INDIA DTT UPDATE – CLARITY ON PRINCIPAL PURPOSE TEST

Rosie Griffin, Tax Underwriter at Themis Underwriting, explores the Indian Central Board of Direct Taxes’ (CBDT) new guidance on the Principal Purpose Test (PPT).

Since the MLI came into force for covered tax agreements involving India there has been much speculation about how the so-called Principal Purpose Test (“PPT” as it is also known) would be implemented by the Indian revenue authority and interpreted by courts. Interest rose further when India concluded several protocols to treaties not covered by the MLI, the treaty with Mauritius being most relevant. The speculation specifically lay in whether the PPT would be applied retrospectively, resulting in challenges to transactions concluded or structures formed prior to the relevant treaty coming into force.

The application of the PPT broadly means that any benefit under a tax treaty may be denied if it is reasonable to conclude that one of the principal purposes of an arrangement or transaction which resulted in such benefit, was to obtain such tax benefit, unless such benefit was inaccordance with the object and purpose of the relevant tax treaty. The PPT, accordingly, has the ability to cast doubt on even the most robust transactions, particularly in the alternative investment funds sector.

The speculation has mostly been settled: the Indian Central Board of Direct Taxes ("CBDT") recently issued long-awaited guidance regarding the applicability of the PPT in India's double tax treaties. The guidance has been welcomed by the market following a period of uncertainty as to the scope of applicability ofthe PPT. In particular, the CBDT has clarified that:

1. the PPT shall apply prospectively from the effective date of the relevant treaty, and not retrospectively. This is the most important aspect of the guidance since it places historical transactions beyond the reach of the  PPT;
2. ‘grandfathering’ benefits under certain India double tax treaties (in particular, India-Mauritius, India-Singapore and India-Cyprus) are not subject to the application of the PPT provision. This is important since it preserves the certainty of time-qualified acquisitions under these treaties; and
3. the PPT provisions shall be applied on a fact-based, case by case basis.

From a tax insurance underwriting perspective, these clarifications are very helpful, particularly in light of the Protocol to amend the India-Mauritius tax treaty, which was signed between India and Mauritius on 7th March 2024. Whilst the Protocol has not yet been notified, there was some uncertainty regarding whether the PPT would be applied prospectively or retrospectively. The recent CBDT guidance clarifies that the PPT should not be applicable to grandfathered transactions (i.e. shares acquired pre-1 April 2017).

It is important to note that it is legislated that circulars issued by the CBDT are binding on the tax authority, and this has been upheld and reiterated by the Supreme Court several times.

Having written 46 policies over a period of five years on a variety of treaty matters in India, Themis is deeply familiar with all aspects of PPT in India.

Do you have a tax risk involving an Indian DTT? Please do not hesitate to reach out to me at rosie.griffin@themisunderwriting.com or +44 7930 970 714.