CONGLOME TECHNCONSTRUCTION PVT. LTD.,,BANGALORE vs. DT.C.I.T., BANGALORE

Per Jason P. Boaz, Accountant Member

IT(TP)A No. 1497/Bang/2014

Page 2 of 20 2.1 The assessee company was incorporated on 13.04.2007 in order to engage in the business of construction, real estate and plotted development of land. For the year under consideration, i.e., for Assessment Year 2009-10, the assessee filed its return of income on 25.09.2009 declaring loss (-) of Rs.44,31,795/-. The return was processed u/s 143(1) of the Income Tax Act, 1961 (in short ‘the Act’). Subsequently, the Assessing Officer (‘AO’) initiated proceedings u/s 147 of the Act as he had reason to believe that income of the assessee exigible to tax had escaped assessment. After recording reasons in this regard, the AO issued notice u/s 148 of the Act on 21.06.2011 and commenced assessment proceedings. A reference u/s 92CA of the Act was made by the AO to the Transfer Pricing Officer (‘TPO’) for determining the Arms Length Price (‘ALP’) of international transactions reported by the assessee. The TPO passed order u/s 92CA of the Act dated 29.01.2013 proposing an adjustment of Rs.23,51,564/- towards interest on Compulsory Convertible Debentures (‘CCDs’) issued by the assessee to its associated enterprise (‘AE’). After receipt of the TPO’s order, the AO completed the assessment u/s 143(3) r.w.s. 147 r.w.s. 144C of the Act vide order dated 03.05.2013; whereby the assessee’s income was determined at Rs.1,64,65,482/- in view of the following additions/disallowance:

(i) Disallowance of pre-operative expenses and Administrative expenses - Rs.1,60,33,712/- (ii) T.P. Adjustment - Rs. 23,51,564/-

IT(TP)A No. 1497/Bang/2014

Page 3 of 20 2.2 Aggrieved by the order of assessment dated 03.05.2013 for Assessment Year 2009-10, the assessee preferred an appeal before the CIT(A)-IV, Bangalore. The CIT(A) disposed off the appeal vide the impugned order dated 09.10.2014 granting the assessee partial relief.

3.1 The assessee, being aggrieved by the order of CIT(A)-IV, Bangalore dated 09.10.2014 for Assessment Year 2009-10, has preferred this appeal before the Tribunal wherein it has raised the following grounds:

On facts and circumstances of the case and in law, the Commissioner of 1) Income Tax (Appeals) [CIT(A)] has erred in upholding that the appellant has not commenced business. In doing so, the CIT(A) has erred in upholding the disallowance made by the AO in respect of appellant's claim for business expenditure and depreciation allowance.

On facts and circumstances of the case and in law, the CIT(A) has erred 2) in holding that the rate of interest of 14% paid by the appellant to its AE, (namely, Greenberry Ltd.) on fully compulsory convertible debentures of Rs.18.57 Crores, is not at Arm's Length Price (ALP).

On facts and circumstances of the case and in law, the CIT(A) has erred 3) in restricting the rate of interest payable by the appellant on the above fully compulsory convertible debentures of Rs.18.57 Crores to the average LIBOR rate, as compared to the rate of 14% paid by the appellant.

IT(TP)A No. 1497/Bang/2014

Page 4 of 20 Without prejudice to the ground taken above, the erroneous application 4) of LIBOR rate as made by the CIT(A) tantamounts to an enhancement without issuing a notice to that effect. The enhancement so made is without granting any opportunity to the appellant, which is violative of the provision of section 251(2) of the Income Tax Act. 3.2 The assessee had raised the first three grounds (supra) in Form No. 36 on 15.11.2014 and filed Revised Form No. 36 dated 27.07.2015 wherein the fourth ground (supra) was included. In the original Form No. 36 dated 15.11.2014, the assessee had raised grounds related to both issues on which additions/disallowance were made. In the Revised Form No. 36, dated 27.07.2015, the assessee has raised ground No. 4(supra) as an additional ground contending that the decision of the CIT(A) on the TP issue amounts to enhancement of income, which has been carried out without issuing any notice and without affording the assessee any opportunity in the matter and is therefore violative of the provisions of Section 251(2) of the Act. We have heard both parties in the matter and carefully perused the material on record. In our considered view, even though raised before the Tribunal for the first time, since the additional ground No. 4 (supra) is purely legal in nature and goes to the root of the matter for adjudication of this appeal on the basis of material already on record, we, therefore, in the interest of substantial justice admit this additional ground raised by the assessee for consideration and adjudication. In coming to this view, we draw support from the ratio of the decision of the Hon’ble Apex Court in the case of NTPC Ltd., (229 ITR 383) (SC).

IT(TP)A No. 1497/Bang/2014

Page 5 of 20 4. Ground No. 1 – Disallowance of Expenses by holding them to be Pre-operative Expenses.

4.1.1 In the course of assessment proceedings, the AO observed that the assessee had earned “other income” of Rs.89,28,267/- comprising of interest, dividend and miscellaneous income and against such income had booked operating and administrative expenses amounting to Rs.1,60,33,712/- and interest and financing charges amounting to Rs.26,63,044/-. It was also observed that no business income was reported by the assessee. Since the assessee had not derived any business income and the expenses incurred did not have any corresponding revenue, the AO held that the business activity had not commenced and treated both the interest income and the expenses claimed to be pre-operative in nature and disallowed the same.

4.1.2 The assessee carried the matter in appeal to the CIT(A) who upheld the AO’s action citing the decisions in the cases of Kingfisher Training and Aviation Services Ltd., Vs. ACIT (2011) 15 taxmann.com 325 (Bangalore – ITAT); ALD Automotive (P) Ltd., (2014) 45 taxmann.com 530 (Mumbai – Trib); and Kakinada SEZ (P) Ltd., (2013) 31 taxmann.com 165 (Hyderabad – Trib).

4.2 Before us, the learned AR of the assessee submitted that the assessee had not only set up its business, but had also commenced its business activities during the year under consideration. It is contended that since the assessee is a real estate company, its business activities stood commenced once it had initiated action to acquire land. It is IT(TP)A No. 1497/Bang/2014

Page 6 of 20 submitted that during this year, the assessee had engaged a land aggregator to acquire land in Hyderabad and also paid advances in this regard. Since the land aggregator failed to get the land within the specified time, the assessee had filed suit for recovery of the advances made. It is further submitted the assessee had also entered into an agreement with another party, M/s. Shriram Land Development India Pvt. Ltd., for acquiring land in Karnataka and paid advance to this party. It is contended by the learned AR that since the land acquiring process has started, the business of the assessee has commenced and therefore the expenses incurred by it for operations in this regard are to be treated as business expenses and allowed as deduction as claimed by the assessee. In support of the aforesaid contentions, the learned AR, inter alia, placed reliance on the decision of this Tribunal in the case of Swire Holdings (P) Ltd., Vs. ITO (2006) 6 SOT 621 (Bang).

4.3 Per contra, the learned DR for Revenue supported the orders of the authorities below.

4.4.1 We have heard and considered the rival contentions and carefully perused the material on record; including the judicial decisions cited. The issue of dispute boils down to what is the stage at which a real estate company can be considered to have commenced its business and becomes eligible to claim the expenses incurred as revenue expenses.

4.4.2 The AO has held that since the expenses claimed do not have corresponding business revenue, the assessee’s business activities have not commenced and therefore, the interest income needs to be charged

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Page 7 of 20 to tax as pre-operative interest in accordance with the decision of the Hon’ble Apex Court in the case of Tuticorin Alkalies Ltd., (1997) 227 ITR 721 (SC). In that view of the matter, the AO held that the business activities of a real estate company can be considered to have commenced only after revenue is booked i.e., only after the project is completed and the properties are sold.

4.4.3 Per contra, the assessee’s contention is that once the company is incorporated and some activity as evidenced by some expenditure being incurred, then the business activities should be taken as having commenced. In this regard, the assessee submitted that it had advanced moneys to two parties for purchase of land at Hyderabad and in Karnataka and therefore it is evidenced that its business activities have commenced.

4.4.4 The AO’s view that business revenues are the deciding feature/factor for commencement of business and reliance on the decision in the case of Tuticorin Alkalies Ltd., (supra), has been distinguished by this Tribunal in the case of Swire Holdings (P) Ltd., (supra) wherein at para 4 thereof it has been held as under:

Page 8 of 20 acquiring and dealing in landed property, the business of the assessee should have been treated as commenced. Interest earned there lay, cannot be treated as pre-operative. The case of Tuticorin Alkali Chemicals & Fertilizers Ltd. v. CIT( 1997) 227 ITR 1721 (SC) relates to the assessee company incorporated on 3-12-1971 for the purpose of manufacturing heavy chemicals such as ammoniurn chloride and soda ash. The trial production of the factories of the company commenced on June 30, 1982. For the purpose of setting up of factories, the assessee had taken term loans from various banks and financial institutions. That part of borrowed funds which was not immediately required by the company was kept invested in short-term deposits with banks. The assessee-company earned interest income from various loans given by the company and also from the bank deposits. On the aforesaid facts, the Hon'ble Supreme Court held that the assessee company could not claim any relief under sections 70 and 71 since its business had not started and there could not be any computation of income or loss incurred by the assessee in the relevant accounting years. As rightly contended by the learned counsel for assessee, the decisions relied on by the authorities below are factually distinguishable. In the case of the assessee neither setting up factory or erection of machinery is required. The moment the assessee-company incorporated and the amounts advanced, it will lead to the conclusion that the business of the assessee has been commenced. Therefore, I find much more in the stand taken by the assessee. The income shown by the assessee has to be treated as income from business and necessary benefits or deductions claimed by the assessee have to be allowed in accordance with law. It is ordered accordingly.”

4.4.5 Further, the point at which a real estate company can be considered as having commenced business has been discussed in the IT(TP)A No. 1497/Bang/2014

Page 9 of 20 decision of the ITAT – Hyderabad Bench in the case of M/s. Surya Info IT Park Ltd., in wherein the distinction between setting up of business and commencement of business was discussed and distinguished. The relevant extract thereof at paras 8 to 10 thereof is extracted hereunder: 8. We have considered the arguments of both the sides and perused the material information and facts on the record. The question which arises for consideration is as to when the assessee ITA No. 863 /Hyd/2014 M/s Surya Infra ITT Parks Pvt. Ltd., said to have commenced its business. It has to be observed that there is a distinction between setting up of the business and commercialization of the operation, which generates actual revenue to the business. What is relevant under the Income-tax Act is the set up of the business and not the commencement of the business by referring to the provisions of section 3 of the Act. In this present case, the assessee is in the business of construction and development of technology park. In this line of business, the process commences from the date of negotiation for acquiring land, actual purchase of the land and then actual development of such land. The concept of commencement will change according to the nature and facts of the particular industry. It may vary depending upon the business model and business cycle of the industry. In the present case under consideration, the business said to have set up, when it is ready or established to commence its operation, for which, we refer to the case law Western India Vegetable Products Ltd., 26 ITR 151 (Bom.). Similarly, in the case of Arcane Developers (supra) date of setting up of business depends upon facts and the nature of the business. This is the reason why we have referred to the objects for incorporation of the company and the main business activities in which assessee was engaged.

IT(TP)A No. 1497/Bang/2014

Page 10 of 20 9. The ratio of the judgment of Hon'ble Delhi High Court in the case of CIT Vs. Dhoomketh Builders & Development (P) Ltd., (supra) are exactly similar to the present case under consideration. The ratio of the judgment is as under: "9. The Tribunal has observed that having regard to the business of the assessee, which is the development of real estates, the participation in the tender represents commencement of one activity which would enable the assessee to acquire the land for development. If the assessee is in a position to commence business, that means the business has been set-up. The Acts of applying for participation in the tender, the borrowing of monies for interest from the holding company, the deposit of the borrowed monies on the same day with NGEF Ltd. as earnest money were all Acts which clearly establish that the business had been set-up. The commencement of real estate business would normally start with the acquisition of land or immoveable property. When an assessee whose business it is to develop real estates, is in a position to perform certain /Hyd/2014 M/s Surya Infra ITT Parks Pvt. Ltd. Acts towards the acquisition of land, that would clearly show that it is ready to commence business and, as a corollary, that it has already been set- up. The actual acquisition of land is the result of such efforts put in by the assessee; once the land is acquired the assessee may be said to have actually commenced its business which is that of development of real estate. The actual acquisition of the land may be a first step in the commencement of the business, but section 3 of the Act does not speak of commencement of the business, it speaks only of setting-up of the business. When the assessee in the present case was in a position to apply for the tender, borrowed money for interest albeit from its holding company and deposited the same with NGEF Ltd. on the same day, it shows that the assessee's business had been set-up and it was ready to commence business. The learned senior standing counsel for the IT(TP)A No. 1497/Bang/2014

Page 11 of 20 revenue would, however, state that till the land is acquired, the business is not set- up. The difficulty in accepting the argument is that an assessee may not be successful in acquiring land for long period of time though he is ready to commence his business in real estate, and that would result in the expenses incurred by him throughout that period not being computed as a loss under the head "business" on the ground that he is yet to set-up his business. That would be an unacceptable position. The other argument of the learned standing counsel for the revenue that the tax auditors of the assessee have themselves pointed out that the assessee is yet to commence its business is also irrelevant because of the distinction between the commencement of the business and setting- up of the same."

Considering the above observation and material facts of this case, we are of the opinion that the assessee's business had commenced since incorporation and the assessee is eligible to claim the expenditure incurred for running of the business activities. Hence, the assessee is eligible for the business expenditure of Rs. 29,54,923/-.

IT(TP)A No. 1497/Bang/2014

Page 12 of 20 also expressed by this coordinate bench in the case of ITO Vs. Trident Shelters Pvt. Ltd., ITA No. 1160/Hyd/2012.”

4.4.6 The principles that emerge on a careful perusal of the aforesaid decisions, cited in the preceding paragraphs (supra), are as follows:

(i) that there is a distinction between setting up of the business and commercialization of the operations which generates the actual revenue to the business. What is relevant under the Income Tax Act is the setting up of the business and not the commencement of the business. (ii) In this line of business, the process commences from the date of negotiation for acquiring land, actual purchase of the land and their actual development of such land. The event of commencement will change according to the nature and facts of the particular industry. It may vary depending upon the business model and business cycle of the Industry. (iii) In the case on hand, the business can be said to be set up when it is ready OR established to commence its operation. (iv) The date of setting up of the business depends on the facts and nature of the business. If the assessee is in a position to commence business, it means the business has been set up. (v) The commencement of real estate business would normally start with the acquisition of land OR immovable property. When an assessee, whose business it is to develop real

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Page 13 of 20 estate is in a position to perform certain acts towards the acquisition of land, that would clearly show that it is ready to commence business and as a corollary thereto, that it has already been set up.

4.4.7 Therefore, whether an assessee is in a position to commence its business operations OR not is the true test for deciding whether the business has been set up and would obviously depend upon the facts and circumstances of each case. Therefore, the above principles need to be applied to the facts of the case to decide whether the business activities have commenced or not.

4.4.8 In this regard, we find that both the CIT(A) and AO have not examined the facts of the case and not brought out the relevant facts on record. Merely, by reproducing two judicial decisions, the CIT(A) has upheld the action of the AO, without bringing on record the facts of the cited case and whether those facts are similar to the facts of the assessee in the case on hand. It is seen that the assessee has placed before the CIT(A) the decision of this Tribunal in the case of Swire Holdings (P) Ltd., (supra), wherein the facts are quite similar to those of the assessee in the case on hand. However, we find that the CIT(A) has not considered the aforesaid decision at all. Further, there is no finding rendered by the CIT(A) on when the business was set up and whether the assessee was in a position to commence its business.

4.4.9 In the light of the above observations, it would be relevant to examine the facts of the case on hand. We find that the assessee had IT(TP)A No. 1497/Bang/2014

Page 14 of 20 raised funds from its AE by issuing CCDs and made advance payments to a party for purchase of land. Part of the advance payment was made in the earlier year and balance amount in the current year. No land has been purchased by the said party as can be seen from the suit filed by the assessee against the party in 2011. Other than payments of advance, it is not known as to whether any other activity happened to establish that the assessee was “in a position to commence business”. In the year under consideration, the assessee has raised funds from its AEs in the form of issue of another series of CCDs and paid advance to Shriram Land Development India (P) Ltd., which has been shown as a related party in the assessee’s TP study. Even in this transaction, other than making the advance payment, nothing has been brought on record to establish that the assessee was in a position to commence business.

4.4.10 We also notice that out of the expenses claimed as deduction, the major components are Legal and Professional Charges and loss on redemption of investment in mutual funds (‘MF’). Whether these expenses are revenue OR capital in nature has not been examined at all. We also find that the TPO has treated the ALP of the interest transactions as NIL and disallowed the interest paid on CCDs. The AO has once again disallowed the same, leading to a double disallowance.

4.4.11 In view of the factual and legal matrix of the case on hand, as discussed above, we deem it appropriate to remand the matter back to the file of the CIT(A) to decide the issue afresh, after proper examination of the facts and test the facts of this case in the light of the legal principles outlined above. Needless to add, both the assessee and AO

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Page 15 of 20 shall be afforded adequate opportunity of being heard and to make submissions/file details required which shall be duly considered before deciding the issue. Consequently, ground No. 1 of assessee’s appeal is allowed for statistical purposes.

5.2 On appeal, the CIT(A) upheld the assessee’s contention that CCDs are debts; but however held that instead of interest thereon @ 14%, the assessee should have adopted LIBOR rate for payment of interest. While doing so, the CIT(A) has referred to certain judicial pronouncements, again without explaining whether the facts of cited decisions are applicable to the assessee in the case on hand, and held that the “majority view” is hereby followed and directed the TPO to adopt LIBOR rates; again without specifying what rate is to be adopted.

IT(TP)A No. 1497/Bang/2014 5.3 Before us, the assessee has raised grounds challenging the decisions of the CIT(A) in applying the LIBOR rates and also on the ground that this decision by the CIT(A) was taken without giving notice u/s 251(2) of the Act as it has resulted in enhancement of income.

5.4.1 We have heard the rival contentions, considered the submissions put forth and carefully perused the material on record. In our considered view, the manner in which the impugned order of the CIT(A) has been framed on this issue is faulty and erroneous; both in deciding whether the CCDs are in the nature of debt OR equity and also the interest rate that should be adopted. The CIT(A) has held the CCDs to be debts by placing reliance on three judicial pronouncements, without first examining whether the facts of the cases cited have any relation to the issue under consideration. For example, in the decision of Hon’ble Bombay High Court in the case of DIT Vs. Besix Kier Dabhol SA (2012) 26 taxmann.com 169 (Bom) the issue for consideration was disallowance of interest on borrowed capital u/s 36(i)(iii)/37 by characterization of debt into equity. In the decision of the AAR in the case of Z, Inre (2012) 20 taxmann.com 91 (AAR – New Delhi) the issue for consideration was whether the capital gains arising from sale of securities is exempt from capital gains tax under the DTAA. In the decision of the ITAT, Bangalore Bench in the case of Logic Micro Systems Ltd., (08 ITR (Trib) 159), the issue for consideration was interest to be charged on outstanding receivables. In none of the above decisions cited by the CIT(A) (supra), was the issue of ALP on IT(TP)A No. 1497/Bang/2014

Page 17 of 20 international transactions on interest payment on CCDs the subject of consideration.

5.4.2 Further, the TPO while taking the view that CCDs are not in the nature of debts has referred to RBI policy and also the facts of the case on hand where the CCDs issued as a first series carried interest @ 14% and interest was then reduced to 0% and the second series of CCDs issued by the assessee on similar conditions carried interest @ 14%. The CIT(A) has also not examined as to whether these two series of CCDs constituted an internal CUP for comparability analysis and determination of ALP. As regards the interest rate to be charged, the CIT(A) has observed that while the Bangalore Bench of ITAT has held that interest rate should be determined as per short term deposits in the home country; the Chennai and Hyderabad Benches of ITAT have held that the average LIBOR rates are to be adopted and is following the ‘Majority View’. This approach by the CIT(A) in deciding the issue, without examining the facts of the decisions relied upon and comparing the same to the facts of the case on hand, is erroneous to say the least. The CIT(A) ought to have first examined the currency in which the borrowings have been denominated, by examining the agreement entered into by the assessee and the AE and then decided the issue.

5.4.3 In this regard, on similar facts, the Hyderabad Bench of ITAT in the case of ADAMA India P. Ltd., in its order in dated 13.01.2017 has held as under:

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Page 18 of 20 “8. We have considered the issue and examined the rival contentions. There is no dispute with reference to the fact that the CCDs were issued in Indian Rupees. Accordingly, following the principles laid down by the Co-ordinate Benches and the Hon'ble High Court as relied on by the assessee in the submissions, we have to hold that TPO has wrongly treated the issuance of CCDs as a loan, by treating it as an external commercial borrowing, ignoring the fact that loan is a debt, whereas CCD is hybrid instrument in nature basically categorised as equity in nature. It was accepted by the Hon'ble Supreme Court in the case of Sahara India Real Estate Corporation Limited and Sahara Housing Investment Corporation Limited & Ors. Vs. Securities and Exchange Board of India & Anr. in Civil Appeal No. 9813 of 2011 dt. 31- 08-2012 (supra) while :- 7 -: ADAMA India Private Limited (Formerly known as Makhteshim-Agan India Private Limited) assigning the jurisdiction to SEBI as an 'equity instrument'. Further, the policy of Govt. of India and also RBI effective from 01- 04-2010 also indicate that issuance of CCD is part of FDI being quasi-equity in nature and considering the same as a loan would be completely against regulations laid by DIPB, RBI and FEMA. It is to be reiterated that issuance of CCDs was denominated in Indian Rupees and not foreign currency. Therefore, TPO has erred in considering LIBOR as benchmark rate which is in complete contradiction to the principles on the issue. The following judicial precedents supports that the rate interest has to be considered in the currency in which loan has originated: i. India Debt Management Pvt. Ltd., IT(TP)A No. 7518/Mum/2014; ii. CIT Vs. Cotton Naturals (I) Ltd., ITA No. 233/2014 (Del.HC); iii. M/s. Brahma Center Development Pvt. Ltd., Vs. ITO, ITA No. 373/Del/2016 (ITAT Del). By respectfully following the Co-ordinate Bench and Hon'ble High Court decisions, we agree with the assessee's contentions that the CCDs cannot be IT(TP)A No. 1497/Bang/2014

Page 19 of 20 categorised as a loan and LIBOR plus two hundred basis points benchmark cannot be accepted on the facts of the case.”

5.4.4 We are also of the view that there is merit in the assessee’s contention that it should have been afforded opportunity of being heard before the CIT(A) decided that the interest rate should be designated in LIBOR and not on the Rupee rate, as was done by the assessee.

5.4.5 In view of the above discussion, as it is clear that the basic facts of the case on this issue have not been thoroughly/properly examined in the right perspective by the CIT(A), we deem it appropriate to remand the issue back to the file of the CIT(A) for fresh adjudication after considering the facts of the case; the principles involved and our aforesaid observations made in this regard. Needless to add that the assessee shall be accorded adequate opportunity of being heard and to file details/submissions in this regard which shall be considered before deciding the issue. We hold and direct accordingly. Consequently, grounds 2 to 4 of assessee’s appeal are allowed for statistical purposes.

Pronounced in the open court on 05th November, 2018.