Compulsory Convertible Debentures are to be considered as Debt and not as Equity

The assessee is engaged in the business of real estate development which is internationally acclaimed and is based in Bengaluru. During the assessment year 2009-2010 assessee has incurred an expenditure of Rs. 21.26 crores by way of interest on 13.5 crores compulsorily convertible debentures (CCD) of face value of Rs.10 each issued to Green Banatelis Limited, Cyprus.

According to the assessing officer the expenditure incurred on the CCD issued is an international transaction, therefore referred it to the Transfer Pricing Officer (TPO).
The TPO relied upon the regulations contained in FEMA and RBI policy which laid down that fully and mandatorily convertible instruments are to be considered as equity under Foreign Direct Investment.
The TPO concluded in his order that the capitalization of interest expenditure in the books of accounts by the assessee is wrong. Accordingly, AO followed the TPO order and disallowed the capitalization on interest on CCD’s.

The assessee in its defence of capitalisation has urged that the RBI policy cannot determine the treatment of payment of interest on CCD’s in income tax proceedings.
The assessee urges that the payment made is to be capitalised and has been correctly done and any other treatment is opposed to law.
The assessee further contended that the thin capitalisation rules were not present in the Income Tax Act, 1961 for the relevant year under consideration so there were no grounds to deny any interest expenditure on debenture and treat the debentures as equity. Thin capitalisation refers to a situation where an entity is financed through a relatively high level of debt as compared to equity.

As per the decision of ITAT, consideration of CCD’s as equity based on the RBI policy and thin capitalisation rule is incorrect. CCD’s will be considered as debt only till the date of conversion and interest has to be allowed under section 36(1)(iii) of the Income Tax Act.

Source: Embassy One Developers Pvt. Ltd V Deputy Commissioner of Income Tax

Articles