Facts of the case
- Ampacet Cyprus Limited (taxpayer) is a resident of Cyprus and is the parent company of Ampacet Speciality Products Pvt Ltd (Indian subsidiary). The taxpayer had advanced a loan to its Indian subsidiary for which the Indian subsidiary paid no interest for the period covered by the moratorium under the loan agreement. During AY 2011-12 and AY 2012-13, the tax officer proposed a transfer pricing adjustment (Approx. INR 30 million) in the hands of the taxpayer for notional interest receivable from its Indian subsidiary, which was upheld by the Dispute Resolution Panel (DRP).
- The taxpayer sought additional grounds of appeal before the Mumbai Tribunal in relation to the adjustment made on account of charging notional interest on the fact that when the Indian subsidiary does not actually pay interest to the taxpayer, there cannot be any question of taxability in the hands of the taxpayer and consequently the transfer pricing adjustment to such interest income in India cannot be made.
- The taxpayer argued that Article 11 of the India-Cyprus tax treaty (Treaty) provides for taxability of interest only on a paid basis, and the interest income of the taxpayer (being a resident of Cyprus) would be chargeable to tax in India only when it is arising and paid to a non-resident. Furthermore, the taxpayer placed reliance on several Tribunal decisions, wherein it was held that the tax treaties provide taxability of interest, royalty, and fees for technical services only on a cash payment basis. Thus, it was contended that only the interest which has actually been paid/received can be the subject matter of taxation, and no transfer pricing adjustment can be made on some hypothetical payable/receivable amount.
- The Relevant clauses of Article 11 of the Treaty have been reproduced below –
- "Article 11- Interest
- Interest arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other State.
- However, such interest may also be taxed in the Contracting State in which it arises, and according to the laws of that State, but if the beneficial owner of the interest is a resident of the other Contracting State, the tax so charged shall not exceed 10 percent of the gross amount of the interest."
Proceedings before the Income-Tax Appellate Tribunal (ITAT), Mumbai
The ITAT made an observation that the judicial precedent relied upon by the taxpayer does not discuss the connotations of the expression 'paid,' especially in the context of Article 3(2) of the Treaty read with Section 43(2) of the Indian Income-tax act.
The expression "paid" is not defined in the Treaty. Accordingly, as per the tax treaty, in such cases, the definition under domestic tax law (Section 43(2) of the Indian Income-tax Act) of the source country is to be adopted.
Considering the facts and circumstances of the case, the ITAT deemed it fit to refer the additional grounds of appeal to a Special Bench (constituting of three or more members) for assigning meaning to the term "paid" used in Article 11 on "interest" in the Treaty.
Proceedings before the Special Bench1
The taxpayer's reliance on the Mumbai HC2 ruling for taxation of interest income on receipt basis as against accrual basis in accordance with Article 11(1) of the Treaty was rejected on the ground that subject appeal is in relation to Article 11(2) wherein no interest is paid/accrued/payable in the first place.
The Special Bench suggested that the taxpayer needs to prove that Article 11(2) can be applicable even in the absence of any interest paid.
Special Bench opined that the question of applicability of Article 11(1) or (2) of the Treaty does not come into play in the instant case since no interest was paid in the given case. For this reason, the ground on which the recommendation of the constitution of Special Bench was made is also irrelevant.
The matter was sent back to the Tribunal's co-ordinate bench in order to adjudicate on the grounds of applicability of transfer pricing provisions and commercial expediency.
In the international tax context, the non-resident taxpayers in India have routinely adopted a position that the income in the nature of Interest, Royalty, and Fee for Technical Services, etc., are taxable in their hands only in the year in which it is received. There are a plethora of judgments by various courts in India, which have also upheld this position.
However, in the context of Transfer Pricing, interest-free loans remain a highly contentious issue to justify the arm's length behavior. Typically, the taxpayers take legal arguments in such situations to avoid adverse implications from a transfer pricing standpoint; 1) The transfer pricing provisions are not applicable in the absence of taxable income, 2) No revenue leakage to the home country (e.g., Section 92(3) of the Indian Income Tax Act), etc.
In the given case also, the taxpayer tried to avoid the adverse transfer pricing implication on interest-free loans by arguing that there is no taxable income arising in the hands of non-resident taxpayers. However, while doing so, it took the support of the Treaty's language, which is now being further litigated.
Interestingly, there was no discussion in the judgment about there being no revenue leakage to the home country since –
- The interest income (if charged) would have been taxable at 10% in the hands of the taxpayer, whereas
- the Indian entity (payer) would claim the interest expenses as tax-deductible with a higher tax rate. Assuming that the Indian entity is subjected to a tax rate of 33%
While there is no conclusion in the matter as yet, the MNEs may want to be more cautious in their intra-group financing arrangement in light of the discussions made by the court in this judgment.
* Ampacet Cyprus Limited (IT (TP) A Nos. 1518/Mum/16 and 560/Mum/2017 [AY 2011-12 & AY 2012-13]).
1. Source-based information – Taxsutra
2. Pramerica ASPF 11 Cyprus Holding Ltd – Tribunal allowed taxation of interest income on receipt basis as against accrual basis in accordance with Article 11(1) and at a concessional rate of 10% under Article 11(2) of the Indo-Cyprus tax treaty.
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