RELIANCE INDUSTRIAL INVESTMENT AND HOLDINGS LIMITED,MUMBAI vs. DEPUTY COMMISSIONER OF INCOME TAX 3(3)(1), MUMBAI

The aforesaid appeal has been filed by the Assessee against impugned order dated 17.03.2012, passed by Ld. Principal Commissioner of Income Tax, Mumbai-3 („PCIT/CIT‟) in his Reliance Industrial Investment and Holdings Limited. revisionary u/s 263 of the Income-tax Act, 1961 („Act‟) for the AY 2017-18.

The core issue under appeal is whether, the instruments, viz., convertible debentures issued by the Assessee is required to be included in the „transition amount‟ u/s. 115JB (2C) of the Act while computing the book profit as directed by the PCIT vide its order under section 263.

The grounds of appeal raised by the Assessee against the order u/s 263 are reproduced as under:

The details and issue of assessment of relevant instrument as on 1st April 2016 are as under:-

All the above instruments were issued to M/s. Reliance Industries Limited, a subsidiary company. The aforesaid instruments were disclosed as a „liability‟ under the head “long term borrowings” in the financial statements up to the year ended 31.3.2016 in compliance with the accounting standards issued by the Institute of Chartered Accountants India [commonly known as Indian Generally Accepted Accounting Principles (“IGAAP”)]

The „Indian Accounting Standards‟ (Ind AS) became applicable to the Appellant Company from the FY 2016-17 as per the Companies (Indian Accounting Standards) Rules, 2015 (“Rules”). The Assessee, in the balance sheet for the year ending 31.3.2017, reflected the same under the schedule of „Other Equity‟ with the title 'Instrument Classified as Equity' in its audited financial statements. In this appeal, taxability of aforesaid instruments is in question, i.e. whether same is required to be included in the „transition amount‟ u/s. 115JB (2C) of the Act while computing the book profit?

After careful examination and analysis of the facts of the case, the law position and reply of the assessee company, the issue under consideration is decided as under: 5.1 On perusal of the entire submissions of assessee company, it is seen that the assessee company has at no point of time controverted or disputed the fact that, inter alia, 'equity component of compound financial instruments' forms 'other equity' which in turn becomes part of 'transition amount' within the meaning of provisions of Section 115JB(2C) of the IT Act. 5.2 The mainstay of assessee's entire argument in support of its contention as to why ZOFCD/FCD (shown in its books as on 31.03.2016) should not be included in 'transition amount' u/s 115JB(2C) is that, these instruments are not Compound financial instruments. In its submission, assessee has vehemently and repetitively argued that the said ZOFCD/FCD are the instruments, entirely equity in nature and for this reason, they cannot be treated as compound financial instruments and hence, there was no question of arriving at their 'equity component' (as they were not compound financial instrument in first place), for the purpose of computation of transition amount/book profit as per provisions of Sec 115JB (2C).

An entity recognizes separately the components of a financial instrument that (a) creates a financial liability of the entity and (b) grants an option to the holder of the instrument to convert it into an equity instrument of the entity. For example, a bond or similar instrument convertible by the holder into a fixed number of ordinary shares of the entity is a compound financial instrument. From the perspective of the entity, such an instrument comprises two components: a financial liability (a contractual arrangement to deliver cash or another financial asset) and an equity instrument (a call option granting the holder the right, for a specified period of time, to convert it into a fixed Reliance Industrial Investment and Holdings Limited. number of ordinary shares of the entity). The economic effect of issuing such an instrument is substantially the same as issuing simultaneously a debt instrument with an early settlement provision and warrants to purchase ordinary shares or issuing a debt instrument with detachable share purchase warrants. ( emphasis supplied ) In the present case, what is outstanding in the books of assessee company as on 31.03.2016 is ZOFCD / FCD, having terms as under: ZOFCDs of Rs. 441.57 crores- Zero Coupon Unsecured Optionally Fully Convertible Debentures of Rs. 5000 each aggregating to Rs. 441 57 lacs. Under this scheme the issuer and debenture holder has either option to convert debenture into equity or redeem at a premium of 5% of the face value of debenture. In the event of the option not being granted by the Company or debenture holders not exercising their option to convert, it may redeem the said Debentures in part or in full at any time during the tenure of the said Debentures but not later than 25 years commencing from the respective dates of allotment. Premium payable on Debentures redeemed during any financial year will become due at the end of the said financial year. As seen above, this is a mixed instrument having both equity as well as debt component and debenture holder has option to convert debt into equity. Therefore, the contention of the assessee that it is Reliance Industrial Investment and Holdings Limited.

Thus, in sum and substance, the findings and the order of Ld. PCIT can be summarized in the following manner:- i. Any optionally convertible bond or debenture, wherein holder of the instrument has an option to convert debt into equity would be a „Compound Financial Instrument‟ (CFI).

The contentions of the Assessee before us and also before the Ld. PCIT were as under:- i) The financial statements of the Appellant for the FY 2016-17 signed on 18.04.2017 were prepared for the first time as per the provisions of Ind AS. ii) During the year under consideration, various companies merged with the Appellant company, vide order of National Company Law Tribunal dated 2nd November 2017, sanctioning scheme of merger with an appointed date of 1st October 2016. Accordingly, to give effect to the scheme of merger, on 15.3.2019, the appellant revised the financial statements. iii) Thereafter, to give effect to the „Guidance Note on Division II – Ind AS Schedule III to the Companies Act, 2013‟ issued in July 2017 by the Institute of Chartered Accountants of India („ICAI‟) (hereinafter referred to as „the Guidance Note‟), the Appellant Reliance Industrial Investment and Holdings Limited.

Main Head Other Equity Original Financials Other Equity Revised Financials Instruments entirely Recasted/ Equity in nature regrouped Financials 2. Sub-head Note 11 - Instrument Original classified as Equity Financials Note 11 - Instrument Revised Financials classified as Equity Note 11A - Instruments Recasted/ entirely Equity in regrouped nature Financials 3. Reconciliation Foot note I to Note 36.2 Original of Profit and - „all convertible issued Financials other equity by the Company between Ind considered under other AS and equity under the head previous Equity component of GAAP compound financial instrument‟ Foot note I to Note 36.2 Revised Financials Reliance Industrial Investment and Holdings Limited.

To understand the issue in hand, it is relevant to note that „Ind AS 32‟ is the relevant accounting standard setting out the principles of recognition and presentation of financial instruments. It classifies a financial instrument into 'financial liability', 'equity instrument' and „financial asset‟. An instrument which has both, the component of financial liability and equity, is termed as a 'compound financial instrument' [“CFI”]. As per the principles of „Ind AS 32‟, since the ZOFCDs and FCDs did not have any „financial Reliance Industrial Investment and Holdings Limited. liability‟ component, it was regarded as equity instruments and, hence, the same were treated by the Assessee as 'instruments classified as equity'.

In addition to the compliance with Ind AS, companies had to present its Balance-sheet as per the format prescribed in Division II of Schedule III of the Companies Act, 2013. The format of Balance Sheet, for Ind As compliant companies, is bifurcated into „Assets‟ and „Equity and Liabilities‟.

Under the caption „Equity‟, it provides for two types of equity, i.e., (i) equity share capital; and (ii) other equity. The constituents of the Schedule of 'other equity' are as follows: a) Share application money pending allotment; b) Equity component of compound financial instruments; c) Reserve and surplus; d) Debt instrument through other comprehensive income; e) Equity instrument through other comprehensive income; f) Effective portion of Cash Flow Hedges; g) Revaluation Surplus; h) Exchange differences on translating the financial statements of a foreign operation; Reliance Industrial Investment and Holdings Limited. i) Other items of Other Comprehensive Income (specify nature); and j) Money received against share warrants.

As per the provisions of section 115JB(2C) of the Act, which provides that the “book profit” of the year of convergence (being first year of adoption of „Ind AS)‟ shall be further increased/ decreased (as the case maybe) by 1/5th of the transition amount for 5 assessment years, the term “transition amount” is defined as aggregate of the amounts adjusted in the “other equity” on the convergence date, with certain exceptions.

The questions raised before us in respect of the Grounds of Appeal can be summarized in the following way:-

He submitted that, when receipt is not in the character of “INCOME” as defined under section 2(24) of the Act, it cannot be included in the computation of book profit for the purpose of section 115JB of the Act. The issue of taxing the capital receipt has been dealt by the Calcutta High Court in case of PCIT v. Ankit Reliance Industrial Investment and Holdings Limited.

Inaddition to above, the CBDT Circular No 24/2017, itself has excluded certain items which are capital in nature and which, on a strict interpretation, clearly falls within the definition of „transition amount‟. Two answers given in this circular are important to indicate the real scope of the section: “Question 7: Under Section 115 JB of the Act, transition amount has been defined as the amount or the aggregate of the amounts adjusted in the „Other Equity‟ (excluding capital reserve and securities premium reserve) on the convergence date. Whether changes in share application money on reclassification to „Other Equity‟ would form part of the Transition Amount? Answer: Share application money pending allotment which is reclassified to Other Equity on transition date shall not be considered for the purpose of computing transition Amount. ……….. Question 9: How do we account for items such as equity component, if any, of financial instruments like Non-Convertible Reliance Industrial Investment and Holdings Limited. debentures (NCDs), Interest free loan etc. included in other equity as per Ind AS for the computation of transition amount under MAT? Answer: Items such as equity component of financial instruments like NCD‟s, Interest free loan etc. would be included in the Transition Amount.”

Thus, it was submitted that clarifications given in the aforesaid circular itself shows that the „transition amount‟ should not include an item which is of capital in nature which has been merely „reclassified‟ to „other equity‟ on transition date.

Rationale of taxing an equity component of CFI is to neutralize excess deduction that will take place in the subsequent years in respect of notional interest on liability component that will be debited to profit and loss account. Since the instruments in question do not have a „liability component‟, there cannot be any charge to profit and loss account towards notional interest thereon.

In view of the foregoing facts and legal position, ld. Counsel for the Assessee submitted that the amount of Rs. 15,824.47 Crores does not form part of the „transition amount‟ as envisaged under section 115JB(2C) of the Act and thus 1/5th of the same should not be added to the book profit under section 115JB of the Act.

He submitted that, since the classification of ZOFCDs and FCDs as „Instruments entirely equity in nature‟ was duly carried out as per the requirements of the Companies Act and the Financial Statements were duly audited as required by the Companies Act as stated above, the tax authorities do not have the jurisdiction to question the classification of the said instruments in the said Financial Statements. For this connection, reliance was placed on the ratio of the decision of Hon‟ble Supreme Court in the case of Apollo Tyres Ltd. v. CIT (255 ITR 273) (2002).

Now we have to examine without prejudice, whether the instruments (ZOFCDs and FCDs) in question are CFI or not. At this juncture, the relevant provision of Ind-AS is required to be examined for classification of the instrument as a CFI. (i) Ind AS 32 provides for presentation of financial instruments as “equity instruments”, “financial asset” or as “financial liability”. Para 28 dealing with CFI states as under: “The issuer of a non-derivative financial instrument shall evaluate the terms of the financial instrument to determine whether it contains both a liability and an equity component. Such Reliance Industrial Investment and Holdings Limited. components shall be classified separately as financial liabilities, financial assets or equity instruments in accordance with paragraph 15.” (ii) Para 29 of Ind AS 32 states that an entity recognises separately the components of a financial instrument that - (a) creates a financial liability of the entity and (b) grants an option only to the holder of the instrument to convert it into an equity instrument of the entity. For example, a bond or similar instrument convertible by the holder into a fixed number of ordinary shares of the entity is a compound financial instrument. From the perspective of the entity, such an instrument comprises two components: a financial liability (a contractual arrangement to deliver cash or another financial asset) and an equity instrument (a call option granting the holder the right, for a specified period of time, to convert it into a fixed number of ordinary shares of the entity). (iii) Para 15 of the said Ind AS states that the issuer of a financial instrument shall classify the instrument, or its component parts, on its initial recognition as a financial liability, a financial asset or an Reliance Industrial Investment and Holdings Limited.

It is seen from the above, to classify a financial instrument as a „compound financial instrument‟, dual conditions are required to be fulfilled, namely – a) there is creation of financial liability; and b) option for conversion is granted only to the holder.

We had called from the terms of ZOFCDs and FCDs. The terms of the ZOFCDs and FCDs in question as on the convergence date Reliance Industrial Investment and Holdings Limited. are required to be examined in order to evaluate, whether these instruments are CFI in light of the above provisions of Ind-AS 32. These were as follows:- i. The instruments are for a fixed term; ii. The instruments do not carry any interest; iii. The instruments are convertible into fixed number of equity shares of Rs. 10 each of the Assessee, i.e., the Issuer (conversion rate is higher of face value or the book value as on 31st March 2015); iv. The instruments can be converted at any time before the expiry of the term, either at a unilateral option of the Issuer or at the option of the holder of the Instrument, i.e., the Investor; v. The Issuer and the Investor may mutually agree for early redemption of the unconverted portion of the instruments, after expiry of 30 days from the date of allotment; vi. Since the instrument do not carry any interest, the Issuer has not made any interest payments.

The criterion to be considered by the Issuer for determining the classification of the instruments as „financial liability‟ at the time of their initial recognition is as below: i. Whether there is any contractual obligation to pay cash to the Investor?  As is seen from the above terms of the instruments, since the option to convert the instrument into equity, is not only available with the Investor but is also available with the Assessee Issuer, there is no obligation to pay cash by the Issuer to the Investor since the issuer can unconditionally avoid delivery of cash by converting into equity shares.  Further the condition for early redemption is only if the issuer and investor, both, agree for the same. Therefore, as the holder of the instrument does not have an unconditional right to call for redemption of investment, the issuer (Assessee) does not have an obligation to pay cash to the investor. The fact that the parties may, at a subsequent point of time,  mutually agree for redemption, does not make it the obligation Reliance Industrial Investment and Holdings Limited. of the Assessee to pay cash as on the date when the instrument is issued or as on the date of convergence. To determine the classification of the instrument for the  purpose of transition to Ind AS, one has to see the position as on the date when Ind AS became applicable and not at the subsequent point of time. Para 19 of Ind AS 32 explains the meaning of “no contractual  obligation to deliver cash” as “if an entity does not have an unconditional right to avoid delivering cash or another financial asset to settle a contractual obligation, the obligation meets the definition of a financial liability.” From this it is clear that if the issuer has an unconditional right to avoid delivering cash, it cannot be classified as a financial liability. In the facts of the case of the Assessee, basis the terms of the Instruments, the issuer (Assessee) has an unconditional right to avoid payment of cash.Hence, this condition is resulting into negative for „financial liability‟. ii. Whether the instruments are convertible into variable number of equity shares?

Paragraph 16 of Ind AS 32 which provides that a financial instrument is an equity instrument rather than a financial liability on fulfillment of certain conditions. Relevant extract is given below: “When an issuer applies the definitions in paragraph 11 to determine whether a financial instrument is an equity instrument rather than a financial liability, the instrument is an equity instrument if, and only if, both conditions (a) and (b) below are met.

Given the above submissions, the Ld. Counsel of the Assessee submitted that the ZOFCDs and FCDs cannot be classified as CFI as the same do not have a „liability‟ component, failing the dual condition to be classified as CFI, i.e., creation of financial liability and option for conversion is granted to the holder, based on the below criterion:  There is no obligation to pay cash by the Issuer to the Investor since the issuer can unconditionally avoid delivery of cash by converting into equity shares;  The instruments are convertible into fixed number of equity shares.

The Ld. Counsel before us further submitted that the accounting treatment of CFI is different than the instruments which Reliance Industrial Investment and Holdings Limited. are entirely equity in nature. In case of a CFI, the relevant interest expenditure is required to be debited to the profit and loss account on the basis of the market rate of interest (and not the rate of interest at which the instrument is issued, i.e., coupon rate). In case of the Assessee, as there is no financial liability on account of the issue of the instrument, there is no debit of any interest expenditure in profit and loss account as is evident from the audited financial statements. This also shows that the instrument is not CFI and the example 9 to Ind AS 32 supports the same.

As per section 115JB(2C) of the Act, for the purpose of companies complying with Ind AS, the book profit in the year of convergence to Ind AS (i.e. FY 2016-17 in the instant case) and each of the following 4 previous years shall be increased or decreased by 1/5th of the 'transition amount'.

Instrument classified as equity does not come within any of the sub-categories of schedule 'Other Equity', as provided in Reliance Industrial Investment and Holdings Limited.

It has been pointed out that from the perusal of the CBDT circular no.2/2018 [F.N0.370142/15/2017- TPL] dated 15th February 2018, it is clear that what is intended to be included in the term 'transition amount' is only adjustments which would otherwise have impact in the profitability of the assessee but on account of adoption of IND AS, the same are adjusted in “Other Equity” schedule and not Profit and Loss account. A transaction not having a bearing on Profit and Loss account was never intended to be covered by the amendment.

The Assessee company has presented the instruments in question under 'other equity' as there was no guidance at the time Reliance Industrial Investment and Holdings Limited. of finalisation of the annual accounts, in April 2017, as to under which head would it be appropriate to show the 'instruments which are entirely equity in nature'. Meanwhile, the Institute of Chartered Accountants of India („ICAI‟) issued a „Guidance Note on Division II – Ind AS Schedule III to the Companies Act, 2013‟ in July 2017 to provide guidance for the preparation of financial statements in accordance with Ind AS. The said guidance note inter-alia provides that the instruments which are classified as „instruments entirely equity in nature' as per IND AS 32 and do not come within the schedule of 'equity share capital', can be presented in the balance- sheet, separate from schedule of 'equity share capital' and 'Other Equity', under a separate category titled 'Instrument entirely equity in nature' as shown below.

To give effect to the Guidance Note for 'Instruments entirely equity in nature', the Assessee re-casted/ regrouped financial statements, which were also audited by the statutory auditors.

Since the Assessee‟s financial statements were signed on 18.04.2017, in the absence of availability of Guidance Note at that time, the Assessee had no option but to show it under the head of „Other Equity‟ and under the said head, it was shown as „Instrument classified as Equity‟ Therefore, by virtue of such presentation and due to lack of guidance as to its presentation, these ZOFCDs and FCDs which are instruments entirely equity in nature, cannot form part of transition amount for the purpose of section 115JB(2C) of the Act. Contention Of the Revenue 38. The ld. CIT DR vide its rejoinder argued that the Assessee in Note 36.2 of the revised audited financial statements of AY 2017-18, had shown the equity component of CFI as Rs. 15824,47,15,000/. However, the assessee did not include 1/5th of the said amount in the book profit as transition amount under section 115JB(2C) of the Act. 39. On the analysis of the terms of the instrument, the Ld. DR submitted that the Assessee had paid interest on the debentures in the past and subsequently on its redemption, cash was paid Reliance Industrial Investment and Holdings Limited. towards principal repayment, interest representing discount on debentures and premium paid on such debentures. Therefore, it was under contractual obligation to deliver cash. 40. The DR also argued that the terms and conditions of the instruments were revised on 05.10.2021 and made effective from 01.04.2016/ 01.04.2015 41. Another argument of the DR was that the financial statements signed on 18.04.2017 were revised to give effect to the scheme of merger and subsequently re-casted by the assessee company voluntarily. These voluntary re-casted financial cannot be relied upon since the provision of the section 131 of the Company's Act, 2013 is applicable to the assessee company and no approval from the Tribunal is obtained for revision and recasting of the financial. 42. The DR further argued that the conditions of para 16 of Ind AS 32 has not been fulfilled, i.e., the instrument can‟t be considered as equity instruments as neither the assessee company nor the debenture holder exercised the option of conversion of such debentures into equity shares of the assessee company. Moreover, here in this case all the debentures has been redeemed, which goes Reliance Industrial Investment and Holdings Limited.

Accordingly, the instruments being Compound Financial Instrument, Equity component of Compound Financial Instrument, i. e. Rs. 15824,47,15,000/- was to be included in the 'Transition amount' on convergence date and 1/ 5th of the transition amount was to be included in the Book Profit u/ s 115JB(2C) of the IT Act. He also referred to various observations of Ld. PCIT and heavily relied upon the same and submitted that he has clearly culled out how these ZFOCs are nothing but financial liability in the form of CFI falling within the definition of „transition amount‟.

The Assessee had filed a rejoinder before the Tribunal rebutting to the arguments of the DR which are as follows: 45. The Assessee in its original and revised audited financial statements had presented the said instruments under the schedule of „Other equity‟ with the title 'Instrument classified as Equity'. However, only in note no. 36.2 of notes to the accounts, relating to reconciliation of profit and other equity between IND AS and Reliance Industrial Investment and Holdings Limited. previous GAAP, it has been mistakenly and inadvertently mentioned that “all convertibles issued by the company considered under the „other equity‟ under the head Equity component of Compound Financial Instruments”. 46. As explained above, the financial statements of the Assessee were recasted/ regrouped pursuant to Guidance note issued by the ICAI to make a correct disclosure in the balance sheet for the instruments that are entirely equity in nature separate from schedule of 'equity share capital' and 'Other Equity', under a separate category titled 'Instrument entirely equity in nature'. 47. Hence, the allegation of the Revenue that the Assessee has itself classified the instruments as Compound Financial Instrument („CFI‟) is patently incorrect and contrary to the records. The reference in note no. 36.2 was an inadvertent error as admitted by the Assessee and, in any case, the aforesaid footnote could not change the fact that the Assessee had classified the instruments in question as „Equity‟ and not as „CFI‟, in its financial statements, which were also audited by the statutory auditors and that such Reliance Industrial Investment and Holdings Limited. audited annual accounts had also been adopted by the shareholders. 48. In view of the above, the submissions made by the DR that the Assessee had presented the instruments as CFI and hence shall be included in the transition amount as per section 115JB(2C) of the Act is factually not correct. 49. In addition to above, the Assessee also obtained an Independent Auditor‟s certificate, confirming that as per the terms of the Instruments in question, they have been rightly treated as in the nature of „instruments entirely equity in nature‟. The Independent Auditor also confirmed the alternate manner of presentation by the Assessee and stated that the same is in conformity with Guidance note issued by ICAI. 50. Further, the fact that the Assessee has not classified the instruments as CFI in the financial statements is evidenced by the very fact that the accounting treatment required to be given to instruments which are CFI as given in Example 9 of Ind As 32 has not been given by the Assessee.

The conclusion drawn by the Ld. DR on the analysis of the terms of the instruments are incorrect as it has been drawn on the basis of the historical terms and conditions of the aforesaid instruments at the time of their issue, subsequent to which the terms and conditions had been changed and as on the convergence date i.e. 1st April, 2016, the rate of interest was 0% which was relevant for the purpose of classification of the said instrument. One has to see whether there is any contractual obligation to deliver cash in future and not basis past terms which are no longer valid. Accordingly, as on 01.04.2016, the Appellant had no contractual obligation to pay interest in respect of these instruments. Further, the observation of the Ld. DR that the interest represents discount, is factually incorrect since in the case of Appellant, the instruments were issued at par and were never issued at discount.

Moreover, the instruments redeemed during the year also included fresh debentures which were issued during the year in support of which a reconciliation of the amounts with the financial statements was submitted during the course of hearing. The ZOFCDs were redeemed at face value, hence there was no payment Reliance Industrial Investment and Holdings Limited. of premium on redemption. Accordingly, there was neither any element of interest/ interest representing discount, nor any premium paid on redemption. 53. With regard to the contractual obligation to deliver cash in the form of principal/ premium, Ld. Counsel reiterated his submission that: a. since the option to convert the instrument into equity, is not only available with the Investor but is also available with the Assessee, there is no obligation to pay cash by the Issuer to the Investor since the issuer can unconditionally avoid delivery of cash by converting into equity shares; b. the condition for early redemption is only if the issuer and investor, both, agree for the same; c. as the holder of the instrument does not have an unconditional right to call for redemption of investment, the issuer (Assessee) does not have an obligation to pay cash to the investor; d. Consequently, the issuer (Assessee) has an unconditional right to avoid payment of cash.

The relevant provisions of sub-section (2C) read with explanation are as under:- Special provision for payment of tax by certain companies. 115JB. (1) Notwithstanding anything contained in any other provision of this Act, where in the case of an assessee, being a company, the income-tax, payable on the total income as computed under this Act in respect of any previous year relevant to the assessment year commencing on or after the 1st day of April, 2012, is less than eighteen and one-half per cent of its book profit, such book profit shall be deemed to be the total income of the assessee and the tax payable by the assessee on such total income shall be the amount of income-tax at the rate of eighteen and one-half per cent: …………. (2A) For a company whose financial statements are drawn up in compliance to the Indian Accounting Standards specified in Annexure to the Companies (Indian Accounting Standards) Rules, 2015, the book profit as computed in accordance with Explanation 1 to sub-section (2) shall be further— Reliance Industrial Investment and Holdings Limited.

Ergo, a company whose financial statements are to be drawn in compliance to the Indian Accounting Standards specified in Annexure to the Companies (Indian Accounting Standards) Rules, 2015, the book profit of the year convergence, which means the first day of Indian Accounting Standards reporting period as defined in IAS 101, for each of the following four previous years, shall be further increased or decreased by one-fifth of the „transition amount‟. The „transition amount‟ has been defined as the amounts adjusted in the other equity (excluding capital reserve and securities premium reserve) on the convergence date. Certain exclusions for the „transition amount‟ have also been elaborated from clauses (A) to (F). Thus, the „transition amount‟ by its nomenclature presupposes that due to transition, certain items which otherwise would have impacted profit and loss account either not do or would do in such a manner so as to distort the book profits merely due to transition from one Accounting Standard to other, i.e., India GAAP to IAS.

The issue now which needs to be decided here is, whether the aggregate amount of the instruments issued by the assesseecompany falls under the ambit of „transition amount‟ as defined in section 115JB(2C); and if answer is „Yes‟, then one-fifth of the same would be taxable for the year under consideration, if „Not‟, then no adjustment is required to be made.

As on 31st March 2016, the assessee had outstanding Zero Coupon Unsecured Optionally Fully Convertible Debentures amounting to Rs 15,544.57 Crores (Rs. 15,103 crores plus Rs. 441.57 crores) and Zero Coupon Unsecured Fully Convertible Debentures of Rs 279.90 crores totaling to Rs 15,824.47 crores issued to RIL - its holding company. (Hereinafter collectively referred to as Convertible Debentures), raised earlier and the same were disclosed as "long-term borrowings" in the audited financial statements as on 31-3-2016 as per the requirements of Indian GAAP. 59. Since „Ind AS‟ had become applicable to the assessee company with effect from financial year 2016-17, it made a transition to Ind AS. Accordingly, it prepared and presented its financial statements Reliance Industrial Investment and Holdings Limited. from the financial year ending 31" March 2017 under Ind AS. Due to the requirement of presenting the comparative information for the previous financial reporting period commencing from 1" April 2015, as per Ind AS 101; first time adoption of Indian Accounting Standards, the assessee prepared its first Ind AS Balance Sheet as on 1st April 2015. As per the requirement of Ind AS 101, for preparing this first Ind AS Balance Sheet, assessee reclassified items that it recognized in accordance with Indian GAAP as one type of asset, liability, or component of equity, as a different type of asset, liability, or component of equity in accordance with various applicable Ind ASs. 60. To comply with this requirement, assessee applied the requirements of Ind AS 32. Accordingly, it re-classified the Convertible Debentures of Rs. 15,824.47 crores, (which were presented as on 31st March 2016 in Indian GAAP balance sheet as "Long term borrowings") as equity instrument in its first Ind AS balance sheet and presented them as "Instruments entirely Equity in nature". These Convertible Debentures were not reclassified as Reliance Industrial Investment and Holdings Limited.

To understand whether the ZCOCDs and OFCDs issued by the assessee company contained any terms and conditions of any financial liability as contemplated in Ind AS 32, the key terms of issue of the „optionally fully convertible debentures‟ outstanding as on 31st March 2016 (after considering the modifications made to the original terms of issue of the various series of convertible debentures on or before 31st March 2016) needs to be understood. Same are summarised below:- •The convertible debentures had a fixed term.

Thus, the key terms of the issue of fully convertible debentures consist of conversion into equity shares of the company. This conversion will be based on higher of the book value or face value of the equity shares as at 31st March 2015.

As a preface, we have to analyse the relevant provisions of the Companies Act 2013 and new accounting standards as laid down in Ind AS. First of all, section 129 of the Companies Act, 2013 provided that the financial statements shall give a true and fair view of the state of affairs of the company or companies, comply with the accounting standards notified under sec. 133 and shall be in the form or forms as may be provided for different class/classes of companies in Schedule III: Provided that the items contained in such financial statements shall be in accordance with the accounting standards. The Central Government by notification No. Reliance Industrial Investment and Holdings Limited.

Ind AS 101: where for the first time adoption of Indian Accounting Standards is to be adopted, it provides:- Para 1:- The objective of this Ind AS is to ensure that an entity's first Ind AS financial statements, and its interim financial reports for part of the period covered by those financial statements, contain high quality information that: (a) is transparent for users and comparable over all periods presented; (b) provides a suitable starting point for accounting in accordance with Indian Accounting Standards (Ind ASs); and (c) can be generated at a cost that does not exceed the benefits. Para 2:- An entity shall apply this Ind AS in: (a) its first Ind AS financial statements; (b).............. Para 6:- An entity shall prepare and present an opening Ind AS Balance Sheet at the date of transition to Ind ASs. This is the starting point for its accounting in accordance with Ind ASs.............. Appendix A: Definition of the term "date of transition to Ind AS"

The „transition amount‟ as discussed above is defined as amount adjusted in „other equity‟ and the constituent of the Schedule of 'other equities' as per the Companies Act are as follows: a) Share application money pending allotment; b) Equity component of compound financial instruments; c) Reserve and surplus; d) Debt instrument through other comprehensive income; e) Equity instrument through other comprehensive income; f) Effective portion of Cash Flow Hedges; g) Revaluation Surplus; Reliance Industrial Investment and Holdings Limited. h) Exchange differences on translating the financial statements of a foreign operation; i) Other items of Other Comprehensive Income (specify nature); and j) Money received against share warrants.

Concurrence between Assessee and DR is that the main issue is as to whether the instrument can be classified as Compound Financial Instrument (CFI) and equity component of it as per clause (b) above by application of Ind AS 32? The foundation of PCIT‟s order is also based on the characterization of said instrument as CFI or otherwise.

Ind AS 32 defines the financial instruments in the recognition and characterization of the instruments. The objective of this Standard is to establish principles for presenting financial instruments as liabilities or equity. It applies to the classification of financial instruments, from the perspective of the issuer, into financial assets, financial liabilities and equity instruments, etc. The following paragraphs define the scope of financial instruments:-

As noted above, the company had to prepare the financial statements for the FY 2015-16 and at that time it was prepared under GAAP and OFCDs were disclosed in the balance sheet as on 31st March 2016 as „long-term borrowings‟. Since,Ind AS 32 was made effective to the Companies Act 2016 for the financial year commencing from 1st April 2015, the assessee company was required to prepare its opening Ind AS 32 balance sheet as on the date of transition, which is the beginning of the earlier period for which an entity presents fully comparative information under Ind AS 32. Whenever opening Ind AS 32 balance sheet is prepared, Ind AS 32 & 101 requires that in this opening balance sheet not only all the assets and liabilities should be recognized but also the classification should be in accordance with the requirements of Ind AS 32. With the classification of assets, liabilities, components of equity made as per the requirements of previous GAPP was different Reliance Industrial Investment and Holdings Limited.

Now whether the characteristic of the convertible debentures issued by the company falls within the scope and definition of „compounding financial instrument‟ as a provided in „Ind AS 32‟ as defined therein in various paras which have been incorporated by us supra. First of all, a convertible debenture is a contract that has mainly two characteristics;  firstly, it gives rise to the financial assets for the party which is the holder of the instrument, since it gives a contractual right to receive cash and other financial assets, for example, financial asset in the form of equity instrument of issuer in case of convertible option; and Reliance Industrial Investment and Holdings Limited.

However, the requirement of Ind AS 32 about classification of financial instrumental is on initial recognition as per the substance of the contractual arrangement. It requires that the classification of a financial instrument or its component parts is to be made by the issuer as financial liability or equity instrument on initial recognition with the substance of the contractual arrangement and the definitions of a financial liability and an equity instrument. The term compounding financial instrument has not been independently defined under Ind AS 32. However, if there is such Reliance Industrial Investment and Holdings Limited. financial instrument, the accounting standard requires that the issuer should first determine the liability component and then separate the liability component from the fair value of the entire financial instrument. One has to ascertain the liability component which is sine qua non for treating it as a „transition amount‟. The financial instrument if it is categorized as a compound financial instrument, then there has to be a liability component embedded in it.

Ergo, we have to see, whether in the present case, what constitute financial liability. Ostensibly, there are two situations in relation to financial instrument which can be reckoned as financial liability; firstly, there is a contractual obligation to make settlement either by monetary payment or by delivering any other financial asset; or secondly, the settlement has to be made by exchange of variable number of its own equity instruments. If we keep this definition as provided in Ind AS 32 incorporated (supra),then the instrument is an equity instrument for the issuer only if both the conditions as stated above are satisfied, i.e., there is no contractual obligation for the issuer to make settlement either by monetary Reliance Industrial Investment and Holdings Limited.

Here on facts of the present case, the convertible debentures can be converted into fixed number of equity shares either unilaterally by the investor or by the issuer without the consent or concurrence of the other party to the contract. In other words, the investors will exercise the option unilaterally to convert convertible debentures into equity shares in a situation where the fair value of the equity shares increases above the issue price of the convertible debentures at any time during the term of the convertible debentures. In second situation, the issuer will exercise the option unilaterally to controvert the convertible debentures into equity shares so as to avoid delivery of cash. The repayment in monetary terms by the issuer to the investor in respect of the convertible debentures upon the expiry of their term is contingent upon non- exercise of the option to convert the convertible debentures both by the investor and the issuer. This eventuality may not arise here in this case, since the option to convert is available not only with the Reliance Industrial Investment and Holdings Limited. investor but also with the issuer and earlier redemption of the convertible debenture available to both, is not a unilateral option, but is subject to mutual agreement of both the investor and the issuer. This does not result in any vesting of right or foisting of any obligation unilaterally on any one or the other party to the contract. Accordingly, both have inferred to a conclusion that settlement of convertible debentures issued by the assessee will be through exchange of own equity instruments of the assessee company only and not by any financial liability as defined in Ind AS 32. This exchange, as per the terms, will be of a fixed number of equity shares. Accordingly, in the case of assessee, the criteria to classify the financial instrument of convertible debentures are not indicative of any compounding financial instrument albeit it is equity.

Now reiterating the same question, whether the convertible debentures under consideration before us can be classified as a „compound financial instrument‟ which has both a liability and an equity component. As specified under Ind AS 32, the liability Reliance Industrial Investment and Holdings Limited. component of the convertible debentures is represented by the present value of the aggregate of the following future payments:- i) Principal repayment ii) Periodical interest payments. In the present case, the notional convertible debentures issued by the assessee, there is neither payment of interest component nor any kind of premium at the time of repayment. The repayment of principal in monetary terms will also not be there, as the settlement will be through issue of own equity instruments of the assessee company. Thus, the liability in monetary terms is „NIL‟ in the present case. Further when the entire financial instrument is classified as equity, there will be no charge on account of notional interest or any kind of financial liability in the statement of profit and loss during the entire tenure of such instrument after initial recognition in the financial accounts. It was for this precise reason; the assessee company has neither provided any interest cost or claimed any kind of financial liability in the profit and loss account. Thus, to summarise, the financial instrument under consideration here in this case, we find that; Reliance Industrial Investment and Holdings Limited.

One of the key arguments on behalf of the revenue and also by the Ld. PCIT in his order is that, assessee company itself has classified is optionally convertible debentures into „other equity‟ which is as per the definition under the „transition amount‟ given in the Explanation gets covered. In order to understand the disclosure requirements of equity finds in the balance sheet which otherwise is called shareholder‟s fund consists of equity shares capital and other equity share. As far as equity share capital is concerned, it consists of various types of share capital issued by the company. As regards the other equity, these consist of various types of reserves which are available to the shareholders. In other words, the funds belongs to the share holders as per the new disclosure scheme, the shareholder has to be indicated how much funds are employed in the company.

We have to understand the term „other equity‟ which is part of the shareholder funds. The „other equity‟ consists of various types of reserves like general reserve, capital reserve, security premium reserve and other reserve similar to the profit and loss attributableto the shareholders. Thus, the disclosure of the total funds available in the account of the shareholders is for thepurpose of valuation and to understand their stake in the company. Merely because the OFCD‟s in the balance sheet has been classified under the head „other equity‟ that does not reach to a conclusion that it is a financial instrument which can be classified as „transition amount‟.

Now to understand the term „transition amount‟, what the Explanation envisages that aggregate amount adjusted in the other equity on the convergence date and there are certain exclusions provided in the Explanation as incorporated (supra). Thus, on the date of convergence the company has to determine various comprehensive incomes on the date of convergence and make their adjustment in the other equity. The comprehensive income should be the in the nature of reserves or income. It can never be in the Reliance Industrial Investment and Holdings Limited. form of a capital liability already recognized in the balance sheet, i.e., before the convergence date. The definition of transition amount itself excludes certain capital reserves, which is evident from the exceptions provided in the various clauses A to F in sub- clause (iii) of Explanation to sub-section 2C of section 115JB. These exclusions itself clarifies that certain reserves even though they are clearly part of the „other equity‟, since they are capital in nature, but are earmarked for other purposes which Companies Act has imposed certain restrictions for their utilization, are not treated part of transition amount. In a nut shell, not all the reserves forming part of other equity are „transition amount‟ as understood by the Revenue authorities. In the earlier part of the order, we have also referred to the CBDT circular number 24/2017 (supra), wherein CBDT has clarified vide question No. 7, which itself indicates that already recognized capital liability cannot be part of the transition amount. What should be the part of the „other equity‟, is, total comprehensive income determined on the date of convergence date based on adjustment determined as per the various accounting standards ofInd AS 101, 16, 38 and other similar adjustment as per Reliance Industrial Investment and Holdings Limited.

In the accounting standard, Ind AS 32, the respective companies has to determine comprehensive income/loss based on composite instrument which has element of equity or financial liability. There are various types of financial instruments which are debt based or equity based instrument for which termsare different for the various types of instruments. On the date of convergence, the company has to determine the comprehensive income or loss based on the status of future financial assets or liability to the respective companies. Accordingly, the company has to recognize only the comprehensive income or loss in the „transition amount‟ and not the capital liability which has already recognized in the balance sheet of pre-convergence date.

The next issue is how to determine the financial gain or loss particularly of the debt financial instrument. First of all, one need to separate debt and equity from the above instrument and determine the impact of comprehensive income or loss in the equity portion and will impact their adjustment in the „other equity‟. This Reliance Industrial Investment and Holdings Limited. will be done in accordance with Ind AS 32. The Ind AS 32 provides an example how to compute the fair value and liability assigned to equity bond. For the sake of ready reference, the same is reproduced as under:- An entity issues 2,000 convertible bonds at the start of year 1. The bonds have a three-year and are issued at par with a face value of currency unit [CD] 1,000 per bond, giving total proceeds of CU 20,00,000. Interest is payable annually in arrears at a nominal annual interest rate of 6 percent. Each bond is convertible at any time up to maturity onto 250 ordinary shares. When the bonds are issued, the prevailing market interest rate for similar debt without conversion option is 9 per cent. The liability component is measured first and the difference between the proceeds of the bond issue and the fair value of the liability is assigned to the equity component. The present value of the liability component is calculated using a discount rate of 9 per cent, the market interest rate for similar bonds having no conversion rights, as shown below: CU Present value of the principal CU 20,00,000 15,44,367 payable at the end of 3 years Present value of the interest CU 1,20,000 payable 3,03,755 annually in arrears for 3 years Reliance Industrial Investment and Holdings Limited.

In case the financial instrument is classified as a compound financial instrument as covered in the illustrative example, then the accounting entries under Ind AS with respect to the data as per the said illustrative example, at the time of initial recognition of above convertible bonds in subsequent periods and at the time of redemption of bonds, will done in the following manner:-

The aforesaid illustrative and the example as given in Ind AS 32 goes to illustrate as to what should be the „transition amount‟. In the above illustration, the value of Instrument/Debenture of Rs. 20 Reliance Industrial Investment and Holdings Limited. lakhs is not the financial liability but the value of Rs. 151,878/- is the value of compounding Income. If we apply the above example in the present case, then it is very difficult to fathom that how the entire optional convertible debentures can be classified and held as financial instrument, i.e., entire debenture is a financial liability so as to be classified under the head „transition amount‟, as held by Ld. PCIT in his order. We have reiterated many times in the earlier part of the order that only the component of financial liability element alone i.e., (financial liability or assets) which has to be taken as „transition amount‟. Ld. PCIT has completely erred in accounting principle while holding that the entire convertible debentures for sums aggregating to Rs.15544.57 crores is a „transition amount‟ which needs to be adjusted over the period of 5 years while computing the book profit. This finding itself vitiates the entire reasoning and the view taken by the Ld. PCIT.

If the above illustration is to be taken as a guideline to determine the „transition amount‟ which needs to be adjusted, then only the financial liability embedded in it alone can be treated as transition amount as per Ind AS 32. Here in this case, there was no Reliance Industrial Investment and Holdings Limited. kind of any financial liability or any interest component which can be ascertained or determined on the said convertible debentures. As we have already held above that, since these Zero Coupon Optionally Convertible Debenture is purely in the nature of equity and there was no financial liability embedded it, neither any liability has been debited to profit and loss account, nor it has been recognized by the assessee company in financial accounts. There is nothing flowing from the terms or substance of the contract of Zero Coupon OFCD or OFCD where one can inferred that there was any kind of interest or coupon rate or premium payable by the Assessee Company which can be inferred under the meaning of „transition amount‟, which required to classified under Ind AS 32 and needs to be adjusted while computing the book profit us 115JB (2C).

In the present case, the assessee has classified various types of liabilities based on its understanding at the time of preparation of balance sheet for the relevant financial year which is in question before us are as under:- (Rs. In crores) Equity Fund 31.10.2017 31.03.2016 Reliance Industrial Investment and Holdings Limited.

We have already noted in the earlier part of our order that Zero Coupon OFCDs issued on 30th June 1995 which was issued at par for Rs. 441.57 crores was converted into 72388770 equity shares in financial year 2020-21 and the total convergence was at par only. The Zero Coupon OFCDs issued in the year 2015 and 2016 issued for sums aggregating to Rs. 1510.30 crores, the entire ZOFCDs was redeemed in the financial year 2016-17 at par. Thus, even though it has been redeemed within the year in a very short span of a year, then also there is neither any interest component nor any financial liability in the form of compounding financial instruments or any kind of discounting factor which can be said to be applicable. Nor assessee has claimed in the financial account or treated it as financial liability. The fact that it was redeemed will not take away the character at the time of issuance of Zero coupon OFCDs as both the issuer and investors had understood that it would be converted into equity shares at par and that‟s the precise Reliance Industrial Investment and Holdings Limited. reason no financial liability has been recognized on these instruments by the assessee. This aspect of this matter has already discussed in the earlier part of the order.

Now coming to the 0% fully unsecured debentures issued in the year 1996, they have been bought back by the company during the FY 2016-17 at par and the OFCDs have been cancelled. Even these OFCDs issued in year 1996 for the period of a decade, no financial liability or any interest cost has been taken into profit and loss account even for the purpose of disclosure under the Companies Act.

Accordingly, we entirely agree with submissions of the assessee made before us and hold that none of the OFCDs which has been shown in the balance sheet of the assessee under the head „Other Equity‟, there exist any kind of financial liability or interest liability in any manner which can be classified or determined as a „transition amount‟. We have already held above, that as per the definition of Transition amount, the capital reserves are eliminated while making adjustment in book profit, similarly, the CBDT has clarified to eliminate the capital liability like Share Reliance Industrial Investment and Holdings Limited.