India Continues Tax Dispute With Cyprus and Mauritius

India has seemingly reached an impasse with both Cyprus and Mauritius over the re-negotiation of their respective double taxation avoidance agreements (DTAA). For the former, the disagreement relates to Cyprus’s status as a notified jurisdictional area (NJA) in India, whilst for the latter, it pertains to the update of their existing tax treaty.

India and Cyprus signed their DTAA in 1994, and the island nation has regularly been one of India’s greatest sources of FDI, ranking seventh overall in the world. However, India last year blacklisted Cyprus as a NJA; a power the Indian government reserves for territories who do not sufficiently share tax-related information. Consequently, transactions between Indian taxpayers and Cyprian residents are now subject to the transfer pricing provisions of the Indian Tax Law (ITL), which increases the withholding tax rate by 30% and greatly complicates the administrative process involved.

Although Cyprus is intent upon being removed from India’s blacklist, it has nevertheless refused the conditions the Asian superpower has placed upon the amendment of their DTAA. This is primarily due to the limitation of benefit (LOB) clause that India insists must be included in the agreement, which would restrict its benefits to Cyprian residents and exclude foreign holding companies that use Cyprus as a conduit to access the Indian market. Cyprus is fearful that agreeing to such a condition would damage its finance industry and negatively affect its economy, whilst India is keen to collect on the taxes of foreigners not directly included in the DTAA.

RELATED: India and Mauritius to Begin Automatic Exchange of Tax-Related Information

The disagreement between India and Mauritius is similar. The Indian government is also insisting that the many foreign holding companies that use Mauritius as a gateway to the Indian market begin paying more tax, but Mauritius is reluctant to do so, largely for the same reasons as Cyprus. As yet, India has not blacklisted Mauritius as a NJA as it has done with Cyprus. This is perhaps due to the small island nation consistently being India’s greatest source of FDI since the turn of the century, as well as the Mauritian government’s greater willingness to share tax-related information, but the prolonging of negotiations makes the possibility that they will be blacklisted in the future more likely.

For India, there is a need to maintain the high level of FDI the country has been receiving in recent years, whist at the same time cracking down on tax avoidance. India loses approximately $US 7 billion a year in tax from offshore accounts and tax havens; an amount the government is intent on decreasing. Upon Narendra Modi’s appointment as India’s prime minister earlier this year, one of the new government’s first actions was to establish a special investigative team to combat undeclared income, or “black money”.

Steps have already been taken to tackle this problem in other countries. A LOB was recently inserted into India’s tax treaty with Singapore – another small island nation commonly used by holding companies – but, rather than limit their finance sector, many commentators have identified Singapore’s willingness to accept the clause as a key reason for it being India’s greatest investor in 2013-14.

RELATED: Singapore Overtakes Mauritius as Top Source of FDI into India as GAAR Looms

For Cyprus and Mauritius, Singapore may serve as an example of what could be should they alter their current stance. Although agreeing to LOBs may indeed affect the two’s respective finance industries, the appeal of the Indian market may now be so great that the necessity of paying tax no longer deters investors, and companies will still use the likes of Cyprus and Mauritius because of the ease of doing business there. Agreeing to India’s tax demands may therefore be simultaneously necessary and ultimately worthwhile.

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