India Sets New Norms for Claiming Tax Treaty Benefits: A Detailed Analysis

The Income Tax Department of India has recently issued a guidance note on the applicability of the Principal Purpose Test (PPT) for claiming tax treaty benefits. This move is part of India’s ongoing efforts to align its Double Taxation Avoidance Agreements (DTAAs) with global standards, particularly those outlined in the OECD’s Base Erosion and Profit Shifting (BEPS) Action Plan 6. The new norms will apply prospectively, ensuring clarity and consistency in the interpretation of tax treaties. This article delves into the key aspects of the new guidance, its implications, and how it interacts with grandfathering provisions in India’s treaties with Cyprus, Mauritius, and Singapore.

Understanding the Principal Purpose Test (PPT)

What is the Principal Purpose Test (PPT)?

The Principal Purpose Test (PPT) is a provision introduced under the OECD’s BEPS Action Plan 6 to prevent the misuse of tax treaties for tax avoidance. The PPT denies tax treaty benefits if one of the principal purposes of an arrangement or transaction is to obtain those benefits, unless granting the benefits is in line with the object and purpose of the treaty.

Application of PPT in Indian Tax Treaties

India has incorporated the PPT into most of its DTAAs as part of its commitment to the BEPS initiative. The PPT is designed to ensure that tax treaties are not exploited for tax evasion or avoidance purposes. The new guidance note issued by the Central Board of Direct Taxes (CBDT) clarifies how the PPT will be applied in India, particularly in relation to grandfathering provisions in certain treaties.

Key Highlights of the CBDT Guidance Note

Prospective Application of PPT

The CBDT has clarified that the PPT provisions will apply prospectively, meaning they will only affect transactions or arrangements entered into after the issuance of the guidance note. This ensures that existing investments and arrangements are not disrupted.

Grandfathering Provisions in DTAAs

One of the most significant aspects of the guidance note is its treatment of grandfathering provisions in India’s treaties with Cyprus, Mauritius, and Singapore. These provisions allow certain investments made before a specified date to continue enjoying tax benefits under the old treaty terms, even after the treaty is amended.

• India-Cyprus DTAA: Grandfathering provisions protect investments made before April 1, 2017.
• India-Mauritius DTAA: Investments made before April 1, 2017, are grandfathered.
• India-Singapore DTAA: Investments made before April 1, 2017, are also covered under grandfathering provisions.

The CBDT has explicitly stated that these grandfathering provisions will remain outside the purview of the PPT. This means that the PPT will not override the specific commitments made in these treaties.

Implications of the New Guidance

Clarity on Treaty-Specific Commitments

The guidance note provides much-needed clarity on how treaty-specific bilateral commitments will interact with the PPT. By carving out grandfathering provisions from the scope of the PPT, the CBDT has ensured that India’s commitments to investors from Cyprus, Mauritius, and Singapore are honored. This move is expected to boost investor confidence and maintain the stability of India’s tax regime.

Likely Notification of India-Mauritius Protocol

According to Rohinton Sidhwa, Partner at Deloitte India, the clarification on the PPT and grandfathering provisions paves the way for the notification of the India-Mauritius protocol. This protocol, which incorporates the PPT, is expected to come into effect from April 1, 2025. The guidance note addresses a key grey area in the protocol, making its implementation smoother.

Supplementary Guidance from BEPS and UN Model Convention

The CBDT has also emphasized that tax authorities should refer to the BEPS Action Plan 6 and the UN Model Tax Convention for supplementary guidance when applying the PPT. However, India’s reservations on certain matters in these frameworks will be taken into account. This approach ensures that the PPT is applied in a manner consistent with India’s tax policy objectives.

Expert Opinions on the New Norms

Rohinton Sidhwa, Partner, Deloitte India

Sidhwa highlighted that the circular clarifies the interpretation of the PPT and establishes the primacy of grandfathering provisions in treaties with Cyprus, Mauritius, and Singapore. He noted that this clarification is a positive step toward resolving uncertainties and ensuring the smooth implementation of the India-Mauritius protocol.

Vishwas Panjiar, Partner, Nangia Andersen LLP

Panjiar pointed out that the guidance note not only confirms the prospective application of the PPT but also protects grandfathering provisions in key treaties. He also appreciated the CBDT’s recommendation to refer to BEPS Action Plan 6 and the UN Model Tax Convention for additional guidance, which adds a layer of transparency to the process.

Summary of News: Principal Purpose Test (PPT) Guidance Note by CBDT