India Issues Guidelines on Principal Purpose Test (PPT) for Tax Treaties

India Issues Guidelines on Principal Purpose Test (PPT) for Tax Treaties

Sub : Eco

Sec: Fiscal Policy

Why in News?

• The Central Board of Direct Taxes (CBDT) has issued new guidelines on the applicability of the Principal Purpose Test (PPT) under Double Tax Avoidance Agreements (DTAAs). The circular clarifies treaty benefits, particularly in cases involving grandfathering provisions with countries such as Cyprus, Mauritius, and Singapore.

Context:

• The PPT provisions are part of India’s efforts to curb tax treaty abuse by ensuring transactions genuinely comply with treaty objectives.
• The guidelines provide clarity on interpreting the PPT, especially in treaties with specific grandfathering provisions, which are carved out of the PPT’s scope.

Key Highlights of the Guidelines

• Applicability of PPT Provisions
  • The PPT will apply prospectively for transactions and tax benefits claimed after the issuance of these guidelines.
  • Taxpayers must demonstrate that the principal purpose of an arrangement is not to gain undue treaty benefits.
• Exemptions for Grandfathering Provisions
  • Treaties with Cyprus, Mauritius, and Singapore include grandfathering provisions that are exempted from PPT application.
  • These provisions will be governed by the specific terms outlined in their respective DTAAs.
  • The CBDT clarified that these bilateral commitments are not intended to interact with PPT provisions.
• Clarity for Tax Authorities
  • Tax authorities are advised to refer to:
    • The Base Erosion and Profit Shifting (BEPS) Action Plan 6.
    • The UN Model Tax Convention for additional guidance on interpreting and applying PPT provisions.
• Key Takeaways for Businesses
  • The circular removes ambiguity surrounding grandfathered treaties, ensuring that treaty-specific benefits are protected.
  • This development is expected to encourage foreign investments, particularly from countries with longstanding DTAAs.

Conclusion

The new CBDT guidelines provide much-needed clarity on the Principal Purpose Test in India’s DTAAs, especially for treaties with grandfathering provisions. These measures aim to balance India’s tax sovereignty with its global tax commitments while boosting investor confidence in bilateral agreements.

Principal Purpose Test (PPT)

The Principal Purpose Test (PPT) is a provision commonly found in modern tax treaties, including Double Taxation Avoidance Agreements (DTAAs). It is designed to prevent treaty abuse and ensure that the benefits of a tax treaty are not granted inappropriately to those who do not have a legitimate claim to them.

Objective:

• The main objective of the PPT is to counteract tax avoidance strategies that abuse tax treaties.
• It aims to ensure that the benefits of a tax treaty are granted only to those transactions or arrangements that have a genuine commercial or economic purpose.

Conditions for Application:

• The PPT provision comes into play when one of the principal purposes of a transaction or arrangement is to obtain tax benefits.
• If it is established that obtaining the tax benefit was a principal purpose, the treaty benefits can be denied.

In essence, the Principal Purpose Test is a mechanism to ensure that tax treaties are not used as a tool for tax avoidance. It emphasizes the importance of genuine economic activities and commercial purposes in availing treaty benefits, discouraging artificial or abusive arrangements solely for tax advantages.

Grandfathering rule

The “grandfathering rule” is a provision often included in tax laws or treaties to protect existing investments or arrangements from the impact of new tax laws or changes in tax treaties. It allows certain investments or transactions that were made before the new rules came into effect to continue enjoying the benefits of the old rules. It provides continuity of benefits, stability, and predictability for investors and businesses, ensuring that they are not unduly affected by sudden changes in tax regimes.