A) Background
(i) India and Cyprus have recently signed a new Double Taxation Avoidance Agreement (New DTAA). The New DTAA replaces the earlier India-Cyprus DTAA signed in 1994 (Old DTAA), which has been a subject matter of renegotiation between the Government of India (GoI) and the Government of the Republic of Cyprus (GoC) for some time now. The New DTAA was signed on 18th November 2016 and both the Governments had previously issued press releases announcing the same. The text of the New DTAA was recently published in the Gazette of the GoC. However, the GoI is yet to make an official publication of the New DTAA. The New DTAA is the outcome of prolonged and extensive negotiations between both the countries.
(ii) Significant provisions of the New DTAA include source country taxation rights on capital gains from shares, subject to grandfathering of shares acquired before 1st April 2017, insertion of Service Permanent Establishment (PE), expanded scope of Dependent Agent PE, revised Article on Fees for Technical Services (FTS) etc. The New DTAA limits source country taxation of Other Income. It also reduces taxation of royalty/FTS at the rate of 10% (as compared to the earlier rate of 15%). Furthermore, a modified version of the exchange of information (EOI) provision has been incorporated, which is in line with existing international standards. An additional Article on “assistance in collection of taxes” has also been introduced in the New DTAA.
(iii) The New DTAA will enter into force once the requisite procedures are completed in both the countries. The old DTAA shall stand terminated upon the New DTAA coming into force.
(iv) The GoI has rescinded the classification of Cyprus as a “Notified Jurisdictional Area” (NJA), retrospectively as from 1st November 2013.
B) Highlights / Salient Features of the New DTAA
1. Expanded scope of PE (Article 5)
The New DTAA expands the scope of ‘permanent establishment’, introducing the concept of a ‘service’ permanent establishment. The New DTAA has also specifically includes (i) sales outlets, (ii) warehouses (in relation to a person providing storage facilities for others) and (iii) farms, plantations or other places where agricultural, forestry, plantation or related activities are carried on, within the inclusive definition of ‘permanent establishment’. Further, the New DTAA provides for the creation of a construction permanent establishment if activities carry on for more than 6 months, instead of the earlier requirement that the activities be carried on for more than 12 months.
Insertion of a Service PE: A new Service PE clause has been introduced whereby furnishing of services, including consultancy services, by an enterprise through employees or other personnel engaged by the enterprise for such purpose, but only where activities of that nature continue (for the same or connected project) within the country for a period or periods aggregating more than 90 days within any 12 month period shall constitute a PE. The above service PE rule is in line with the UN Model Convention 2011 (2011 UN MC), except that the time threshold is lower at 90 days as compared to 183 days in the 2011 UN MC.
The criteria for the constitution of an agency PE has been amended. Accordingly, the person other than an agent of independent status shall constitute an agency PE if:
– He is acting on behalf of an enterprise and has, and habitually exercises, in a contracting state an authority to conclude contracts in the name of the enterprise;
– Has no such authority, but habitually maintains in the first-mentioned state a stock of goods or merchandise from which he regularly delivers goods or merchandise on behalf of the enterprise;
– Habitually secures orders in the first mentioned state, wholly or almost wholly for the enterprise itself.
The above provisions are consistent with most of the Indian DTAAs.
There are a number of other changes in the PE definition which include, inter alia:
a) Lowered threshold for triggering construction/installation/supervisory PE to 6 months from the existing limit of 12 months.
b) Inclusion of sales outlet, warehouse as fixed PE.
c) Removal of “delivery” function from the scope of exempted activities.
2. Profit Attribution / Business Profits (Article 7)
The New DTAA has removed the ‘force of attraction’ rule. Accordingly, the business profits of an enterprise may be taxed in the other state but only so much of them as is attributable to that PE.
No deduction shall be allowed in respect of amounts paid by way of royalties, fees or other similar payments in return for the use of patents, know-how or other rights, or by way of commission or other charges for specific services performed or for management, or, except in the case of banking enterprises, if any, paid (other than reimbursement of actual expenses) by the PE to the head office or any of its other offices, by way of interest on money lent to the PE.
Similarly, no account shall be taken, in the determination of the profits of a PE, of amounts charged by way of royalties, fees or other similar payments in return for the use of patents, know-how or other rights, or by way of commission or other charges for specific services performed or for management, or, except in the case of banking enterprises (other than reimbursement of actual expenses) by the PE to the head office or any of its other offices, by way of interest on moneys lent to the head office of the enterprise or any of its other offices.
This provision is comparable to Article 7(3) of the 2011 UN MC and has been adopted lately by India in most of its DTAAs.
3. Shipping and Air Transport (Article 8)
The criteria of ‘registration’ and ‘headquarters’ have been removed. Accordingly, profits derived by an enterprise of a contracting state from the operation of ships or aircraft in international traffic shall be taxable only in that state
The term profits for the purpose of shipping and air transport has been amended. Accordingly, profits from the operation of ships or aircraft in international traffic shall include profits derived from the rental of ships or aircraft on a full time (time or voyage basis) or bareboat basis.
Exception is provided for the taxability of profits from the use, maintenance, or rental of containers for the transport of goods or merchandise solely between places within the other contracting state.
The New DTAA provides that interest on funds connected directly with the operation of ships or aircraft in international traffic, shall be regarded as profits derived from the operation of such ships or aircraft, and the provisions of Article 11 (interest) shall not apply in relation to such interest.
by the enterprise are covered under ‘capital gains’. It shall be taxable only in the contracting state in which the alienator is a resident.
4. Associated Enterprises (AEs) (Article 9)
The New DTAA aligns with the OECD Model Convention (OECD MC) in relation to the provisions related to AEs. Article 9(2) of the old DTAA has been removed, which provided powers to the competent authority to apply domestic laws which allow to use discretion/estimates for computing liability under Article 9(1) in cases where it is not possible, from the available information, to determine profits attributable to the concerned enterprise.
5. Dividends (Article 10)
The rate of dividend in source state shall not exceed 10%. The rate of 15% has been removed.
6. Interest (Article 11)
Tax rate of interest in source state shall not exceed 10% if the beneficial owner of the interest is a resident of the other contracting state.
Following entities are additionally exempt from tax:
– Export-Import Bank of India
– National Housing Bank
– Any other institution as may be agreed upon from time to time between the competent authorities of the contracting states through the exchange of letters.
7. Royalties and FTS (Article 12)
Under the New DTAA, royalties and FTS will attract tax withholding at the rate of 10%, as against the rate of 15% provided in existing DTAA. However, the scope of source taxation has been modified as follows:
– The term FIS has been replaced by the term FTS.
– The tax rate of royalties and FTS in the source state is reduced to 10% from 15 %.
– The term royalty has been amended to include payment only.
– The definition of the term ‘royalty’ has been amended as follows:
‘The term ‘royalties’ means payment of any kind received as a consideration for the use of, or the right to use, any copyright of literary, artistic or scientific work including cinematograph films or films or tapes used for television or radio broadcasting, any patent, trade mark, design or model, plan, secret formula or process, or for the use of, or the right to use, industrial, commercial or scientific equipment, or for information concerning industrial, commercial or scientific experience. The term ‘royalties’ will not include income for the use of, or the right to use aircrafts and ships.’
– The term ‘FTS’ has been amended as follows:
‘FTS’ means payments of any kind as consideration for managerial or technical or consultancy services, including the provision of services of technical or other personnel.
Further, the ‘make available’ clause has been removed from the term FTS.
Additionally, Article 12(5) provides that where royalties or FTS do not arise in one of the contracting states, and the royalties relate to the use of, or the right to use, the right or property, or the FTS relate to services performed in one of the contracting states, the royalties or FTS shall be deemed to arise in that contracting state.
8. Source based taxation of capital gains from shares (Article 13)
Capital gains arising from the transfer of shares are taxable solely in the Resident State of the alienator under the old DTAA. The New DTAA provides taxation rights to the State of residence of the company whose shares are alienated (i.e., Source State).
Additionally, taxation of indirect transfer whereby capital gains from sale of shares of a company, the assets of which consist, directly or indirectly, principally of immovable property in a Contracting State (Source State), would be taxable in the Source State.
However, shares acquired up to 31st March 2017 have been grandfathered from both the above rules on source taxation. The exemption will apply irrespective of the date of subsequent transfer of such shares.
Therefore, the source based taxation under the New DTAA shall only be applicable to capital gains arising from the transfer of investments made on or after 1st April, 2017, and capital gains arising from the transfer of investments made prior to 1st April, 2017 should continue to be taxed only in the jurisdiction in which the taxpayer is a resident.
The aforesaid provisions on direct transfer of shares are similar to the recent amendment under the India-Mauritius DTAA. The India-Mauritius DTAA additionally provides for a transitional relief of 50%, subject to fulfilment of Limitation of Benefit (LOB). Such a provision does not feature in the New DTAA with Cyprus.
The clause relating to alienation of ship and aircraft amended to provide that gains from the alienation of ships or aircraft operated in international traffic or movable property pertaining to the operation of such ships or aircraft shall be taxable only in the contracting state of which the alienator is a resident.
A new clause has been inserted to provide that gains from the alienation of shares of the capital stock of a company, the property of which consists directly or indirectly principally of immovable property situated in a contracting state, may be taxed in that state.
9. Independent Personal Services (Article 14)
The New DTAA has introduced the rolling period concept i.e. for a period or periods amounting to or exceeding in the aggregate 183 days in any 12 month period commencing or ending in the fiscal year concerned.
10. Dependent Personal Services (Article 15)
The New DTAA has introduced the rolling period concept i.e. the remuneration derived in respect of an employment exercised in the other contracting state shall be taxable in source state only if the recipient is present in the other state for a period or periods not exceeding in the aggregate 183 days in any twelve month period commencing or ending in the fiscal year concerned.
In case the remuneration derived in respect of an employment exercised aboard a ship or aircraft operated in international traffic by an enterprise, the New DTAA has removed the place of effective management criteria. Therefore, the remuneration derived in respect of an employment exercised aboard a ship or aircraft operated in international traffic by an enterprise of a contracting state, shall be taxed in that state.
11. Limited source taxation of “Other Income” (Article 22)
Under the old DTAA, any income not expressly covered by other Articles of the DTAA and arising in a Source State could be taxed in that Source State also. The said provision has been removed in the New DTAA.
The New DTAA listed certain specified income for taxability in source state. Accordingly, if a resident of a contracting state derives income from sources within the other contracting state in the form of lotteries, crossword puzzles, races including horse races, card games and other games of any sort or gambling or betting of any nature whatsoever, such income may be taxed in the other contracting state.
12. Methods for elimination of double taxation (Article 23)
Benefits relating to tax sparing and deemed foreign tax credit (FTC) in respect of dividend, interest, royalty and FTS under the old DTAA have been removed.
13. Non Discrimination (Article 24)
The New DTAA has amended the non-discrimination clause. It provides that nationals of a contracting state shall not be subjected in the other contracting state to any taxation or any requirement connected therewith, which is other or more burdensome than the taxation and connected requirements to which nationals of that other state in the same circumstances, in particular with respect to residence, are or may be subjected. This provision shall also apply to persons who are not residents of one or both of the contracting states.
Interest, royalties and other disbursements paid by an enterprise of a contracting state to a resident of the other contracting state shall, for the purpose of determining the taxable profits of such enterprise, be deductible under the same conditions as if they had been paid to a resident of the first-mentioned state. Similarly, any debts of an enterprise of a contracting state to a resident of the other contracting State shall, for the purpose of determining the taxable capital of such enterprise, be deductible under the same conditions as if they had been contracted to a resident of the first-mentioned State.
14. Tie-breaker rule for determining residency of non-individuals through Mutual Agreement Procedure (MAP) (Article 25)
In cases of persons other than individuals who are residents of both India and Cyprus, place of effective management (POEM) rule is applied to determine residency. The New DTAA additionally provides that if POEM cannot be determined then the competent authorities of the Contracting States shall settle the question by mutual agreement within 2 years from the date of invocation of MAP under Article 25.
15. Exchange of Information (Article 26)
The scope of the EOI Article in the New DTAA has been enhanced to align with international standards on transparency and the provision in the OECD MC. The EOI Article extends to information relating to taxes of every kind and description imposed by a State or its political subdivisions or local authorities, to the extent that the same is not contrary to the taxation as per the New DTAA. Furthermore, the information can be used for purposes other than tax, with the prior approval of the authority providing such information.
EOI would also be possible in respect of persons who are not residents of the Contracting State, as long as the information requested is in possession of the concerned State. Specifically, information held by banks or financial institutions can be exchanged under the EOI Article.
16. Assistance in Collection of Taxes (Article 27)
The New DTAA includes an Article on “assistance in collection of taxes” largely in line with the OECD MC. Broadly, this Article enables the revenue claims of one State to be collected through the assistance of the other Contracting State, subject to fulfilment of certain conditions and requirements. Assistance would also involve undertaking measures of conservancy by freezing assets located in the requested State, subject to the laws therein.
Clause 4 of the Protocol clarifies that for the purpose of this Article, a State is not obliged to take measures inconsistent with its laws and policies in respect of collection of its own taxes.
C) India rescinds notification treating Cyprus as “Notified Jurisdictional Area”
The Government of India (GoI) vide Notification No. 114 of 2016 dated 14th December 2016 (Recent Notification) has rescinded its earlier Notification No. 86 of 2013 dated 1st November 2013 which had notified Cyprus as a Notified Jurisdictional Area (NJA) u/s. 94A of the Income-tax Act, 1961 (Act).
On 1st November 2013, the Central Board of Direct Taxes (CBDT) invoked the provisions of Section 94A of the Act and notified Cyprus as an NJA owing to inadequate exchange of information by Cyprus tax authorities. On 1st July 2016, GoI issued a press release that negotiation on the revision of India-Cyprus tax treaty (Cyprus Treaty) between both the countries has been completed with –
– Rights to source based taxation of capital gains and grandfathering of investments made prior to 1st April 2017.
– India considering the removal of Cyprus from the list of NJAs under the Act retrospectively and initiating necessary procedures.
On 18th November, 2016, GoI issued a press release announcing the signing of the New Cyprus Treaty. Subsequent to this notification, Government of Cyprus released the text of the New Cyrus Treaty. GoI vide its recent notification has rescinded the earlier notification resulting in Cyprus not being a NJA under the Act. The recent notification also states that things done or omitted to be done before such rescission shall be an exception. On 16th December 2016, GoI has issued another press release confirming completion of internal procedures to amend the Cyprus Treaty. In this press release, GoI has also stated that Cyprus’s status as an NJA u/s. 94A of the Act has been rescinded with effect from 1st November 2013.
Impact of the Recent Notification
– Deeming fiction provided in section 94A to deem Cyprus tax residents or a person located in Cyprus as an associated enterprise and any transactions with them as an international transaction will no longer be applicable.
– Claim for deduction of any expenditure / allowance arising on account of transactions with Cypriot tax resident or a person located in Cyprus would now be allowable under general provisions of the Act without documentation requirements as per Rule 21AB of the Income-tax Rules, 1962 read with Form 10FC prescribed u/s. 94A of the Act.
– Consequent to the Recent Notification, any taxable income accruing / arising to a Cypriot tax resident or a person located in Cyprus would now be subject to the withholding tax rates prescribed under the Act or the New DTAA (as and when India notifies the same), whichever is beneficial to the tax payer.
To illustrate, payments made to Cyprus tax residents or persons located in Cyprus would be subject to withholding tax as follows:
– Royalties / Fees for Technical Services, earlier liable to withholding u/s. 94A at the rate of 30%, would now be liable to withholding at 10% under the Act.
– Interest income, earlier liable to withholding u/s. 94A at the rate of 30%, would now be liable to withholding at 10% under the Cyprus Treaty or at an applicable lower rate under the Act, whichever is beneficial.
This is a long awaited and significant development between India and Cyprus and resets the tax position for various transactions on par with other jurisdictions.
D) Impact and Analysis of New India-Cyprus DTAA
1. Shift towards source based taxation.
By and large, India’s network of 94 tax treaties provide for source and residence based taxation of capital gains arising from the transfer of shares of a company. However some exceptions exist, for example, India’s tax treaties with Singapore, Jordan (provided the transferor is subject to tax in the state of residence), Philippines, Portugal, and Zambia provide for taxation of gains arising from the transfer of shares of a company only in the state of residence of the transferor.
Over the last few years, India has undertaken a concerted effort to revise its tax treaties and has successfully revised its treaties with Indonesia, Thailand, Mauritius and most recently Korea, to provide for source based taxation of capital gains arising from the transfer of shares of a company. The revision of the treaty with Mauritius (one of India’s largest sources of foreign investment) showed the determination of the Indian government to move towards a source based taxation of capital gains regime. The Indian Government is reportedly also in the process of amending its treaty with Singapore along similar lines. The New DTAA with Cyprus marks yet another milestone in this process.
For the time being, residence based taxation of gains arising from the transfer of investments in instruments other than shares e.g., debentures continues. Under India’s tax treaties, with the exception of gains arising from the transfer of (i) immoveable property, (ii) movable property forming part of a permanent establishment and, (iii) ships and aircraft, gains arising from the transfer of any other property are usually taxable only in the state of residence of the transferor. India’s tax treaties with China, USA, UK, Canada and Australia are some notable exceptions, with gains from any transfer of other property being taxable in both the state of source and the state of residence. Conversely, India’s tax treaties with Fiji, Greece and Egypt, provide for taxation of gains from the transfer any other property only in the country of source. The recently amended tax treaties with Mauritius, Korea and Thailand continue to provide for residence based taxation of gains arising from the transfer of “other property”.
Further, in the absence of an enabling treaty provision along the lines of that in the tax treaty with South Africa (Article 13(5) of the India-South Africa tax treaty provides that “Gains derived by a resident of a Contracting State from the sale, exchange or other disposition, directly or indirectly, of shares or similar rights in a company, other than those mentioned in paragraph 4, which is a resident of the other Contracting State, may be taxed in that other State.” ) gains arising from the indirect transfer of Indian shares should continue to be taxable only in the state of residence of the transferor (Article 13(6) of the New DTAA provides that “Gains from the alienation of any property other than that referred to in paragraphs 1, 2, 3, 4 and 5, shall be taxable only in the Contracting State of which the alienator is a resident). Based on the ruling of the Andhra Pradesh HC in Sanofi Pasteur Holding SA vs. Dept. of Revenue [2013] 30 taxmann.com 222 (AP) gains arising from the transfer of shares of a Cypriot company whose value is derived substantially from shares of an Indian company should fall within the scope of Article 13(6) and therefore be taxable only in Cyprus.). However, other view is also possible in this regard.
2. Cyprus as a tax efficient jurisdiction for investing into India
While Mauritius negotiated a better interest withholding rate (7.5%) than the New DTAA currently contains (10%), and, unlike the India-Mauritius tax treaty, the New DTAA does not provide for a transition period [Under the recently notified Protocol amending the India-Mauritius Tax Treaty (set to come into effect from April 1, 2017), gains from the sale of investments made after April 1, 2017 but before March 31, 2019 are subject to taxation in the source country at only 50% of the applicable domestic tax rate. Gains from the sale of investments made prior to March 31, 2017 remain taxable only in Mauritius, but gains from investments made after March 31, 2019 will be taxable in Mauritius and India.] of taxation at reduced rates, the continuation of residence based taxation for gains arising on transfer of instruments other than shares, and Cyprus’ membership of the European Union should serve to return some of the country’s lustre as an efficient jurisdiction for investment into India. De-notification of Cyprus as an NJA may even encourage fresh investments through Cyprus prior to April 1, 2017.
3. Limitation of Benefits Clause
Interestingly, the New DTAA does not contain a Limitation of Benefits clause (“LOB”). This is contrary to the trend that has arisen in recent years, with India amending / revising many of its tax treaties to include an LOB clause. India has incorporated variations of a LOB clause in its tax treaties with the USA (1990), Singapore (1994 / 2005), Namibia (1999), Armenia (2004), UAE (2007), Iceland (2008), Kuwait (2008), Syria (2009), Luxembourg (2010), Myanmar (2010), Tajikistan (2010), Finland (2011), Mexico (2011), Mozambique (2011), Georgia (2012), Lithuania (2012), Norway (2012), Tanzania (2012), Taiwan (2012), Uzbekistan (2012), Ethiopia (2013), Jordan (2013), Malaysia (2013), Nepal (2013), Romania (2013), UK (2013), Albania (2014), Bhutan (2014), Columbia (2014), Fiji (2014), Latvia (2014), Sri Lanka (2014), Uruguay (2014), Macedonia (2015), Malta (2015), Thailand (2015), Poland (2015), Indonesia (2016), Korea (2016) and Mauritius (2016). In the times to come, it will be exciting to see the interplay between the General Anti-Avoidance Rules (“GAAR”) which are slated to come into effect from April 1, 2017 and the re-negotiated tax treaties (especially the LOB clauses) and the impact on structures and investments. Notably, the Shome Committee report had recommended that where anti-avoidance rules are provided for in a treaty, the GAAR provisions should not apply to override the provisions of the treaty. Interestingly, the LOB clause in the amended Mauritius tax treaty requires a company desirous of claiming benefits to either (i) be listed on a stock exchange in Mauritius or (ii) incur expenditure on operations in its state of residence to a tune of Rs. 2.7 million in the 12 months immediately preceding the date on which the gains arise. This is similar to the language of the LOB clause in the Singapore tax treaty. However, the Singapore LOB clause will cease to be in effect on April 1, 2017, unless the Singapore treaty is amended prior to that date.
E) Concluding Remarks
The New Cyprus DTAA is similar to the recently amended India-Mauritius DTAA in terms of inclusion of Service PE and source taxation of capital gains, as well as grandfathering relief. However, as compared to the amended India-Mauritius DTAA, there is no transitory concessional relief available (subject to LOB) in respect of gains made on shares acquired post 1st April 2017 but transferred before 31st March 2019.
Some other provisions on PE, FTS, EOI are also consistent with the recent trends in Indian DTAAs. Interestingly, the New DTAA does not contain an LOB provision, contrary to the trend in Indian DTAAs being signed/amended lately.
After Mauritius and Cyprus, renegotiation of the India-Singapore DTAA and the India-Netherlands DTAA is expected to be completed.
Taxpayers will need to evaluate the impact of the New DTAA based on the facts of their specific cases. One may also need to watch how the New DTAA will get impacted by the Multilateral Instrument released by the OECD recently.
The above article provides only an overview of the salient features of the New India-Cyprus DTAA. The reader is advised to go through the detailed provisions of the Treaty minutely.
