Context:
The Income Tax department has come out with a fresh guidance note on applicability of Principal Purpose Test (PPT) for claiming tax treaty benefits, which will apply prospectively. The PPT will apply prospectively and aligns with India’s commitments to address treaty abuse as part of the Base Erosion and Profit Shifting BEPS framework.
Principal Purpose Test (PPT)
The “Principal Purpose Test” (PPT) is a tax treaty mechanism used to deny benefits to transactions where the primary motivation is to obtain a tax advantage through treaty shopping, rather than a legitimate business purpose. It prevents tax avoidance by scrutinizing the “principal purpose” of a transaction when claiming treaty benefits.
- Objective
- To avoid taxpayers from artificially structuring transactions only to avail of tax benefits under a treaty, not for any genuine economic activity.
- How it works?
- Tax authorities assess whether, based on all relevant facts and circumstances, “obtaining a treaty benefit“ was one of the principal purposes of the transaction. If so, the treaty benefit may be denied.
- Subjective element
- The test is partly subjective because it involves assessing the intentions and motives behind a transaction.
- Objective element
- Despite being subjective, the PPT is also concerned with whether granting the treaty benefit would be consistent with the general object and purpose of the applicable treaty provision.
Where is the PPT applied?
- Multilateral Instrument (MLI)
- Most countries have incorporated the PPT into their tax treaties through the MLI, a multilateral agreement designed to implement BEPS action plan measures.
- Example of how PPT might be applied
- A company located in a high-tax country forms a subsidiary in a low-tax treaty jurisdiction to have profits flow through that subsidiary, so it may obtain a reduced tax rate by invoking the treaty. If the tax authorities decide that the “principal purpose” of this plan is to use the treaty, they could withhold the treaty benefit and tax the income at the higher domestic rate.
Important Clarifications on PPT
- Scope
- The PPT provisions will apply prospectively and therefore will affect only claims for treaty benefits going forward Tax authorities are also advised to refer to BEPS Action Plan 6 and the UN Model Tax Convention for further guidance on this issue.
- Treaties with Cyprus
- Mauritius and Singapore have grandfathering provisions specifically carved out of the PPT.
- Bilateral commitments are protected and continue to be governed by the provisions in the respective Double Tax Avoidance Agreements (DTAAs).
- Treaty Specific CarveOut
- The guidance confirms that PPT provisions do not override treaty specific grandfathering clauses.
- This clarification ensures consistency with prior commitments in treaties with the three nations.
Implications For Taxpayers
The enhanced clarity regarding the applicability of PPT provisions helps to reduce uncertainty in treaty benefit claims Businesses and investors who are relying on grandfathering provisions in treaties with Cyprus Mauritius and Singapore are not impacted by the PPT rules.
For India’s Tax Framework
It indicates that India takes seriously its need to reconcile its antiabuse efforts under the BEPS action plan with its treaty obligations on a bilateral basis. The guidance should further facilitate the smooth implementation of revised treaty protocols and enhance tax certainty for foreign investors.
Source: The Hindu
