The Union cabinet on Wednesday approved the revised double taxation avoidance agreement (DTAA) with Cyprus which will help close gaps and enable Indian authorities to tax capital gains in the country for investments originating in the Mediterranean island nation.

The move follows the recent amendment of DTAA with Mauritius. As in case of Mauritius, the treaty with Cyprus had provided for residence-based taxation of capital gains.

"With the revision of the treaty now approved by the cabinet, capital gains will be taxed in India for entities resident in Cyprus, subject to double tax relief. In other words, India will have the right to tax capital gains arising in India," according to a government statement.

Since assuming power in May 2014, the NDA government has taken several steps to clamp down on tax evasion, round-tripping of funds and had reworked the treaty with Mauritius, which had been pending for nearly two decades. The statement said the provisions in the earlier treaty for residence-based taxation were leading to distortion of financial and real investment flows by artificial diversion of various investments from their actual countries of origin, for avoiding tax. "As in the case of Mauritius, this amendment will deter such activities. Negotiations with Singapore are also under way for similar changes," the statement said. Talks are on to revise the India-Singapore tax treaty.

India had put Cyprus on a blacklist for failing to share information on tax evasion. With the revision of the treaty, India is expected to remove Cyprus from that list, which will provide relief to investors from that country who had seen increase in compliance costs, tax consultants said.

"This is the best possible solution for those who have made investments through Cyprus as well as balancing the need to have similar DTAA provisions with other countries," said S P Singh, senior director at consultancy firm Deloitte Haskins and Sells.

Tax authorities now need to revise a similar treaty with Netherlands to ensure that all gaps are closed and companies pay tax at least in one jurisdiction. In the case of the Netherlands, if an asset is sold to a foreign buyer, the tax treaty allows for capital gains tax exemption.

Being a European country, several entities prefer to route funds through the Netherlands given the DTAA and the legal and tax framework, tax consultants say.

The proposed DTAA with Cyprus will align the applicable provisions with the policy followed by India and the revised international standards.

It will also prevent the abuse of beneficial provisions of the DTAA that can distort financial and real investment flows and create challenges for tax collection.

The proposed DTAA provides for source based taxation of capital gains on transfer of shares, instead of residence based taxation as provided in the existing DTAA.

Indian tax authorities will be able to levy capital gains tax on sale of shares by firms based in Cyprus after April 1, 2017, as there is a grand fathering provision in the agreement.