DCIT (INTERNATIONAL TAXATION), NEW DELHI vs. M/S TMW ASPF I CYPRUS HOLDING COMPANY LTD.,, GURGAON

The cross objections are in support of the directions given by the DRP.

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 has also placed before us copy of the agreements concluded between the investee companies and the TMW ASPF. As per the aforesaid agreements, the assessee was entitled to a coupon rate of 4%. Further, post 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. As stated by the Ld. Counsel before us that 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 companies.

The case of the assessee company was selected for detailed scrutiny and the matter was referred by the Assessing Officer to the Transfer Pricing officer 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%. Consequently, the TPO computed Arm's Length adjustment with respect to Interest Income adjustments as under: - Name of the AE Amount to be Adjusted Supreme Buildcap Pvt Ltd Rs.2,25,00,000 /- DD Housing Ltd. Rs.27 ,89,58,000 /- Ritesh Spinning Mills Ltd Rs.5,40,00,000 /- TOTAL Rs. 35,54,58,000/- Accordingly, taxable income was revised to Rs.36,75,86,430/- in the draft assessment order by the AO.

Aggrieved by the action of the TPO and the consequent addition by the Assessing Officer, assessee filed its objections against the draft assessment order before the DRP. The assessee raised the following contentions: 5.1 The assessee submitted that Ld. TPO has erred in misconstruing the facts of the case, by not appreciating that as per the terms 'of the agreements entered between the Assessee with the investee companies, there are three separate and independent events:

The DRP concurred with the contentions of the Assessee and held as under: “6.1 DRP has duly examined the issue. The relevant facts are that the non-resident assessee company has invested by way of subscription to Fully Compulsorily Convertible Debentures (FFCD)

Aggrieved by the aforesaid finding the Revenue department has filed an appeal before us.

After drawing our attention, the relevant observation made by the TPO, Ld. CIT DR submitted that here in this case the assessee has incurred losses due to non receipt of interest and consequent to that it had to sell its investment to other 3rd parties on a loss. No independent entity in the market shall invest its resources in such high risk and if such investment is made which carries maximum risk then same has to be compensated at a higher value and here in this case, assessee has agreed to have only 4% of interest. The market rate of corporate loans of this kind fetches interest income at the rates anywhere between 16% to 30%, but the assessee has agreed for a much lesser compensation @ 18%. However, the assessee has received interest of Rs. 1,21,28,480/- @ 4%. Assessee has advanced deemed loan to its AE through internal accruals thereby implying that its funds were used to advance loans. An independent person would definitely expect the maximum return on its investment. Since Assessee Company is a tested party the same needs to be benchmarked independently with comparable uncontrolled transactions. He further submitted that the interest paid also includes payable and there was specific provision that 18% would payable and therefore, tax should be levied on accrual basis. He further submitted that benchmarking has to be done on entire amount which is payable 13 with independent third parties, whether such payment is justified or not, if it is an international transaction. Here in this case, the debentures have been issued by AE and therefore it has to be benchmarked. Since 18% was payable therefore, entire interest needs to be benchmarked. It would not be a proper interpretation that only paid / received is to be benchmarked. Thus, order of the TPO should be confirmed. Thus order of the TPO should be confirmed.

The Ld. Counsel for the assessee, Shri Kanchun Kaushal filed Paper book and made detailed oral & written submissions before us. He submitted that the assessee being a non resident is entitled to the benefit of the India- Cyprus Double Taxation Avoidance Agreement ['DTAA'] by virtue of Section 90(2) of the Income-tax Act, 1961. It was further argued that Article 11 of the India-Cyprus DTAA provides that interest income can be taxed in India only on fulfilment of the twin conditions of 'arising' and 'payment'. He then read out Article 11(1) of the India-Cyprus which states that; “1. Interest arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other State.” It was, accordingly, submitted by him that the aforesaid clause makes it clear that for taxing the interest income in the hands of a non-resident, it is necessary that the twin conditions of 'accrual' as well as 'payment' are satisfied. Accordingly, if the twin conditions are not satisfied, the taxability of such interest in the hands of a non-resident under Article 11 of DTAA does not arise.

In support of the aforesaid contentions the Ld. Counsel first relied upon the decision of the coordinate Mumbai bench in the case of DDIT v. Siemens Aktiengesellschaft (2009) taxmann.com 1019 (Mumbai - Trib.) wherein the tribunal while deciding the issue whether the commissioner of income tax (appeals) was correct in directing the AO to tax royalty income on accrual basis had held that the royalty and fees for technical services should be taxed in the hands of the assessee on receipt basis. The Ld. Counsel submitted that the Article pertaining to Royalty was similarly worded as the Article pertaining to interest in the India-Cyprus DTAA. He also brought to our notice that the aforesaid decision of the ITAT stood approved by the Hon'ble Bombay High in the case of DIT v. Siemens Aktiengesellschaft (ITA124 of 2010), wherein Hon'ble Bombay High Court observed and held as under:

The Ld. Counsel then relied on the decision of Mumbai ITAT in the case of Pramerica ASPF II Cyprus Holding Ltd. v. DCIT [2016] 179 TTJ 211 (Mumbai - Trib.) wherein the assessee company was incorporated in Cyprus and was engaged in making investment in real estate development companies in India, much like the assessee in the case at hand. The Assessing Officer in Pramerica (Supra) made an addition on the ground that interest income earned on aforesaid income was liable to be assessed on accrual basis. The Ld. Counsel also pointed out that the assessee in the aforesaid decision of Pramerica (Supra), took a similar argument and represented before the ITAT that Article 11 of the India- Cyprus DTAA pertaining to Interest Income fastens a tax liability only on payment of interest Income. The ITAT while agreeing with the arguments of the assessee in Pramerica (Supra) held:

The Ld. Counsel then proceeded to submit that the issue can also be examined from the angle of the TDS provisions. It was submitted that the Hon’ble Supreme Court in the case of GE Technology Centre (P.) Ltd. V. CIT [2010] 327 ITR 456 has held that when a credit afforded by, or a payment made by, an Indian resident, to a non-resident, does not trigger the taxability of that income in the hands of recipient, the tax deduction liability does not come into play at all. The tax at source is attracted at the very first instance when the income accrues to the payee. Accordingly, in this case by virtue of Article 11 of the Indian-Cyprus DTAA the tax liability of the payer can only be fastened at the time of payment and not before that. The Ld. Counsel stated that the decision to withhold tax from a credit or payment to a non-resident is not taken in vacuum. It is taken in the light of the tax liability of the non-resident in respect of the amount in question. Essentially, therefore, the provisions of Section 195 are to be read in conjunction with the charging provisions under the statue, as also in conjunction with the relevant double taxation avoidance agreements which override these charging provisions. He also placed reliance on the decision of Saira Asia Interiors (P.) Ltd. V. Income Tax Officer [[2017] 79 taxmann.com 460] wherein, the tribunal while examining the decision rendered in the case of GE Technology (Supra) has held that the mere fact that an Indian resident credits the amount of royalty payable to an Italian resident does not trigger taxability under article 13 of the Indo-Italian DTAA and it is only at point of time when payment takes place, that income embedded In payment becomes taxable. Relevant Para reads as under:

It was accordingly argued that when the income is not taxable in terms of Section 4 of the Act, then chapter X cannot become applicable at all. Section 92 of the Act provides for computing the 'income' arising from an 'international transaction' with reference to the ALP.

It was accordingly submitted that the alleged adjustment on account of interest made by the TPO, except to the extent actually received by the appellant, cannot be said to have been chargeable to tax in the hands of the Assessee. Therefore, Ld. TPO's computation of ALP under section 92 of the Act read with Article 11 of DTAA to the said extent is not justified. It was further submitted that the Ld. TPO can examine only to the extent of interest received by Assessee from Investee Companies and not otherwise. Since the assessee never received the agreed coupon rate in the subject year or any other amount from the investee companies; by virtue of applicability of Article 11 of the Indo-Cyprus DTAA, no income is chargeable to tax in India and therefore, any adjustment on account of application of Transfer Pricing provisions becomes purely academic. Further, the Ld. Counsel submitted that the term Paid will not include payable. Reliance in this regard was placed on the decision of the ITAT, Chennai in the case of DCIT v. Inzi Control India Limited [2019] 101 taxmann.com 112. Relevant Para is reproduced below:

Lastly, the Ld. AR brought to the attention of this Bench that the benchmarking done by the TPO by adopting the rate of 18% to make an adjustment in the present case is from the controlled transaction between the assessee and the Investee companies and for this reason alone, the adjustment made is not at all justified and hence has to be deleted.

It was further submitted that the TPO ought to have considered that the Conversion of FCCDS and sale of equity shares to promoters at a consideration providing annualized 18% return on investment were independent future events with the debenture subscription agreement providing specific conversion mechanism.

We have heard the rival submissions and also perused the relevant findings given in the impugned orders and the materials referred to before us. 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 Rs. 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%.

As per the terms of agreements entered between the assessee with the investee companies there were three separate and independent events: I. Subscription to FCCDs bearing an annual interest of 4%; II. Conversion of FCCDs into equity at a conversion price on the completion of the specified term or as may be determined by the parties; and III. Post conversion, sale of equity shares to the promoters at a consideration providing annualized 18%/19% return on investment.

One of the main contention raised before us by the Ld. 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 :-

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 vs. Inzi Control India Limited (supra). Thus, 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.

Since CO is in support therefore the same is also to be treated as allowed.