Treaty-based taxation of interest on payment basis bars transfer pricing on notional FCCD returns

Article 11(1) of the India-Cyprus DTAA taxes interest only when it is actually paid or received, so notional or contingent interest on FCCDs that neither accrued nor was paid during the year could not be taxed. The transfer pricing adjustment under Chapter X was therefore unsustainable because section 92 cannot be used to bring hypothetical income to tax where the charging provisions are not satisfied. The note further states that only interest actually received is within the treaty's taxing scope, not an expected return dependent on future contingent events.

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Issues: Whether notional interest on FCCDs could be brought to tax by transfer pricing adjustment under section 92 when, under Article 11(1) of the India-Cyprus DTAA, interest is taxable only when paid or received.

Analysis: The assessee, a Cyprus resident, had invested in Indian real-estate companies through FCCDs carrying a coupon rate of 4%. The proposed 18% return depended on future contingent events and no such contingent return had accrued or been paid during the year. The Court held that Article 11(1) of the DTAA requires both arising and payment, so only interest actually received could be taxed. It further held that Chapter X cannot be applied to bring to tax hypothetical income that does not satisfy the charging provisions of the Act.

Conclusion: The transfer pricing adjustment on notional interest was not sustainable, and the assessee succeeded.

Ratio Decidendi: Under a treaty article taxing interest on payment basis, only interest actually received can be subjected to tax or transfer pricing adjustment, and not contingent or notional interest that has neither accrued nor been paid.

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