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 ...

The issue in this case was whether tax administration could tax a “non-existent income” through the “deeming provisions” of s 98 of Zimbabwe’s Income Tax Act. A lease agreement and a separate logistical agreement had been entered by CRS Ltd and a related South African company, for the lease of its mechanical trucks, trailers and tankers for a fixed rental. The tax payer contended that the rentals in the agreements were fair and reasonable. The tax administration contended that they were outrageously low so as to constitute under invoicing and tax avoidance. The court ruled in favor of the tax administration. Excerps from the Judgement: “Where any transaction, operation or scheme (including a transaction, operation or scheme involving the alienation of property) has been entered into or carried out, which has the effect of avoiding or postponing liability for any tax or of reducing the amount of such liability, and which in the opinion of the Commissioner, having regard to the circumstances under which the transaction, operation or scheme was entered into or carried out- (a) was entered into or carried out by means or in a manner which would not normally be employed in the entering into or carrying out of a transaction, operation or scheme of the nature of the transaction, operation or scheme in question; or (b) has created rights or obligations which would not nonnally be created between persons dealing at arm’s length under a transaction, operation or scheme of the nature of the transaction, operation or scheme in question; and the Commissioner is of the opinion that the avoidance or postponement of such liability or the reduction of the amount of such liability was the sole purpose or one of the main purposes of the transaction, operation or scheme, the Commissioner shall determine the liability for any tax and the amount thereof as if the transaction, operation or scheme had not been entered into or carried out, or in such manner as in the circumstances of the case he considers appropriate for the prevention or diminution of such avoidance, postponement or reduction.” “Accordingly, I agree with Mr Bhebhe that the agreements had the stipulated effect of avoiding or reducing the appellant’s liability for income tax. The circumstances prevailing at the time the agreement was entered into or carried out In the hyperinflationary era, the appellant averred that it could not secure local contracts that would enable it to fully utilize all its assets. The local currency Jost value at an alarming rate. The pricing of transport services became a nightmare. The income derived from transport services could not sustain the local operations. It was faced with the spectre of liquidation and staff retrenchments. The effect of which was that its loyal and skilled manpower mainly consisting of approximately 110 drivers would lose their only source of livelihood for themselves and their families while the company mechanical horses and trailers would deteriorate through disuse. The appellant could not access the foreign currency required to purchase spare parts and fuel necessary to keep the local operations running.” “It is a notorious fact of commercial life that related parties enter into contractual amngements. I did not discern any abnormalities in the nature of the agreements nor in the identities of the signatories. There was however an admixture of the normal and abnormal in the manner in which the agreements were carried out. For starters, the appellant overemphasized the indisputable uniqueness of the manner in which the agreements were carried out. In the letter of 24 October 2013 at p 50.1 para 11 the external accountants for the appellant wrote that “the appellant’s position is unique in the transport regime of Zimbabwe and there is no other haulier which provides a similar service.” The same point was repeated in the letter of 6 December 2013 at p 45.1 in para 1.2 where the same accountants indicated that they “were unaware of any Zimbabwean company which operates in the same unique situation as the appellant.” “In assessing the information availed to the Commissioner by the appellant and to this Court by both the appellant and the Commissioner, I am satisfied the agreements were carried out in a manner which would not normally be employed in such transactions. In the light of the formulation of Trollip JA in Hicklin v Secretary for Inland Revenue, supra, it appears to me that the two parties were not acting at arm’s length.” “It was clear that each party derived tangible benefits from the agreements. The related party had the right to lease the equipment and the obligation to pay rentals and maintain the equipment. The appellant received a fixed rental. The obligation to meet the maintenance and running expenses was unique and abnonnal. The fixed rentals which negated the cost plus mark-up principle was abnormal and would not have been concluded by parties dealing at arm’s length.” “It seems trite to me that the purpose of a private company is to make a profit. The appellant is not a non-profit making organisation. The appellant was content with the untenable situation in which it made and continues to make losses without any prospects of ever making a profit. It seems to me that the fixed rental was deliberately designed to ensure that the appellant would remain viable enough to survive liquidation and costly retrenchments and at the same avoid or reduce its income tax liability.” “I am satisfied that the avoidance or reduction of income tax liability was one of the main purposes of the agreement (s).” “In my view, the transactions undertaken by the appellant fell into the all-embracing provisions of s 98. The respondent correctly invoked this provision in assessing the appellant to income tax in each of the four tax years in question.” “The appellant strongly argued against the alteration of the contract of lease concluded between the related parties by the respondent. While Mr Bhebhe conceded that the respondent did not have the legal authority to alter the contract of the related parties ...