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India-Cyprus double tax avoidance agreement to be finalised soon

Posted by admin on February 28, 2014

MUMBAI: A new India-Cyprus double tax avoidance agreement (DTAA) or tax treaty, inches closer to finalisation. The delegates of the two countries are slated to meet in early-mid March to tie up the loose ends.

While the revised treaty will contain more stringent provisions relating to exchange of information, it is also likely to include a 'Limitation of Benefit' (LOB) clause. This tax treaty is in force since December 21, 1994.

As reported by TOI earlier, the Government of India (GOI) took a unilateral step and on November 1, notifying Cyprus as a 'notified jurisdictional area' (NJA). GOI has the powers to do so under section 94A of the Income-tax (I-T) Act.

The GOI took this step as the Cyprus regulatory authorities were not providing the information requested by the Indian tax authorities under the exchange of information clause of the India-Cyprus tax treaty. Cyprus is the first country that India has notified as NJA. Cyprus ranks seventh in the list of countries investing in India. During April 2000 to August 2013, nearly Rs. 33,836 crore was invested in India via Cyprus.

The immediate fall-out of such notification by the GOI, in respect of investments via Cyprus, included higher disclosure requirements, applicability of transfer pricing provisions and also higher with-holding of tax in India.

For instance, under the India-Cyprus tax treaty the withholding tax on interest is just 10% as opposed to 20% (The 5% withholding has limited coverage only for corporate bonds and government securities) under the Indian tax laws. This makes Cyprus an attractive destination for debt funds vis-a-vis India. Consequent to the notification, the withholding tax on interest income earned by a Cyprus investor will be at least 30%, even as the Cypriot investor can claim a refund for the additional tax that has been withheld.

This development was followed by assurances from the Cyprus MOF which assured India of its commitment to rework the tax treaty. Later on December 3, 2013, an official statement released by the Cypriot Ministry of Finance referred to the cordial discussions held between officials of the two countries in end November to address two key issues - an effective exchange of information between the two countries and the long pending renegotiation of the tax treaty between the two countries.

It was also agreed by the delegates of the two countries that as and when the notification issued by India's MOF is rescinded, it will be with retrospective effect from November 1, 2013 - the date when the notification was issued by India.

Of course, a lot now depends on how the final talks which will also include discussions relating to the limitation of benefit clause pan out. A LOB clause deters treaty shopping. Of late, India has renegotiated and inserted LOB clauses in its tax treaties with several countries including Singapore.

Under this LOB clause, a Singapore resident investor is not entitled to capital gains exemptions (available under the India-Singapore tax treaty), if the primary purpose for setting up a company in Singapore is to avail of this exemption. A Singapore Company which is listed in India or Singapore or whose annual expenditure in Singapore was at least Rs. 50 crore during the two years immediately before the capital gains arose is also not regarded as a shell company.

The discussions on LOB clause between the Indian and Cypriot delegates is likely to result in some substance requirements being introduced under the India-Cyprus tax treaty.

Source: The Times of India