The same cannot be said for governments, however. Faced with a global slowdown leading to high fiscal deficits on account of foregone tax revenues, countries are increasingly directing their efforts towards extracting information regarding tax foregone on account of beneficial provisions being exploited in tax havens. Information is also crucial as corporations increasingly shift to low tax jurisdictions and tax havens.
A meeting of the G-8 countries hopes to give further momentum to these efforts. Representatives from Germany, France, Britain, Italy and Spain recently convened to discuss and develop mechanisms to clamp down on tax evaders and tax havens by ensuring seamless information exchange. Countries such as Jersey and Cayman Islands, which have many shell corporations, agreed to sign a multi-lateral convention on information-swapping.
India is not far behindthe current government approached various jurisdictions, including Mauritius, for data on offshore bank accounts of certain Indian entities, motivated by the issue taking the spotlight in the run up to the general elections in 2009. The efforts are not limited to purely obtaining information. Indian tax authorities now have provisions in the income tax legislation and double taxation treaties which disincentivise trade and transactions with identified tax havens.
The concept of notified jurisdictions legislated vide the Finance Act, 2011, is a step in this direction. The introduction of Section 94A ensures that certain countries which do not effectively exchange information may be notified by the government. As a consequence of the notification, transactions with such territories shall attract increased scrutiny and higher rates of withholding, among other restrictions.
The legislative intent behind the introduction of Section 94A is to mandate rigorous documentation on the part of the Indian resident undertaking transactions with entities in the notified territory, allowing Indian tax authorities to scrutinise such transactions in depth. The Section specifies that:
*Any resident of India entering into any form of transaction with a party in the notified territory shall have to comply with Indian transfer pricing norms
*Any payment made to a party in the notified territory shall attract withholding tax in India at a blanket rate of 30%
*No deduction or expense on account of any transaction with entities in the notified territory shall be allowed to an Indian resident in computing tax liability, unless satisfactory documentation is produced before the Indian tax authorities. Further, absence of satisfactory documentation may also trigger taxability of sums received from the notified jurisdiction by the Indian party.
Till recently, the power granted to the Indian government to notify any territory had not been exercised. However, the recent notification of Cyprus by the Indian government as a notified territory marks a first.
Cyprus has globally been viewed as a tax haven, offering benefits in the nature of non-taxation of dividend payments or capital gains, and allowing opening of bank accounts with limited information and compliance. As India increasingly seeks to clamp down on global tax havens, imposing restrictive covenants on transactions with Cyprus signals Indias strong commitment to the cause. One school of thought suggests that lack of information has triggered this action by the Indian government.
By mandating transfer pricing compliance for the transacting parties, the government has assured a mechanism to closely examine each transaction to prevent erosion of tax revenues. Not only will this lead to closer examination by the authorities, it will reinforce the maintenance of rigorous documentation by the Indian entity and increased administrative compliance.
A blanket rate of 30% of withholding tax on every form of payment made to a Cypriot entity is another focal point. The withholding tax now applicable to any sum paid or credited to a Cyprus-based entity not only poses an administrative and compliance burden on the paying party but also weighs heavily on the cash flows of the entity to whom the amount is due. Since the withholding provisions do not alter the taxability of income, the amount withheld may not be irrecoverable. To that extent, say where the tax is withheld at 30% on a royalty payment, the income shall continue to be taxed at 15% as per the rate prescribed by the treaty effecting entitlement to a refund of 15% to the Cypriot entity, subject to filing the return of income. It is pertinent to note that granting of refund may preclude litigation and Indian tax authorities may not be as forthcoming.
Additionally, being designated as a notified territory may not only encourage existing investors to exit Cyprus but may prompt prospective investors to explore alternate jurisdictions to invest in India. It needs to be highlighted that a mere change in the tax residency with an objective to exit, may not ensure freedom from the confines of Section 94A, since applicability squarely falls on companies registered in Cyprus. In this regard, in spite of, say the Singapore tax authorities accepting tax residency of a Cypriot company in Singapore, the company may still be considered as located in the notified territory, as long as it remains registered in Cyprus.
Indian parties transacting with Cyprus may also have their tryst with the taxman under the prescribed Section with the provisions mandating that the absence of satisfactory documentation and information shall have onerous implications on Indian entities. Not only does the Section prescribe that absence will mandate receipts being deemed taxable in India, it also mandates that expenses incurred on account of transactions may not deductible while computing taxable profits. In light of the fact that the seventh-highest FDI amount in India flows from Cyprus (with cumulative inflows of $33 million), the definition of what constitutes satisfactory will be a welcome move in allaying investor fears.
Cyprus being designated a notified territory marks an important landmark in the arena of tax information exchange. A combination of provisions mandating transfer pricing compliance and documentation requirements for receipts of the Indian entity to and from the Cyprus-based entity may discourage investors from using the Cyprus route. Adding to the concern is the high blanket rate of withholding prescribed. The solution may not be as easy as looking for other jurisdictions as the provisions of the General Anti Avoidance Rules come into play in context of such countries.
The Cyprus government has been prompt in responding to this move by India. It has clarified that the treaty benefits are still in place and has ensured full cooperation to the Indian government in the form of tax treaty negotiation and better information exchange.
Bilateral talks between India and Cyprus are also expected soon, as the Cyprus government looks to shed the notified territory tag.
Many consider this move as a trigger for higher uncertainty as it may encourage the government to notify other countries with whom information exchange is not successful.
Prashant Vig, manager, KPMG in India contributed to the article
The author is director, Tax and Regulatory, KPMG In India.
Views are personal