India, today took another major step in the fight against tax evasion, "round tripping" and "base erosion/profit shifting". The Union Cabinet chaired by the Prime Minister Shri Narendra Modi has given its approval for signing of an Agreement and the Protocol between the India and Cyprus for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income.

This step follows the recent amendment of the Double Taxation Avoidance Agreement with Mauritius. As in the 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. 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 true countries of origin, for the sake of avoiding tax. As in the case of Mauritius, this amendment will deter such activities. Negotiations with Singapore are also underway for similar changes.

​​ A revised Agreement is proposed to be signed between the Republic of India and the Republic of Cyprus for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income (“DTAA”) and Protocol to this Agreement, which will replace the existing DTAA signed by both countries on 13th June, 1994.

Detailed provisions of the proposed DTAA are summarized as below:

The proposed DTAA will align the applicable provisions with the consistent 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 in respect of 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. However, the Protocol to the Agreement has a grandfathering provision provide that the provisions of the proposed DTAA in respect of capital gains will not be applicable on shares acquired at any time prior to 1st April, 2017. The proposed DTAA also enables source based taxation of capital gains from transfer of shares of any company the property of which consists directly or indirectly principally of immovable property situated in a Contracting State.

The proposed DTAA also includes a provision for Assistance in Collection of Taxes. It also provides for a revised provision for Exchange of Information that would enable the use of information exchanged for other purposes, with the permission of the Competent Authority of the country providing the information. The proposed DTAA also expands the scope of the Permanent Establishments (PE) that enables source based taxation of business income. The provision on income from Shipping and Aircrafts has been aligned with International standards in the proposed DTAA.

Other provisions, including the provisions on Royalty, Fees for Technical Services, Artists and Sportspersons, Other Income, Mutual Agreement Procedure, Exchange of Information and definitions of relevant terms like Resident, Business Profits, Associated Enterprises, Dividend, Interest, have also been aligned with India’s consistent policy and International Standards accepted by India.

The Protocol to the Agreement provides clarification about taxation of dividends in India that are subjected to dividend distribution tax, and clarifies that provisions on Assistance in Collection of Taxes shall not be construed to impose any obligation that is at variance with the laws, practices or public policy of a Contracting State. It also clarifies that Article 24 on Non Discrimination will not be construed as preventing a Contracting State from charging the profits of a permanent establishment at a rate which is higher than that imposed on a domestic company.

All the consulted Ministries / Departments have conveyed their concurrence with this proposal. The DTAA will enter into force on the date of the notification by the two countries (date of later notification), and shall have effect in India from the first day of the next fiscal year. The existing DTAA shall be terminated on the day the proposed DTAA comes into effect.

Source-based taxation of capital gains enables the source jurisdiction to tax gains, with grandfathering and expanded PE rules. The revised treaty shifts taxation of capital gains on share transfers to source-based taxation, with a Protocol grandfathering clause excluding shares acquired before a specified cutoff; it also subjects gains from shares of companies whose principal assets are immovable property in a Contracting State to source taxation.