Treaty interest taxation depends on actual payment, and notional interest cannot support a transfer pricing adjustment.

Article 11(1) of the India-Cyprus treaty was read as taxing interest only when it has actually arisen and been paid or received, rather than on a merely contingent or hypothetical basis. On that reading, the term "paid" was not extended to cover "payable" for taxing notional interest. The analysis also states that transfer pricing adjustments under section 92 of the Income-tax Act can apply only to income that is otherwise chargeable to tax, so a contingent return that neither accrued nor was received could not be benchmarked as deemed interest income. Earlier judicial and tribunal views on the same treaty language were noted as consistent with this approach.

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Issues: Whether, under Article 11(1) of the India-Cyprus Double Taxation Avoidance Agreement, interest can be taxed only on actual receipt/payment basis and not on a merely hypothetical or contingent basis, and whether a transfer pricing adjustment can be made on notional interest that had neither accrued nor been received.

Analysis: Article 11(1) uses the expression that interest arising in one Contracting State and paid to a resident of the other Contracting State may be taxed in that other State. Read with the other clauses of Article 11, the provision was held to contemplate actual interest arising and payment, not a deeming of mere receivable interest as taxable income. The adjustment made by the TPO was founded on a contingent return that would have arisen only if a future option had been exercised, although no such event had in fact occurred during the year. The transfer pricing mechanism under Section 92 of the Income-tax Act, 1961 can operate only on income that is otherwise chargeable to tax under the Act, and not on a hypothetical amount which had neither accrued nor been received. The Tribunal also noted the consistent view taken in earlier judicial and tribunal decisions on the same treaty language.

Conclusion: The expression "paid" in Article 11(1) was not extended to include "payable" for the purpose of taxing the disputed interest. The notional interest adjustment was unsustainable, and the assessee succeeded on the main issue.

Final Conclusion: The appeal was allowed, and the addition on account of deemed interest income and the related transfer pricing adjustment did not survive.

Ratio Decidendi: Under Article 11(1) of the India-Cyprus treaty, interest is taxable only when it has actually arisen and been paid or received, and transfer pricing provisions cannot be invoked to tax a merely contingent or notional interest amount.

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