PRINCIPLE PURPOSE TEST: ECONOMY

PRINCIPLE PURPOSE TEST: ECONOMY

NEWS: Tax avoidance treaties: India sets new norms for claiming benefits

 

WHAT’S IN THE NEWS?

The Central Board of Direct Taxes (CBDT) has issued guidelines on the applicability of the Principal Purpose Test (PPT) under India’s Double Tax Avoidance Agreements (DTAAs). The guidelines address the interpretation of PPT provisions, particularly for treaties with grandfathering provisions involving countries like Cyprus, Mauritius, and Singapore, to balance tax treaty compliance with safeguarding foreign investments.

 

Principal Purpose Test (PPT)

1. Definition and Objective

  • The Principal Purpose Test (PPT) is a provision included in modern tax treaties to prevent abuse of tax treaty benefits.
  • Objective:
  • To ensure that tax treaty benefits are granted only for transactions or arrangements with a legitimate economic or commercial purpose.
  • To deny treaty benefits if the principal purpose of a transaction is to obtain an undue tax advantage.

2. Key Conditions for Application

  • The PPT is triggered if obtaining tax benefits was one of the principal purposes of a transaction or arrangement.
  • Tax authorities may deny treaty benefits if the purpose was primarily tax avoidance, unless genuine commercial motives are demonstrated.

 

Applicability of PPT Provisions

1. Prospective Enforcement

  • The PPT provisions are applicable only to future transactions and benefits claimed after the issuance of these guidelines.
  • Past transactions are not subject to these provisions, reducing uncertainty for businesses.

2. Taxpayer Responsibility

  • Taxpayers must prove that their arrangement's principal purpose was not to exploit tax treaties.
  • Arrangements lacking genuine economic substance are at risk of being denied treaty benefits.

 

Grandfathering Provisions

1. Definition of Grandfathering

  • Grandfathering Rule: Protects certain pre-existing transactions or investments from being affected by new tax laws or treaty provisions.
  • It ensures that arrangements made before a specific date continue to enjoy the benefits of earlier rules, providing stability to businesses.

2. Application in DTAAs

  • Treaties with Cyprus, Mauritius, and Singapore include grandfathering provisions.
  • These provisions exempt pre-existing transactions from PPT application, ensuring that:
  • Treaty benefits under the old rules remain valid.
  • Bilateral commitments under these treaties are respected.

3. Key Clarifications

  • Grandfathered provisions are governed by specific terms in the respective DTAAs and do not interact with PPT provisions.
  • This provides certainty for businesses relying on these treaties for investments.

 

Guidance for Tax Authorities

1. Resources for Consistent Interpretation

  • Authorities are directed to refer to:
  • The Base Erosion and Profit Shifting (BEPS) Action Plan 6, which deals with treaty abuse.
  • The UN Model Tax Convention, providing a framework for applying PPT provisions.

 

Base Erosion and Profit Shifting (BEPS) Framework:

1. Overview

  • BEPS is an initiative by the OECD and G20 to combat global tax avoidance.
  • It addresses tactics used by multinational corporations (MNCs) to reduce taxes by shifting profits to low-tax regions.

2. Established

  • BEPS Framework was launched in 2016 and includes 147 member countries, including India.

3. Key Issues Addressed

  • Profit Shifting: Moving profits to countries with lower tax rates.
  • Base Erosion: Reducing taxable income through deductions like royalties and interest.

4. Two Pillars

  • Pillar One: Redistributes a portion of profits to countries where consumers are located.
  • Pillar Two: Imposes a Global Minimum Corporate Tax (GMCT) of 15% for large MNCs.

5. BEPS Action 6

  • Focuses on treaty shopping (abusing tax treaties to avoid taxes).
  • Sets minimum standards to prevent treaty abuse.
  • Provides guidelines on tax policy before signing tax agreements.

This framework ensures fair taxation globally and limits exploitative tax practices by MNCs.

 

2. Ensuring Uniform Enforcement

  • The guidelines reduce misinterpretation, ensuring tax authorities follow international best practices in applying PPT provisions.

 

Implications for Businesses

1. Clarity on Grandfathered Transactions

  • The guidelines remove ambiguity for businesses regarding the treatment of transactions under grandfathering provisions.
  • Genuine investments are safeguarded, reducing the risk of denial of treaty benefits.

2. Boosting Investor Confidence

  • By protecting treaty benefits for longstanding DTAAs, India strengthens its position as an investor-friendly destination.
  • Grandfathering provisions offer stability and predictability for foreign investors.

Balancing Tax Sovereignty and Global Commitments

India's tax framework ensures:

  • Prevention of tax treaty abuse through the PPT, aligning with international standards.
  • Fulfillment of bilateral obligations by safeguarding grandfathered treaties.
  • Promotion of foreign direct investment by offering a stable and predictable tax regime.

Source: https://www.thehindu.com/news/national/tax-avoidance-treaties-india-sets-new-norms-for-claiming-benefits/article69129197.ece