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India: Renegotiation of tax treaties by India

With a view to examining consequential issues arising out of amendments to the India-Mauritius tax treaty and related issues, a Working Group has been set up.

Rakesh DharawatHari Gangadharan

Last month saw India and Mauritius conclude their long-standing renegotiation of the tax treaty between the two countries. Among the most important changes made is the provision enabling India to tax capital gains on the sale of shares of Indian resident companies. This applies to shares acquired on or after April 1 2017. Certain transition provisions have also been put in place, which provide for a 50% reduction of the Indian tax on gains on investments acquired and transferred between April 1 2017 and March 31 2019.

With a view to examining consequential issues arising out of amendments to the India-Mauritius tax treaty and related issues, a Working Group consisting of Central Board of Direct Taxes (CBDT) officers, together with representatives from the Securities Exchange Board of India, custodians, brokerage firms and fund managers, has been constituted. The Working Group has been asked to submit its report to the CBDT within three months, after examining the relevant issues.

The government has also announced that an in-principle agreement has been reached on certain pending issues in relation to the tax treaty between Cyprus and India. The press release issued by the government states that it has been agreed to provide for source based taxation of capital gains on the transfer of shares. However, as with the India-Mauritius tax treaty, a grandfathering clause would be provided for investments made prior to April 1 2017, in respect of which capital gains would be taxed in the taxpayer's resident country.

Further, the press statement notes that India is considering rescinding the notification of Cyprus as a "notified jurisdictional area" (NJA), with retrospective effect from November 1 2013. This notification was under section 94A of the Income-tax Act, 1961, which provides a toolkit of measures designed to discourage transactions with persons in certain jurisdictions that did not effectively exchange information with India. Several consequences arise from a country being notified as a NJA. For instance, deductibility of payments made to persons in such countries is restricted and subject to several conditions, and tax withholding at a higher rate of 30% is made applicable.

Interestingly, earlier in 2016, the constitutional validity of the notification listing Cyprus as a NJA was challenged before the Madras High Court in the case of T. Rajkumar & others v. Union of India. The petitioners in this case had acquired certain securities from a Cypriot resident. The sale consideration was less than the cost basis and hence, the transferor suffered a capital loss. Since no income arose to the transferor, no taxes were withheld by the resident payers. However, the Indian revenue authorities proceeded to treat the resident payers as an "assesse in default" for their failure to withhold tax at the rate of 30% as required under the Indian income-tax law. The High Court rejected the challenge and upheld the constitutional validity of the notification of Cyprus. This decision is currently pending a final hearing before the Supreme Court pursuant to a special leave petition filed by the petitioners against the High Court order.

Close on the heels of these developments are reports suggesting that India's treaties with other key jurisdictions will also undergo renegotiations. Specifically, these indicate that India's treaties with Singapore and the Netherlands (both of which provide for an exemption from capital gains tax in India on sale of shares in Indian companies) will undergo modifications in the coming days. It is expected that these renegotiations will pave the way for expansion of India's source based taxing rights over capital gains.

Rakesh Dharawat (rakesh.dharawat@dhruvaadvisors.com) and Hari Gangadharan (hariharan.gangadharan@dhruvaadvisors.com)
Dhruva Advisors
Tel: +91 22 6147 1000
Website: www.dhruvaadvisors.com

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