Recent Updates on Principal Purpose Test
Background
The OECD came up with 15 Action Plans on Base Erosion
and Profit Shifting (BEPS). Action Plan 15 consisted of
the implementation of a Multi-Lateral Instrument (MLI)
to implement the treaty-based amendments in line with
the BEPS Action plans. The MLI modifies some of India's
Double Taxation Avoidance Agreements (DTAAs). MLI
entered into force in India on 1 October 2019.
A key provision of the MLI is the Principal Purpose Test (PPT) which seeks to curb revenue leakage by preventing treaty abuse in line with Action Plan 6. While the PPT is included in most of India's DTAAs through the MLI, it is part of some other DTAAs through bilateral processes.
The PPT reads as follows:
Notwithstanding the other provisions of this
Convention (or Agreement), a benefit under this
Convention (or Agreement) shall not be granted in
respect of an item of income if it is reasonable to
conclude, having regard to all relevant facts and
circumstances, that obtaining that benefit was one
of the principal purposes of any arrangement or
transaction that resulted directly or indirectly in that
benefit unless it is established that granting that
benefit in these circumstances would be in accordance
with the object and purpose of the relevant provisions
of this Convention (or Agreement).
The determination of whether one of the principal purposes for entering transaction(s) or arrangement(s) is to obtain tax advantage(s) should be based on an objective assessment of the relevant facts and circumstances.
CBDT1 has recently come up with a circular to provide clarity and certainty on the application of the PPT provision under India's DTAAs, the broad guidance provided is discussed below.
Application of PPT
To ensure parity and uniformity in the application of the
PPT provision under India's DTAAs, it is clarified that the
PPT provision is intended to be applied prospectively.
Accordingly, the PPT provision under India's DTAAs shall
apply as follows:
| Sr No. | Perticulars | Application |
|---|---|---|
| 1. | Treaties where PPT has been Incorporated through bilateral processes (Such as Chile, Hong Kong, Iran, China etc.) | From the date of entry into force of the DTAA or the amending protocol incorporating the PPT. |
| 2. | Treaties where the PPT has been incorporated through the MLI. |
For taxes withheld at
source: MLI will apply
from the previous year
that begins after the
latest date on which MLI
comes into force for the
countries involved in the
DTAA. For all other taxes levied: MLI will apply from the previous year beginning after a period of six calendar months after the latest date on which MLI comes into force for the countries involved in the DTAA. |
The interplay of PPT and Certain Treaty-specific Bilateral
Commitments
India has made certain treaty-specific bilateral
commitments in the form of grandfathering provisions
under the following DTAAs, as of date:
- India-Cyprus DTAA
- India-Mauritius DTAA
- India-Singapore DTAA
Under these three treaties, capital gains were taxable only in the resident state as per the erstwhile clauses. However, a grandfathering clause was introduced in all three treaties whereby shares acquired before 1 April 2017 would be exclusively taxed in the resident state. However, shares acquired after 1 April 2017 would also be taxed in the source state.
In view of the same, CBDT in its circular has clarified that the grandfathering clauses will remain outside the purview of PPT provisions and shall be governed by Specific Provisions of the respective Treaties.
Thus, the following is the state of taxability under the above three treaties:
| Particulars | India-Mauritius Treaty | India-Singapore Treaty | India-Cyprus Treaty |
|---|---|---|---|
| Shares acquired before 1 April 2017 | Not taxable | Not taxable | Not taxable |
| Whether Line Of Business (LOB) remains applicable to the above transactions? 2017 | No | Yes | No |
| Whether PPT remains applicable to the above transactions? | No | No | No |
| Share acquired after 1 April 2017 | Taxable | Taxable | Taxable |
Sources of Guidance
As stated above, PPT is a context-specific, fact-based
exercise to be carried out on a case-to-case basis.
Therefore, CBDT has clarified that sources of guidance
include Action Plan 6 of the final report (subject to India’s
reservations) as well as Commentary to Articles 1 and 29
of the UN Model Tax Convention.
Our Comments
The CBDT's above guidance on the application of the
PPT provisions is a positive step as it helps clarify its
overall scope and applicability on tax treaties where MLI
is applicable. With the MLI now in effect between India
and most of its treaty partners, the PPT provisions are
already applicable to many international tax agreements.
This new guidance from the CBDT will assist businesses in
understanding and dealing with the impact of the PPT on
their cross-border transactions.
Additionally, the Circular clears up India's stance on
providing "grandfathered" benefits to treaty residents
from Mauritius, Singapore, and Cyprus. This means these
countries' residents may still enjoy certain tax benefits
under older rules.
1. CBDT Circular No.01/2025 dated 21 January 2025