India-Cyprus tax treaty talks at an impasse

New Delhi: Talks between India and Cyprus on amending their bilateral tax treaty appear to be deadlocked over India’s demand to include a limitation of benefit (LOB) clause, which restricts benefits under the agreement to genuine resident investors of the Mediterranean island-nation. As a result, it may take longer than previously thought for Cyprus to be removed from the Indian government’s blacklist, an anti-tax avoidance measure in which it was included last year for failing to share information. India wants LOB to be part of its double taxation avoidance agreement (DTAA) with Cyprus to prevent investors from misusing the treaty to avoid paying taxes in India. Cyprus, along with countries such as Mauritius, are among countries that have signed DTAAs with India that allow capital gains arising from the sale of shares in India to be taxed in the country of residence of the shareholder. A large number of foreign investors route their investments into India through these nations, taking advantage of their zero capital gains taxes. Cyprus has been a preferred nation for companies based in Europe and the US to route their investments through, benefiting from its favourable tax regime. India, keen to crack down on tax evaders and hunt down black money, blacklisted Cyprus by declaring it a “notified jurisdiction” last November. This meant that companies that had business dealings with entities in the Mediterranean island-nation came under increased scrutiny of the Indian income tax department. Cyprus is keen that it be removed from the list of notified jurisdictions, but India insists it will only do so after the DTAA is amended to its satisfaction. A senior Delhi-based government official said there are still unresolved issues between both sides over amending the DTAA. “There are some crucial points on which there is no agreement as yet. There is no plan to visit Cyprus as of now (for further talks on the DTAA). Once those issues are resolved and the DTAA is amended, Cyprus will be removed from the list of notified jurisdictions,” he said. The LOB clause seeks to limit the benefits from a tax treaty to only genuine companies that are resident in the country with which India has a DTAA. It could be in the form of a monetary threshold—like the one in the India-Singapore treaty that says that only those companies that spend a minimum of $200,000 in Singapore can avail treaty benefits—or in any other form such as stipulations on infrastructure, staffing or listing on stock exchanges. In an emailed response to a query, Ravi Bangar, the Indian high commissioner to Cyprus, said the main issue that both sides need to resolve is the LOB clause. “I would not like to term the talks as hitting a stalemate. Cyprus in July this year has signed Council of Europe-OECD Convention on Mutual Assistance in Tax Matters and its Protocol. Cyprus has conveyed its commitment to closely work with India in finalizing and signing of a revised DTAA,” he said. “Both sides are engaged in an early resolution of the issue. It would not be fair to put any time frame on it.” Cyprus became the first nation to be declared a notified jurisdiction by India under Section 94A of the Income Tax Act because of its alleged failure to share more information on Indian tax avoiders based there. However, the notification made it difficult for Indian taxpayers to claim deductions on transactions with entities based in Cyprus. The move also increased the tax outgo for such taxpayers and subjected them to enhanced reporting requirements. It meant that if an Indian tax assessee entered a transaction with an entity based in Cyprus, the latter would be treated as an associate enterprise and the deal itself as an international transaction attracting transfer -pricing regulations. It also meant that no tax deduction would be allowed in respect of any other expenditure or allowance arising from a transaction with a person or a firm in Cyprus, or in respect of a payment made to a financial institution. Payments to a Cypriot entity would attract a withholding tax of 30% and receipts from Cyprus would have to be explained. Both sides have agreed that once the DTAA is amended, the classification of Cyprus as a notified jurisdictional area will be rescinded with retrospective effect from 1 November 2013, the date when the notification was issued. According to Indian government estimates, Cyprus is the seventh largest source of foreign investment into the Indian economy with cumulative investments of $7.6 billion between April 2000 and June 2014. The India-Cyprus DTAA is more beneficial to Cyprus residents compared to the tax treaties that India has with Mauritius and Singapore, said Daksha Baxi, executive director at Khaitan and Co., a law firm. For example, interest paid to entities in Mauritius is subject to a withholding tax at rates specified in the Indian Income Tax Act and can be as high as 40% in case of interest on rupee-denominated debt. It is, however, 15% in case of entities based in Singapore and only 10% for entities in Cyprus. “By insisting on an LOB clause, India wants to ensure that the benefits of the treaty are available only to genuine Cyprus-based entities. Cyprus has less rigorous KYC (know-your-customer) norms than, for example, in Singapore. This increases the concern of the Indian government that the investments from Cyprus are not genuine funds from outside India and that they may be a part of round-tripping from India,” she said.