The Multilateral Convention to implement tax treaty-related provisions to prevent Base Erosion and Profit Shifting (“MLI”) entered into India with effect from 1st October 2019. MLI is a tool that helps the government to close gaps in international tax rules. The MLI introduced a key provision of the Principal Purpose Test (“PPT”) in India’s Double Tax Avoidance Agreement (DTAA). PPT seeks to prevent revenue leakage by preventing treaty abuse. PPT was introduced in some of the DTAA through MLI. However, later on, it was introduced in some of the DTAAs through bilateral.
PPT is a provision in DTAA that determines whether the transaction or arrangement is primarily entered to take the benefit of a tax treaty. Therefore, if a transaction is entered only to gain the benefit of the treaty and not for commercial purposes then the PPT denies treaty benefit to such transaction or arrangement.
The CBDT issued detailed guidance on the applicability of PPT provisions vide Circular No. 01/2025 dated 21st January 2025 as follows:
1. Principal Purpose Test (“PPT) provisions in DTAA
- The relevant extract of PPT provisions:
“Notwithstanding the other provisions of this Convention (or Agreement), a benefit under this Convention (or Agreement) shall not be granted in respect of an item of income if it is reasonable to conclude, having regard to all relevant facts and circumstances, that obtaining that benefit was one of the principal purposes of any arrangement or transaction that resulted directly or indirectly in that benefit unless it is established that granting that benefit in these circumstances would be under the object and purpose of the relevant provisions of this Convention (or Agreement).”
- The PPT provisions deny the benefit under DTAA where it is concluded, as per facts and circumstances, that the principal purpose of the transaction is to obtain the benefit of DTAA whether directly or indirectly.
- However, the last part of the PPT provision allows the person to establish that obtaining the benefit in these circumstances would be under the object and purpose of the relevant provisions of the convention.
- Therefore, The PPT is intended to ensure that DTAAs apply by the objects and purpose for which they were entered into, i.e., to provide benefits in respect of bonafide exchange of goods and services, and movement of capital and persons.
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2. Guidelines on the application of PPT Provisions
It has been clarified that the principal purpose of a transaction or arrangement should be determined based on an objective assessment of the relevant facts and circumstances. The CBDT has provided the following guidelines on the application of PPT provisions:
2.1 Date of Applicability of PPT Provisions
- The PPT provisions shall apply prospectively.
- The PPT provisions under the Indian DTAA shall apply as follows:
| Scenarios | Date of Applicability of PPT Provisions |
| Where PPT provisions are incorporated in DTAA through bilateral processes (e.g. China, Iran, Hong Kong, Chile, etc) | Date of enforcement of DTAA or Amending protocol incorporation of the PPT |
| Where PPT provisions are incorporated through MLI | Concerning TDS provisions, the event date occurs on or after the first date of the previous year after the latest date; To other provisions, previous years beginning on or after the expiry of a period of 6 calendar months from the latest date. * Latest date is the latest of the following dates:date of entry into force of MLI provisions in India, i.e., 1st October 2019;The date on which the MLI was enforced for the DTAA partner country |
2.2 Interaction of PPT provisions with Grandfathering provisions
- India has made certain treaty-specific bilateral commitments in the form of grandfathering provisions under the following DTAAs, as of date:
- India-Cyprus DTAA;
- India-Mauritius DTAAi and
- India-Singapore DTAA.
- These commitments are not intended to interact with the PPT provision as such
- Therefore, the grandfathering provisions under such DTAAs shall be governed by the specific provisions of DTAA itself and shall remain outside the purview of the PPT provision.
2.3 Supplementary source of guidance:
- PPT provisions shall be applied based on the facts of the case, i.e., on a case-to-case basis keeping in view the objective facts and findings.
- Supplementary source of guidance:
- BEPS Action Plan 6 Final Report;
- Commentary to Articles 1 and 29 of the UN Model Tax Convention
3. Conclusion
The CBDT has clarified that provisions of PPT shall apply on a case-to-case basis and also shall come into force prospectively. Also, clarification on the date of applicability in specific situations has put an end to the ambiguity prevailing to the date of applicability. Further, the contradiction between the applicability of grandfathering provisions and PPT provisions has come to an end with a circular.
