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With Cyprus treaty cleared, govt faces conundrum on tax refund
August, 26th 2016

If Cyprus is removed from blacklist, tax department has to set up mechanism to return excess tax deducted since 2013

With the cabinet clearing the India-Cyprus treaty, paving the way for the removal of the Mediterranean island nation from an Indian blacklist, the tax department is faced with the difficult task of setting up a mechanism to refund excess tax deducted since 2013.

According to the agreement between India and Cyprus, a revised double taxation avoidance agreement will be followed, removing Cyprus from the list of notified jurisdictions with effect from November 2013, the date on which it was blacklisted, though the press release issued by the Indian finance ministry on Wednesday after the cabinet nod was silent on retrospectively rescinding the notification.

Once the notification is rescinded with retrospective effect, the tax department will have to refund the excess tax deducted by Indian companies while making payments to Cypriot companies.

The department is working to create a mechanism to deal with the implications of the notification being withdrawn retrospectively, said a senior official, who did not wish to be identified.

“The procedure has to be seen. Three years have passed since it was notified. It will now have to be done from 2013. What if something has happened in between? That has to be worked out,” said the official.

The existing treaty provided for capital gains tax exemption and a low withholding tax rate of 10% on interest payments made to entities based in Cyprus. However, the Indian government’s decision to declare Cyprus a notified jurisdiction made it mandatory for Indian taxpayers to deduct a withholding tax of 30% for any payments made to a Cyprus company.

“In the event that the notification classifying Cyprus as notified jurisdiction is taken off retrospectively, this will create an opportunity for deductors to apply for refund by revision of TDS (tax deducted at source) returns. However, for the said purposes, an adequate mechanism for refund will have to be set up,” said Amit Singhania, a partner at law firm Shardul Amarchand Mangaldas and Co.

To be sure, analysts said there may not be many such transactions routed from Cyprus as companies were adopting a wait-and-watch approach.

Rahul Mitra, head of the transfer pricing practice at KPMG India, said that after Cyprus was declared a notified jurisdiction, there may not have been many transactions.

“One needs to see how many such transactions are there. People were waiting for things to get normalized,” he said.

Other than the higher TDS rate, the 2013 notification also made it difficult for taxpayers to claim deductions on transactions with Cyprus-based entities. It also had enhanced reporting requirements for taxpayers.

No deduction in respect of any other expenditure or allowance arising from a transaction with a person in Cyprus, or a payment made to a financial institution, is allowed unless the assessee provides the required documents.

If an assessee enters into a transaction with an entity in Cyprus, it is treated as an associate enterprise and the deal as an international transaction, attracting transfer pricing regulations.

Transfer pricing is the practice of arm’s-length pricing for transactions between group companies based in different countries to ensure that a fair price—one that would have been charged to an unrelated party—is levied.

Cyprus was one of the key destinations through which companies based in Europe and the US invested in India, benefiting from the treaty between both countries. In 2015-16, Cyprus ranked eighth in terms of foreign direct investment into India at $3.3 billion.

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