Section 94A of Income Tax Act: Tax Haven Transactions Under Scrutiny

The Indian taxation system is complex, especially when it comes to international transactions. To prevent tax evasion & ensure transparency in dealings with foreign jurisdictions, the government has introduced several provisions under the Income Tax Act, 1961. One such powerful anti-avoidance measure is Section 94A of the Income Tax Act. This section deals with special measures in respect of transactions with persons located in a notified jurisdictional area.

Simply put, Section 94A empowers the Indian government to take strict action against countries or territories considered non-cooperative in sharing tax information. It lays down how income, expenditure, and tax deductions should be treated if someone transacts with such jurisdictions. In this blog, we’ll break down what Section 94A is, why it matters, and how it impacts taxpayers and businesses.

What is Section 94A of Income Tax Act?

Section 94A of the Income Tax Act was introduced to tackle tax avoidance through dealings with tax havens. It allows the Indian government to notify a country or jurisdiction as a non-cooperative area if it does not effectively share tax-related information.

Once a jurisdiction is notified, any transaction with entities or persons located there is subjected to stringent reporting & taxation rules. The objective is to ensure that taxpayers cannot hide income or avoid taxes by routing transactions through these regions.

For example, if an Indian resident enters into business transactions with an entity in a country notified under Section 94A, the Indian tax authorities can impose higher compliance & withholding obligations."

Special Measures under Section 94A

The law provides special measures in respect of transactions with persons located in notified jurisdictional area. Some of the key measures include:

1. All parties treated as Associated Enterprises (AEs)
   • Even if there is no shareholding or ownership link, any person in India who transacts with an entity in a notified jurisdiction is deemed an Associated Enterprise (AE).
   • This means Transfer Pricing provisions automatically apply, and such transactions must be at Arm’s Length Price (ALP).
2. Denial of Deductions
   • No tax deduction will be allowed for payments made to a financial institution located in such jurisdictions unless the taxpayer obtains authorised information about the recipient.
3. Increased Withholding Tax
   • Payments made to entities in notified jurisdictions attract higher TDS (Tax Deducted at Source). For instance, TDS is deducted at a rate of 30%, which is significantly higher than usual rates.
   • For certain cases, TDS is deducted at a rate of 10% on interest income.
4. Disclosure Requirements
   • Taxpayers are required to provide detailed documentation & evidence when claiming deductions on transactions with these entities.

In short, Section 94A makes it extremely unattractive for Indian taxpayers to route money through tax havens.

Also Read: Special Provisions for Trade, Professional and Similar Associations

Why Was Section 94A Introduced?

Globalization has made cross-border transactions common, but it also opened doors for tax evasion through shell companies and tax havens. Several non-cooperative jurisdictions provide no information to Indian authorities, making it easy for people to park unaccounted money abroad.

Section 94A was introduced to:

• Deter taxpayers from using such jurisdictions.
• Bring transparency in international transactions.
• Ensure fair taxation by imposing higher TDS and stricter compliance.
• Encourage foreign governments to sign tax treaties & share information with India.

Example of Section 94A in Action

Imagine an Indian company pays consultancy fees to a firm located in a notified jurisdictional area. Normally, it may deduct expenses and apply lower TDS. But under Section 94A of the Income Tax Act, the rules change:

• The consultancy firm is treated as an Associated Enterprise.
• The Indian company must follow Transfer Pricing norms.
• A higher TDS rate (30%) applies.
• The deduction for consultancy fees is denied unless full details of the foreign party are disclosed.

This makes transactions with tax havens less profitable & less attractive.

Countries and Jurisdictions Notified under Section 94A

The Central Government has the power to notify countries under Section 94A. In the past, Cyprus was notified as a non-cooperative jurisdiction because it did not share adequate information with Indian authorities.

• Once notified, all transactions with Cyprus attracted the provisions of Section 94A.
• However, after signing an agreement and improving information exchange, Cyprus was removed from the list in 2016.

This shows how Section 94A is not permanent but can be applied & withdrawn depending on cooperation levels of foreign jurisdictions.

Also Read: A Detailed Guide on Bilateral Relief from Double Taxation

Key Implications for Taxpayers

If you are an Indian taxpayer dealing with foreign entities, here’s how Section 94A can affect you:

1. Higher TDS Burden
   • Payments such as royalties, fees, & interest will attract 30% TDS instead of normal rates.
2. No Deductions without Proof
   • You cannot claim deductions for payments to entities in notified jurisdictions unless you provide complete details of the recipient, including beneficial ownership.
3. Transfer Pricing Scrutiny
   • Even unrelated entities in such jurisdictions are treated as AEs, making it mandatory to maintain transfer pricing documentation.
4. Compliance Hassles
   • Businesses must maintain detailed records & face higher compliance checks from the Income Tax Department.

Section 94A vs. GAAR

Some people confuse Section 94A with the General Anti-Avoidance Rules (GAAR). While both aim to curb tax evasion, they work differently:

• GAAR applies broadly to any arrangement designed to avoid taxes.
• Section 94A is specific to dealings with persons in notified jurisdictions.

In short, Section 94A is a targeted measure, while GAAR is more comprehensive.

Practical Steps for Businesses

Businesses engaged in cross-border dealings should take these steps to avoid issues under Section 94A:

• Avoid transactions with entities in notified jurisdictions, unless absolutely necessary.
• Maintain documentation of all foreign transactions, including invoices, ownership details, and tax residency certificates.
• Consult a tax advisor before entering into international contracts.
• Ensure timely deduction & deposit of TDS at higher rates where applicable."

Importance of Section 94A in Curbing Black Money

Section 94A is one of the critical provisions that aligns with India’s larger effort to curb black money and tax evasion. By making it difficult and costly to deal with tax havens, it encourages taxpayers to transact transparently.

It also sends a strong message to foreign governments: cooperate in sharing tax information or face consequences.

Also Read: Taxation Rules for Non-Residents on Dividends, Interest, Royalties & Fees

Conclusion

To sum it up, Section 94A of the Income Tax Act acts as a safeguard against tax avoidance through non-cooperative jurisdictions. It enforces special measures in respect of transactions with persons located in notified jurisdictional area, mandates higher TDS, and places the burden of disclosure on taxpayers.

For businesses and individuals, the key takeaway is clear—be transparent & compliant when dealing internationally. Any shortcuts through tax havens can backfire, leading to penalties, disallowances, and reputational damage.

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