The Multilateral Instrument (MLI) to prevent Base Erosion & Profit Shifting (BEPS) entered into force for India on October 1, 2019, and the same modifies some of India’s Double Taxation Avoidance Agreements (DTAAs or Tax treaties). In accordance with Article 7 of the MLI– Prevention of Treaty Abuse, which embodies a new test for limiting the ability to claim Tax treaty benefits, i.e. the Principle Purpose Test(‘PPT’), benefits under the Tax treaty would not be granted if obtaining that benefit was one of the principal purposes of any arrangement or transaction taking into cognizance the underlying facts and circumstances.
The Central Board of Direct Taxes issued a Circular on January 24, 2025, providing detailed guidance on the application of the PPT under Tax treaties to bring about consistency in application of the PPT by the taxpayers and tax authorities.
The aspect of retroactive applicability of the PPT to deny even such grandfathering benefit was raising serious concerns amongst Non-resident investors who have adopted various structures/routes for Indian investments.
The circular reiterated that the PPT intends to ensure that Tax treaties apply in accordance with their underlying objects and purpose, i.e. to provide benefits for bona-fide exchange of goods and services, and movement of capital and people.
The circular outlines that the determination of the principle purpose of the transaction should be based on an objective assessment of the relevant facts and circumstances. Further, application of the PPT provision is expected to be a context-specific fact-based exercise, to be carried out on a case-by-case basis whilst providing the following broad guidance:
- Clarification that the PPT is intended to be applied prospectively which would ensure parity and uniformity
- The grandfathering provisions subsumed in the various Indian Tax treaties would not be affected by PPT and would remain outside its purview
- Additional/supplementary sources of guidance for Tax authorities in the form of Commentary to Articles 1 and 29 of the UN Model Tax Convention (updated in 2021), subject to India’s reservations, while deciding on the invocation and application of the PPT provision.
Further, CBDT rolled out a Press release[1] to provide further clarifications with respect to applicability of the Circular:
- The guidance therein shall apply to the PPT provision only in those Indian Tax treaty wherein such a provision PPT exists.
- It is not intended to interfere or interact with any other provision of the Indian Tax treaty (other than the PPT) including such provisions for examination of treaty entitlement or denial of treaty benefits.
- It is not intended to interfere or interact with anti-abuse rules under the domestic law which would continue to apply independently, viz. General Anti-Abuse Rule (GAAR).
- The clarifications do not introduce any new legal interpretation but applies only to the PPT without affecting other provisions of the Income-tax Act
The Circular and subsequent clarifications reaffirm that the Circular applies only to the PPT and is intended to aid in the consistent application and interpretation of the PPT whilst pacifying some concerns and showcasing the Government’s stance and ability to resort to other mechanisms under the existing legal framework.