Cyprus until now
India had notified Cyprus as a ‘non-cooperative jurisdiction’ owing to lack of effective exchange of information, vide a notification of the Central Board of Direct Taxes (CBDT) dated 1 November 2013 (Notification) under Section 94A of the Income Tax Act, 1961 (IT Act), a provision which enables the Central Government to notify any jurisdiction which does not co-operate in exchange of information. The implications of the Notification inter alia included application of: (i) a minimum withholding tax rate of 30% on payments to persons located/resident in Cyprus (irrespective of a lower rate applicable otherwise); and (ii) transfer pricing provisions to transactions with Cypriot persons even if otherwise unrelated. The CBDT has now rescinded the Notification, vide its notification dated 14 December 2016 (Rescission Notification).
As per the Rescission Notification, the Notification shall be rescinded with effect from 14 December 2016 i.e. the date of notification in the Official Gazette. The Rescission Notification is prospective in its application, and is in force with effect from 14 December 2016. Thus, transactions already undertaken before 14 December 2016 would not be impacted by the Rescission Notification.
As a result of the rescission, the implications under Section 94A of the IT Act such as higher withholding tax, deemed applicability of transfer pricing provisions would cease to apply to transactions with Cypriot persons undertaken on or after 14 December 2016.
India and Cyprus had also signed a protocol on 18 November 2016 (Protocol) to amend their existing tax treaty. While the actual text of the Protocol is awaited, a press release issued by the CBDT on 18 November 2016 highlights the following key changes in the revised tax treaty:
- In relation to capital gains taxation on alienation of shares, residence based taxation would be amended to source based taxation (i.e. gains from transfer of shares of an Indian company would be taxable in India). Investments made prior to 1 April 2017, would be grandfathered and thus, the existing residence based taxation and exemption in the source country would continue to be available for such investments;
- There would be a wider definition of permanent establishment and a reduced rate for royalty i.e. 10% (from 15%);
- Revised tax treaty would also contain updated provisions for assistance in collection of taxes, and exchange of information; and
- The Protocol after completion of necessary procedures, is expected to enter into force from April 1, 2017.
This is a welcome development and brings much awaited respite to the Cypriot investors and Indian residents transacting with Cypriot persons. However, contrary to the expectations of stakeholders and what was expressed in the press release issued by the CBDT on 1 July 2016, whereby India was to consider rescinding the Notification with retrospective effect from 1 November 2013, the rescinding is prospective in nature. Thus, going forward, Cyprus may be considered as one of the preferred jurisdictions for investing in India (potentially for debt investments, subject to any changes in the revised treaty to withholding tax rate on interest). Given the applicability of the General Anti Avoidance Rules from 1 April 2017, ‘substance’ would remain a critical factor.