New Delhi: India and Cyprus are poised to sign a new tax treaty which, like in the case of a similar pact with Mauritius, will shut the doors on investors using loopholes in the bilateral agreement to avoid paying taxes in India.
The new agreement 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 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 will get the right to tax capital gains from sale of shares on investments made by Cyprus-based companies after 1 April 2017.
But this will be effective prospectively. Consequently, all investments made earlier have been protected, similar to the provision made in the India-Mauritius treaty.
“On June 29th, 2016, the negotiation on the Double Taxation Agreement for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to taxes on income between Cyprus and India has been successfully completed, in New Delhi. The completion of the negotiation and the agreement reached on all pending issues will pave the way for the removal of Cyprus from the list of notified jurisdictional areas place in November 2013,” said a statement put up on the Cypriot finance ministry’s website late on Thursday.
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.
The notification makes it difficult for taxpayers to claim deductions on transactions with entities based in Cyprus. It also subjects a taxpayer to enhanced reporting requirements and higher tax outgo.
The statement didn’t say whether investors would be offered a transitionary period like the one provided by the India-Mauritius treaty, under which only half the capital gains tax rate will be applicable between 2017 and 2019.
A statement from the Indian finance ministry said an in-principle agreement had been reached on all contentious issues and the signing of the final, revised treaty will be subject to approval by the Union cabinet.
“It was agreed to provide for source-based taxation of capital gains on transfer of shares. However, a grandfathering clause would be provided for investments made prior to 1 April 2017, in respect of which capital gains would be taxed in the country of which taxpayer is a resident,” the statement said.
A grandfathering clause provides for an old rule to apply to existing cases and a new rule to future ones.
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 completion of tax treaty negotiations with both Mauritius and Cyprus, on which talks have been under way for years, will be considered a victory by the NDA in its fight against black money.
Other pacts that will see similar changes in the coming months include India’s tax treaties with Singapore and the Netherlands.
Although it will increase the tax outgo for investors, it will also end uncertainty for investors routing their investments from these countries.
“The development on the India-Cyprus tax treaty is another welcome step towards providing certainty in tax. The intent to grandfather existing investments, which is in line with a similar change proposed in the tax treaty with Mauritius, should provide comfort to existing investors,” said Gautam Mehra, leader (tax) at PricewaterhouseCoopers India.
Cyprus will be removed from the Indian blacklist retrospectively with effect from 1 November 2013. Mint hadreported on 9 June that Cyprus was willing to allow India the right to tax capital gains in exchange for removal from the list of notified jurisdictions.
Amit Singhania, a partner at law firm Shardul Amarchand Mangaldas and Co., said that retrospectively rescinding the classification will have significant repercussions for many entities that have deducted tax while making payments to Cyprus entities.
“It needs to be seen how the Indian government will provide for refund for those transactions and also provide for revision of withholding tax return,” he said.
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.
“If the assessment of Indian entities who have transacted with Cyprus entity in past has entailed an addition in their income under transfer pricing, then how will the CBDT (Central Board of Direct Taxes) provide for revision of return/assessment order to nullify the effect of Cyprus notification retrospectively? In substance, nullifying the effect of Cyprus notification seems to be difficult,” said Singhania.