CBDT clarifies exemptions from principal purpose test in double taxation avoidance agreements

India’s Central Board of Direct Taxes (CBDT) has clarified that exemptions from the Principal Purpose Test (PPT) under Double Taxation Avoidance Agreements (DTAAs) with countries like Mauritius, Cyprus, and Singapore won’t interfere with domestic anti-abuse rules.

This clarification is significant, especially since India and Mauritius amended their tax treaty in April 2024 to include the PPT. The PPT aims to prevent large companies from avoiding taxes by scrutinizing business arrangements made purely for tax benefits .

In January, the CBDT had announced that the PPT wouldn’t apply to past investments made under certain tax treaties with countries like Mauritius, Cyprus, and Singapore. This move was intended to give certainty to investors. However, there were concerns that the exemption might be sought even in cases where tax abuse investigations were ongoing .

The CBDT has now reaffirmed the government’s commitment to preventing treaty abuse and ensuring that tax benefits aren’t misused. The circular provides much-needed clarity on the application of the PPT provision, ensuring consistency in tax law interpretation while upholding the existing legal framework .

The PPT, a provision in the global tax treaty, aims to prevent large companies from avoiding taxes by scrutinizing business arrangements that have been made purely for tax benefits as their main purpose. India is among 140 nations which signed the tax treaty.

Foreign Portfolio Investors (FPIs) had to prove they had a genuine commercial reason for being based in Mauritius to claim tax benefits.However it left a grey area leading to industry apprehension that even past investment before the amendment date or treaty date may be subject to scrutiny and may be reopened.This created jitters among investors.

The January circular has put to rest industry concerns that past investments might be reopened for scrutiny.