CBDT issues clarification on applicability of PPT while granting Tax Treaty benefits

The Principal Purpose Test (“PPT”) is a key anti-abuse provision introduced as part of Action 6 under the OECD’s Base Erosion and Profit Shifting (“BEPS”) Project.

This provision is outlined in Article 7 of the Multilateral Instrument (“MLI”), which addresses the prevention of treaty abuse. Its primary aim is to prevent the misuse of tax treaties by denying treaty benefits to arrangements/transactions where it is reasonable to conclude that obtaining such benefit was one of the principal purpose unless its is established that granting such benefit is in accordance with the object and purpose of the relevant provision of the Tax Treaty. When both countries involved in a tax treaty (referred to as Contracting Jurisdictions) adopt the MLI, the PPT alters the existing tax treaty to include its provisions.

The PPT has become particularly significant for India, reflecting its dedication to combating BEPS and enhancing tax transparency. India has proactively worked to incorporate the PPT into its tax treaties, both through the MLI framework and direct negotiations with treaty partners. Countries like Mauritius, Singapore once favored for investment due to their advantageous tax structures, have seen updates to their treaties with India to include the PPT. A notable milestone was the revision of the India-Mauritius tax treaty in March 2024, explicitly embedding the PPT which marked a significant change, as Mauritius had long been considered a conduit for foreign investment into India under the earlier favorable tax treaty terms.

CBDT has now issued a Circular1 providing guidance on the applicability of PPT under India’s tax treaties ensuring clarity on its interpretation and consistent approach in its enforcement.