The Principal Purpose Test (PPT) is a key provision in India’s Double Taxation Avoidance Agreements (DTAAs), introduced through the Multilateral Convention to Implement Tax Treaty Related Provisions to Prevent Base Erosion and Profit Shifting (MLI). Effective from 1st October 2019 (for India), the PPT aims to curb treaty abuse and ensure that tax treaty benefits are granted only for genuine transactions.
What is the Principal Purpose Test (PPT)?
The PPT denies tax treaty benefits if it is reasonable to conclude that obtaining such benefits was one of the principal purposes of a transaction or arrangement. Exceptions exist where granting benefits aligns with the treaty’s object and purpose, such as facilitating bona fide trade, investment, or movement of people. Key Features of the PPT:-
i) Objective Assessment: Determination is based on relevant facts and circumstances.
ii) Focus on Treaty Intent: Ensures benefits align with the treaty’s purpose.
Application of PPT: Timelines
The PPT provision applies prospectively to ensure consistency in tax administration.
DTAAs with Bilateral Incorporation
i) Effective from the date of the DTAA or Amending Protocol, as applicable.
ii) Examples include treaties with Chile, Iran, Hong Kong, and China.
DTAAs Modified by the MLI
i) Taxes Withheld at Source: Applies to events after the first day of the previous year beginning on or after the latest MLI enforcement date.
ii) Other Taxes: Applies to previous years starting six months post-MLI enforcement.
For India, the MLI enforcement date is 1st October 2019. The corresponding date for treaty partners must be confirmed through the OECD’s MLI database.
Key Clarifications by CBDT
Recently, the Central Board of Direct Taxes (CBDT) has provided significant clarity, vide Circular 1/2025 on the tax treatment of foreign investments from Mauritius, Singapore, and Cyprus. Accordingly, investments made before April 1, 2017, will enjoy zero or minimal capital gains tax benefits, regardless of the principal purpose of such investments. This update offers relief to foreign investors amidst evolving tax treaty provisions.
Treaty-Specific Commitments
Certain bilateral commitments, such as grandfathering provisions in the following DTAAs, are excluded from the PPT’s scope:
i) India-Cyprus DTAA
ii) India-Mauritius DTAA
iii) India-Singapore DTAA
These commitments are governed by specific provisions within the respective treaties.
Grandfathering of Investments
i) Investments from Mauritius, Singapore, and Cyprus made before April 1, 2017, are exempt from the Principal Purpose Test (PPT).
ii) PPT aims to deny treaty benefits if tax avoidance is a principal purpose of an arrangement.
iii) This provision was introduced under the OECD’s Base Erosion and Profit Sharing (BEPS) framework.
Scope of the Grandfathering Provisions
i) The clarification ensures that older investments remain outside the ambit of anti-abuse measures under India’s tax treaties.
ii) India-Cyprus, India-Mauritius, and India-Singapore DTAA protocols uphold the grandfathering benefit.
Understanding PPT and BEPS Framework
Principal Purpose Test (PPT):
i) Aimed at curbing treaty abuse by denying benefits when obtaining tax advantages is one of the primary purposes of a transaction.
ii) Applicable only to investments made after April 1, 2017, in India-Mauritius DTAA and similar treaties.
Base Erosion and Profit Sharing (BEPS):
i) An OECD initiative designed to prevent tax avoidance in cross-border arrangements.
ii) India has aligned its tax treaties under BEPS to strengthen anti-abuse provisions.
Impact of Amendments to India-Mauritius DTAA
i) A 2016 amendment ended the zero-capital-gains-tax benefit for investments post-April 1, 2017.
ii) Gains from share sales became taxable at Indian rates, following a transitional phase.
iii) Older investments retain their earlier benefits due to the grandfathering provision.
Supplementary Guidelines for PPT Application
i) Tax authorities are guided to refer to BEPS Action Plan 6 and the UN Model Tax Convention.
ii) These serve as additional interpretative sources for applying PPT provisions.
iii) Circulars issued by CBDT are binding on tax authorities but only persuasive for taxpayers and courts.
India-Mauritius Tax Treaty Evolution
i) Mauritius was the first country with which India updated its DTAA preamble to prevent opportunities for non-taxation or reduced taxation.
ii) PPT will apply only after notification by respective governments, ensuring compliance with BEPS standards.
This guidance reassures investors of continued benefits for pre-2017 investments while aligning India’s tax treaties with global anti-abuse frameworks. (Financial Express)
CBDT Income Tax Circular 1/2025 dated 21st January 2025: Guidance for application of the Principal Purpose Test (PPT) under India’s Double Taxation Avoidance Agreements