In a first instance of its kind, India has classified Cyprus as a non-cooperative tax jurisdiction, and the move has evoked mixed responses. Finance Act 2011 introduced a “toolbox” through Section 94A in the Income-Tax Act, 1961, for transactions with entities in non-cooperative countries/ jurisdictions. This was meant as an anti-avoidance measure

to discourage transactions with a jurisdiction that does not exchange information with India; and

to empower the Central Government to blacklist or specify a country as a Notified Jurisdictional Area (NJA) if it did not cooperate on information exchange.

India and Cyprus had entered into a tax treaty in 1994, and are obliged to exchange information. On November 1, 2013, the Indian Ministry of Finance notified Cyprus as an NJA following failed discussions to secure the desired level of cooperation from Cyprus. This has come as a surprise to some.

Subsequently, the Cyprus Ministry of Finance issued a press release on November 7, clarifying that the Double Taxation Avoidance Agreement (DTAA) between the two countries continues to be in force. It also clarified that Cyprus desires excellent political relations with India, and was making every effort to clarify/ resolve the situation.

Key impact of the NJA

Transfer pricing: Transactions by Indian taxpayers with a person located in Cyprus will be deemed as transactions between related parties/ associated enterprises. Consequently, they would be subject to transfer pricing regulations and all related compliances (including maintenance of documentation).

High withholding tax: Any payment to a person located in an NJA will attract withholding tax of 30 per cent, or the rate prescribed under the Income-Tax Act, or the rates in force, whichever is higher.

Tax deduction: Payment to a financial institution in an NJA will be allowed for tax deduction if it authorises the Central Board of Direct Taxes or other specified authority to seek information from it. No tax deduction would be allowed for any other expenditure/ allowance (including depreciation) derived from a transaction with a person located in an NJA in the absence of prescribed documents/ information.

Deemed income: If any sum is received or credited in the books of a taxpayer in India from a person located in Cyprus, the onus is on the taxpayer to satisfactorily explain the source of the money, as otherwise it shall be deemed as the taxpayer’s income.

The notification has triggered several issues:

Override of treaty: Section 94A prescribes a higher withholding rate of 30 per cent. Will treaty benefit be available? The implications under Section 94A largely override the provisions of the Income-Tax Act, including DTAAs. However, Section 90, which deals with treaty benefit, does not override Section 94A. The notification does not appear to override the treaty. Therefore, Cyprus recipients can explore the option of filing tax returns to claim refund of withheld taxes. However, the impact of high withholding on cash flows and, in turn, return on investments cannot be ruled out.

Impact on investments: The notification is likely to impact the flow of foreign direct investment and foreign institutional investments through Cyprus. It would also impact existing investments from Cyprus, especially those with lock-in conditions such as in real estate. Investments already routed through/ in Cyprus will also be affected due to the higher withholding and increased reporting/ disclosure requirements.

In effect, investors, especially real-estate funds, may be deterred from routing funds to India through a Cyprus financial centre. It remains to be seen if the two governments can mutually resolve the issue. Meanwhile, taxpayers dealing with persons located in Cyprus should review the impact on their transactions/ business structures, as non-compliance with the various requirements entails onerous consequences.

The author is a chartered accountant.

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