Volume 6, Issue 17

19 November 2013

Tax Alert

CBDT Designates Cyprus as a Notified Jurisdictional Area

The Government of India (GOI) introduced Section 94A into the Indian Income Tax Act, 1961 (ITA) in 2011 to discourage transactions between taxpayers and persons located in countries or jurisdictions that do not engage in an adequate information exchange with India. 

Recently, the Central Board of Direct Taxes (CBDT), for the first time, invoked the provisions of Section 94A of ITA (vide a Press Release dated 1 November 2013) by notifying Cyprus as a notified jurisdictional area (NJA).

The Press Release

  • India had entered into a comprehensive Double Taxation Avoidance Agreement (Treaty) with Cyprus in 1994.  The said Treaty has many beneficial provisions that made investors favour Cyprus for channelling investments into India, particularly in debt instruments. 
  • As per Article 28 of the Treaty, both the countries were bound to share/exchange any such information that may be necessary for carrying out the provisions of the Treaty or of domestic laws of these countries, in particular for the prevention of fraud or evasion of taxes.  However, the CBDT has observed that the Cypriot authorities have not been providing the information requested for by the Indian tax authorities as provided for under the Treaty.
  • This led to the CBDT notifying Cyprus as an NJA under Section 94A of the ITA.


According to Section 94A (and as reiterated in the Press Release), the following key implications would arise for transactions with Cypriot entities:

  • Automatic application of Transfer Pricing regulations – If an Indian taxpayer enters into a transaction with a person in Cyprus, then all the parties to the transaction shall be treated as associated enterprises and the transaction shall be treated as an international transaction resulting in the application of Indian Transfer Pricing Regulations (ITPR), including maintenance of documentation.
  • Providing authorisation to seek information – No deduction in respect of any payment made to any financial institution in Cyprus shall be allowed unless the taxpayer furnishes an authorisation allowing seeking relevant information from the said financial institution.
  • Maintenance of prescribed information – No deduction in respect of any other expenditure or allowance arising from a transaction with a person located in Cyprus shall be allowed unless the taxpayer maintains and furnishes the prescribed information.  This information is likely to be in addition to the transfer pricing documentation required to be maintained and as discussed above. 

  • Explanation on source of money – If any sum is received from a person located in Cyprus, then the onus is on the recipient Indian taxpayer to satisfactorily explain the source of such money (in the hands of the Cypriot remitter).  Failure to do so would result in such amount being deemed to be the income of the recipient taxpayer.
  • Higher tax withholding – Any payment made to a person located in Cyprus shall be liable for withholding tax at 30% or a rate prescribed in the ITA, whichever is higher. 

Press Release from the Cypriot Government

In response to the Press Release by the CBDT, the Cypriot Ministry of Finance issued a Press Release on 7 November 2013.  In this Press Release, it has attempted to clarify that the Treaty between the two countries has not been terminated.  Further, the Cypriot Government has assured that it will make every effort to help resolve the tense situation and finalise the long pending review of the Treaty.

SKP’s Comments

  • Since Cyprus is the first jurisdiction to be notified as an NJA, there is a lack of clarity on how these provisions will be administered and the level of documentation that will have to be maintained by Indian taxpayers. The uncertainty that this notification will create will impact the transactions between Indian and Cypriot entities until further clarity emerges. 
  • Indian taxpayers would need to be cautious and comply with various formalities as discussed above while transacting with Cypriot entities. Thus, it is critical for Indian taxpayers to evaluate the proposed transactions with their Indian tax consultants to understand the implications of such transactions.
  • Indian taxpayers will need to ensure that transactions with Cypriot entities meet the arm’s length price and proper documentation is maintained. This would result in an additional compliance burden for Indian taxpayers.
  • Indian taxpayers will also need to comply with the formality of giving an authorisation to the Indian tax authorities. It is relevant to note that the Indian taxpayer may need to obtain a counter authorisation from the Cypriot entity since eventually, the Cypriot entity will be questioned by the Indian tax authorities.
  • The obligation of explaining the source of funds in the hands of the Cypriot entity is onerous and it is unclear how this obligation can be satisfactorily discharged by the recipient taxpayer.
  • The risk of Indian tax authorities disputing the source of income and thus adding the same to the income of the Indian taxpayers is real on account of past actions of tax authorities on similar transactions in the context of subscription to share capital.
  • The major impact of this development seems to be on account of the increased rate of withholding tax of 30%. This is likely to impact the payment of interest, royalties, fees for technical services, etc. which generally provide for lower tax withholding under the Treaty. This will further impact the cash flows of Cypriot entities. While it is possible for Cypriot entities to file their tax returns in India and claim refund of the excess taxes withheld, this will not be a desired option since obtaining tax refunds in India can be time consuming. Further, one wonders whether the tax authorities will expect such tax withholding on payments that are exempt from tax in India (e.g. dividend or capital gains), which would be highly unfair. 
  • It is interesting to note that according to Section 94A, the increased rate of withholding tax applies to any sum or income or amount on which tax is deductible under Chapter XVII-B whereas according to the Press Release, any payment made to a person located in Cyprus shall be liable for withholding tax at the increased rate. Given the risks for Indian taxpayers, one would need to carefully evaluate the interplay between the section and the Press Release to adopt a suitable tax position.