2019 (8) TMI 1430 - AT - Income Tax

TP Adjustment - Indo Cyprus DTAA - taxability is of 'interest arising' in a contracting state which is paid to the resident of other contracting state - TPO has made the adjustment on the ground that assessee was to earn an assured return of 18% and accordingly, determined the arm s length price by taking the coupon rate to be 18% instead of coupon rate of 4%. - HELD THAT - The assessee is a Cyprus based company engaged in the business of making investment in real estate sectors via fully convertible debentures. It was due to these investments in the investee companies that they are treated as associated enterprises as per the provisions of TP. As per the agreement between the investee companies and the assessee, the assessee was entitled to a coupon rate of 4% and further post the conversion of FCCDs into equity shares, the promoters of the Indian Companies would buy back shares at an agreed option price. The option price was stipulated to be such that the investor gets the original investment paid on subscription to the FCCD s plus a return of 18% per annum. Undisputedly, the assessee has only received interest income of ₹ 60,46,895/- from one of the investee companies and that too only for the half of the year. No actual interest other than this amount has been received by the assessee from any other investee companies. The TPO has made the adjustment on the ground that assessee was to earn an assured return of 18% and accordingly, determined the arm s length price by taking the coupon rate to be 18% instead of coupon rate of 4%. 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. In view of Article 11(1) we hold that, only the interest which has actually been received can only 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.

Issues Involved:
1. Taxability of interest income under Article 11(1) and (2) of the Indo-Cyprus DTAA.
2. Determination of interest income on a paid basis versus payable basis.
3. Applicability of Transfer Pricing (TP) provisions.
4. Benchmarking of Arm's Length Price (ALP) for interest income.
5. Waiver of interest due to financial difficulties of investee companies.
6. Impact of notional income on tax base erosion.
7. Jurisdictional powers of the Transfer Pricing Officer (TPO) and Assessing Officer (AO).

Detailed Analysis:

1. Taxability of Interest Income under Article 11(1) and (2) of the Indo-Cyprus DTAA:
The primary issue was whether interest income should be taxed on a paid basis or an accrual basis under Article 11(1) and (2) of the Indo-Cyprus DTAA. The DRP held that interest income is chargeable to tax on a paid basis, not on an accrual basis. This interpretation was consistent with various judicial precedents, which emphasized that for taxing interest income in the hands of a non-resident, the twin conditions of 'arising' and 'payment' must be fulfilled. The tribunal upheld this view, noting that Article 11(1) of the DTAA explicitly states that interest must be "paid" to be taxable.

2. Determination of Interest Income on a Paid Basis versus Payable Basis:
The revenue argued that the term 'paid' should include 'payable,' but the tribunal disagreed. The tribunal referred to the specific wording of Article 11(1) of the Indo-Cyprus DTAA, which requires actual payment for taxability. The tribunal cited decisions from the Mumbai ITAT and the Bombay High Court, which supported the interpretation that interest income should be taxed on a receipt basis, not on an accrual basis.

3. Applicability of Transfer Pricing (TP) Provisions:
The TPO had determined that the assessee should have earned an assured return of 18% and adjusted the interest income accordingly. However, the tribunal found that the TP provisions were not intended to apply in situations where the interest income was neither received nor accrued. The tribunal emphasized that only the interest actually received by the assessee could be subject to TP adjustments.

4. Benchmarking of Arm's Length Price (ALP) for Interest Income:
The TPO had benchmarked the interest income at 18%, arguing that this was the market rate for similar transactions. The tribunal, however, noted that the investments were akin to equity rather than loans, and the agreed coupon rate was 4%. The tribunal found that the TPO's adjustment was based on a hypothetical scenario and not on actual transactions. The tribunal upheld the DRP's decision to delete the TP adjustment.

5. Waiver of Interest Due to Financial Difficulties of Investee Companies:
The assessee had waived its right to receive interest due to the financial difficulties faced by the investee companies. The tribunal accepted this explanation, noting that the waiver was mutually agreed upon and documented. The tribunal found that the waiver was a legitimate business decision and should not be disregarded for tax purposes.

6. Impact of Notional Income on Tax Base Erosion:
The revenue argued that imputing interest income would lead to unintended tax base erosion. The tribunal, however, found that taxing notional income, which was neither received nor accrued, would be contrary to the principles of the DTAA and the Income Tax Act. The tribunal emphasized that TP provisions should not be used to tax hypothetical income.

7. Jurisdictional Powers of the Transfer Pricing Officer (TPO) and Assessing Officer (AO):
The tribunal held that the TPO and AO had exceeded their jurisdiction by taxing notional interest income. The tribunal reiterated that only actual income, which is chargeable under the Income Tax Act and the DTAA, could be subject to TP adjustments. The tribunal upheld the DRP's direction to delete the TP adjustment and dismissed the revenue's appeal.

Conclusion:
The tribunal dismissed the revenue's appeal and upheld the DRP's directions, emphasizing that interest income under the Indo-Cyprus DTAA should be taxed on a paid basis, not on an accrual basis. The tribunal found that the TPO's adjustments were based on hypothetical scenarios and not on actual transactions. The tribunal also accepted the assessee's waiver of interest due to financial difficulties as a legitimate business decision. The tribunal concluded that TP provisions should not be used to tax notional income, which was neither received nor accrued.

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