrolled price for this assessee’s pre-conversion interest.

40. The judgment in Ferro Alloys Corpn. Ltd. v. A.P. State Electricity Board 1993 Supp (4) SCC 136, concerned security deposits required from electricity consumers. The Court examined the conditions of supply, the Boards’ statutory functions, the credit enjoyed by consumers between supply and billing, and the absence of a general right to interest on every such deposit. In assessing a clause that expressly withheld interest, it observed that “Nor all deposits need carry interest in every transaction.” Its conclusion that such a clause was not arbitrary rested on the purpose of the consumption security and the terms on which electricity was supplied. Where a Board’s terms provided for interest, that provision likewise had to be addressed. A consumer’s security deposit under those conditions is no comparable to an international CCD subscription with an express coupon. Ferro Alloys supplies neither a prohibition on paying the agreed coupon nor an ALP of nil for it.

41. The Revenue’s reliance onAshima Syntex Ltd. v. Asstt. CIT [2006] 100 ITD 247 (Ahmedabad – ITAT) must likewise be tested against the expenditure actually in issue. That decision examined expenditure incurred in issuing convertible instruments, including an instrument partly converted on allotment. Brooke Bond India Ltd. v. CIT 225 ITR 798 (SC) addressed expenditure incurred to raise share capital. The present adjustment concerns a recurring amount stated to be payable to the holder while conversion has not occurred. An answer to whether the cost of procuring capital is capital or revenue expenditure does not automatically answer whether a later coupon has an arm’s length price.

42. The same distinction governs the decisions cited by the assessee on issue expenditure. InCIT, Udaipur v. Secure Meters Ltd. [2008] [2010] 321 ITR 611 (Rajasthan), the Rajasthan High Court applied India Cements Ltd. v. CIT [1966] 60 ITR 52 (SC), to expenditure incurred in raising funds through convertible debentures. Its reasoning examined the character of expenditure when the funds were raised, and rejected the contention that prospective conversion necessarily made that expenditure a cost of raising share capital. CIT v. ITC Hotels Ltd. considered the same kind of issue expenditure. Those holdings are relevant to the error of treating future conversion as if it had already occurred; they do not determine the price of the coupon in this case.

43. The judgement of Hon’ble Bombay High Court in HDFC Bank Ltd. v. Dy. CIT 477 ITR 197 (Bombay), makes that boundary particularly clear. The assessee there incurred printing, advertisement, professional, stamp duty, filing and bank expenses in connection with a rights issue of fully convertible debentures. The authorities had denied the expenditure on the premise that the true object was to increase share capital, applying Brooke Bond. In paragraphs 14 to 17, the High Court examined the decisions in Ranbaxy Laboratories, Havells India, Secure Meters, Faze Three and Reliance Natural Resources. It followed the established treatment of expenditure on issuing convertible debentures and answered the question in the assessee’s favour. The factual basis and the authorities considered by the Court must accompany its answer to the question. Its judgment supports rejecting an automatic inference from future conversion to present share-issue expenditure. Because HDFC Bank concerned issue costs, it does not itself establish either that a recurring 14% coupon is deductible in full or that 14% is its ALP.

44. Decisions dealing directly with pre-conversion interest provide closer guidance. In Embassy One Developers Pvt. Ltd. (supra), the Co-ordinate Bench examined why CCDs were described as equity under the foreign investment framework: compulsory conversion removed a future foreign currency repayment obligation. It reasoned that this regulatory description could not be carried over without examination to the separate questions of interest, dividends and voting rights before conversion. Crucially, when it came to the rate of interest, it dealt with that as a separate ALP question and restored it for determination. We adopt that separation of questions, not any supposed finding in Embassy One that a particular coupon is arm’s length.

45. CAE Flight Training (India) Pvt. Ltd., IMS Health Analytics Services Pvt. Ltd., Religare Finvest Ltd. and TE Connectivity Services India (P.) Ltd. v. National Faceless Assessment Centre, Delhi (Bangalore – Trib.)/[IT(TP)A No. 191/Bang/2022] were cited for the treatment of the holder’s rights and the issuer’s interest obligation before conversion. Their reasoning assists in rejecting the proposition that compulsory future conversion, without more, makes a current coupon a dividend or extinguishes an agreed obligation. Their respective questions of deductibility and contractual character must nevertheless be distinguished from the separate task of pricing this assessee’s transaction under Chapter X.

46. There are also decisions addressing transfer pricing itself. In Sthal India Pvt. Ltd. (supra), the Coordinate Bench considered a nil-ALP determination on CCD interest. The assessee had presented 57 uncontrolled CCD issuances, yielding a range of 10% to 12.65%, within which its 11% coupon fell. The Bench noted that the TPO had discarded that analysis without cogent reasons and “did not conduct any search in accordance with TP regulations.” Its conclusion was thus supported by both its examination of the legal premise and actual comparable evidence. The record before us must be judged on its own comparables; Sthal India is authority against replacing that examination with a bare nil figure.

47. In Ebixcash World Money Ltd. (supra), the coordinate Bench considered a 9% coupon on CCDs and a substantial adjustment founded on the TPO’s treatment of the instruments as equity. The decision addresses the defect in assigning a nil price merely from that classification and examines the holder’s rights before conversion. We find that approach persuasive to the extent it requires examination of the actual obligation and its pricing. It does not dispense with scrutiny of this assessee’s 14% stated rate, moratorium and conversion terms. Indorama Ventures Oxides Ankleshwar Pvt. Ltd., concerning a proposed adjustment for an alleged embedded call option, similarly illustrates the need to identify and support the particular transaction said to be priced; it supplies no price for this coupon.

48. The currency of the instrument matters to the choice of benchmark. In Praxair India Pvt. Ltd., the Tribunal examined rupee-denominated CCDs and rejected an automatic foreign currency borrowing benchmark. The Special Bench in Hyderabad Infratech Pvt. Ltd. was specifically asked whether interest on debentures denominated in Indian currency should be benchmarked with the domestic prime lending rate (“PLR”) or LIBOR. Its answer favoured the domestic currency benchmark. That ruling resolves the question referred to it; it does not fix a universal coupon for every rupee CCD, or relieve a party of examining tenor, credit standing, conversion rights, security and other material differences. The authorities below could therefore scrutinise the assessee’s proposed SBI PLR comparison, but could not reject any domestic-rate inquiry solely by calling the CCD equity.

49. WeWork India Management Pvt. Ltd. is pertinent for another reason. In dealing with CCD interest, the Tribunal distinguished the transfer pricing provisions, which address the arm’s length price of the transaction, from section 94B, which restricts interest deductibility by a statutory computation. It did not treat the application of section 94B as proof that every rupee of interest had been priced correctly. Equally, a section 94B disallowance does not permit the TPO to bypass Chapter X when determining ALP.

50. We have also considered the Revenue’s submission founded on EKL Appliances Ltd. (supra). The Hon’ble Delhi High Court, discussing the OECD guidance, recognised that the tax administration ordinarily examines the transaction the parties actually undertook. It also identified exceptional circumstances: a difference between economic substance and form, or an arrangement whose actual structure, viewed as a whole, is commercially irrational and practically impedes determination of an appropriate transfer price. Thus neither the assessee’s assertion that recharacterisation is invariably forbidden nor the Revenue’s assertion that it may always substitute equity for a CCD states the full principle. The relevant contractual and economic facts must establish the basis for such a course.

51. Here, the TPO said that an independent investor would have subscribed only as an equity participant and consequently valued every rupee of the stipulated coupon at nil. Yet the order itself discusses creditworthiness, tenure, conversion and possible interest-rate comparisons. It does not explain why these features make determination of an appropriate price impracticable. It does not reconcile its assumed fifteen-year term or fixed share ratio with the clause reproduced by the assessee. Nor does it identify evidence establishing that the obligation to pay the coupon was a sham or that, notwithstanding the agreement, the issuer bore no such obligation. The exceptional basis discussed in EKL Appliances has therefore not been established on this record.

52. Calling this exercise the “Other Method” does not alter what rule 10AB requires. The method has regard to the price charged or paid, or that would have been charged or paid, in a same or similar uncontrolled transaction under similar circumstances. The Revenue identifies no uncontrolled CCD issue, financing arrangement or other sufficiently analysed transaction under which an investor bearing the relevant risks received a nil pre-conversion return. An assertion that an independent party would have chosen another capital structure requires evidence and reasoning before it can displace an identified payment obligation. Low creditworthiness, a long tenor and lack of principal redemption are potentially significant pricing characteristics; none logically produces a price of exactly zero without analysis.

53. The assessee’s benchmarking does not escape examination merely because the nil determination fails. Its stated coupon is 14%; it claims that the moratorium produces an effective rate of 10.50% and compares that figure with an SBI PLR of 12.23%. The calculation of the effective rate, the applicable date of the comparison, and adjustments for tenure, risk, the absence of cash redemption and the future conversion entitlement would require support if a rate were being independently fixed. We do not pronounce those figures proved merely by deleting an adjustment founded on an erroneous legal premise and an unsupported nil price. The TPO, however, did not demonstrate a defect leading through an appropriate prescribed method to the ALP he actually determined.

54. The DRP’s accounting premise presents an additional difficulty. The assessee disputes that it prepared Ind AS accounts or recognised an equity component in the manner attributed to it by the DRP, and relies on the notes to its audited accounts, its description of long-term borrowings, Form 3CEB and its transfer pricing documentation. The DRP has identified no entry in the audited accounts recognising the supposed equity component. A regulatory classification under FEMA or an accounting treatment under an applicable standard may illuminate the instrument; neither, without the underlying facts and the Chapter X inquiry, establishes a nil ALP. Grounds 5 and 6 succeed insofar as they challenge that unsupported factual premise.

55. The submission that the AE offered the interest to tax in India and that tax was deducted does not independently decide ALP or deductibility. The payer’s expenditure and recipient’s income have to be considered under the provisions applicable to each. Equally, the possibility of tax in the recipient’s hands provides no missing uncontrolled price of nil. Ground 4 supplies no separate ground of relief.

56. For these reasons, the determination of the ALP of interest of Rs.3,40,27,280/- at nil cannot be sustained. The defect is substantive: the current interest obligation was displaced by a conclusion about eventual equity ownership; material terms of conversion were inaccurately stated; and a nil price was not established through the asserted method. We direct deletion of that transfer pricing adjustment. We do not determine in these proceedings that a 14% coupon, or the asserted effective 10.50% rate, is a universally applicable arm’s length rate for CCDs. Grounds 1 to 3 and 8 are allowed to the extent stated.

57. The DRP’s alternative disallowance under sections 36(1)(iii) and 37(1) substantially rests on the same proposition that the CCDs already represented issued equity and that no interest could consequently be due. The decisions concerning pre-conversion obligations, considered above, do not support that proposition on the terms identified here. Whether an otherwise allowable interest amount is to be deducted currently or capitalised must be determined under the applicable provisions with reference to utilisation and the assessee’s records. The DRP has made no separate, supported finding about utilisation or business purpose that sustains its alternative denial of the whole amount. That alternative disallowance, as reasoned in the directions under appeal, is set aside. Ground 9 is allowed.

58. The DRP’s consequential direction to reduce the capital asset or work-in-progress base by Rs.3,40,27,280/- was founded on its nil-ALP conclusion and falls with it. While giving effect to this order, the Assessing Officer shall verify the amount actually capitalised and apply the governing provisions so that the same expenditure is neither deducted twice nor denied merely because the TPO assigned the coupon a nil price.

59. The assessee states that it had disallowed Rs.41,33,106/-under section 94B. The Assessing Officer shall verify the original computation and give effect to section 94B, including any consequential carry-forward, in accordance with law after deletion of the transfer pricing adjustment. The same amount must not be disallowed twice. The DRP’s treatment of the carry-forward as nil solely as a consequence of sustaining the nil ALP cannot survive. Ground 7 is disposed of accordingly.

60. Any statutory interest or fee affected by the recomputation shall be recalculated under the provision that authorises it, with its period and computation identified in the order giving effect. We express no view that an otherwise lawful levy disappears merely because the section was omitted from a computation sheet. Ground 10 is disposed of in these terms. Ground 11, concerning initiation of proceedings under section 270A, is premature: no penalty determination is before us, and any subsequent penalty order must meet its own statutory requirements on the assessment as modified by this order.

61. Accordingly, the Assessing Officer shall delete the transfer pricing adjustment of Rs.3,40,27,280/-, set aside the alternative disallowance founded on treating the unconverted CCDs as presently issued equity, and give consequential effect to the directions concerning capitalisation, section 94B and statutory levies.

62. In the result, the appeal filed by the assessee is partly allowed in the terms indicated above.