The Indian Government has come down heavily on Cyprus by blacklisting it as a non-cooperating country for exchange of information. The notification, dated November 1, 2013, was made under section 94A of the Income-Tax Act, which was introduced in 2011 to check black money and money laundering, especially through tax havens. The stated reason is that Cyprus is not providing adequate information as requested by the Indian Revenue department, which is obligatory under the ‘Exchange of Information’ article of the India-Cyprus tax treaty. It is learnt there are over 50 such cases where information is pending. Further, India’s efforts to introduce a ‘Limitation of Benefits’ clause in the tax treaty with Cyprus have not progressed.

This is the first such notification by India. Cyprus has faced similar treatment from other countries — Italy and Russia named it as a non-cooperating tax haven some years back; corrective action Cyprus’ part helped clear its name.

The fallout from the notification will be significant. Cyprus is a financial centre with a liberal tax regime. Investments have been routed into real estate and other sectors in India from/ through Cyprus, especially in the form of Compulsorily Convertible Debentures (CCDs) and others. Significantly:

Any transaction with a Cyprus tax resident, even if unrelated to the Indian counterpart, would attract transfer pricing regulations. This would lead to significantly difficult tax compliances for the Indian party, especially over deduction of expenses. Transfer pricing documentation with unrelated parties may become more difficult. Moreover, the history of transfer pricing litigation in India is not very encouraging.

Recipients of funds (loans) would have to pay tax on such receipts if the source of the funds in the hands of the Cyprus payer is not satisfactorily explained to Indian Revenue — another difficult task when the lender is a third party.

Payments to Cyprus entities require withholding tax at a rate of 30 per cent — which is likely to result in increased cost for Indian payers. There is a possible ambiguity in the law such that payments that are not subject to tax (such as payment for import of goods from Cyprus) may also attract the withholding tax.

The position for withholding tax on expenses incurred and booked up to October 31, 2013, but paid thereafter, can be litigious. Indian entities may have to look at erring in favour of the steep withholding rate to avoid negative consequences — namely, disallowance of expenses, charge of tax, interest, and penalty for not withholding appropriate tax.

The Cyprus entities would have to file tax return in India to claim refund of the delta between the tax withheld and actual tax liability. Lower tax withholding through the dispensation order route is practically closed. The advance ruling route could be explored.

Additionally, transactions between Indian and Cyprus entities would require larger disclosures to Indian Revenue, especially in case of Cyprus financial centres, and would be subject to extra scrutiny. While there is a case for grandfathering of past investments, such a benefit may not be expected, given the punitive nature of the Government’s action.

Tax transparency is a key concern today for Governments around the world. The Organisation for Economic Co-operation and Development (OECD) introduced its Base Erosion and Profit Shifting (BEPS) action plan in July this year in trying to address member-state concerns on tax base erosion through aggressive tax planning and practices, which may result in Stateless income. The project has received the mandate of the G-20 countries (including India).

Increasing expectation and demand for greater tax transparency is one of the three themes on which the OECD’s efforts are centred. The BEPS action plan requires governments to spontaneously exchange information on preferred regimes and the requirements of their business substance. Taxpayers, on the other hand, are to disclose their aggressive tax planning arrangements. In addition to its efforts to check black money and money laundering, India’s move to blacklist Cyprus demonstrates its commitment to transparency — which is significant given its participation in the Global Forum on Transparency and Exchange of Information for Tax Purposes.

Acknowledging the likely negative impact of the move on bilateral trade and commerce, the Cyprus government, in a press note dated November 7, 2013, has agreed to enter into direct consultation with India at the Competent Authority level to resolve the current imbroglio and to renegotiate the tax treaty.

What’s the way forward for businesses? The Government’s action may not significantly affect outbound investments from India routed through Cyprus. One may, however, look at migrating the investment (both inbound and outbound) to a robust tax treaty jurisdiction, which would help genuine investments.

Gaurav Bajoria, Senior Manager, TaxRegulatory Services, contributed to this article.

The author is Executive Director — Tax and Regulatory Services, PwC India.

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