MOVATE TECHNOLOGIES PRIVATE LIMITED,CHENNAI vs. DEPUTY COMMISSIONER OF INCOME TAX, CHENNAI

7. The Ld. TPO and the Ld. DRP erred in law and on facts in including following companies as a comparable, though the company is functionally dissimilar and has high turnover in comparison to the Appellant’s AE- IT services segment. i) L&T Infotech Limited ii) Tata Elxsi Limited 8. The Ld. TPO and the Ld. DRP erred in law and on facts in including following comparable companies, though the company is functionally dissimilar to the Appellant’s AE- IT services segment. ii) Daffodil Software Private Limited 9. The Ld. TPO erred in making transfer pricing adjustment on interest on CCDs to the extent it is classified as equity as required in the IND-AS financial statements.

9.1 The Ld. TPO and the Ld. DRP erred in law and on facts in disallowing the interest paid on CCDs to the extent classified as equity, without appreciating the fact that such classification of CCD into equity and debt is merely a requirement under IndAS financials, and the same is made only for disclosure purposes, and does not change the character of such payment as interest.

:-3-: ITA. No:2467/Chny/2024 does not bear any risk and is remunerated at cost plus 16% mark-up for both IT & ITES. For the non-AE segment, Movate India primarily sells services to domestic third-party customers, competing with other software players, hence functions as a high risk bearing entrepreneurial entity. For the Assessment Year (‘AY’) 2020-21, the assessee filed its return of income on15.02.2021, declaring Rs.28,52,61,330/-. The return of income was taken up for scrutiny assessment under CASS and a reference was made u/s.92CA(1) of the Act to the Deputy Commissioner of Income-tax, Transfer Pricing Officer, Corporate Circle, Chennai (“Transfer Pricing Officer” or “TPO”) for determination of the arm’s length price (“ALP”) of the international transactions entered into by the assessee with its Associated Enterprise (“AE”) dated 19.01.2022. The TPO disregarded the submissions filed by the assessee and passed the Transfer Pricing (‘TP’) order on 21.07.2023 proposing a total adjustment of Rs.10,49,92,531/-. Subsequent to the order of the TPO, the AO passed a draft assessment order on 26.09.2023 u/s.144C r.w.s 92CA (3) of the Act.

:-4-: ITA. No:2467/Chny/2024 7.1 The TPO has rejected the AE segmental in IT division with the reasoning that the External accountant certificate submitted by Movate India is after issuance of SCN and hence cannot be considered as evidence. Further, the TPO has held that most of the expenses on non-AE segment are on account of employee cost and the Assessee has not furnished Month-on-month data for allocation of expenses between the segments not furnished. Accordingly, TPO rejected the segmental and has reckoned the margin of the Assessee at 12.73% vis a vis fresh comparable search conducted the TPO arrived at margins of 13 comparables at 13.24% to 20.34%, thereby holding that the Assessee did not fall within the arms length range of comparable selected by the TPO and made adjustment.

7.2 The DRP had confirmed the action of the TPO with the finding that there were no segmental results in the TP study was conducted by the Assessee. Further, the Segmentation is not audited for AE and Non-AE segment and the allocation of expenses between AE and Non-AE was on the basis of salary cost are not on actual basis which is not rational and has no basis.

7.3 The Ld.AR contended that the AE and Non-AE segments are functionally different owing to the profile of functions and risk borne. In the AE segment, the Assessee does not undertake any strategic functions, does not undertake marketing, pricing negotiations, customer contracting, etc. Accordingly, it does not bear market/price risk, service liability risk, credit risk, etc. However, in the Non-AE segment, the Assessee performs all the critical function around marketing, customer contracting, etc. Consequently, in the Non-AE segment, it bears market / price risk, credit risk, service liability risk, idle capacity risk, etc. Moreover, the segmental approach is also supported under Rule 10B(2)(b). The segmental details were part of the TP documentation and during the course of TP assessment the Assessee has taken extra efforts to get the said segmental audited as :-5-: ITA. No:2467/Chny/2024 well. Therefore, it is the contention of the Ld.AR that the segmental cannot be rejected. Further, the Ld.AR also contended that in case the segmental is accepted, the margin of the Assessee would be 16% and it will be within the arms length range of the comparable selected by the TPO as well.

7.4 The Ld.DR supported the orders of the lower authorities and contended that allocation keys adopted by the Assessee is not clear and further contended that apparently the allocation seems to be inappropriate as the expenses in Non-AE segment is inflated vis a vis the AE segment.

7.5 We have heard the rival contentions and perused the material on record. Apropos we find that the segmentation was provided as part of TP Study report maintained by the Company [page 61 to 168 of paperbook]; further the Assessee had submitted the segmentation certified by another external CA along with its reply to SCN on 13.07.2023 [page 391-397 of paperbook], which is arbitrarily disregarded by the TPO by merely saying it is obtained after issuance of SCN though it was obtained and furnished before the completion of TP assessment. In fact, we are of the view that the IT Act/Rules does not mandate that audited segmental should be furnished. In support of the view, we gainfully rely on the following decisions:

7.6 The Chennai Tribunal decision in the case of M/s.3i Infotech Limited in has held as under:

“On the above facts, in view of the decision of the Delhi Bench of the Tribunal quoted above, we find that rate of profit achieved in other comparable cases are to be compared with the profit level declared by the Assessee in respect of its AE transactions after excluding domestic transactions.”

7.7 The Chennai Tribunal decision in the case of M/s. Honeywell Electrical Devices & Systems India Ltd. in has held as under:

:-6-: ITA. No:2467/Chny/2024 “In the above facts and circumstances, we do not find any valid reason for not accepting the segmental reports in determining the ALP on the AE sales for this assessment year i.e. 2007-08 having accepted the segmentation approach for the earlier assessment years i.e. 2005-06 and 2006-07 and especially when there is no change in the facts and circumstances of the case in the current year.”

7.8 Respectfully following the above decisions we are of the view that since the Assessee has originally furnished segmental of AE as part of its TP report and also subsequently furnished audited segmental, therefore the lower authorities ought to have considered the segmental results of the AE for the purpose of benchmarking. Even the reasons given for not accepting the segmental seems to be based on conjectures and surmises. Therefore, as rightly submitted by the Assessee, we find that the margins of the AE segment is at 16% which is within the arms length range of comparable selected by the TPO i.e. 13.24% to 20.34% and therefore deleted this TP adjustment. Hence, the ground of appeal No.2 is allowed.

8. Ground No.3: The Ld.AR has not pressed Ground No.3 and therefore it is dismissed as not pressed.

10. Ground No.9: Transfer pricing adjustment on interest on CCDs to the extent it is classified as equity as required in the IND-AS financial statements:

10.1 During the impugned FY 2019-20 (AY 2020-21), the assessee paid an actual interest amounting to Rs.284,043,074/- at 10% per annum towards outstanding CCDs. The Assessee has benchmarked this :-7-: ITA. No:2467/Chny/2024 transaction i.e. the rate of the interest at 10% was compared to the prime lending rate as per the State Bank of India which ranges from 12.90 percent to 13.70 percent and concluded to be at arm’s length. The TPO rejected the analysis made by the Assessee and held that interest is allowable only on the debt portion not on the equity portion reported by the Assessee itself. Accordingly, the TPO allowed only the interest on the debt portion and disallowed the excessive interest charged by the assessee in assessee’s P&L account on the portion classified as equity. The DRP upheld the rejection by the TPO by holding that Once the CCD has been classified into equity and debt, the equity portion can't change and interest can be charged only on debt part. Since some part of the CCDs are converted into equity and the balance remain the debt portion, the interest is allowable only on the debt portion. Both the authorities have also relied on the TP order of the previous A.Y.2018-19, wherein the same adjustment was made and on appeal to the ld.CIT(A), the order is yet to be passed.

10.2 The Ld.AR submitted that the Assessee had issued 3,77,690 CCDs of Rs.10,000/- each, allotted on 23.03.2017 (AY 2017-18) with a put option to transfer the CCD to the Company or any other person nominated by it at arm’s length any time on or after 23.03.2018, but prior to 24.09.2026. During A.Y. 2019-20, the subscriber to CCDs had exercised the option of transfer to the CCDs to the Company and accordingly, 25% of the outstanding CCDs i.e. 94,423 were redeemed. The total outstanding CCDs thereafter is 2,83,267 i.e. Rs.283.27 crores. During F.Y. 2019-20, the assessee paid an actual interest amounting to Rs.284,043,074/- at 10% per annum towards outstanding CCDs. In the first year in which the CCDs were issued i.e. A.Y.2017-18, the Assessee had adopted the normal IGAAP format of the Financials wherein entire CCDs were disclosed as debt and the TPO had upheld the transaction to be at arm’s length. From the second year being A.Y.2018-19, based on the thresholds provided in the Companies Act Section 133 and Companies (Ind AS) Rules 2015, the Assessee was required to adopt Ind-AS format of presentation of financial

:-8-: ITA. No:2467/Chny/2024 statements. Specifically, IND-AS 32 titled “Financial Instruments: Presentation”, requires CCD like hybrid instruments be reclassified between equity and debt component. It is pertinent to note that the classification of CCD into debt and equity component is purely notional in the financial statements is as per the disclosure requirements specified under Ind AS, as such there is no change in the underlying nature of the instruments. Thus, even though some portions of the CCDs are split and presented in the financial statements as equity, this does not affect the claim as per the provisions of the Indian Income Tax Act, 1961.

10.3 The Ld.DR contended that when the CCD is already converted into equity there is no question of payment of interest on the same and thus the Ld.DR supported the findings of the lower authorities and prayed that the adjustment should be sustained.

10.4 We have heard the rival contentions, perused the material on record and gone through the orders of the Authorities. At the outset, we feel it is imperative to determine whether the CCD are actually converted into equity or it is only a change in the disclosure in financials without actual redemption or conversion. Apparently, the mandate of Ind-AS 32 seems to reclassify compound financial instruments such as CCDs. Mere reclassification for the purpose of disclosure in Financials will not alter the true nature of the subsisting CCD. Further, the Chennai Tribunal in the case of Stahl India Pvt. Ltd. Vs DCIT [IT(TP)A No.52/CHNY/2024 dated 10.12.2024 has concluded that CCDs until conversion are in nature of debt:

“7.5 We have heard rival submissions and perused the material on record. The TPO exceeded his jurisdiction in recharacterizing CCDs as equity, in line with thin capitalization, which cannot be applied in the present case. It has been a judicially well settled proposition that CCDs constitute debt and interest payable thereon is a deductible expenditure till the time the same are converted into equity. The Hon’ble Rajasthan High Court in the case of Secure Meters Ltd reported in 321 ITR 611 (Raj), held that the debentures when issued is a loan, and therefore, whether it is convertible, or non-convertible, does not militate against the nature of the debenture, being loan.

:-9-: ITA. No:2467/Chny/2024 10.5 Further the Ld.AR also pointed out that the TPO and the DRP have held that since the adjustment was made in A.Y.2018-19 and it is pending in appeal, the adjustment is being made/sustained in the subject A.Y. as well. However, presently, the ld.CIT(A) has decided the appeal for A.Y.2018-19 and copy of the said order was placed on record. The ld.CIT(A) has held that as under:

“5.4.4 On an analysis of the above, it is clear that reclassification was mandated by Ind AS and the appellant had accordingly treated CCDs as compound financial instruments in its accounts. The nature of presentation does not alter the characteristics of CCDs. Despite its treatment in the accounts, CCDs continued to be debt instruments until converted into equity. Further, it is seen that as per clause 3.5 of Investment Agreement for issue of compulsorily convertible debentures between Glow Networks Pvt Ltd and CSS Corp Technologies (MAURITIUS) Ltd, the Subscriber shall have a put option to transfer the CCDs to the Company (or any person nominated by it) at any time after the expiry of one year from the date of issue of the CCDs, at a price worked out as per any internationally accepted pricing methodology on an arm's length basis on the date of exercise of the optionality. Thus it is not necessary that the CCDs would eventually be converted to equity. It would therefore be premature to consider any portion of CCDs as equity without its actual redemption for the purpose of transfer pricing. Thus on careful consideration of the material on record, I hold that the transfer pricing adjustment made on account of interest disallowance on the equity component as per Ind As fair valuation, is without merit. As the CCDs were not redeemed into equity during the year, the appellant is entitled to claim the interest incurred on CCDs, subject to restriction of interest u/s 94B. Accordingly, the AO is directed to delete the addition of Rs.9,59,90,000/- on account of downward adjustment of interest charged by the appellant in the P & L account and paid to AE in respect of the portion of CCDs classified as equity. Thus ground no 4.1 to 4.3 are allowed.”

10.6 Therefore, in view of the above, we are also of the opinion that the actual interest paid on subsisting CCD cannot be disallowed by the TPO. However, the TPO and DRP have rendered a finding that there has been actual conversion of CCD into equity, therefore in the interest of justice and fair play we direct the Assessee to furnish necessary document to establish the fact that during the subject A.Y. there is no actual conversion/redemption of CCD into equity and it is only a mere reclassification as per the mandate of Ind-AS. In case there has been no actual conversion/redemption of CCD into equity then the actual interest

:-10-: ITA. No:2467/Chny/2024 paid should be allowed as deduction. Accordingly, this ground of appeal No.9 is allowed in principle subject to verification by TPO. Hence, the ground no.9 is allowed for statistical purpose.

Order pronounced in the open court on 16th February, 2026 at Chennai.