CBDT notifies Cyprus for lack of effective exchange of information

 

Through a notification[1]dated November 1, 2013, Central Board of Direct Taxes (‘CBDT’), the apex administrative body for tax administration in India, has notified Cyprus as a notified jurisdictional area (‘NJA’) under Section 94A of the Income tax Act, 1961 (the ‘Act’) for lack of effective exchange of information. While the Double Taxation Avoidance Agreement (‘DTAA’) between India and Cyprus, executed in 1994, provides that both countries would exchange information as is necessary for carrying out the provisions of the DTAA or those of the domestic laws of each country for the prevention of fraud or evasion of taxes, the genesis of this notification seems to be non-cooperation from authorities in Cyprus on requests from India.

Pursuant to this notification, Ministry of Finance of Cyprus has issued a press release on November 7, 2013 clarifying that the DTAA between India and Cyprus is not terminated by virtue of the above notification and continues to be in effect. The press release also clarifies that the Government of Cyprus desires to maintain excellent political relations with the Government of India and is in direct contact with it and exerting every effort to clarify and resolve the situation that affects business communities in both countries.

The notification of Cyprus is likely to have a significant bearing on investments into India from Cyprus, both of the past and those in the future.

This edition of BMR Edge examines in brief the provisions of Section 94A and the potential implications of the current development on investments from Cyprus into India.

Provisions of Section 94A

Introduced in 2011 as an anti-avoidance measure, under the section, the Indian Government may notify any country or territory as a NJA having regard to the lack of effective exchange of information with such country or territory. Such notification would impact the transactions of any taxpayer where one of the parties is a ‘person located in the NJA‘[2]. The impact would be in the following forms:

(i) Transfer pricing to apply: All parties to the transaction are deemed to be ‘associated enterprises’ for the purposes of Indian transfer pricing rules, requiring due compliances and filings to be made.

(ii) No tax deduction for payments by a taxpayer: A taxpayer would not be allowed a deduction of any payment to a financial institution in a NJA unless the taxpayer furnishes an authorisation to the CBDT to seek relevant information from such financial institution. Further, a taxpayer would also not be allowed a deduction of any other expenditure or allowance (including depreciation) from a transaction with a person located in a NJA, unless the taxpayer maintains and furnishes prescribed documents or information.

(iii) Deemed income for receipts by a taxpayer: Any sum received or credited by a taxpayer from a person located in a NJA is deemed as income of such taxpayer, if the source of such sum (for the payer or the beneficial owner of such sum) is not explained to the satisfaction of the Indian Revenue.

(iv) Mandatory high withholding tax: Where tax is deductible on any income or sum that a person located in a NJA is entitled to receive, such tax would be deducted at the higher of rates in force, specified rate, and rate of 30 percent.

For implementing this provision, the CBDT notified rules[3]on June 26, 2013. The rules prescribe the form[4] and procedure in relation to authorisation and information to be maintained, for item (ii) above. The authorisation format seeks to enable the CBDT to obtain information and records maintained by the financial institution in relation to the taxpayer and to waive all protection in relation to data protection, privacy or banking secrecy.

Key impact of this notification

With Cyprus being the first country to be notified under Section 94A, the above mentioned four implications would apply to taxpayers located in Cyprus and parties transacting with persons located in Cyprus. Such taxpayer may be resident of India or a non-resident.

The implications should apply to all transactions with persons located in Cyprus with effect from the date of its publication in the official gazette. While it would cover future transactions, it is also likely to impact current transactions based on past arrangements. Implications under Section 94A are largely overriding in nature, over other provisions of the Act. This would mean that they would operate in priority over any other provisions of the Act, including those relating to DTAAs.

The implications would tend to create significant comparative disadvantages for transactions with a person located in Cyprus. These would result in an irreversible impact in the form of possible denial of deduction for payments to persons located in Cyprus [in point (ii) above] and possible deemed income for income received from persons located in Cyprus [in point (iii) above].

Applicability of transfer pricing would only impact unrelated party arrangements which would though typically be at arm’s length and hence ought not to have a substantive impact. However, the compliance burden, with growing transfer pricing litigation in India, could be a deterrent.

Particularly with respect to the increased rate of withholding tax on certain payments, since withholding tax is not the final tax, the impact may only be a concern from a timing perspective, since the earner of the income in Cyprus should be able to avail any benefits as may be available under the Act or the DTAA in the final tax analysis.

In relation to the withholding tax related implication, it may also be noted that the higher rate of withholding would apply only in a situation where the income or sum earned by the person located in Cyprus is chargeable to income tax in India. Accordingly, for income streams such as capital gains for a person located in Cyprus, which is not taxable in India under the DTAA, the onerous withholding tax implication should not have any effect.