The data trove comprises documents from six offshore service providers in Cyprus. Besides information on Indian investors who became Cypriot nationals under the country’s Golden Passport scheme, it also has documents relating to entities set up by leading business houses to take advantage of the liberal tax regime in the island country in the Eastern Mediterranean.

What does the India investigation show?

The investigation attempts to lift the veil of secrecy for government and regulatory agencies. The documents reveal how entities with offshore residency were controlled from India, and instructions for financial transactions in these entities are given by individuals in India.

Can Indian companies set up offshore entities in Cyprus?

It is not illegal to set up an offshore company in Cyprus. India has double-taxation avoidance agreements (DTAAs) with several countries, including Cyprus, which offer low tax rates. Companies use their tax residency certificates in such countries to enjoy tax benefits that are available legally. These jurisdictions are generally characterised by lax regulatory oversight and airtight secrecy laws.

What is India’s tax treaty with Cyprus?

India’s tax arrangement with Cyprus has had three distinct phases over the last two decades.

PRIOR TO 2013: India and Cyprus had a tax treaty offering investors exemption from capital gains tax at the time of exit. Incidentally, Cyprus too didn’t tax capital gains. Thus, investors paid zero tax on gains made from their equity investment in India. Cyprus also had a low 4.5 per cent withholding tax, and was hence a favoured destination for individuals/ businesses to set up entities and invest in India.

Withholding tax is an effective way to ensure tax compliance by non-residents who may be subject to different tax regulations than residents. It is applicable in case of payments done to non-resident individuals. It is the payee’s responsibility to deduct tax when depositing the payment in the account of the NRI.

The payee deposits the deducted withholding tax with the government, and the tax rate is decided as prescribed in the Income-tax Act, 1961, or Double Taxation Avoidance (DTA) Agreement, whichever is lower.

A decade of offshore investigations: HSBC Swiss Leaks (2015), Panama Papers (2016), Paradise Papers (2017), Pandora Papers (2021),  Cyprus Confidential

SINCE 2013: On November 1, 2013, India included Cyprus in a list of countries that refrained from sharing or exchanging valuable tax-related information. In technical terms, it was categorised as a Notified Jurisdictional Area (NJA) under Section 94A of the Income-tax Act.

NJA countries face consequences such as a higher withholding tax rate of 30 per cent for payments received by entities registered there. Further, transactions with entities in NJA are subjected to Indian transfer pricing regulations.

SINCE 2016: A revised DTAA was signed with Cyprus on December 14, 2016. India rescinded Cyprus as NJA, and subsequently clarified that the rescission was with retrospective effect from November 1, 2013.

The text of the new DTAA provides for source-based taxation of capital gains arising from alienation of shares. Alienation refers to voluntary sale/ transfer or relinquishment of the asset by the owner.

Further, a grandfathering clause has been provided for investments made prior to April 1, 2017. This allowed for capital gains to be taxed in the country of which the taxpayer is resident. These changes are consistent with those brought about by the renegotiated India-Mauritius tax treaty, i.e., source-based taxation of capital gains and a grandfathering clause.

What tax benefits does Cyprus offer?

Offshore companies and offshore branches managed and controlled from Cyprus are taxed at 4.25 per cent, and offshore branches managed and controlled from abroad and offshore partnerships are totally exempt from tax.

There is no withholding tax on dividends, and the beneficial owners of offshore entities or branches are not liable to an additional tax on dividends or profits over the amount paid by the respective legal entities.

No capital gains tax is payable on the sale or transfer of shares in an offshore entity, and no estate duty is payable on the inheritance of shares in an offshore company.

There is no import duty on the purchase of cars, office or household equipment for foreign employees. It also assures anonymity of the beneficial owners of offshore entities.

How does the India-Cyprus DTAA work?

It allows Cyprus — which has a low tax regime — to be used as a jurisdiction for tax planning. Many foreign investors set up their investment firms in Cyprus to invest in India to benefit from the DTAA.

Cyprus is now an alternative to Mauritius for setting up an offshore entity for investment in India. As dividends paid out from India will be subject to withholding tax, no taxation will arise in Cyprus as this will be adjusted or credited against the 4.25 per cent tax in Cyprus.

What are Offshore Trusts?

As per Cyprus International Trust Law, offshore trusts are trusts whose property and income are outside Cyprus, and even the settlor and beneficiaries are not permanent residents of Cyprus.

If the trustee is a Cypriot, the offshore trust is exempt from estate duty, and does not have to pay any tax on the income and gains. The trust need not be registered with any government or other authority, and confidentiality is enshrined in the new law.

In other words, the trust allows businesspersons to avoid tax that would have otherwise been paid by the settlor had she/ he remitted the income arising from overseas operations, to the country of residence.

Offshore branches of companies not having management and control of their business in Cyprus are granted complete exemption from income tax in Cyprus in respect of their profits derived from sources outside Cyprus, whereas if the management and control is in Cyprus they are subject to a tax of 4.25 per cent. For offshore branches, there is no withholding tax on repatriation of profits.

Can the Indian taxman still call to question entities in countries with which India has a DTAA?

A DTAA does not stop the I-T department from denying tax treaty benefits if it is established that a company has been inserted as the owner of shares in India at the time of disposal of the shares to a third party, solely with a view to avoid tax.

In such a situation, the taxman is entitled to question the entire transaction.