GOVERNMENT FAST TRACKS INTERNATIONAL TAX CLARIFICATIONS
5 July 2016
INDIA-CYPRUS DTAA: INDIA LIKELY TO GET THE RIGHT TO TAX CAPITAL GAINS FROM TRANSFER OF SHARES OF INDIAN COMPANY
On 1 July 2016, the Central Board of Direct Taxes (CBDT) has issued a press release stating that India and Cyprus have reached an in-principle agreement on all pending issues. However, the provisional India-Cyprus Double Taxation Avoidance Agreement (DTAA) would have to be placed before the Indian Government’s Cabinet (Cabinet) for its approval before execution.
The salient features of the issues on which India and Cyprus have reached agreement are as follows:
De-Notification of Cyprus as ‘non cooperative jurisdiction’
Owing to lack of effective exchange of information, India had previously notified Cyprus as ‘non co-operative jurisdiction’ under the Income Tax Act, 1961 (IT Act). As an effect of that, inter alia a higher withholding tax of at least 30% is applicable on all payments made to a Cypriot entity on which tax is deductible. Further, such payments also require compliances under transfer pricing regulations in India even if such transactions are not between related parties.
India is now contemplating a retrospective rescission of Cyprus’ notification (with effect from the date of notification) and will initiate the process for de-notification.
Capital gains tax exemption to be withdrawn, investments made prior to 1 April 2017 to be grandfathered
It is contemplated that the revised India-Cyprus DTAA will provide for a source based taxation of capital gains on transfer of shares of an Indian company, thereby withdrawing the capital gains tax exemption enjoyed by Cypriot resident selling shares of an Indian company. Also expected is a grandfathering clause to govern investments made prior to April 1 2017 which would confirm that capital gains from the transfer of such investments will be taxed in Cyprus.
The press release has cleared the air around the re-negotiation of India-Cyprus DTAA and its notification as a ‘non co-operative jurisdiction’. Once the process of rescission of the notification is complete, it will provide a huge respite to several Cypriot investors, who had invested in India through debt or equity route.
It will be interesting to see the manner in which investments will be grandfathered, although much would depend on the exact terms of the India-Cyprus DTAA. Once approved by the Cabinet, a phased operation of grandfathering clause, in the manner provided in the protocol to India-Mauritius DTAA, is likely to be the way forward. The revised India-Cyprus DTAA may also contain provisions for robust exchange of information between India and Cyprus. Also, clarity is expected on whether debt and derivative instruments will continue to attract residence based taxation.
HIGHER WITHHOLDING TAX NOT APPLICABLE IF NO PERMANENT ACCOUNT NUMBER (PAN)
The CBDT in a vital update has brought a breather to non-residents who receive certain payments on which tax is deductible in India. Payments on which tax is deductible at source under the provisions of the IT Act, are generally subject to a higher withholding tax irrespective of the lower rate under a DTAA or the domestic tax laws, if the payee does not furnish its PAN. This provision, however did not apply to interest on long term infrastructure bonds payable to a non-resident.
The CBDT has relaxed the applicability of higher withholding tax on certain payments payable to non-resident in the absence of PAN in India, provided that they furnish certain documents and information.
Newly inserted rule
Under the newly inserted rule, payments in the nature of interest, royalty, fees for technical services, or payments for transfer of capital asset, made to a non-resident not having a PAN in India, would not be subject to higher withholding tax under the provisions of the IT Act provided such non-resident furnishes the following information and documents:
Name, email id, contact number;
Address in the country of residence;
Tax Residency Certificate from the government of the country of residence, if the law of such country provides for issuance of such certificate; and
Tax Identification Number in the country of residence, and in case no such number is available, then a unique number on the basis of which such non-resident is identified by the government of the country of which he claims to be a resident.
Consequential amendments have also been made to the form in which a deductor is required to furnish its quarterly withholding tax return.
This relaxation will enable taxpayers to avail of beneficial tax rates under the various tax treaties or the domestic tax laws even in the absence of PAN in India. While this is a welcome move by the CBDT, payments which are not specifically exempted would continue to attract higher withholding tax under the provisions of the IT Act.
GENERAL ANTI AVOIDANCE RULES (GAAR): GOVERNMENT ACTS ON ITS PROMISE TO GRANDFATHER INVESTMENTS MADE PRIOR TO 1 APRIL 2017
With the GAAR coming into effect from 1 April 2017, the Government had promised that the investments made prior to 1 April 2017 would not be subject to GAAR. Acting on its promise, the Government has amended the relevant rules relating to GAAR to include a grandfathering clause for investments made prior to 1 April 2017.
This amended rule provides that GAAR will not apply to any income accruing or arising to or deemed to accrue or arise to or received or deemed to be received by any person, from transfer of investments made before 1 April 2017.
It also provides that GAAR will apply to any arrangement, irrespective of the date on which it has been entered into, in respect of tax benefits obtained from the arrangement on or after 1 April 2017.
It may be noted that as long as the investment was made before 1 April 2017, GAAR will not apply, irrespective of the date on which income from transfer of such investments arises (before 1 April 2017 or after).
Without prejudice to the above position, GAAR would apply to any arrangement where the tax benefit from such arrangement arises on or after 1 April 2017. Thus, any income other than ‘income from transfer of investments’ viz. interest, etc. from an arrangement entered prior to 1 April 2017 would continue to be subject to GAAR.
CBDT NOTIFIES THE RULES FOR GRANTING FOREIGN TAX CREDIT TO RESIDENT INDIANS
Residents are generally given credit in the home country for the taxes paid by them in a foreign jurisdiction, in order to avoid double taxation. In this context, the Finance Act, 2015 had amended the domestic tax law enabling CBDT to prescribe rules on the procedure for granting of relief or deduction of any income tax paid in any country outside India (Foreign Tax) against the income tax which is payable under the IT Act (FTC). The CBDT has amended the Income Tax Rules, 2016 to bring the rules relating to credit of Foreign Tax into force (Rules) with effect from 1 April 2017. Summarized below are the key features of these Rules:
Meaning of Foreign Tax
Foreign Tax has been defined to mean: (i) the tax covered under DTAA (if any) between India and the relevant foreign jurisdiction; or (ii) in relation to a foreign jurisdiction with which India does not have a DTAA, the tax payable under the law in force in that jurisdiction in the nature of ‘income tax’ as referred to under the domestic Indian laws.
Manner of calculating FTC
A resident taxpayer will be allowed a credit against the Foreign Tax paid by way of deduction in the year in which the income corresponding to such tax has been offered to tax in India or assessed in India. Under the Rules, FTC will be available against tax, surcharge and cess payable under the IT Act but not in respect of interest, fee or penalty. Credit shall be the lower of the tax payable under the IT Act, or the Foreign Tax paid on such income or tax payable under the DTAA.
The Rules also provide for the mode of computing FTC separately for each source of income arising from foreign jurisdiction.
Disputed Foreign Tax
The Rules provide that no credit would be available against Foreign Tax disputed by the taxpayer. However, credit for disputed tax would be allowed in the year in which it is offered to tax in India if the taxpayer furnishes:
Evidence of settlement of dispute;
Evidence of discharge of liability for payment of the disputed Foreign Tax; and
Undertaking to the effect that no refund in respect of such amount, directly or indirectly has been or shall be claimed.
Requirements to claim FTC
FTC will be available only when the taxpayer furnishes the following documents, namely:
Statement of income from the foreign jurisdiction offered for tax, and Foreign Tax deducted or paid on such income in the prescribed form before the due date for filing of return of income;
Certificate specifying the nature of income and amount of tax deducted or paid by the taxpayer from the tax authority of the foreign jurisdiction, or from the person responsible for deduction of such tax;
Where the certificate specifying the nature of income and amount of tax deducted is signed by the taxpayer, such certificate should accompany (i) an acknowledgment of online tax payment or bank counter foil or slip or challan for tax payment where Foreign Tax has been paid by the taxpayer; and (ii) proof of deduction where Foreign Tax has been deducted.
Further, the Rules also require a taxpayer to furnish statement of income from the foreign jurisdiction, in situations where the carry backward of loss of current year results in refund of Foreign Tax to the taxpayer, in respect of which FTC has been claimed in earlier years.
The Rules provide a respite to Indian companies (and other taxpayers) with foreign income, as it puts into a place, a procedure to enable such Indian residents to (i) claim credit for Foreign Tax, which is paid in a country with which India has a DTAA; and (ii) for the taxes paid in a country with which India does not have a DTAA.
The CBDT must be applauded for the consultative approach it had adopted while inviting stakeholders’ view before notifying the Rules. The draft Rules had not contemplated availability of credit for disputed Foreign Tax. The Rules, however incorporate a procedure to enable a taxpayer to claim credit for disputed Foreign Tax, which has been settled subsequently.
Khaitan & Co | Direct Tax Team
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