The recent Cyprus Confidential investigation has made public a web of financial activities involving offshore entities in Cyprus, pointing a finger at affluent individuals in India. This international offshore investigation, led by the International Consortium of Investigative Journalists (ICIJ), unveiled the utilization of Cyprus as a tax haven by global elites.
Understanding Tax Havens and Offshore Companies
A tax haven is generally an offshore nation that provides minimal or non-existent tax liability in a politically and economically stable environment. Businesses and individuals from abroad primarily establish offshore companies to leverage the favourable tax legislations or economic climate in a foreign country.
The Allure of Cyprus As a Tax Haven
Cyprus offers attractive taxation benefits for offshore companies and their branches managed and controlled from Cyprus which are taxed at 4.25%. Moreover, such offshore entities enjoy zero withholding tax on dividends, no capital gains tax on sale or transfer of shares, and exemption from estate duty for inheritance of shares. Furthermore, Cyprus provides import duty exemptions on purchase of certain equipment for foreign employees and ensures anonymity and confidentiality of the beneficial owners of offshore entities.
The Backstory of India’s Tax Treaty with Cyprus
Prior to 2013, India’s tax treaty with Cyprus exempted investors from capital gains tax upon exit, with zero taxation on capital gains making Cyprus a preferred destination for equity investments from India. In addition to the low 4.5% withholding tax, payees were responsible for deducting tax and depositing it with the government as per the Income-tax Act, 1961, or the Double Taxation Avoidance Agreement (DTAA), whichever was lower.
A DTAA, a treaty signed between two or more countries, aims to prevent taxpayers from being taxed twice for the same income. It applies when a taxpayer resides in one country and generates income in another.
Since 2013, under Section 94A of the Income-tax Act, Cyprus was labelled as a Notified Jurisdictional Area (NJA) which led to higher withholding tax rate for payments to entities in Cyprus. Moreover, transactions with entities in the NJA became subject to Indian transfer pricing regulations.
Changes Since 2016 and Their Impact
In 2016, India and Cyprus signed a revised DTAA, which clarified the rescission of the NJA status from 2013. The new DTAA introduced source-based taxation of capital gains from the alienation of shares, protecting investments made before April 1, 2017, by taxing capital gains in the country of the taxpayer’s residence.
This reflects the dynamism in India’s tax arrangements with Cyprus aligning with the global efforts to deter tax evasion and promote fair revenue distribution. Also, it demonstrates the influence of heightened scrutiny on tax matters worldwide on India’s tax treaties.
The Legality of Indian Companies in Cyprus
Setting up an offshore company in Cyprus is not illegal for Indian businesses. In fact, India has DTAAs with various countries, including Cyprus, offering low tax rates. Companies utilize these tax residency certificates in such countries to avail tax benefits legally, despite the lax regulatory oversight and stringent secrecy laws of these jurisdictions.
Investors and Their Use of Cyprus as a Tax Haven
Money laundering in Cyprus is facilitated through funds channelled via numerous shell companies. Cyprus’ banking secrecy and reluctance to automatically share financial account information with other countries aids investors in hiding their assets and income from authorities and creditors. Additionally, they can manipulate politics and policymaking through strategic donations and lobbying.
Strategies for Curbing Tax Evasion
To counter the use of Cyprus as a tax haven, India must strengthen enforcement and compliance mechanisms, and equip tax authorities with necessary resources and powers. Enhancing the transparency and accountability of offshore entities, and mandating disclosure of their beneficial owners, directors, and financial activities.
India could also enforce withholding taxes and anti-avoidance measures on payments made to Cypriot entities or individuals. Implementing robust laws to tackle abuse of tax treaties and promoting ethical taxpayer behaviour are also effective measures.
Unveiling Cyprus
Cyprus is an island nation in the Eastern Mediterranean Sea and the third-largest and third-most populous island in the Mediterranean. Internationally recognised as a member of the European Union since 2004, its capital is Nicosia. Cyprus has a delightful Mediterranean climate, attracting numerous tourists with its hot summers and mild winters.