Transfer Pricing Adjustment on Interest Which Has Neither Been Received Nor Accrued To The Assessee Cannot Be Chargeable: ITAT

TMW ASPF CYPRUS (assessee), a private limited company incorporated in Cyprus was engaged in the business of making investments in the real estate sector via fully convertible debentures (FCCDs). The company in the year 2008 made investments in independent third-party companies in India (collectively ‘Investees’). Due to these investments, the investee companies were treated as associated enterprises as per the provisions of the transfer pricing (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.

A detailed scrutiny was conducted on the assessee company, 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.

During the impugned assessment year, the assessee had received interest income of Rs. 60,46,895/- from one of the investee companies and that too only for the half of the year. It asserted that it did not receive any actual interest other than this amount from any other investee companies.

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%. The taxable income was revised to Rs.36,75,86,430/- in the draft assessment order.

Aggrieved by the action of the TPO and the consequent addition by the AO, the assessee filed its objections against the draft assessment order before the Dispute Resolutions Panel. The DRP had accepted the contention of the assessee that imputing interest income in hands of non-resident assessee when it has not been claimed by the Indian payer to have accrued/arisen or paid in favour of the assessee shall lead to unintended consequences of erosion of tax base as such interest expenses shall be tax deductible in hands of Indian company which are subject to tax @30% whereas it shall be taxable in hands of recipient assessee @10% as Double Tax Avoidance Agreement (DTAA). Transfer Pricing provisions are not intended to be applicable under such circumstances. In view of above discussion, the DRP held that in the present case TP adjustment is not called for.

The DCIT (International Taxation) filed an appeal against assessee with the Income Tax Appellate Tribunal, Delhi (ITAT) from an order of the Dispute Resolutions Panel (DRP).

The question before the ITAT was whether the DRP erred in holding that as per Article 11(1) and (2) of Indo-Cyprus DTAA, interest income is chargeable to tax on paid basis when the usage of the word 'paid' always includes 'payable' and vice versa.

Secondly, whether on the facts and in the circumstances of the case, the DRP erred in observing that it has been judicially held in various case laws relied upon by the assessee that as per Article 11(1) and (2) of Indo-Cyprus DTAA, interest income would be chargeable to tax on paid basis.

The ITAT held that 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. The interest income in question can only be taxed on payment/receipt basis.

The ITAT ruled 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. The TPO/AO sought to tax what the 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, the entire edifice of the TPO/AO was based on fixation of contingent event which the assessee was supposed to receive. The transfer pricing adjustment was made on the hypothetical amount of interest receivable.

The ITAT further cited the case of the case of Vodafone India Services (P) Ltd. vs. Union of India where the question was whether such notional income can be brought to tax even under the transfer pricing provision. The Bombay High Court had given a ruling 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.

The Income Tax Appellate Tribunal, Delhi held that only the interest which has actually been received can only be subject matter of taxation and no transfer pricing 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 was upheld and the grounds raised by the DCIT were dismissed.

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