“India via Cyprus” may continue

Manuj Sabharwal

As a part of one of the measures to check tax avoidance, the Indian Legislature has introduced section 94A in the Income-tax Act, 1961 (‘Act’) vide Finance Act, 2011, which allows the Government of India (‘GoI’) to categorize a country as a ‘notified jurisdictional area’ (or ‘NJA’) having regard to the lack of effective exchange of information with any country or territory outside India.

Recently, GoI declared Cyprus as an NJA vide notification no. 86/2013 dated November 1, 2013, a move that increased the scrutiny on any business transaction with entities based in Cyprus by Indian Revenue authorities.  The same may be on account of the fact that Cyprus has not been effectively exchanging the information in terms of the existing DTAA / tax treaty between India and Cyprus.

Earlier, the rules under section 94A of the Act were notified as per Income-tax (8th Amendment) Rules, 2013, vide S.O. 1856 (E) dated June 26, 2013, by inserting rule 21AC and Form 10FC in the Income-tax Rules, 1962.

The implications of Cyprus being treated as NJA in terms of both the aforesaid notifications are as follows:

• If a taxpayer enters into a transaction any Cyprus based entity, all the parties to the transaction shall be treated as associated enterprises and the said transaction shall be treated as an international transaction, thereby triggering transfer pricing regulations, resulting in compliance and maintenance of onerous documentation.

• No deduction in respect of payment made to any financial institution in Cyprus or in respect of any other expenditure or allowance arising from the transaction with a person located in Cyprus, be allowed unless the taxpayer furnishes an authorization in the prescribed form and/ or maintain the prescribed documentation.

• Where any sum is received or credited from a person located in Cyprus, the onus is on the taxpayer to explain the source of such amount, and in case of his failure to do so, the amount shall be deemed to be the income of the taxpayer.

• Any payment made to a person located in Cyprus shall be liable for withholding tax at 30 per cent or a rate prescribed in Act, whichever is higher.

This has seriously impacted / dented the status of Cyprus as an attractive investment destination on account of its favourable tax regime.

Recently, on the basis of consultations held between Cyprus and India on the issue of effective exchange of information/ renegotiation of DTAA, the Ministry of Finance of Cyprus, on December 3, 2013, has issued a Press release, wherein both the parties to the DTAA has agreed:

• to adopt the provisions of the new Article 26 of the OECD Model Tax Convention (approved by the OECD Council on 17 July 2012) relating to exchange of information in a new DTAA between the two countries

(Article 26 lays down a framework under which a country can seek information from another nation and the rules governing that information);

• to improve the channels of communication and exerting every effort in facilitating each other in processing requests and responses in a swift and effective manner.

Additionally, the parties have also agreed to renegotiate/ finalize a new DTAA.  It was further agreed that, once the notification of Cyprus as NJA under section 94A of the Act, is rescinded, it will have retrospective effect from November 1, 2013 (i.e. the date of declaration of Cyprus as NJA).