In 2011, the Union government had enacted a provision in the income-tax Act, 1961 allowing it to notify a country or territory as a ‘notified jurisdiction area (NJA)’, where the country or territory in question was not effectively exchanging information with India. On November 1, 2013, invoking these provisions, Cyprus was notified as a NJA on the basis that the island-nation had been less than forthcoming with information.
This notification was the first of its kind by India (and, till date, Cyprus remains the only country to be so notified) and the implications were almost catastrophic in nature. All transactions with entities in Cyprus were deemed to be related-party transactions, necessitating maintenance of extensive documentation, and, more importantly, the treaty rates of withholding were superseded by the requirement to withhold tax at 30% on payments to the Cyprus-based entity that were liable to tax in India.
While the treaty was technically still in force and the Cyprus-based entities were eligible to claim a refund of the higher withholding, there was an immediate impact on cash-flows, impacting overall returns on investment. The real estate sector was already struggling to come to terms with the downturn which had left developers with unsold inventory and stalled projects, and with much of the PE investments in the sector being from Cyprus, the additional cash burden of higher withholding tax impacted both developers and investors alike. The problems of investors were compounded when Indian Revenue took a view that all payments to a Cyprus entity, whether or not in the nature of income chargeable to tax in India, should suffer the higher withholding of 30%. With the validity of the notification of Cyprus as a NJA being upheld by the Madras High Court, there was practically no light at the end of the tunnel.
A sliver of hope came when, after the renegotiation of the tax treaty between India and Mauritius, it was announced that the India and Cyprus tax treaty would also be renegotiated on similar lines and a press release on July 1, 2016, indicated that the two sides had formally concluded negotiations. Recently, the Union Cabinet approved the changes, and although the formal text of the revised treaty has not been made available, the following key changes seem to have been made: India has been given the right to tax capital gains on investments from Cyprus prospectively from April 1, 2017. All existing investments, including those made upto March 31, 2017, have been sought to be grandfathered like in the Mauritius treaty. However, the Mauritius treaty additionally provides for 50% capital gains tax exemption for two years from April 1, 2017, to March 31, 2019, subject to fulfilment of conditions. This appears to be absent in the revised Cyprus treaty.
There does not appear to be a revision in the rate of withholding for interest income and, at 10%, this is now higher than the 7.5% that the new Mauritius treaty provides. Some provisions can also be interpreted to suggest capital gains exemption will not be available in cases where the shares of the Indian company principally derive their value, directly or indirectly, from real estate in India.
Most importantly, it appears that the notification of Cyprus as a NJA will be withdrawn with retrospective effect from November 1, 2013.
Once the changes are formalised, it will—like in the case of Mauritius—provide clarity on the tax treatment of investments from Cyprus. More importantly, the retrospective removal of Cyprus as a NJA will pave the way for the pending tax refunds and address a longstanding demand of investors.
The changes are also another pointer to India’s overall position on tax treaties and the attention now turns entirely to the treaty with Singapore.
With inputs from Pallavi Garg, manager (direct tax)
The author is partner (direct tax), PwC India