INDORAMA VENTURES OXIDES ANKLESHWAR PRIVATE LIMITED ,MUMBAI vs. DCIT, CIRCLE 14(1)(1), MUMBAI

Re: Transfer pricing adjustment of INR 16,78,40.626/-on account of purchase of business from Huntsman International (India) Private Limited ("HIPL”) 4.1. On the facts and in the circumstances of the case and in law, the learned transfer pricing officer ("Ld. TPO")/Ld. AD under the directions of the Ld. DRP erred in making upward adjustment of INR 16.78,40,626/- to the purchase price of the surfactants business of HIIPL purchased by the Appellant. 4.2. On the facts and in the circumstances of the case and in law, the Ld.. TPO/Ld. AD under the directions of the Ld. DRP erred in holding that purchase of surfactants business of HPL by the Appellant was a 'deemed international transaction under section 928(2) of the IT Act 4.3. On the facts and in the circumstances of the case and in law, the Ld. TPO/Ld. AO under the directions of the Ld. DRP erred in holding that purchase of surfactants business was taxable under section 56(2)(x) of the IT Act. 44 On the facts and in the circumstances of the case and in law, the Ld. AO/Ld. DRP erred in not following the mandatory and binding procedure set out in instruction No. 3 of 2016 dated 10 March 2016 issued by the Central Board of Direct Taxes, Ministry of Finance, Government of India and accordingly aforesaid adjustment was in direct contravention of the same and is liable to be deleted.

The assessee is a private limited company primarily involved in manufacturing of surfactants. The assesseefiled its Income Tax Return (“ITR”) for AY 2020-21 declaring total loss at INR 6,78,11,415/-.During impugned assessment Indorama Ventures Oxides Ankleshwar Pvt Ltd year the assesseeacquired surfactants business (i.e.,business undertaking) of Huntsman International (India) Private Limited (“HIIPL”), an unrelated party under ‘slump sale’ in terms of Business Transfer Agreement dated 03/10/2020, copy of the agreement is enclosed pages 212-266 of the factual paper book. Acquisition of this business undertaking was part of a global business acquisition agreement signed between Indorama Ventures Holdings LP and Huntsman International LLC.The acquisition consideration for HIIPL’s surfactants business was determined based on the ratio of HIIPL’s EBITDA (i.e., Earnings before Interest, Depreciation and amortisation) to the total EBITDA of the business acquired globally.The acquisition price for the business undertaking was Rs. 1,74,01,59,374/- (approx. Rs. 174 crores).To finance such acquisition, assessee issued compulsorily convertible debentures (in short “CCDs”) to Indorama Netherlands B.V. (in short “INBV”)i.e., associated enterprise of the assesseeand the balance amount was financed by way of short-term loan from bank. The key terms of the CCDs were as under:

In ground no 2 the assessee contends that final assessment order is passed beyond the limitation period prescribed under section 153 of the Act, which is not pressed before us, hence dismissed.

In ground no3 the assessee agitates that the Ld. DRP erred in making adjustment of INR 38,88,00,000/-on account of alleged optionpremium arising on alleged sale of embedded call option to Indorama Netherlands BV. The Ld.AR of the assessee submitted that CCDs cannot be equated with call option.The assessee did not enter into sale of any ‘call option’ to its AE, INBV and thus the question of receiving any ‘option premium’ does not arise. The CCDs were issued in accordance with the terms of the CCD subscription agreement dated 30/12/2019 and the same was not a contract for sale of any ‘call option’, the CCD subscription agreement dated 30/12/2019 is enclosed at pages 177-183 of the factual paperbook. A ‘call option’ contract gives the holder the right, but not the obligation, to buy an underlying security at a specific price within a specified time. This is in contrast with the terms of the CCD issued wherein the CCDs may be converted into equity shares at any time at the option of both the CCD holder and the assessee. Further, in case no option is exercised by any of them, the CCDs shall be compulsorily convertedon expiry of one year of its issuance. In the instant case, option to convert the CCDs before one year period was available to both the CCD holder and the assessee and not just to the CCD holder and as a fact, the instant conversion was made at the instance of the assessee. Accordingly, question of receiving any option premium does not arise at all. Further, the Ld.AR submitted that the holder of a call option pays a fee, known as ‘premium’. Such Indorama Ventures Oxides Ankleshwar Pvt Ltd premium is maximum that the holder can lose on a call option. This is in contrast with the CCD wherein no such premium is paid by the holder to the assessee. The entire CCD value was paid by the holder i.e. INBV at the time of issuance of CCDs amount to Rs. 1,000/- per CCD. Under CCD agreement, interest was charged by the holder until conversion, which is not the case with a call option.

It was further submitted that fair market value (“FMV”) is inclusive of ‘premium’ on shares: The “Ld. DRP” has erroneously added premium of INR 10 over and above the FMV of INR 19.72 per share, as determined in terms of valuation report dated 26/12/2019, annexed in pages 189 to 206 of the factual paperbook. Without appreciating the fact that the FMV of a share already includes its premium amount. This value includes the face value and premium of each share. Accordingly, 50 equity shares of value to Rs. 19.72 each which comes to Rs 986/- were exchanged in lieu of CCDs of Rs. 1,000/-. Thus, no premium income was earned or received by the assesseeon account of issuance or conversion of the CCDs.

The Ld.AR also argued that there is no ‘income’ element in the deal asissuance of CCDs was a capital account transaction not giving rise to any ‘income’. It is a settled position that transfer pricing provisions are not charging provisions and in the absence of ‘income’ chargeable to tax under any charging provisions of the Act, transfer pricing provisions cannot be invoked. Respectfully the reliance is placed on the decision of Hon’ble Jurisdictional High Court in the case of Vodafone India Services (P.) Ltd v UOI [(2014) 368 ITR 1. For abovementioned reasons, it cannot be said that the Assessee has transacted in Indorama Ventures Oxides Ankleshwar Pvt Ltd any options contract. Consequently, in the absence of any income (notional or otherwise) in the nature of options premium, transfer pricing adjustment cannot be made. He further submitted that the RBI took on record issuance of CCDs worth Rs. 80 crores by the assessee; CCDs were issued to foreign AE under automatic approval route of RBI.

With regard to ground no. 4 pertaining to transfer pricing adjustment of Rs. 16,78,40,626/- on account of purchase of business from HIIPL. The Ld. AR argued onnon-applicability of section 56(2)(x) of the Act on purchase / receipt of ‘business undertaking’.He submitted that therevenue has made this adjustment primarily on the ground that the business was purchased amount to Rs.1,74,01,59,374/- whereas its fair value computed under the DCF method (treated as ALP) was amount to Rs.1,90,80,00,000/-and thus difference amount to Rs. 16,78,40,626/- was taxable under section 56(2)(x) of the Act. In this connection he submitted that section 56(2)(x) can apply only to receipt of ‘property’ as defined in that section. The definition of ‘property’ under section 56 does not include ‘business undertaking’. As the assessee has acquired a ‘business undertaking’ for running business for a lump-sum consideration, provisions of Section 56(2)(x) are inapplicable and accordingly the entire adjustment ought to be deleted on this count itself. The Ld.AR further submitted that section 92(1) does not create an independent charge to tax ‘income’ which is otherwise not chargeable under the Act. And that, if income is not chargeable to tax under normal provisions of the Act, provisions of Chapter X cannot be invoked. Chapter X of the Act pre-supposes existence of ‘income’ and lays down machinery provisions to compute ALP for such income. In this regard he placed reliance on Indorama Ventures Oxides Ankleshwar Pvt Ltd the judgement of the Hon’ble jurisdictional High Court in the case of Vodafone India Services Pvt. Ltd. v UOI [2014] 368 ITR 1 (Bom), wherein it has been held as under: -

It is hereby informed that the Board has accepted the decision of the High Court of Bombay in the above mentioned Writ Petition. In view of the acceptance of the above judgment, it is directed that the ratio decidendi of the judgment Indorama Ventures Oxides Ankleshwar Pvt Ltd must be adhered to by the field officers in all cases where this issue is involved. This may also be brought to the notice of the ITAT, DRPs and CIT (Appeals)”

The Ld.AR further submitted that there is contravention of Instruction No. 3/2016 dated 10/03/2016: The assessee declared the international transaction with HIIPL in Form 3CEB with qualifying remark that the transaction was not a ‘deemed international transaction’, and that it was reported out of abundant caution. In such circumstances,Instruction 3/2016 required the Ld. AO to record satisfaction and provide opportunity of being heard before making a TP reference. This jurisdictional requirement has not been complied with, and therefore the transfer pricing adjustment is bad on this count as well.Respectfully the ld. AR relied on the decision of Hon’ble Delhi High Court in the case of Indorama Synthetics (India) Ltd v ACIT [2016] 71 taxmann.com 349 (Delhi).

The Ld.AR further argued that the acquisition of Huntsman group’s global business was between two unrelated parties, and the EBITDA method for valuation of businesses has arrived at between such parties. In the absence of cogent reasons, the EBITDA method cannot be rejected. The ld. AR mentioned that in any merger and acquisition deal with a third party, EBITDA is the primary driver for the determination of purchase price.

With regard to ground no.5 pertaining to adjustment on account of interest of Rs.1,91,34,1247/- on CCDs paid to INBV. The Ld.AR submitted thatCCDs are debt instruments until conversion.The CCDs are fundamentally distinct from equity shares, as: (i) there is an obligation to pay interest until conversion date. (ii) they do not carry voting rights.

After examining the applicability of the Tribunal order rendered in the case of Besix Kier Dabhol, SA v. DDIT (supra), we now examine the applicability of the decision of Special Bench of the Tribunal rendered in the case of Ashima Syntex Ltd. v. ACIT as reported in 100 IID 247 (Ahd) (SB) on which reliance has been placed by Id. DR of revenue in the written submissions filed by him as reproduced above. From the facts noted by the Tribunal in this case, it is seen that in that case the assessee issued convertible debentures for subscription Indorama Ventures Oxides Ankleshwar Pvt Ltd at the rate of Rs. 75 per debenture and these were in two parts Part-A of Rs. 35 to be compulsorily converted into one equity share of the face value of Rs. 10 each at a premium of Rs. 25 per share on the date of allotment of the debenture and Part-B of Rs. 40 to be compulsorily converted into one equity share of the face value of Rs. 10 each at a premium of Rs. 30 per share on the expiry of 15 months from the date of allotment of the debenture. Part-B debenture was to carry an interest at the rate of Rs. 14 per annum till the date of conversion payable half yearly on 30th June and 31st December each year and on conversion. The issue in dispute in that case was regarding the allowability of expenses incurred on issue of such debentures and the issue in that case was not of interest on debentures before its conversion as in the present case. This is also an important aspect of the matter of that case that one part of the debenture was to be converted on the date of allotment of debenture itself, second part of the debenture has to be converted on the date of share on the expiry of 15 months from the date of allotment of the debenture. Part-B debenture was to carry an interest at the rate of Rs. 14 per annum till the date of conversion payable half yearly on 30th June and 31st December each year and on conversion. The issue in dispute in that case was regarding the allowability of expenses incurred on issue of such debentures and the issue in that case was not of interest on debentures before its conversion as in the present case. This is also an important aspect of the matter of that case that one part of the debenture was to be converted on the date of allotment of debenture itself, second part of the debenture has to be converted only on expiry of 15 months from the date of allotment of debenture and under these facts, it was held by Special Bench of the Tribunal in that case that the expenses incurred on issue of such debentures has to be considered as expenses incurred for issue of shares because it was found that first part of the debentures was to be converted into shares on the date of allotment itself and the second part was to be converted after expiry of 15 months from the date of allotment of debenture and therefore it was held that expenses incurred were actually incurred for issue of shares and not issue of debentures. In the present case, the issue is not regarding expenses incurred on issue of shares. In the present case, the dispute is regarding interest on CCDs for a period before conversion. Hence in our considered opinion, this decision of special bench of the Tribunal is not applicable in the facts of present case because the issue in dispute is different. In that case the issue in dispute is regarding expenditure incurred on issue of convertibles whereas in the present case the issue is regarding allowability of interest expenditure on convertible debentures for the pre-conversion period. Hence, we hold that the revenue does not find any support from this decision of Special Bench of the Tribunal in that case.”

The Ld.AR further submitted that the assessee required additional funds for business operations and given that it already had high debt in nature of CCDs, it was facing difficulty in obtaining term loan and working capital loan from banks. Accordingly, the assesseeentered into an arrangement with HSBC Bank for obtaining additional debt. Given the assessee’s high debt-to-equity ratio, the amended loan arrangement with HSBC required the assesseeto, inter-alia, convert all CCDs into equity shares by 31/03/2020 as a condition precedent to providing a term loan and working capital loan.

The Ld.AR submitted that it is a settled position that the Ld. TPO cannot step into the shoes of the assessee to determine whether it should have made the commercial choice of issuing CCDs to raise capital for business.Respectfully Indorama Ventures Oxides Ankleshwar Pvt Ltd reliance in this regard is placed on the decision of Hon’ble Supreme Court in the case of S.A. Builders Ltd vs. CIT(A) [2007] 288 ITR 1.

The Ld.AR submitted that the FEMA / RBI guidelines are not relevant in this case The Ld. DRP erroneously placed reliance on the characterization of CCDs under FEMA / foreign direct investment (“FDI”) regulations as ‘equity instruments.’ The Ld. DRP failed to appreciate the fact that these rules were introduced in an entirely different context of Indian foreign exchange regulations, and that treatment under FEMA does not change the essential nature of the CCDs as a ‘debt instrument’ for the purpose of IT Act.The Ld. DRP also relied on Circular No. 74 dated 8 June 2007 issued by the RBI wherein RBI stated that instruments which are fully and mandatorily convertible into equity would be treated as part of ‘equity’ under foreign direct investment policy. The Ld. TPO/ Ld. DRP placed reliance on such circular and held that CCDs would be in the nature of ‘equity’ for Indian transfer pricing purposes. They failed to appreciate the context of the circular, which was to prevent Indian companies from raising debt by means of issuing optionally convertible debentures without complying with the conditions specified under the applicable ‘External Commercial Borrowings’ (“ECB”) regulations. Such a policy decision is from the perspective of conserving Indian foreign exchange by regulating borrowing from foreign sources, their permissible use in India, interest payment thereon, etc andwould have no bearing on the income tax implications regarding interest expenditure on CCDs.

Further, with regard to allowability of interest under section 36(1)(iii), the Ld.AR submitted that as CCDs are debt instruments until their conversion, interest paid on CCDs should be considered as ‘interest on borrowings’ for section Indorama Ventures Oxides Ankleshwar Pvt Ltd 36(1)(iii).It is not disputed that proceeds from issuance of CCDs were utilised for the purpose of business (which included payment of purchase consideration for acquisition of ‘business undertaking’ from HIIPL) as a going concern on a slump sale basis. This is also specifically mentioned in the CCD subscription agreement. Therefore, the proceeds derived from issuance of CCDs are in the nature of ‘capital borrowed for the purpose of business. Consequently, interest ought to be allowed under section 36(1)(iii) of the IT Act, as a legitimate business expense.

The Ld.AR also alternatively submitted that the CCDs were issued to raise funds for acquisition of the surfactants business of HIIPL. As this was for business purpose, and CCDs are debt instruments till date of conversion, interest paid on CCDs is also allowable as deduction under section 37 as well.

It was also submitted that the ALP of a transaction cannot be regarded as Nil: The Ld. TPO has treated ALP of interest payment as Nil on an arbitrarybasis primarily treating the same in the nature of equity on which no interest is to be paid. This action of the Ld. TPO / Ld. DRP is not permissible since CCDs remain debt until they are converted.

The Ld.AR contended thatduring the course of transfer pricing proceedings, the assessee submitted set of 8 comparables having an arm's length range of 8.00% to 12.00% per annum. Since, the assessee’s interest payment of 9.7% was within this range, it was treated at arm’s length. The Ld. TPO / DRP disregarded the independent benchmarking analysis undertaken by the assesseeby neither giving any cogent reasons nor independently conducting any search in accordance with the transfer pricing regulations under the Act.

The Ld.AR further submitted thatthe assesseeobtained a secured term loan from HSBC bank in April 2020 wherein the interest is charged at 9.05%. As availing unsecured loans from third parties entails higher interest rates, the interest rate of 9.7% paid by the assessee on its CCDs should be considered to be at arm’s length.

The Ld.AR summed up his arguments by submitting that RBI took on record issuance of CCDs worth INR 80 crores by the assessee; CCDs were issued to foreign AE under automatic approval route of RBI, copy is annexed in page 305 of the factual paperbook.

We heard the rival submission and considered the documents available in the record. We find that the assessee issued CCDs to the AE through the CCD subscription agreement dated 30/12/2019. The CCDs Cannot be equated with call options. The assessee did not enter into the sale of any call option to its AE.

In the result, the appeal of the assessee bearing is allowed.