India in Talks with Mauritius and Cyprus to Prevent Tax Base Erosion

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By Patricia Ieong

Jan. 10 – India is currently revisiting its double tax avoidance agreements (DTAAs) with both Mauritius and Cyprus as it takes measures to protect its tax base.  The two tax havens are India’s largest and seventh-largest sources of FDI inflows, respectively, together comprising almost 45 percent of India’s FDI in 2013 (around US$10 billion in the financial year ended March 2013).

One of the main reasons for the significant inflows from these small island nations is the favorable tax DTAAs they have with India.  Only three countries – Mauritius, Cyprus and Singapore – have DTAAs where India is not granted the right to levy a capital gains tax.  This is significant, as those three countries do not have a capital gains tax, meaning that investors can route their investments through one of the islands into India in a tax-efficient manner. As explained previously on India Briefing, holding companies in these tax havens can be used to repatriate profits from India through share buybacks. To counter this, Singapore’s DTAA contains a limitation of benefit (LoB) clause, which aims to prevent “treaty shopping” by drawing a line between genuine investors and mere holding companies by requiring businesses to meet certain conditions relating to residency and spending before they can avail themselves of the treaty’s benefits.

Unlike Singapore, however, the Mauritius and Cyprus DTAAs do not yet contain a LoB clause. In a bid to move away from its reputation as an offshore tax haven and to establish itself as a global financial center in its own right, Mauritius has recently agreed to include an LoB clause in its DTAA, though the exact details of what form this clause will take have yet to be ironed out. Meanwhile, India is also negotiating revised terms of the India-Cyprus tax treaty after India blacklisted Cyprus as a “non-cooperating” nation under section 94A of its Income-Tax Act in November last year. It is confirmed that Article 26 of the OECD Model Tax Convention will be inserted to govern the bilateral exchange of information in the revised treaty, but Indian finance ministry officials have refused to comment on whether an LoB clause is also sought. The blacklisting notification came after Cyprus failed to furnish information on tax evaders that India claimed it was obliged to provide under the DTAA and triggered a number of penal provisions including a mandatory 30 percent withholding tax on all transactions from India to Cyprus. Last month India gave Cyprus two months to provide the requested information before deciding whether to rescind tax benefits on investments coming through the island nation; the blacklisting notification has been withdrawn in the meantime.

India has further decided to set up an Income Tax Overseas Unit (ITOU) in Cyprus (along with seven other countries: France, Germany, the Netherlands, Japan, UAE, UK and USA) as part of its strategy to stem “black money” flows, and facilitate the obtaining and exchange of information.  Final approval from the Prime Minister’s Office have been obtained and the ITOU should be operational shortly.  India already has ITOUs set up in Singapore and Mauritius.

It remains to be seen what amendments the countries will ultimately agree to incorporate, so it is not yet clear how FDI inflows into India will be impacted.  Most likely, investment structures into India via Mauritius or Cyprus will need to be re-examined or re-worked once the outcomes of the treaty negotiations are made public.

Dezan Shira & Associates is a specialist foreign direct investment practice, providing corporate establishment, business advisory, tax advisory and compliance, accounting, payroll, due diligence and financial review services to multinationals investing in emerging Asia.

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