Tackling tax-information exchange tangle

Written by Vikram Bohra | Updated: Nov 19 2013, 09:22am hrs
Over the past few years, various countries, including India, have been focusing on introducing anti-avoidance measures to combat tax evasion with exchange of information across countries being one of the key tools. The scope of the information to be exchanged is provided either under the respective tax treaties or a specific Tax Information Exchange Agreement (TIEA) executed between countries/territories.

Given the ability of the tax authorities to conduct roving enquiries and request information beyond the scope agreed between nations, the OECD has been instrumental at various intervals in facilitating mutual economic cooperation on accessibility of information.

India introduced its General Anti Avoidance Rules (GAAR) in 2009 (though presently deferred) to combat tax evasion. In order to ensure a robust framework to obtain information on cross-border transactions, the Indian government manifested its intention to negotiate its tax treaties, particularly to amend and widen the scope of the exchange of information article. Independently, India has entered into TIEAs with 10 countries as of today.

It also introduced the Section 94A in the Income Tax Act, 1961), which empowers the government to notify countries/territories (notified jurisdictions) that do not effectively exchange information. The government has recently notified Cyprus as one such jurisdiction, which also happens to be the first country to get notified under these provisions.

It has wide ramifications on aspects like taxability, deductibility, reporting and compliances in respect of transactions with persons located in Cyprus.

Coverage: While the language of the Act is wide enough to cover any transaction between two non-residents (one of whom is a Cypriot entity), the memorandum explaining the provisions of the relevant Finance Bill that introduced the Section 94A states its objective is to discourage transactions by a resident assessee with persons located in notified jurisdictions.

Transfer pricing: Any transaction between an assessee and a Cypriot entity shall be deemed to be an international transaction between two associated enterprises and shall be governed by the provisions relating to transfer pricing under the Act (for example, Section 92).

Arguably, this should not impact the transactions in respect of which there is no income chargeable to income tax. For example, dividends paid by the Indian companies to Cypriot entities should not be impacted by this provision. It would be interesting to mull over cases where the income is not chargeable to tax pursuant to the India-Cyprus tax treaty.

This would also result in practical challenges to comply with the transfer pricing documentation and reporting requirements for public trades/transactions, as it is not clear on whom is the onus to comply with such provisionsa clearing house, a broker, an authorised dealer, the government/RBI (in respect of interest payable on government securities).

Withholding tax: Any payment made to a Cypriot entity, which is otherwise subject to withholding tax, shall be liable to a withholding of a higher of 30% or the rates in force. Therefore, this provision should not impact cases where there is no requirement under the Act to withhold tax. Further, this only increases the withholding tax rate and not the tax rate per se. The Cypriot entity can claim a refund of excess taxes paid, though one needs to factor in the time gap in payment of withholding taxes and receipt of refund.

Taxability of amounts received where source cannot be explained: These provisions cast a burden of proof on the Indian resident to satisfactorily explain the moneys source for the Cypriot person or the beneficial owner from whom such sum is received. The terms 'source of income' or 'beneficial owner', however, has not been defined and could be subject to different interpretations and information requests.

Cyprus seems to be facing its own set of challenges one after the otherfirst, the levy of additional taxes and now this unexpected move of the Indian government. This could have a bearing on it being considered as a global/regional investment hub.

The Cyprus government issued a press release on November 7 stating that Cyprus is fully committed to finding a solution and is taking all necessary steps to resolve the issue. It also believes that this notification does not result in termination of the India-Cyprus tax treaty, and rightly so, since the tax treaty is an agreement and can be terminated by following mutually agreed procedures for its termination.

Meanwhile, follow-up meetings are scheduled at ministerial and political levels to manage this situation. Considering the significant bearing that this move would have on existing and future investments from Cyprus into India, the Cyprus government is committed towards holding direct negotiations with the Indian government with the aim of finalising the long-pending review of the India-Cyprus DTAA.

Is this an awakening call for other countries/territories

With inputs from Kiran Bhatia (Manager) and Bhakti Khemani (Associate), PwC India

The author is associate director, Tax & Regulatory Services, PwC India. Views are personal