The facts in brief are that TMW ASPF CYPRUS (hereinafter referred to as ‘assessee’) is a private limited company incorporated in Cyprus and is engaged in the business of making investments in the real estate sector. The company in the year 2008 had made investments in independent third-party companies in India (hereinafter collectively known as ‘investee companies’) engaged in real estate development vide fully convertible debentures (FCCDs). It was these investments that made the investee companies an associated enterprise of the assessee as per TP provisions. The assessee had also entered agreements, according to which the assessee was entitled to a coupon rate of 4%. Further, after the conversion of the FCCDs into equity shares, the promoter of Indian Companies would buy back at an agreed option price. The option price would be such that the investor gets the original investment paid on subscription to the FCCDs plus a return of 18% per annum.
During the impugned assessment year, the Assessee had received an interest income of Rs.60,46,895/ – from one of the three investee companies and that too only for the first half of the year. No interest was received by the assessee from any other company. The Assessee Company had sent multiple notices and followed up with the investee companies in relation to the defaults and non compliances with the agreed terms of the agreements. However, no resolution could be sought in this regard. The assessee company on account of the downturn in the real estate market and the fact that the companies were in bad financial position and facing cash crunch, waived its right to receive interest under a mutual agreement with the investee.
The case of the assessee company was selected for detailed scrutiny and the matter was referred by the Assessing Officer (AO) to the Transfer Pricing officer (TPO) to examine whether the international transactions entered by the assessee during the captioned assessment year were at arm’s length or not. The TPO held that the assessee was to earn an assured return of 18% and determined the arm’s length price of the coupon rate to be 18%, instead of coupon rate of 4%. Accordingly, taxable income was revised to Rs.36,75,86,430/- in the draft assessment order by the AO.
Decision of the Court:
One of the main contention raised before us by the Counsel that assessee being a non resident and Cyprus based company therefore it was entitled to the benefit of India Cyprus DTAA Article 11(1) of India-Cyprus DTAA reads as under :-
“Interest arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other State.”
The aforesaid para envisages that for taxing the interest income in the hands of a non-resident, it is necessary that the interest should arise in a contracting state, i.e., twin conditions of accrual as well as the payment are to be satisfied. If there is no accrual or actual payment received then same is to be decided within the scope of Article 11(1). What the TPO/AO have sought to tax is that, assessee was supposed to receive interest of 18%, if the contingent event would have arisen, i.e., if in the event, the option was exercised by the assessee to sell its converted shares to the promoters of investee company at an option price then it would have given the return of 18%. Thus, entire edifice of the TPO/AO was based on fixation of contingent event which assessee was supposed to receive. It is also matter of record no such conversion was actualised and assessee remained invested even during the year under consideration. The transfer pricing adjustment has been made on this hypothetical amount of interest receivable. Whether such notional income can be brought to tax even under the transfer pricing provision, has been dealt by the Hon’ble Bombay High Court in the case of Vodafone India Services (P) Ltd. vs. Union of India (supra), wherein their Lordships have held that even income arising from international transaction must satisfy the test of income under the Act and must find its home in one of the charging provisions. Here in this case, nowhere the TPO/AO has been able to establish that notional interest satisfy the test of income arising or received under the charging provision of Income Tax Act. If income is not taxable in terms of section 4, then chapter X cannot be made applicable, because section 92 provides for computing the income arising from international transactions with regard to the ALP. Only the interest income chargeable to tax can be subject matter of transfer pricing in India. Making any transfer pricing adjustment on interest which has neither been received nor accrued to the assessee cannot be held to be chargeable in terms of the Income Tax Act read with Article 11(1) of DTAA. Here it cannot be the case of accrual of interest also, because none of the investee companies have acknowledge that any interest payment is due, albeit they have been requesting for waiving of interest of even coupon rate of 4%, leave alone the return of 18% which was dependent upon some future contingencies. Assessee despite all its efforts has acceded to such request. Further, in the India Cyprus DTAA wherein similar phrase has been used pertaining to FTS and Royalty in India Cyprus DTAA, Hon’ble Bombay High Court held that assessment of royalty or FTS should be made in the year in which amount have actually received and not otherwise. The coordinate bench of Mumbai ITAT in the case of Pramerica ASPF II Cyprus Holding Ltd. vs. DCIT (supra) on exactly similar set of facts, addition on account of notional interest was made; the Tribunal has held that the interest income in question can only be taxed on payment /receipt basis. The relevant observation has already been incorporated above. The Hon’ble Bombay High Court has confirmed the said finding. Similar view has been taken by the ITAT Chennai Bench in the case of DCIT Inzi Control India Limited (supra). Thus, in view of Article 11(1) we hold that, only the interest which has actually been received can be subject matter of taxation and no TP adjustment can be made on some hypothetical receivable amount which was contingent upon certain event which has actually not been taken place during the year. Thus, the order of the Direction of the DRP is upheld and the grounds raised by the revenue are dismissed.
India vs TMW, August 2019, Tax Tribunal, Case No ITA No 879 DEL 2016 DCO1565349384-ITA