India and Cyprus have recently revised the Double Taxation Avoidance Agreement (DTAA) to be effective from April 01, 2017 and January 01, 2017 in India and Cyprus respectively.
Before 2013, Cyprus was a favoured jurisdiction for investments into India as capital gains from the sale of shares held by Cyprus based investors in Indian companies was not taxable in India. However, due to non-compliance of its information sharing obligations, India declared Cyprus a Notified Jurisdictional Area (NJA). This led to significant uncertainties. While the DTAA had not been rescinded, this development resulted in adverse implications for Cyprus based investors, including, inter alia, higher rate of withholding taxes, application of transfer pricing provisions to transactions with Cyprus based entities even though they are not related, etc. Thus, conducting regular business transactions between entities of both countries became difficult with many transactions getting deferred.
The revised DTAA is the culmination of prolonged negotiations and discussions between both the countries to address this situation. Pursuant to the execution of the revised DTAA, the notification declaring Cyprus as NJA has been rescinded.
Key Revisions To The DTAA
- Under the revised DTAA, capital gains arising to a Cyprus based investor from the alienation of shares of an Indian company acquired on or after April 01, 2017, will also be subject to tax in India. However, for investments done on or before March 31, 2017, Cyprus based investors will not be liable to pay capital gains tax in India. This change is along the lines of the India-Mauritius DTAA. However, interestingly, while India-Mauritius DTAA allows for a two year transition period (until March 31, 2019), during which Mauritius based investors will pay tax on capital gains at 50% of the applicable rate, such concession has not been extended to Cyprus based investors.
- Business profits earned by a non-resident is subject to tax in India only if the non resident has a permanent establishment (PE) in India. The revised DTAA significantly expands the definition of PE by including a wider definition of the fixed place PE, reducing the threshold for constituting construction PE from 12 months to 6 months, introducing the service PE clause, widening the scope of agency PE, etc. This would make Cyprus based entities being liable for tax in India in respect of business income earned by them from India which was hitherto not taxable.
- Under the revised DTAA non-resident enterprises with PE in India, will be taxed only to the extent of profits attributable to such PE. The existing DTAA had the force of attraction principle (under which profits derived through the PE as well as profits from activities same as or similar to that carried out by the PE would have been taxed in India) which has been deleted under the revised DTAA.
- The tax on dividends has been reduced from 15% to 10%. However, this is unlikely to affect Cyprus based investors because the extant Indian tax regime exempts dividends paid or declared by Indian companies from tax in the hands of shareholders and instead, imposes a dividend distribution tax on the company.
- The revised DTAA grants exemption to certain Indian institutions from tax in Cyprus on interest income earned there.
- The scope of taxation of income in the nature of fees for technical services (FTS) has been expanded to include additional services like managerial services. Further, FTS earned by a Cyprus based entity will now be subject to tax in India even if such services do not make available the requisite knowledge, experience or knowhow to the Indian recipient. At the same time, in line with current Indian tax rates, the tax rate for royalties and FTS has been reduced to 10% from 15%.
- The revised DTAA updates the exchange of information article as per the international standards, and allows for the use of such information for purposes other than taxation. A new article to facilitate cooperation between both countries in collection of taxes has also been introduced.
Impact Of The Revised DTAA On Investments Into India
The revised DTAA may have a significant impact on the volume of investments into India through Cyprus. For investors using Cyprus merely to claim the benefits under the erstwhile DTAA, this route may no longer be attractive. However, strategic and financial investors, for whom tax is typically not the sole determinant, may not be unduly worried by the dis-continuance of the tax exemption. Such investors may continue to invest in India, either through Cyprus or otherwise.
Foreign Portfolio Investors (FPIs) investing in India in listed securities, Participatory Notes, etc. may review their investment strategy pursuant to the revised DTAA coming into effect. Investments in listed securities with an over-12 months holding period may not be impacted because capital gains earned from the sale of such investments will continue to be non-taxable whereas investments held for less than 12 months would now be subject to tax in India. Similarly, participatory notes issued by FPIs could become less attractive to investors as the FPIs may pass on their tax burden to them.
Private equity and venture capital investors, who have a limited investment periods and whose predominant objective is to maximise returns, may reallocate their investment portfolio as their returns from Indian securities could be depleted on account of the capital gains tax payable in India. However, India may remain an attractive investment jurisdiction for foreign investors because despite the imposition of capital gains tax, the post tax returns could still be better than the returns from other jurisdictions as India is one of the fastest growing major economies.
The revised DTAA is a welcome move since it clears up uncertainty and provides clarity regarding the tax treatment of capital gains and other income earned by investors in both countries. The increased focus on sharing information and cooperation in tax collection matters is also likely to further transparency and prevent the abuse of the DTAA.