India Cyprus Tax Treaty to be revised with Source based taxation of Capital Gains;
Retrospective removal of Cyprus from Blacklisting notification;
The Union cabinet on Wednesday approved the revised double taxation avoidance agreement (DTAA) with Cyprus which will help close gaps and enable Indian authorities to tax capital gains in the country for investments originating in the Mediterranean island nation.
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 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.
The move follows the recent amendment of DTAA with Mauritius. As in case of Mauritius, the treaty with Cyprus had provided for residence-based taxation of capital gains.
The proposed DTAA provides for source based taxation of capital gains on transfer of shares, instead of residence based taxation as provided in the existing DTAA.
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.
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.
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,
It needs to be seen how the Indian government will provide for refund for those transactions and also provide for revision of withholding tax returnIf 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
The proposed DTAA also enables source based taxation of capital gains from transfer of shares of any company the property of which consists directly or indirectly principally of immovable property situated in a contracting state.
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,
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 Indian tax authorities will be able to levy capital gains tax on sale of shares by firms based in Cyprus after April 1, 2017, as there is a grand fathering provision in the agreement.
The agreement provides clarification about taxation of dividends in India that are subjected to dividend distribution tax, and clarifies that provisions on assistance in collection of taxes shall not be construed to impose any obligation that is at variance with the laws, practices or public policy of a contracting state.
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.
It also provides for a revised provision for exchange of information that would enable the use of information exchanged for other purposes, with the permission of the competent authority of the country providing the information.
the provisions in the earlier treaty for residence-based taxation were leading to distortion of financial and real investment flows by artificial diversion of various investments from their actual countries of origin, for avoiding tax. “As in the case of Mauritius, this amendment will deter such activities. Negotiations with Singapore are also under way for similar changes
India had put Cyprus on a blacklist for failing to share information on tax evasion. With the revision of the treaty, India is expected to remove Cyprus from that list, which will provide relief to investors from that country who had seen increase in compliance costs
Tax authorities now need to revise a similar treaty with Netherlands to ensure that all gaps are closed and companies pay tax at least in one jurisdiction. In the case of the Netherlands, if an asset is sold to a foreign buyer, the tax treaty allows for capital gains tax exemption.
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