Home / Politics / Policy /  Cabinet clears new India-Cyprus tax treaty

New Delhi: The Union cabinet on Wednesday approved a revised India-Cyprus tax treaty that seeks to plug loopholes used by investors to avoid paying taxes in India.

The new agreement, which will replace the 1994 treaty, will enable Indian authorities to tax capital gains on investments routed through Cyprus; it will also lead to the removal of the Mediterranean island nation from an Indian government blacklist on which it was placed for not providing financial information sought by India.

The revisions in the treaty are on the lines of the recent changes notified in the India-Mauritius tax treaty and those still being negotiated in the India-Singapore treaty.

India will get the right to tax capital gains from sale of shares on investments made by Cyprus-based companies after 1 April 2017.

This will be effective only prospectively. Consequently, all investments made earlier have been protected, similar to the provision made in the India-Mauritius treaty.

The renegotiated tax treaties are part of an effort by the National Democratic Alliance (NDA) government to curb treaty abuse, tax evasion and round-tripping of funds—the practice of money stashed overseas by Indians returning home through tax havens such as Mauritius in the garb of foreign capital. India declared Cyprus a notified jurisdiction in November 2013, putting it on a blacklist, saying the nation had failed to share adequate information on tax evaders. As a result, business transaction with entities based in Cyprus came under increased scrutiny of the income-tax department.

According to the agreement between the two countries, the notification blacklisting Cyprus will be rescinded with effect from 1 November 2013.

“India has been given the right to tax capital gains on investments routed through Cyprus prospectively from 1 April 2017. All existing investments, including those made up to 31 March 2017, have been sought to be grandfathered like the Mauritius Treaty," said Abhishek Goenka, partner, direct Tax, PwC India, adding that domestic general anti-avoidance rules are likely to apply from 1 April 2017.

“However, Mauritius treaty additionally provides for 50% capital gains tax exemption for two years from 1 April 2017 to 31 March 2019, subject to fulfilment of limitation of benefit conditions. This appears to be absent in the revised Cyprus treaty," added Goenka.

A grandfathering clause provides for an old rule to apply to existing cases and a new rule to future ones.

Besides capital gains taxation of share transactions in India, the proposed treaty also permits taxation of capital gains from transfer of shares of any company that has immovable property in the country. The treaty also expands the scope of the permanent establishments to allow for source-based taxation of business income.

The announcement will help address uncertainties surrounding investments from Cyprus, said Amit Singhania, a partner at law firm Shardul Amarchand Mangaldas and Co.

“The revised version will give India right to tax on capital gains arising from Indian shares, taxation of profits of permanent establishment on source basis, taxation of royalty, fees from technically services and more importantly, smooth flow of exchange of information for varied purposes," he said.

Cyprus was one of the key destinations through which companies based in Europe and the US invested in India, benefiting from the treaty between both countries. In 2015-16, Cyprus ranked eighth in terms of foreign direct investment into India at $3.3 billion. The existing treaty provides for capital gains tax exemption and a low withholding tax rate of 10% on interest payments made to entities based in Cyprus.

The government’s move to decision to declare Cyprus a notified jurisdiction made it difficult for taxpayers to claim deductions on transactions with entities based in Cyprus. It also subjected taxpayers to enhanced reporting requirements and higher tax outgo.

At present, any payment to a Cypriot entity attracts a withholding tax of 30%. No deduction in respect of any other expenditure or allowance arising from a transaction with a person in Cyprus, or a payment made to a financial institution, is allowed unless the assessee provides the required documents.

If an assessee enters into a transaction with an entity in Cyprus, it is treated as an associate enterprise and the deal as an international transaction attracting transfer pricing regulations.

Transfer pricing is the practice of arm’s length pricing for transactions between group companies based in different countries to ensure that a fair price—one that would have been charged to an unrelated party—is levied.

“Excessive taxes paid by way of higher withholding taxes from 1 November 2013 being the date from when Cyprus was notified as a non-cooperative jurisdiction could possibly be claimed as refunds given if the withdrawal of the notification is with retrospective effect. Further, the deemed application of the transfer pricing provisions and cumbersome documentation requirements have been done away with which were required to be maintained on certain transactions with Cyprus entities vide the section 94A notification," Goenka said.

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