Tax Avoidance Treaty

The Central Board of Direct Taxes (CBDT) has clarified its stance on Principal Purpose Test (PPT) regarding Double Taxation Avoidance Agreement (DTAA), stating that it will be applicable prospectively, allowing grandfathering of prior investments. This clarification is especially important for investments made before the PPT was introduced in certain treaties, specifically the India-Mauritius, India-Cyprus, and India-Singapore DTAAs.

What is the Principal Purpose Test (PPT)?

• The PPT is a test used to determine whether the main purpose of a transaction or arrangement is to gain tax benefits from a Double Taxation Avoidance Agreement (DTAA) between countries.
• Substance requirements: To pass the PPT, taxpayers must prove that their activities have real substance in the country where they claim tax benefits (e.g., employees, offices, turnover, expenses).

Key Points in the New Guidance Note:

• Applicability of PPT: The PPT provisions will only apply prospectively. This means that it will apply to agreements made after the guidance note was issued, and not retroactively to agreements or transactions entered into before this.
• Grandfathering Provisions in Some DTAAs: India has made special bilateral commitments in its treaties with Cyprus, Mauritius, and Singapore. These commitments are known as grandfathering provisions.
  • These grandfathering provisions will not be affected by the new PPT guidelines. They will continue to apply as per the terms agreed in the respective DTAAs.
• Clarification on Treaty-Specific Commitments: The CBDT (Central Board of Direct Taxes) has clarified that these grandfathering commitments in the India-Cyprus, India-Mauritius, and India-Singapore treaties are separate from the new PPT provisions.
  • These commitments will be governed by the specific terms outlined in the treaties with these countries, and won’t be impacted by the PPT.
• Impact on the India-Mauritius Treaty: Before this clarification, there was some uncertainty about how the India-Mauritius treaty would be affected by the PPT provisions. With this guidance note, it is now clear that the grandfathering provisions in the India-Mauritius treaty will remain intact, which might allow the protocol for this treaty to come into effect starting April 1, 2025.
• Reference to BEPS Action Plan 6 and UN Model Tax Convention: The guidance also encourages tax authorities to refer to the BEPS Action Plan 6 (Base Erosion and Profit Shifting) and the UN Model Tax Convention when deciding how to apply the PPT provisions.
  • BEPS Action Plan 6 aims to prevent tax avoidance through treaty abuse.
  • The UN Model Tax Convention provides a framework for countries to draft their tax treaties, with certain reservations by India.