India has been following high standards of transparency and exchange of information in line with the global economies. India secured membership of the Financial Action Task Force (FATF) in 2010. This was an important initiative of the G-20 against money laundering.
India has also joined the taskforce on Financial Integrity and Economic Development, Eurasian Group (EAG) and Global Forum on Transparency and Exchange of Information.
To facilitate effective tax administration and exchange of information, the Government recently made amendments in the tax statute. The Government has also entered into tax information exchange agreements with various territories. Even existing tax treaties have been amended to revise the exchange of information article.
As an anti-avoidance measure, the provisions of Section 94A have been introduced in the Finance Act, 2011, which vested power in the Government to notify jurisdictional areas with respect to the lack of effective exchange of information within the territory concerned in relation to transactions.
In July 2013, the Central Board of Direct Taxes (CBDT) introduced Rule 21AC in the Income-tax Rules, 1962, which prescribes the procedure and documentation for claiming deduction if payment is made to a person located in a notified jurisdictional area. The CBDT prescribed forms and documentation to ensure effective administration relating to income received/ credited and expenditure/ payments arising in certain international transactions.
On November 1, 2013, the Ministry of Finance issued a press release announcing Cyprus as a notified jurisdictional area under Section 94A of the Act — the first country to be so notified after these provisions were introduced.
Key implicationsApplicability of transfer pricing provisions: All parties to a transaction with a person located in Cyprus shall be treated as associated enterprises and the transactions shall be treated as international transaction resulting in application of transfer pricing regulations including maintenance of documentations, benchmarking, and so on. Therefore, a transaction which is not with an associated enterprise as defined under Section 92A would also be covered by the transfer pricing regulations.
Deemed income: If any sum is received from a person in Cyprus, the taxpayer will be required to satisfactorily explain the source of such money in the hands of the person in Cyprus or in the hands of the beneficial owner. Failing to do this will mean the amount shall be deemed to be the income of the taxpayer.
Tax withholding: Any sum payable to a Cyprus entity and on which tax is deductible at source shall be liable for withholding tax at 30 per cent or the rate prescribed in the provisions of the Act or the rates in force, whichever is higher.
Cyprus is often used as a jurisdiction for obtaining debt and therefore the withholding implication on interest payments needs to be evaluated. Taxpayers will have to withhold tax at the highest rate. Further, for claiming deduction of such interest, the taxpayer will need to maintain documentation. The benefits available under the India-Cyprus tax treaty with respect to lower withholding tax rate on interest and various other payments will not be available. It is important to note that the override is only with respect to the rate mentioned in the India-Cyprus tax treaty.
Cyprus does not impose capital gains tax on its residents and therefore under the India-Cyprus tax treaty capital gains transactions are not taxable in India. However, the taxpayer will need to withhold tax at the highest rate. Applicability or otherwise of higher withholding rate on capital gains is an interesting aspect that needs to be evaluated.
Deduction for expenditure related to transaction with a Cyprus entity: For any payment to a financial institution located in Cyprus, deduction shall be allowed if the taxpayer furnishes an authorisation (in Form 10FC) allowing CBDT or any other specified Income-Tax authority to seek relevant information from the said financial institution. Further, no deduction in respect of any expenditure or allowance (including depreciation) arising from a transaction with a Cyprus entity shall be allowed unless the taxpayer maintains and furnishes the prescribed information. Form 10FC provides irrevocable authorisation to the CBDT to obtain KYC documents relating to the account holder, financial statements, account opening documents and so on.
Important documents Key information and/or documents to be maintained by the taxpayer relating to expenditure or allowance for transactions with a Cyprus entity include:
Description of ownership structure of the Cyprus entity including details of entities having directly or indirectly more than 10 per cent shareholding or ownership interests.
Profile of the multinational group of which the Cyprus entity is a part, along with ownership links among them.
Broad description of business of the Cyprus entity along with the industry it operates in.
Information/ documents referred to in Rule 10D of the Income-Tax Rules and any other information, data or document which may be relevant for the transaction.
These documents have to be maintained till the date of filing of income-tax returns by the taxpayer. Further, such information/ documents are to be maintained for a period of eight years from the end of the relevant assessment year.
Impacting investments
The Finance Ministry announcement will impact investments made in India from Cyprus, especially where there are lock-in conditions, for example, transactions in the real estate sector.
Transactions with entities based in Cyprus will necessitate maintaining a lot of information and documentation.
Further, while the Cyprus entity may claim refund for taxes withheld pursuant to this announcement, claiming the beneficial provisions of the India-Cyprus tax treaty, such high tax withholding may have an impact on cash flows and thereby the overall return on investment.
It is imperative that both governments reach an understanding expeditiously so that the adverse implications on various parties on account of the notification are minimised.
(The author is Co-head of Tax, KPMG in India)