CBDT clarification on applicability of PPT while granting treaty benefits:
Background:
1. MLI coming into force:
On October 1st, 2019, the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting, otherwise referred to as the Multilateral Instrument or MLI, came into force.
2. BEPS Action Plan:
OECD’s Base Erosion and Profit Shifting Action Plan 6 – recommended the introduction of one or more of the following three treaty provisions, as a minimum standard to address treaty abuse:
1. The Principal Purpose Test (“PPT”) only, which is a general anti-abuse rule based on the principal purpose of transactions or arrangements;
2. A PPT supplemented with either a simplified or a detailed LOB provision; or
3. A detailed LOB provision, supplemented by a mutually negotiated mechanism to deal with conduit arrangements not already dealt with in tax treaties.
3. Taxing capital gains:
India had amended its tax treaties with Mauritius, Singapore and Cyprus to allocate India the right to tax capital gains arising on transfer of equity shares acquired after April 1, 2017. Acquisitions prior to April 1, 2017, were grandfathered from capital gains tax in India.
4. Introduction of PPT in the treaties:
With introduction of PPT in such tax treaties pursuant to MLI or bilateral negotiation (in case of Mauritius), it was not clear whether the muster of PPT will have to be satisfied even in cases of grandfathered transactions. While technically, given the specific grandfathering it was possible to argue that PPT should not apply as it was the ‘object and purpose’ of the tax treaty to provide such benefit, there was no certainty on this aspect.
CBDT clarification: With this background, CBDT issued a clarification vide circular 1/2025.
1. PPT should be applied prospectively in the following cases:
* Tax treaties (like Chile, China, Iran, Hongkong) in which PPT was negotiated bilaterally – PPT should apply from date of entry into force of the tax treaty or the amending protocol incorporating PPT
* Tax treaties in which PPT has been incorporated through the multilateral instrument (“MLI”) – the entry into effect of the PPT would depend on when the contracting state deposits the instrument for ratification. For tax treaty partners (like Australia, Ireland, Netherlands, Singapore, Luxembourg, UK, UAE etc.) who have deposited the instrument of ratification before June 30, 2019, PPT will be applicable from financial year (“FY”) 2020-21.
2. Singapore, Mauritius and Cyprus:
Interaction of PPT with treaty-specific bilateral commitments: With respect to treaty specific bilateral commitments in form of grandfathering provisions under the India-Singapore tax treaty, India-Mauritius tax treaty and India-Cyprus tax treaty, it has been explicitly clarified that such provisions are not intended to interact with PPT. Therefore, the grandfathering provision are outside the purview of PPT.
3. Case by case basis:
The clarification also provides that PPT provision is expected to be a context-specific fact-based exercise, to be carried out on a case-by-case basis, keeping in view the objective facts and findings.
Note:
While Mauritius has not ratified the India-Mauritius tax treaty as a CTA, the tax department has nevertheless included Mauritius treaty in this clarification. This may be because of the 2024 protocol which proposed addition of PPT to the Mauritius tax treaty as well.
