India and Cyprus have recently revised the Double Taxation Avoidance Agreement (DTAA) to be effective from April 01, 2017 and January 01, 2017 in India and Cyprus respectively.
Before 2013, Cyprus was a favoured jurisdiction for investments into India as capital gains from the sale of shares held by Cyprus based investors in Indian companies was not taxable in India. However, due to non-compliance of its information sharing obligations, India declared Cyprus a Notified Jurisdictional Area (NJA). This led to significant uncertainties. While the DTAA had not been rescinded, this development resulted in adverse implications for Cyprus based investors, including, inter alia, higher rate of withholding taxes, application of transfer pricing provisions to transactions with Cyprus based entities even though they are not related, etc. Thus, conducting regular business transactions between entities of both countries became difficult with many transactions getting deferred.
The revised DTAA is the culmination of prolonged negotiations and discussions between both the countries to address this situation. Pursuant to the execution of the revised DTAA, the notification declaring Cyprus as NJA has been rescinded.
Key Revisions To The DTAA
Impact Of The Revised DTAA On Investments Into India
The revised DTAA may have a significant impact on the volume of investments into India through Cyprus. For investors using Cyprus merely to claim the benefits under the erstwhile DTAA, this route may no longer be attractive. However, strategic and financial investors, for whom tax is typically not the sole determinant, may not be unduly worried by the dis-continuance of the tax exemption. Such investors may continue to invest in India, either through Cyprus or otherwise.
Foreign Portfolio Investors (FPIs) investing in India in listed securities, Participatory Notes, etc. may review their investment strategy pursuant to the revised DTAA coming into effect. Investments in listed securities with an over-12 months holding period may not be impacted because capital gains earned from the sale of such investments will continue to be non-taxable whereas investments held for less than 12 months would now be subject to tax in India. Similarly, participatory notes issued by FPIs could become less attractive to investors as the FPIs may pass on their tax burden to them.
Private equity and venture capital investors, who have a limited investment periods and whose predominant objective is to maximise returns, may reallocate their investment portfolio as their returns from Indian securities could be depleted on account of the capital gains tax payable in India. However, India may remain an attractive investment jurisdiction for foreign investors because despite the imposition of capital gains tax, the post tax returns could still be better than the returns from other jurisdictions as India is one of the fastest growing major economies.
Conclusion
The revised DTAA is a welcome move since it clears up uncertainty and provides clarity regarding the tax treatment of capital gains and other income earned by investors in both countries. The increased focus on sharing information and cooperation in tax collection matters is also likely to further transparency and prevent the abuse of the DTAA.