Context:
The Central Board of Direct Taxes (CBDT) has issued new guidelines clarifying the applicability of the Principal Purpose Test (PPT) for claiming tax treaty benefits under India’s Double Taxation Avoidance Agreements (DTAAs).
More In News:
- The Multilateral Instrument (MLI) to Implement Tax Treaty Related Provisions to Prevent Base Erosion and Profit Shifting (BEPS) entered into force for India on 1St October 2019.
- The MLI modifies some of India’s Double Taxation Avoidance Agreements (DTAAs).
- A key provision of the MLI is the Principal Purpose Test (PPT), which seeks to curb revenue leakage by preventing treaty abuse.
- The new guidelines will apply from the next financial year, starting April 1, 2025.
Key Points from the CBDT’s Clarification
- For DTAAs where the PPT is incorporated through bilateral processes (e.g., Iran, Hong Kong, Chile, China), it will apply from the date the DTAA or amending protocol enters into force.
- India has made treaty-specific bilateral commitments with Cyprus, Mauritius, and Singapore, in the form of grandfathering provisions.
- The CBDT clarified that these grandfathering provisions will remain outside the scope of the PPT and will be governed by the specific provisions of each respective DTAA.
What is the Principal Purpose Test (PPT)?
- The Principal Purpose Test (PPT) is an anti-abuse provision included in India’s tax treaties to prevent misuse of tax benefits.
- Under this test, tax treaty benefits may be denied if the main reason for a transaction is to gain those benefits, without any genuine business purpose.
- This rule is part of India’s commitment to the Organisation for Economic Co-operation and Development (OECD) guidelines on Base Erosion and Profit Shifting (BEPS), which are designed to address and mitigate tax avoidance practices by multinational corporation.
- The guidelines encourage tax authorities to refer to BEPS Action Plan 6 and the U.N. Model Tax Convention (with India’s reservations) for additional guidance when applying the PPT provision.
Why is the tax rule important?
- The clarification ensures that investments made before April 1, 2017, under older agreements won’t face retrospective scrutiny.
- This is crucial for foreign portfolio investors (FPIs) using Mauritius as a base, who were concerned about justifying past commercial decisions.
- The changes apply only to future investments, reassuring businesses and reducing the risk of disputes.
- This move strengthens investor confidence and promotes fair tax practices.