CCD Interest TP Adjustment Vacated and Goodwill Depreciation on Slump Sale Upheld: ITAT Chennai in Stahl India Pvt. Ltd. vs DCIT

1. Background and Procedural History

Stahl India Pvt. Ltd., a private limited company incorporated on 29.01.1998 and engaged in the manufacture and distribution of specialty chemicals for the leather and fabric industries, filed its return of income for Assessment Year 2020-21 on 23.01.2021, declaring total income of Rs. 17,18,84,540. The case was selected for complete scrutiny under CASS, and a notice under Section 143(2) of the Income Tax Act, 1961 was duly served on 29.06.2021.

During the course of assessment proceedings, the matter was referred to the Transfer Pricing Officer (TPO) to determine the arm's length price (ALP) of international transactions entered into by the assessee with its associated enterprises (AEs). The TPO, vide order dated 22.06.2023 passed under Section 92CA(3), proposed the following transfer pricing adjustments:

  • An upward adjustment of Rs. 11,88,635 on account of interest on receivables
  • An upward adjustment of Rs. 56,71,137 on account of margin adjustment
  • A downward adjustment of Rs. 9,58,98,001 on account of interest on Compulsorily Convertible Debentures (CCDs)

Following the TPO's order, a draft assessment order dated 28.09.2023 was passed under Section 144C(1), incorporating the above TP adjustments along with a corporate tax disallowance of depreciation on goodwill amounting to Rs. 15,98,76,563.

The assessee filed objections before the Dispute Resolution Panel (DRP) on 27.10.2023. The DRP disposed of those objections vide its directions dated 18.06.2024. Pursuant thereto, the TPO gave effect to the DRP's directions vide order dated 15.07.2024, granting relief of Rs. 56,71,137 in respect of the margin adjustment. The final assessment order was then passed on 19.07.2024 under Section 143(3) read with Section 144C(13) read with Section 144B, determining the total income at Rs. 42,88,47,739.

Aggrieved, the assessee filed an appeal before the Income Tax Appellate Tribunal (ITAT), Chennai Bench, raising six grounds and various sub-grounds. During the hearing, the assessee's authorized representative confined arguments to Ground Nos. 4 and 5, and accordingly, Grounds 1, 2, 3, and 6 were dismissed. The two surviving issues — the TP adjustment on CCD interest and the disallowance of goodwill depreciation — are discussed below.

2. Transfer Pricing Adjustment on Interest Paid on Compulsorily Convertible Debentures

(i) Factual Matrix

On 25.04.2014, the assessee issued 76,88,412 CCDs of Rs. 190 each to its AE, Stahl Netherlands BV, aggregating to Rs. 146 crore. These CCDs were convertible into 76,88,412 equity shares of Rs. 10 each, with conversion to occur on 30.04.2024 or at any earlier time at the discretion of the debenture holder. A coupon rate of 11% per annum was fixed. During Assessment Year 2020-21, the assessee accrued interest on the CCDs amounting to Rs. 9,58,98,001.

The TPO recharacterised the CCDs as equity instruments and accordingly determined the ALP of interest at Nil, resulting in a TP adjustment of Rs. 9,58,98,001. The DRP upheld this determination. The assessee contended before the Tribunal that the TPO exceeded his jurisdiction in recharacterising the CCDs as equity, and that the benchmarking analysis conducted by the assessee adequately demonstrated that the 11% coupon rate was at arm's length.

The ITAT held that the TPO had overstepped his jurisdiction in applying a thin capitalisation-like approach to recharacterise the CCDs as equity. The Tribunal reaffirmed the settled legal position that CCDs retain their character as debt instruments until they are actually converted into equity, and that interest payable on such instruments during the pre-conversion period is a deductible expenditure.

The Rajasthan High Court's ruling in Secure Meters Ltd., reported in 321 ITR 611, was relied upon for this proposition. The High Court had therein held:

"Admittedly 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, and therefore, the expenditure incurred would be admissible as revenue expenditure."

The Bangalore Bench of the ITAT in CAE Flight Training (India) Pvt. Ltd., reported in, had similarly held that CCDs are to be treated as debt until they are converted into equity. This position was further reinforced by the following decisions:

  • Embassy One Developers Pvt. Ltd. (ITAT Bangalore)
  • Indorama Ventures Oxides Ankleshwar (P.) Ltd. (ITAT Mumbai), TS-471-ITAT-2024
  • WeWork India Management (P.) Ltd. (ITAT Bangalore), 150 taxmann.com 432

(iii) Rejection of the DRP's Reliance on Narendra Kumar Maheshwari and RBI/FEMA Regulations

The Tribunal noted that the DRP's reliance on the Supreme Court's judgment in Narendra Kumar Maheshwari, reported in AIR 1989 SC 2138, was misplaced. That decision was rendered in the context of the Companies Act, 1956 and the Securities (Contract and Regulation) Act, 1956, and dealt with whether the Controller of Capital Issues had the power to allot CCDs — it had no bearing on the income-tax treatment of interest during the pre-conversion period.